L:UTILITIES_NYDEPT_ONLYPersonal FoldersBLUXTim SchwarzUtility Industry Presentation.pptA2XP16 SEP 20

1
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\1
Investment Banking View of the Utility Industry
21 September 2005
2
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\2
Table of Contents
Section 1
Utility Sector Update
Section 2
Perspectives on Recent Strategic Activity
Section 3
Energy Policy Act
Section 4
Transmission Environment Update
Appendix A
Bio

• Timothy R. Schwarz

3
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\4
Section 1
Utility Sector Update
4
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\5
Utility Sector Update
A Brave New World of Growth is Emerging

• Growth stocks are starting to make a comeback
  after 5 consecutive years of trailing value
  stocks
• Year-to-date performance supports our view, as
  growth, measured by the Barra indexes, has
  marginally outperformed value. More telling could
  be that growth has triumphed over value during
  each of the last six months
• However, unlike past rebounds in growth stocks,
  we expect a GARP orientation to dominate during
  this cycle
• Earnings growth and dividend growth have
  reconnected after the long absence that defined
  the 1990s

Growth
Growth
Tech 2000
Nifty Fifty Peak
EnergySector Peak
Kuwait/Recession
Jul 94
Value
Value
Apr 77
Oct 84
Source Ibbotson, Morgan Stanley Research
Source Morgan Stanley Research
Source SP, Thomson Financial, Morgan Stanley
Research
Source SP, Thomson Financial, Morgan Stanley
Research
1
5
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\6
Utility Sector Update
Utility Sector Sensitivity to Interest Rates

• With the Fed tightening 10 consecutive times,
  U.S. long-term interest rates have not risen in
  line with expectations
• U.S. utilities have not been as sensitive to
  interest rate movements as historically observed
• Morgan Stanley forecasts that the 10 and 30 year
  US Treasuries will reach 4.75 and 5.0,
  respectively, by the end of the year

Source FactSet and Morgan Stanley Research
Source Bloomberg and Morgan Stanley Research and
The Wall Street Journal
Notes 1. Forecast as of August 8, 2005 all
forecast values are for the end of the indicated
period
2
6
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\7
Utility Sector Update
Utility Sector Valuation Relative to Broader
Market

• Current valuations are not compelling as the
  sector is trading close to one standard deviation
  above its long-term average on most metrics
• Valuations also are unattractive relative to the
  broader market
• Utility sector trading at 107 of the SP 500 on
  a forward P/E basis, above the 5-year historical
  average of 74

Source FactSet, Bloomberg, Morgan Stanley
Research
Source FactSet, Bloomberg, Morgan Stanley
Research

• Notes
• Morgan Stanley Research data as of September 6,
  2005
• Market data as of September 6, 2005

3
7
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\8
Utility Sector Update
Investor Perception of the Utility Sector

• Morgan Stanley recently conducted an informal
  survey of the top 25 investors in the utility
  sector asking two fundamental questions on
  current valuation levels and their sustainability

• Question 1 The outperformance of the utility
  industry relative to other sectors for the past
  12-18 months has surprised many in the investment
  community, what do you think are the principal
  factors supporting this phenomenon?
• Macro Factors
• Interest rate environment
• Risk-adjusted growth relative to broader market
• Lack of direction for broader economy
• Tax law changes
• Sector Specific Factors
• Commodity price environment
• Constructive regulatory environment
• PUHCA repeal
• Question 2 Looking out over the next 12-24
  months, do you think this outperformance will be
  sustainable?
• Macro Factors
• Interest rate environment (Fed actions and shape
  of the yield curve)
• Growth in other sectors (i.e., alternative
  investment opportunities)
• Economy (slow-down sustainability of
  outperformance / growth underperformance)
• Sector Specific Factors
• Special situation stories can only turn around
  once
• MA / strategic environment

4
8
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\9
Utility Sector Update
Analyzing Utilities Based on Commodity Exposure

• Utilities with commodity growth kickers
  continue to be in favor, however, fully regulated
  names have also performed well over the past six
  months

(1)
High
(2)
(3)
(4)
Commodity Exposure
(5)
(6)
Low
(7)
Source FactSet
(8)
High
(2)
(3)
(4)
Commodity Exposure
(5)
(6)
(7)
Low
Source FactSet
5

• Notes
• Includes RRI, NRG, DYN and CPN
• Includes D, TXU, WMB, EP
• Includes DUK, FPL, CEG, SRE, DTE, TE
• Includes EXC, ETR, EIX, AEE, PNM
• Includes FE, AEP, PPL, CIN, DPL
• Includes PNW, PSD, IDA, AVA
• Includes SO, PCG, ED, PGN, XEL, POM, NU
• Includes RRI, NRG and DYN. CPN was excluded
  because its YTD share price change was -25.4

9
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\10
Utility Sector Update
Does EPS Growth Matter?

• Given the spotted track record of the utility
  sector over the past three years, investors are
  largely discounting EPS growth rates greater than
  5
• Taking on greater business risk, in the search
  for incremental EPS growth, is not necessarily
  being rewarded appropriately by the investment
  community for the commensurate risk
• The market does not see significant value in
  distinguishing between 4-6 growth for a couple
  of year period vs. 2-3 long-term growth when
  visibility is limited to the regulatory treatment
  of rate base and timing of rate increases

Source FactSet, IBES
IBES 2006E P/E
IBES 2006E P/E
Projected Beta
SP Business Profile Rating
Sources FactSet, IBES and SP Credit Reports
Sources FactSet, IBES and Barra
6
10
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\11
Utility Sector Update
What is the Market Rewarding?

• There continues to be a negative relationship
  between growth and P/E multiples
• Market is skeptical of Utilities achieving stated
  growth objectives above 5
• Premium is being placed on lower risk, low growth
  strategies (i.e., stick to core competencies)
• The market is also placing premium valuations on
  companies that are returning cash to shareholders
  if they dont have a use for it in their core
  business
• High dividend paying stocks are being rewarded by
  the market
• Conclusion Any growth investments face a high
  hurdle rate for investors

IBES 2006E P/E
IBES 2006E P/E
Payout Ratio ()
IBES LT Growth Rate ()
Source FactSet and IBES
Source FactSet and IBES
7
11
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\13
Section 2
Perspectives on Recent Strategic Activity
12
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\14
Perspectives on Recent Strategic Activity
Key Observations

• MA activity in 2005 continues to be robust
• YTD announced global volume up 35 over same
  period in 2004

Source Thomson Financial as of 9 Sept 2005

• Valuation levels provide support to the current
  MA environment
• Acquisition premiums are down as buyers
  demonstrate increased discipline

Source Thomson Financial

• Notes
• Includes global announced transactions of 100MM
  or more excludes terminated transactions
• Annual amounts based on mean of percentage
  premiums paid over unaffected stock price which
  is defined as stock price 4 weeks prior to the
  earliest of the deal announcement announcement
  of a competing bid and market rumors before 31
  March 2005
• Includes all announced bids irrespective of
  consideration offered (i.e., includes all cash,
  all stock and hybrid bids). Excludes outliers

8
13
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\15
Perspectives on Recent Strategic Activity
The Market Is More Receptive to MA

• Improved market receptivity to announced
  transactions

• Note
• Aftermarket performance compared to acquirors
  unaffected stock price (1-day prior to
  announcement)

9
14
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\16
Perspectives on Recent Strategic Activity
Comparison of Recent MA Transactions
Key Merger Statistics

• Price performance since announcement

(1)
(1)
(2)
(1)
(1)
(1)
(3)
(4)
(3)
(5)
(2)

• Notes
• Based on unaffected prices as of 5/6/2005,
  12/15/2004, and 5/23/2005, for Duke/Cinergy,
  Exelon/PSEG, and Scottish Power, respectively
• Aggregate Value without securitized debt is
  25Bn EV/2005E EBITDA without securitized debt
  is 10.4x
• Based on equity research estimates
• LTM P/E (March 05) is 20.5x
• LTM EV/EBITDA (March 05) is 8.6x

10
15
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\17
Perspectives on Recent Strategic Activity
Emergence of Alternative Sources of Capital

• Financial sponsors and hedge funds have emerged
  as an increasingly important pool of capital
• Proliferation of 1Bn funds
• Convergence of hedge funds and private equity
• Growth in number and size of alternative
  investment funds driven by search for
  outperformance in low-return environment
• Traditional strategies generating lower-return
  prospects

Source 19962004 Thomson Financial
Source HFR report

• Note
• Transactions greater than 400MM. Includes
  transactions with U.S. based seller or buyer

11
16
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\18
Perspectives on Recent Strategic Activity
Financial Player Activity in the Power Sector
New Financial Players Enter the Project Finance
Merchant Energy Sector. . .

• Not all financial players are the same. Those
  actively involved in the power sector include
• A mix of private equity partnerships and funds
• Commercial banks that have reluctantly become
  owners through foreclosures
• Hedge funds that have entered the sector by
  trading distressed debt and equity
• Financial institutions seeking long-term, stable
  annuity-like returns, such as pension funds or
  newly formed infrastructure funds
• Investment banks looking to expand their
  commodity positions

12
17
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\19
Perspectives on Recent Strategic Activity
CalBear Energy Marketing and Trading Venture

• On September 8th, Bear Stearns and Calpine
  announced the formation of a new energy marketing
  and trading venture focused on physical natural
  gas and power trading

Calpine Corporation
Bear Stearns Companies Inc.
Distribution of Profits
350MM Credit Intermediation Agreement for Power
Gas Trades Around Calpine Assets
100 Ownership
Calpine Energy Services, L.P. (CES)
CalBear Energy LP (CalBear)
Services
Calpine Merchant Services Company (CMSC)
Services
Fees
Service Fee Equal to 50 of CalBear Profits
Transactions RELATED to Calpine Assets
Transactions NOT RELATED to Calpine Assets
Sept. 8th Announcement
1-Aug 10-Aug 19-Aug
30-Aug 12-Sept
Source Factset
13
18
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\21
Section 3
Energy Policy Act
19
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\22
Energy Policy Act
The Energy Policy Act
Overview of PUHCA Repeal

• The repeal of PUHCA in the Energy Act will
  facilitate MA activity in the utility industry
• The SECs traditional role in reviewing MA
  proposals has been removed, as has the
  requirement for utility combinations to be
  contiguous or interconnected
• However, an increase in MA activity is not
  assured, as state approval for MA will still be
  required and both FERC and the states have been
  granted additional authority
• How that authority is implemented will be
  critical to future consolidation in the industry

• It is our view that PUHCA repeal will increase
  strategic activity in the sector over time,
  however, regulatory hurdles in the utility
  industry will continue to represent obstacles to
  mergers and acquisitions
• State commissions have, and will continue to
  represent hurdles, particularly to acquisitions
  by entities not already in the utility business
  (e.g. rejection of the TPG / Portland General and
  KKR / Unisource transactions)
• FERC can be expected to apply its merger
  guidelines rigorously to protect consumers from
  the anticompetitive effects of utility mergers
  and acquisitions that would permit the exercise
  of horizontal or vertical market power
• In addition, holding companies will be subject to
  enhanced information reporting to both FERC and
  state utility regulators to facilitate rate
  regulation and protection of ratepayers from
  abusive company transactions
• Despite its enhanced regulatory role, FERCs
  oversight should not be nearly as intrusive as
  was the SECs under PUHCA
• The new legislation, which will be implemented
  through FERC rulemaking, appears to limit the
  scope of FERCs review to anti-trust related and
  cross subsidization issues rather than the
  wide-ranging review required by the SEC under
  PUHCA
• Moreover, congress has limited FERCs merger
  review process to 180 days (absent a showing of
  good cause) in striking contrast to the
  open-ended SEC process in which some utility
  mergers simply died from SEC inaction
• As a consequence, electric and gas utilities may
  be newly vulnerable to strategic approaches and
  may have increased pressure to perform
  financially and therefore may increasingly look
  to acquisitions as a means to grow and improve
  financial performance through the potential
  synergies derived from consolidation

14
20
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\23
Energy Policy Act
The Energy Policy Act
Potential Implications of PUHCA Repeal

• The market is still the driving factor behind
  transactions, but the Energy Act removes some
  obstacles that have historically stood in the way
  of economically sound MA transactions

• New entrants
• Financial players, foreign entities and
  non-utility energy companies that have
  historically balked at subjecting themselves to
  regulation under PUHCA
• Construction or technology companies (not merely
  Bechtel or GE, but purveyors of clean coal
  technology, transmission or even new nuclear
  facilities) can now take an equity interest in
  projects they build or design
• New acquirers
• Utilities in strong financial positions that are
  not contiguous to many other utilities (e.g.
  those in Florida), as well as those in highly
  integrated pools or RTOs (e.g., PJM), may be
  particularly well placed for increased MA
  activity
• New targets
• Small and medium sized utilities will likely
  enjoy a broader range of potential acquirers
• Transmission consolidation
• A utility which knows how to operate a complex
  electric transmission network can now own
  electric transmission across the country, without
  regard to integration of those systems, or in
  distant states where they cannot be accused of
  manipulating transmission to benefit their own
  native generation
• Restructuring Opportunities
• Flat utilities that have operations in several
  states and non-utility subsidiaries will be able
  to restructure as holding companies with separate
  state utilities and non-utility businesses held
  apart from the utility ownership chain without
  having to register under PUHCA (such a structure
  may simplify state regulatory issues)

15
21
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\25
Section 4
Transmission Environment Update
22
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\26
Transmission Environment Update
The Energy Policy Act
Transmission Implications

• The Energy Act advances the objective of
  integrating regional markets for wholesale power
  by ensuring generator access to increased
  investment in and streamlined operations of the
  national transmission grid

16
23
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\27
Transmission Environment Update
Strategic Trends in Transmission
FERC Gives Utilities Incentives to Sell
Transmission

• Federal regulators, namely FERC and the
  Department of Energy, have noted a decline in
  transmission investment, and recognize that a
  reversal of this pattern is needed to improve
  reliability, reduce blackouts and lower the cost
  of electricity
• The DOE estimates that 50-100 billion of
  investment is required to modernize the
  transmission grid
• FERC has been supportive of the creation of
  independent transmission companies such as ITC,
  and has awarded a 100 bps bonus ROE to encourage
  them
• In approving ITCs IPO, FERC has shown its
  support for independent transmission businesses,
  as they fall only under FERCs jurisdiction, and
  do not have to seek cost recovery from state
  regulators who may have different agendas
• FERC recently proposed policy changes to further
  encourage electric utilities to sell transmission
  assets, stating that the current policy has led
  to too few divestitures
• Policy set in January 2003 allows transmission
  companies independent of utilities to charge
  higher rates for the use of their transmission
  systems
• Proposed change would allow the higher rates even
  when a utility retains a stake in the
  transmission company (utility ownership limited
  to 5 of voting control and 49 of economic
  interest)
• Combined with other incentives, an independent
  company may qualify for a return as high as 15
  on new transmission lines, compared with about
  12 for a typical utility
• In addition, recent tax bill allows utilities to
  defer taxes on profits from the sale of
  transmission systems for eight years

• Given the signing of the Energy Policy Act and
  recent developments with respect to transmission
  assets, we believe strategic activity in the
  transmission sector will accelerate over the next
  6-12 months

17
24
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\28
Transmission Environment Update
Strategic Trends in Transmission
Case Study ITC Holdings Corp. 331MM IPO (1)

• On July 25, 2005, Morgan Stanley, with Lehman and
  CSFB, priced the 330.6MM IPO of ITC Holdings at
  23/share
• 57.5MM primary shares
• 273.1MM secondary shares
• IPO priced above the filing range of 19-21
• Book was over 17x oversubscribed
• Implied 2005E P/E of 25.5x on a fully distributed
  basis
• Dividend yield of 4.6 at pricing and 4.0 on a
  fully distributed basis

Transaction Overview

• ITC priced at 23.00 per share--2.00 above the
  original filing range of 19-21
• Investors were primarily attracted to ITC's
  unique business model, combination of high growth
  potential and dividend yield, earnings visibility
  (automatic rate recovery through Attachment O
  mechanism), attractive rate of return and
  experienced management team
• An extensive 10-day marketing program was
  undertaken by management, including 39
  one-on-ones, 12 two-on-ones, 2 three-on-ones, 6
  conference calls, and 6 group meetings in 17
  cities
• Management achieved a one-on-one hit ratio of
  over 90
• The offering was over 17x oversubscribed
  (pre-greenshoe) with minimal price sensitivity,
  with almost 400 institutional investors in the
  order book, and 79 investors placing orders for
  10 of the transaction
• Retail interest in the offering was almost 16MM
  shares
• ITCs stock began trading on July 26, 2005 and
  opened at approximately 27. ITC closed the day
  at 26.40

210.4
Source DealAxis Morgan Stanley

• Notes
• Total IPO proceeds include overallotment
• Overallotment option of 1.875MM shares consists
  of 100 secondary shares

18
25
L\UTILITIES_NY\DEPT_ONLY\Personal
Folders\BLUX\Tim Schwarz\Utility Industry
Presentation.ppt\A2XP\16 SEP 2005\555 PM\30
Appendix A
Bio
26
Bio
Timothy R. Schwarz
Timothy R. Schwarz Executive Director

19