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********************************************************************* Sponsored By: The McGraw-Hill/EEI/AGA Information Technology Expo in Phoenix Arizona, November 5-7, 2000. Hear JON BROCK, Director of Strategic and Competitive Intelligence,=20 SCIENTECH/RCI, address the ramifications of legislative and regulatory requirements on your Information Technology Infrastructure. ********************************************************************* =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D SCIENTECH IssueAlert, November 3, 2000 AEP Restructures, Moves Away from Distribution Focus By: Will McNamara, Director, Electric Industry Analysis =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D Earlier this week, AEP announced its plans to restructure into two companie= s to support a new focus on power generation, marketing and trading. "Our focus for moving forward, plain and simple, will be the wholesale business= =01* generation and related energy assets, wholesale marketing and trading," said Dr. Linn Draper, AEP's CEO. Draper added that AEP has no plans to expand its utility distribution operations in the United States and overseas. ANALYSIS: First, let's be clear about what AEP is doing. Under the=20 restructuring, one corporation will hold AEP's utility and non-utility subsidiaries whose revenues are derived from competitive (unregulated) business ventures. The second corporation will hold AEP's utility subsidiaries (primarily T&D subsidiaries) that are subject to regulation by at least one state regulatory commission, or foreign subsidiaries subject to rates or tariffs regulation. This announcement represents a 180-degree turn from what AEP has previously espoused as its competitive strategy, both during and after the recent completion of its merger with CSW. It's not so surprising that AEP would want to focus on generating, marketing and trading, or separate its high-ri= sk and low-risk operations into two companies. What's most surprising about this restructuring is AEP's move away from the T&D side of its business, since up until a few weeks ago distribution remained a key part of AEP's core business strategy. For instance, when the merger with CSW was completed in June, Draper said, "AEP's post-merger strategy consists of three key elements: wholesale, energy delivery and retail. The two that will be most important for us initially are the wholesale and energy delivery businesses." This made sense because, as a combined company, the new AEP owns more than 38,000 miles of transmission lines and 186,000 miles of distribution lines. As recently as October, this remained AEP's strategy. Draper told me in an exclusive interview, "At least for the foreseeable future, being in the distribution business is a good idea. We're not going to make a fortune at it [because rates are continually going to be regulated by state=20 commissions], but AEP is going to be in the wires business." If anything, Draper question= ed whether or not AEP would remain in the retail business, as he was unsure that AEP was "skilled enough" to succeed in this end of the business. Thus, this seemingly sudden decision to put no further emphasis on expandin= g the T&D operation is rather surprising. We can speculate about the various reasons why AEP would be changing its path. For starters, unquestionably AEP's wholesale generation and trading business has grown considerably over the last two years. According to figures released this week in AEP's Fact Book 2000 (presented at the EEI Financial Conference earlier this week), the company's trading volumes continue to increase (2Q 2000 reflects 103.7 million/MWh, compared to 78.5 million/MWh in 2Q 1999). (Third-quarter figures were not yet available). Regarding gross profits, for the first six months of 2000, trading contributed $112 million, while wholesale=20 marketing contributed $138 million. On the other hand, the regulated T&D business currently is characterized by both slow growth and a low rate of return. Thus, it would make little sense for AEP to continue to expand this part of its business, as further expansion would bring little value to its=20 shareholders. This theory may be supported by the fact that Draper clearly stated the restructuring is "focused on obtaining higher profit margins in the=20 unregulated wholesale energy markets." I confirmed this with a quick call to AEP yester= day afternoon. I was told by my contact there that from this point "any=20 discretionary cash is going into the wholesale side." By splitting the company's operatio= ns in two, undivided attention can now be placed on growing the unregulated side of the business, where AEP's sees the most growth for its operation. For the most part, separating its business into two companies=01*essentiall= y one regulated and other unregulated=01*appears to be a smart move for AEP as the two business offer strikingly different risk portfolios. The=20 restructuring is part of a growing trend among companies that have scale on both the generation and T&D sides, and realize these two very different operations attract a different kind of investor. Just recently, Reliant Energy announc= ed that it is initiating a similar restructuring, separating into two publicly traded companies (one regulated and one unregulated). Reliant's decision was motivated in part because of Texas' mandate that utilities in the state must construct firewalls between their operating companies. In other words, Texas utilities must have separate companies=01*with separate financial rec= ords=01* for energy services, distribution, generation, etc. Yet, beyond the mandate, it is a smart move for Reliant because it can now attract two different sets of investors=01*one attracted to high-risk ventures and the other aver= se to them. In addition, high-risk ventures such as power generation, marketin= g and trading, telecom, etc., will not have a negative impact on the unregula= ted company's stock value. The same logic applies to the restructuring that AEP has announced. Other companies that recently have spun off high-risk subsidiaries into separate companies are Southern Company (Southern Energy) and Xcel Energy (NRG Energy, Inc). One difference between these examples and AEP is that AEP has not confirmed that its two companies will become two stand-alone, publicly traded compani= es. Draper has said that the company is reserving that decision until the end of next year, the time at which he believes the restructuring will have received all the necessary regulatory approvals (considering how long the AEP/CSW merger took to complete, the restructuring could take longer than a year). Draper did allude to the fact that AEP has "a number of options to consider." This statement may or may not support speculation that the company is planning an imminent acquisition, one that might dramatically expand its generation portfolio and further support its trading and wholesa= le marketing efforts. In addition, I think it's valid to speculate that AEP might eventually divest itself of the T&D business altogether. Certainly, the restructuring does not place this end of the company's business very high on the totem pole, as it was only a few months ago. Another question that probably cannot be answered at this point is whether or not AEP, as a holding company, will remain under regulation from the Public Utilities Holding Company Act of 1935 (PUHCA). After the restructuri= ng has been completed, AEP will have several options. It could operate as it is now, that is with a holding company structure under which the two stand-alone corporations would be held. Or it could issue two IPOs for the two companies. Assuming that after the restructuring has been completed AEP decides to issue IPOs for both its unregulated and regulated companies, thereby eliminating a holding company entity, it is questionable whether or not AEP would still be bound by PUHCA restrictions. This could be an important part of AEP's strategy regarding the restructuring. As AEP contin= ues to compete in deregulated markets, it faces an array of restrictions under PUHCA that, for example, Enron does not face as it is not a registered holding company. Disengaging itself from PUHCA restrictions (assuming that PUHCA has not been repealed by that point) would certainly offer AEP a new level of competitive agility. However, perhaps most interesting of all will be what AEP decides to do with its T&D business, which represents approximately 5 million customers that are connected to AEP's transmission system. Certainly, once this regulated business is fully separated from the deregulated businesses, AEP will be able to do a more accurate=20 cost/benefit analysis and determine if it wants to remain in the T&D business at all. =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D Learn more about SCIENTECH's Issues and Analysis products and services at: http://www.consultrci.com/web/rciweb.nsf/web/Depts-IA.html =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D SCIENTECH is pleased to provide you with your free, daily IssueAlert. Let us know if we can help you with in-depth analyses or any other SCIENTECH information products. If you would like to refer a colleague to receive our free, daily IssueAlerts, please reply to this email and include their full name and email address or register directly at: http://www.consultrci.com/web/infostore.nsf/Products/IssueAlert Sincerely, Will McNamara Director, Electric Industry Analysis wmcnamara@scientech.com =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D Feedback regarding SCIENTECH's IssueAlert should be sent to=20 wmcnamara@scientech.com =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D= =3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D SCIENTECH's IssueAlerts are compiled based on independent analysis by=20 SCIENTECH consultants. The opinions expressed in SCIENTECH's IssueAlerts are not intended to predict financial performance of companies discussed or to be the basis for investment decisions of any kind. SCIENTECH's sole purpos= e in publishing its IssueAlerts is to offer an independent perspective regard= ing the key events occurring in the energy industry, based on its long-standing reputation as an expert on energy and telecommunications issues. Copyright 2000. SCIENTECH, Inc. If you do not wish to receive any further IssueAlerts from SCIENTECH, pleas= e reply to this message and in the body of the email type "remove."
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