"Institurional investors are still largely underweight in the utilities sector...and the reluctant flow of cash from large funds will probably keep the general utilities area fairly buoyant."
 
  -Lowell Miller
 
 
Fields in Dutchess County Copyright Judy Glasel  
Distribution / Merging Utilities
The Distribution/Merging Utilities Portfolio is a specialty strategy designed to capitalize on the consolidation and convergence in the utility industry. Focus is on investments in public securities of small and mid-capitalization utility companies, that we believe are both undervalued and potentially subject to acquisition.
     
   
   
   
   
   
   
     
   
   
   
   
   
     
   
   
   
   
 
 
Investment Philosophy
Deregulation and industry competitive factors have forced utilities into a consolidation phase. The consolidation trend began in 1997 and since that time, many utility acquisitions and mergers have occurred. Currently there are approximately 120 publicly traded utility companies; management, financial analysts and industry executives generally believe that consolidation will result in an industry with 15-20 super-regional or national companies during the next five years. Too, repeal of the Public Utility Holding Company Act appears to draw ever closer and we believe repeal will inspire considerable M&A activity among utilities.
 
Investment Strategy
The Distribution/Merging Utilities Portfolio invests only in utility companies that we consider to be likely takeover candidates, and only when such stocks are considered to offer substantial potential price appreciation based on their projected acquisition value. We expect the majority of investments to be in small and mid-sized electric, gas and water companies since such companies offer a substantial dividend yield, have excess cash flow, low capital expenditures, sell at a low multiple of earnings and book value compared to other companies, and feature minimal business or competitive risk. The portfolio will focus primarily on distribution companies ("wires and pipes" companies that deliver the services rather than those that generate power), which we believe to represent the lower risk segment of the utility industry. These companies continue to have local monopoly status.
 
Investment Process
In this portfolio the key driver is our evaluation of the potential attractiveness of a particular company to another utility company as an acquisition, and the potential profit we may derive should a transaction occur, based on current market prices. We compare all stocks in the universe to a model of private market value based on the numerous transactions that have already been completed in the industry. For those companies that reveal a potential of at least 30% premium to current market value in a transaction, we evaluate the regulatory environment that might enhance or impede a potential deal. Some jurisdictions are "difficult," some are facilitators of free market activities. We also analyze a company's strategic fit with potential acquirers, and the problems or burdens which could diminish a company's appeal. We further investigate management's view of consolidation and convergence, and the proportion of shares held by investors who might be congenial to a transaction. Stocks are held indefinitely in anticipation of a transaction, or may be sold in the event that current market pricing comes into equilibrium with potential private market valuation. In addition, stocks may be sold if management voices a clear antagonism toward a deal, or if company fundamentals deteriorate sufficiently to alter the potential private market value.