UPDATE: FirstEnergy In $4.7 Billion Deal To Acquire Allegheny Energy

FirstEnergy Corp. (FE) has agreed to a $4.7 billion takeover of Allegheny Energy Inc. (AYE), a deal that would create one of the largest electricity providers in the U.S. and could spur further consolidation.

The proposed combination comes in an industry where consolidation is often touted, but deals have been tough to get done because of push back from state regulators. The deal announced Thursday would bring together two large coal-fired generators as the power-plant fuel faces challenges, including tighter regulation on traditional air pollutants and potential limits on carbon-dioxide emissions linked to global climate change.

The all-stock deal would give Allegheny holders 0.667 share of FirstEnergy for each share they own, valuing the stock at $27.65 based on Wednesday's closing price. That is a 32% premium. The transaction would also entail the assumption of some $3.8 billion of Allegheny debt.

Allegheny shares recently traded 10% higher to $23.15, well below the offer price and perhaps indicating concerns among investors that the deal may not get done. FirstEnergy shares fell 6.1% to $38.93.

FirstEnergy, based in Akron, Ohio, and Allegheny, of Greensburg, Penn., both operate regulated utilities and merchant power plants that sell electricity at market prices rather than regulated rates. The combined company would have 6.1 million utility customers and 24,000 megawatts of generation concentrated in the Mid-Atlantic region.

FirstEnergy and Allegheny must navigate the state regulatory process where large utility mergers in recent years have collapsed. The key states for the companies will be Maryland, Pennsylvania and West Virginia. Allegheny will also need approval in Virginia, where it is already in the process of shrinking through the sale of its utility to electric cooperatives.

"In all of those three jurisdictions we have very good relationships, we're good corporate citizens, we have very high customer satisfaction," Allegheny Chairman and Chief Executive Paul Evanson said in an interview with Dow Jones Newswires.

Regulators from Maryland, West Virginia and Pennsylvania weren't immediately available for comment.

Evanson and FirstEnergy CEO Anthony Alexander described the deal as a good geographic and strategic fit. The takeover will create a stronger balance sheet, giving the combined company greater growth opportunities in a capital-intensive industry. Alexander said Allegheny brings a strong transmission-development business and efficient coal-fired plants. He said he expects FirstEnergy to increase the output of the plants and the combined fleet to produce improved returns.

The companies estimate pre-tax savings of $180 million in the first full year of the combination and $350 million in the second year. Alexander said savings are expected to come mostly from combining the generation fleets, while expecting few job cuts.

"We are seeing the bulk of the synergies in the generation and fuel side," he said.

Talks between the companies started in December, when FirstEnergy approached Allegheny. Evanson said he wasn't shopping the company. During a conference call, the executives said, however, that the takeover wasn't a simple negotiated deal and further details of the process would be available through filings with the U.S. Securities and Exchange Commission.

Neither executive expects the deal will require asset sales because of market-power concerns, and Allegheny expects to win approval from its bondholders for the deal, which is required because of change-of-control provisions. The combined company should maintain an investment-grade rating.

Analysts at Credit Suisse in a note to clients wrote that the deal came as a surprise and also questioned whether the deal would face challenges from state regulators in light of the current economy. They question whether such a large reliance on coal-fired generation makes sense in the current regulatory environment.

For investors, the FirstEnergy deal could become a barometer for merger-and-acquisition activity. The utility industry consists of mostly regional companies and, with large capital spending expected in the coming years, balance-sheet strength has been an ongoing question. But large mergers in recent years have stumbled, including mergers between FLP Group Inc. (FPL) and Constellation Energy Group Inc. (CEG), and Exelon Corp. (EXC) and Public Service Energy Group Inc. (PEG).

"The proposed deal may pave the way for additional M&A activity in the space, and as such expect it to be a positive catalyst for the industry as a whole," wrote Andrew Smith, an analyst for JP Morgan in a note clients Thursday.

The deal is expected to close in about a year. FirstEnergy expects the deal to boost its earnings in the first year after closing.

-By Mark Peters, Dow Jones Newswires; 212-416-2457; mark.peters@dowjones.com

(Kevin Kingsbury contributed to this article.)

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