Appendix D

Case Study⁽⁸⁶⁾

In 1993, Gulf States Utilities Company (Gulf States or GSU) merged with Entergy Corporation (Entergy) to form a new registered holding company under the Public Utility Holding Company Act of 1935 (PUHCA), also called Entergy Corporation. The focus of this analysis is to determine, using public data, if the objectives of the merger were realized. The objectives of the merger were: (1) to save $1.7 billion in costs from 1994 through 2003; (2) to provide shareholders more attractive earnings prospects due to a financially and operationally stronger, combined company that is strategically positioned for additional growth and increased market recognition; (3) to provide GSU's customers lower electricity rates due to lower fuel costs and a 5-year cap on base electric rates; (4) to provide all other Entergy customers lower costs of service and lower customer rates due to reduced operations and maintenance (O&M) expenses and capacity deferral savings,^{(87), (88)} and (5) to help GSU alleviate operational and financial problems brought on, in part, by rate base disallowances for nuclear plant construction costs.⁽⁸⁹⁾

Data sources for this case study were (1) the Federal Energy Regulatory Commission (FERC): Merger application and testimony, and FERC Form-1, (2) the Securities and Exchange Commission (SEC): 10K filings, and (3) annual reports of the merging companies.

Description of the Companies

The merger of Entergy Corporation, a Florida corporation, with GSU, a Texas corporation, actually consisted of interim corporate mergers resulting in a new holding company, named Entergy Corporation, a Delaware corporation. After the merger, GSU became a wholly- owned subsidiary of the new Entergy Corporation. The acquisition of GSU was consummated on December 31, 1993, shortly after obtaining approval of the merger by the FERC on December 15, 1993 (Order/Opinion No. 385), and two days after receiving final approval from the Public Utility Commission of Texas.

Entergy Corporation (Pre-Merger)

Prior to the merger, Entergy Corporation was incorporated in Florida in 1949, and was a holding company under PUHCA. Entergy owned all the common stock of four major electric utilities: Arkansas Power and Light Company (AP&L), Louisiana Power & Light Company (LP&L), Mississippi Power & Light Company (MP&L), and New Orleans Public Service, Incorporated (NOPSI).⁽⁹⁰⁾ These four retail utilities provided electricity to 1.7 million ultimate consumers located within the States of Arkansas, Missouri, Louisiana, Mississippi, Mississippi and Louisiana, and to 23 wholesale customers. In addition, NOPSI provided gas service to 154,251 customers within the City of New Orleans.⁽⁹¹⁾

At the time of the merger, Entergy Corporation owned all the common stock of another major utility, System Energy Resources, Inc. (System Energy). System Energy owned 90 percent of Grand Gulf 1 (a nuclear power plant), and sold all of the plant's electricity at wholesale to Entergy's four retail utilities.

In addition, Entergy Corporation owned four other nonutility subsidiaries: Entergy Services, Inc., Entergy Operations, Inc., Entergy Power, Inc., and Entergy Enterprises, Inc. Entergy Services provided general executive and advisory services, and accounting, engineering, and other technical services to certain of the Entergy Corporation subsidiaries, generally at cost. Entergy Operations is a nuclear management company that operated all the nuclear facilities on the Entergy System,⁽⁹²⁾ subject to the owner oversight of AP&L, GSU, LP&L, and System Energy. Entergy Power is an independent power producer that owned 809 MW of generating capacity at the close of 1993, and marketed its capacity and energy in the wholesale markets not otherwise presently served by the Entergy System. Entergy Enterprises was utilized to invest in businesses whose products and activities were of benefit to the Entergy System's utility businesses, and to market technical expertise developed by the Entergy System companies when it was not required for the operations of the Entergy System.

In addition to Entergy's nonutility subsidiaries, the four retail electric utility subsidiaries jointly owned System Fuels, Incorporated, a non-profit subsidiary that implemented and/or maintained programs to procure, deliver and store fuel supplies for the Entergy System. As early as the close of 1993, Entergy Corporation and its various subsidiaries (including   those   which   are  not  wholly-owned by Entergy Corporation itself and are not described above) also had a variety of investments in non-regulated businesses associated with overseas power development and new electro-technologies. Entergy was also seeking at the end of 1993 to provide telecommunications services based on its experience with interactive communications systems that allow customers to control energy usage.⁽⁹³⁾

Gulf States Utilities Company: Gulf States Utilities Company (GSU) was incorporated in Texas in 1925. At the end of 1993, GSU served approximately 593,000 retail electricity customers in Texas and Louisiana, and 85,000 natural gas customers in the Baton Rouge, Louisiana area. As such, GSU had about one-third the number of electricity customers as did Entergy Corporation prior to the merger, but total assets were about 46 percent of Entergy's. GSU's steam products department also produced and sold, on an unregulated basis, process steam and by-product electricity from its steam electric extraction plant to a large industrial customer.

GSU had four wholly-owned subsidiaries at the end of 1993: Varibus Corporation, GSG&T, Inc., Southern Gulf Railway Company, and Prudential Oil & Gas, Inc. Varibus Corporation operated intrastate gas pipelines in Louisiana, used primarily to transport fuel to two of GSU's generating stations. Varibus Corporation also marketed computer-aided engineering and drafting technologies and related computer equipment and services. GSG&T, Inc. owned a gas-fired generating plant that is leased and operated by GSU. Southern Gulf Railway Company was formed to own and operate several miles of rail track being constructed at the end of 1993 in Louisiana for the purpose of transporting coal for use by one of GSU's generating plants. Prudential Oil & Gas, Inc., an oil and gas exploration company, was inactive at the end of 1993.

Entergy Corporation (Post-Merger Entergy)

A new holding company, originally named Entergy-GSU Holdings, Inc. and later renamed Entergy Corporation, was formed from the merger. All of the wholly-owned subsidiaries of the predecessor Entergy Corporation became wholly-owned subsidiaries of the new Entergy Corporation. As a consideration to GSU's shareholders, Entergy Corporation paid $250 million in cash and issued 56,667,726 shares of its common stock at a price of $35.8417 per share, in exchange for outstanding shares of GSU common stock. This amounts to a total capital cost of approximately $2.3 billion for GSU. GSU also became a wholly-owned subsidiary of the new Entergy Corporation and thereby became the fifth major retail operating utility of Entergy.

After the merger, Entergy Corporation was the second largest electric utility in the Nation. When the six major utilities are combined, the new Entergy Corporation had 2.3 million electric customers, $23.6 billion in total assets and $6.7 billion in total utility operating revenues. When all other regulated and non-regulated subsidiaries are also taken into account, the newly formed Entergy had $22.9 billion in assets, $6.27 billion in total utility operating revenues ($6.14 billion electric, $0.12 billion gas), $631 million in net income, and 16,679 employees.⁽⁹⁴⁾

Pre-Merger Estimated Savings and Costs of the Merger

The merging entities estimated cost savings of $539 million over the first five years (1994-1998) of the merger, and approximately $1.7 billion over the first 10 years (1994-2003).⁽⁹⁵⁾ These savings were expected from: (1) $274 million over the first five years ($849 million over the first 10 years) due to fuel savings achieved by combining the two fuel purchasing systems and coordinating generation dispatch;⁽⁹⁶⁾ (2) $265 million over the first five years ($673 million over the first 10 years) due to nonfuel O&M cost reductions resulting primarily from Entergy taking over the operation of GSU's nuclear generation plant and the streamlining of GSU's steam production, administrative, and customer support activities; and (3) $184 million during the last five years of the decade following the merger (1999-2003) due to deferral of resource capacity additions on Entergy's system made possible because of the coordination of the dispatch of Entergy's and GSU's generation systems. Of the estimated $539 million in savings over the first five years, GSU would receive $515 million. Of the estimated $1.7 billion in merger savings over the first 10 years, GSU would receive $1.43 billion. The $184 million associated with deferral of capacity additions represented the greatest potential source of cost savings for Entergy. Without the merger, on a stand-alone basis, the Entergy system would have incurred a resource capacity deficit in 1999; GSU not until 2006. The combined Entergy and GSU system was projected to show a resource capacity deficit not until the year 2001, and a smaller resource capacity deficit than that for Entergy as a stand-alone system. Thus, Entergy is the benefactor of all the savings associated with capacity deferrals in the 1999-2003 period. Combining these savings with approximately $95 million in nonfuel O&M cost reductions for Entergy, $59 million in fuel savings due to generation dispatch coordination, and netting out Entergy's additional costs associated with System Agreement synergies, Entergy's share of total merger savings over the 10-year period was estimated at approximately $260 million.

Merger costs consist of both merger transaction costs and costs to achieve merger savings. These included: (1) one-time capital costs of $37 million, incurred over the first three years after the merger, to add or modify facilities and equipment at GSU's River Bend nuclear plant; (2) one-time capital costs of $28 million, incurred over the first four years after the merger, to conform GSU fossil steam generation equipment to Entergy specifications; and (3) one-time O&M expenditures of $12.4 million for the implementation of an early retirement program and directors' and officers' insurance premiums in order to facilitate workforce reductions and administrative cost savings.⁽⁹⁷⁾ Although not specified at the time of the merger application before the FERC, merger transaction costs were known by the close of the merger to be $33.5 million, as accounted for in Entergy's SEC 10-K report for 1993. Thus, by the close of the merger, total estimated merger costs were approximately $111 million.

Allocation of Merger Costs and Savings to Customers and Shareholders

Each State regulatory commission provided formulas for allocating merger costs and savings between ratepayers and shareholders. These allocation formulas are worth noting because they may demonstrate the effects of the merger on electricity rates and shareholder returns on equity. The settlement agreement regarding the allocation formulas is usually complex, and therefore, only the highlights of the formula are discussed.⁽⁹⁸⁾

The Louisiana Public Service Commission (LPSC) and the Public Utility Commission of Texas (PUCT) each approved separate regulatory proposals that included a five-year rate cap on GSU's retail electric base rates in the respective States, and provisions for passing through to retail customers in the respective States the jurisdictional portion of the GSU fuel savings created by the merger. The LPSC plan provided that nonfuel merger savings will be shared 60 percent by the shareholder and 40 percent by the ratepayers during the eight years following the merger. The PUCT plan provided that such savings will be shared equally by the shareholder and ratepayers, except that the shareholder's portion will be reduced by $2.6 million per year on a total company basis in years four through eight.

AP&L, MP&L and NOPSI entered into separate settlement agreements, approved by their respective State regulatory commissions, whereby their retail customers would be protected from: (1) increases in the cost of capital resulting from risks associated with the merger; (2) recovery of any portion of the acquisition premium or  transactional  costs  associated  with  the merger; (3) certain direct allocations of costs associated with GSU's River Bend nuclear plant, and (4) any losses of GSU resulting from resolution of litigation in connection with its ownership of the River Bend nuclear plant.

In connection with the merger, AP&L agreed that it would not request any general rate increase that would take effect before November 3, 1998, with certain exceptions. MP&L agreed that retail base rates would not be increased for a five-year period above the level in effect as of November 1, 1993. NOPSI agreed to reduce base rates by $4.8 million on November 1, 1993 and to freeze base rates until October 31, 1996, with certain exceptions.

In connection with the merger, the FERC approved certain rate schedule changes to integrate GSU into the System Agreement, which provides for the coordination of planning, construction, and operation of Entergy's generation and transmission facilities. The FERC also required cost-tracking mechanisms and other commitments to provide reasonable assurance that the ratepayers of the existing Entergy operating companies before the merger, would not be allocated higher costs.

Merger savings associated with fuel costs would normally be recovered entirely by the ratepayers through the exercise of fuel adjustment clauses approved by the various regulatory agencies.⁽⁹⁹⁾

Effects of the Merger on Entergy's Growth, Efficiency, and Profits

As stated previously, one objective of the merger was to achieve cost savings from improved efficiency in operations and administration, and thereby to increase returns to equity shareholders and reduce rates to customers. Another objective was to place the merged company in a better strategic position for growth and profitability. Success in achieving this latter objective can be measured by comparing growth of electric revenues,  sales, and income before and after the merger.

Overall Growth Measurements

Entergy enjoyed rapid growth in electric operating revenues before the merger (1991-1993) at 5.8 percent annually,   but after the merger (1993-1997), annual growth slowed to 1.4 percent (Figure D1).⁽¹⁰⁰⁾ This deceleration after the merger was caused by a decline in both wholesale and retail revenues. Growth in retail electric operating revenues declined after the merger, to 1.5 percent annually, from 4.1 percent annually before the merger. In comparison, total wholesale electric operating revenues before the merger were increasing at an annual rate of 19.8 percent, but after the merger (1993-1997), Entergy's growth in wholesale operating revenues slowed to a 0.9-percent annual rate. From this data, it can be concluded that even though revenues were generally increasing, the merger did not appear to stimulate additional growth.

In contrast, Entergy experienced accelerated growth in electricity sales after the merger. Entergy's total sales before the merger (1991-1993) were growing at an annual rate of only 0.6 percent. After the merger (1993-1997), these grew at an annual rate of 3.3 percent (Figure D2).⁽¹⁰¹⁾ Of this total, annual growth in retail sales increased from 1.9 percent before the merger, to 2.8 percent after the merger. Wholesale sales for Entergy/GSU, which were actually declining before the merger at an annual rate of 5.4 percent, increased to 6.1 percent annually after the merger.

Figure D1. Entergy's Electric Operating Revenue, 1991-1997

Figure D2. Entergy's Retail and Wholesale Electricity Sales, 1991-1997

Along with increasing sales, the merging companies also experienced a growth in the number of retail customers after the merger (Figure D3). Before the merger, the number of retail customers was growing at an annual rate of 0.5 percent, but increased to 1.2 percent annually after the merger. Although wholesale sales were increasing, the total number of electric wholesale customers  for  Entergy/GSU  declined after the merger mainly because GSU experienced a net loss of 9 wholesale customers over the 1994-1997 period (Figure D3). GSU may have experienced a loss of wholesale customers because of increased competition in the wholesale electricity markets starting around 1994. In any event, the loss of wholesale customers was offset apparently by the increasing volume of wholesale sales to the remaining customers.

Entergy continued its progress in decreasing the workforce which had begun when they reorganized along functional lines in 1990,⁽¹⁰²⁾ and was extended to GSU after the merger in 1994. Entergy's total electric utility workforce had declined by 17.4 percent in the two years before the merger, and then was cut in half in the four years after the merger (Figure D4). GSU's workforce held steady at about 4,500 positions before the merger, and was reduced by two thirds, to 1,459 positions in the four years after the merger. In the four years following the merger, Entergy experienced a 57.6 percent reduction in its electric department workforce, from 10,915 employees to 4,633.

Figure D3. Entergy's Retail and Wholesale Customers, 1991-1997

Figure D4. Entergy's and Gulf States Utilities' Electric Employees, 1991-1997

This statistic probably overstates the reduction in the company's total manpower because in the extension of the reorganization along functional lines effective after the merger, some of the employees and/or electric department administrative functions of GSU were probably transferred to Entergy Services. As stated previously, Entergy Services, a wholly-owned subsidiary of Entergy Corporation, provides administrative and professional support to other subsidiaries, mostly at cost. Entergy Services' workforce increased from 1,986 at the end of 1993, to 3,131 at the end of January 1998.⁽¹⁰³⁾

Overall Efficiency Measurements

Figure D5. Entergy's and Major Investor-Owned Utilities' Retail Electricity Rates, 1991-1997

The most important efficiency measurement to a ratepayer is the change in retail customer electricity rates. Retail electricity rate is defined as the average revenue per kilowatthour of sales to retail customers. Retail customer rates for Entergy/GSU combined increased 2.1 percent annually before the merger, but declined 1.35 percent annually after the merger (Figure D5). This decline in retail growth rates after the merger was greater than the trend experienced by all IOUs in the Nation. Between 1991 and 1993, average retail rates for all IOUs were increasing by 1.2 percent annually, and declined by an average annual rate of 1.1 percent over the 1993-1997 period. Entergy/GSU's retail rates were about 8.3 percent less than the IOU national average in 1993, but 9.1  percent less than the IOU national average by 1997.

When adjusted for inflation, the effectiveness of the merger in reducing retail electricity rates appears even more dramatic (Figure D6). Average real retail rates for Entergy/GSU combined fell 12.9 percent over the 1993-1997 period, as compared to a drop of 12.1 percent for the national average of all IOUs. In terms of annual rates, Entergy/GSU combined rates were dropping by 0.7 percent per year before the merger, and 3.38 percent per year after the merger, as compared to a drop of 3.16 percent per year over the 1993-1997 period for all IOUs. Much of the reduction in rates is attributable to GSU's annual rates, which fell 4.39 percent per year after the merger, as compared to a decline of 1.25 percent per year before the merger.

Figure D6. Entergy's and Major Investor-Owned Utilities' Ultimate Customer Revenue, 1991-1997

Changes in operating and maintenance (O&M) costs is a more direct measurement of operational efficiency than electricity rates. O&M costs include: fuel costs as well as nonfuel operating and maintenance charges associated with power production; transmission and distribution O&M expenses, customer-related expenses, sales expenses, and administrative and general expenses.

Prior to the merger, Entergy's real total O&M costs were fluctuating around 3.7 cents per kWh (Figure D7).⁽¹⁰⁴⁾ GSU's real O&M costs were increasing, from 3.71 cents per kWh in 1991 to 4.13 cents per kWh in 1993, a gain of 11.3 percent. For Entergy/GSU combined, real O&M costs increased slightly by 2.5 percent over the 1991-1993 period.

Figure D7. Entergy's and Gulf States Utilities' Total O&M Cost Minus Purchased Power Expenses, 1991-1997

Entergy's and GSU's real O&M costs declined rapidly the first two years after the merger, but began increasing again in 1996 with a recovery in fossil fuel prices. Even with the recovery of fuel prices, however, Entergy and GSU had real O&M cost savings over the 1993-1997 period, indicating efficiency gains. GSU's O&M costs declined from 4.13 cents per kWh in 1993 to 3.39 cents per kWh in 1997, a decrease of 18 percent. Entergy's O&M costs declined from 3.66 cents per kWh to 3.28 cents per kWh, a decrease of 10.4 percent. For Entergy/GSU combined, real total O&M costs declined from an average of 3.81 cents per kWh in 1993 to 3.31 cents per kWh in 1997, a decrease of 13 percent.

Because Entergy associated some of the nonfuel O&M savings to workforce reductions, it is worthwhile to inspect indicators of electric department employee efficiency before and after the merger. Some caution must be taken when drawing conclusions using electric department employee statistics after the merger, because it is likely that some of the functions that were performed by electric department employees of GSU prior to the merger, were being performed by employees within the Entergy subsidiary, Entergy Services, after the merger. Employees within Entergy Services are not counted as electric department employees by Entergy, even when they may be fully occupied in providing administrative support services to the six major utilities of Entergy. Thus, increases in employee efficiency may be overstated when using employee department statistics as a basis for measurement. Since there are no public data that allocates Entergy Services' employees to the electric departments of the six major utilities of Entergy, no known adjustment can be made to correct the potential overstatement in manpower efficiency gains.

Figure D8. Entergy's and Gulf States Utilities' Megawatthour Sales, 1991-1997

Entergy's and GSU's total megawatthours of sales (ultimate consumer sales and sales for resale) per electric utility department employee increased dramatically after the merger (Figure D8). In 1993, average megawatthours  of  sale per electric department employee equaled 11,925. By 1997, this average had increased by 122 percent to 26,469 megawatthours of sales, primarily due to sales growth and workforce reductions. For GSU, the apparent efficiency gains are even more outstanding. Total megawatthours of sales per employee increased from 6,274 in 1993 to 24,118 in 1997, a gain of 284 percent. For Entergy and GSU combined, total megawatthour sales per employee increased from 9,582 in 1993 to 25,729 in 1997, a gain of 168 percent. Entergy's dramatic gain in worker efficiency was due to: (1) an increase in the volume of retail sales and sales for resale after the merger; (2) a workforce reduction program put in place by Entergy after the merger;⁽¹⁰⁵⁾ and, as noted above, (3) a probable shift in some of the employees and functions of GSU electric utility department employees to Entergy Services after the merger.

Another measurement of employee efficiency is the average number of electricity customers served per electric department employee. Prior to the merger, in 1993, GSU was less than half as efficient by this measure than Entergy, serving 131 customers per employee as compared to 272 for Entergy (Figure D9). By 1997, the total number of customers serviced per electric department employee of GSU had grown to 436, but Entergy similarly had grown to 570. Entergy/GSU combined grew from 214 customers per electric department employee in 1993, to 528 in 1997, a 146-percent increase in worker efficiency over four years. This was due primarily to: (1) Entergy's workforce reduction and restructuring programs⁽¹⁰⁶⁾ put in place after the merger which redefined and consolidated worker activities and sharply reduced the number of electric department employees; and (2) the probable shift in some of the administrative functions and positions of GSU to Entergy Services after the merger.

A customer-related measure of efficiency is the total customer expense per customer, adjusted for inflation. For this purpose, customer expense is defined as the sum of customer accounts and service expense and informational expense, as reported on FERC Form 1. Real customer expense per customer increased slightly before the merger, from $54.1 per customer in 1991 to $59.8 per customer in 1993 (Figure D10). By the end of 1997, this measure had declined to $43.5 per customer, a savings of 27.3 percent from 1994 levels.

Figure D9. Entergy's and Gulf States Utilities' Electricity Customers, 1991-1997

Figure D10. Entergy's and Gulf States Utilities' Customer Expense, 1991-1997

Overall Profitability Measurements

After the merger, Entergy's operating income never regained the levels reached in 1993 when the two companies operated individually (Figure D11). Operating income per kilowatthour of sales fell from 1.31 cents per kWh in 1993 to 1.0 cents per kWh in 1997, a decline of 23.7 percent. Important factors causing this decline were mandated base rate reductions after the merger and rate cap agreements entered into in connection with the merger, all of which constrained base rate operating revenues. Another factor was potential losses associated with the River Bend nuclear plant, including the establishment of reserves for the financial effects of potential adverse rulings by regulatory agencies. (Entergy also wrote off deferred costs associated with the River Bend plant of $169 million, net of taxes, effective January 1, 1996). While before the merger, Entergy and GSU combined were more profitable on a net kilowatthour of sales basis than all IOUs, for the first two years after the merger, they were significantly less profitable than all IOUs on the average, but by the 1996-1997 period, as merger savings and operating efficiencies began to become significant, Entergy began to be about as profitable as all IOUs on average.

Figure D11. Entergy's and Major Investor-Owned Electric Utilities' Net Electric Utility Operating Income, 1991-1997

Actual net earnings per average common share for Entergy (including all regulated and non-regulated subsidiaries), were lower in each year after the merger through 1997 compared with 1993 levels (Figure D12). The vast number of acquisitions and joint ventures made both domestically and in foreign countries after the merger through 1997 failed to produce profits to offset the decline in operating income of Entergy's major domestic operating utilities. Entergy's earnings per common share dropped from a 1993 pre-merger level of $2.62 to a post-merger level in 1997 of $1.03.

The decrease in earnings per share was a result in part of Entergy's aggressive expansion in both foreign and domestic markets, particularly in non-regulated businesses. Between 1993 and 1997, Entergy's investments in businesses other than domestic regulated utility business had grown from $142 million to over $1.3 billion.⁽¹⁰⁷⁾ But not all of these investments turned out to be sound ones, in terms of producing positive net income. In the years 1996 and 1997, all of the business segments of Entergy, other than domestic utility operations, when combined, resulted in net losses. These investments had left Entergy overextended financially, and debt had reached unacceptable levels, at 56.7 percent of total capital by the end of 1997. In 1998, Entergy was forced to reduce its dividend from $1.80 to $1.50 per common share.

Figure D12. Entergy's Net Earnings per Average Common Share, 1991-1997

By mid-1998, Entergy changed its strategy, changed its chief executive officer (CEO), and began to refocus on its core operations. It also began a huge divestment program, selling off many of the assets acquired since 1993. The new CEO decided to refocus on three core competencies: domestic utility operations, global power development, and nuclear power operations. The catchy name for this new strategy was Divest to Reinvest.⁽¹⁰⁸⁾

Regarding domestic utility operations, the new CEO indicated that service performance had suffered due to the concentration on reducing utility costs over recent years. For example, in 1997 customers received over 400,000 busy signals when attempting to call Entergy for assistance. At the urging of the regulators, Entergy committed to new service standards and practices that are expected to improve service reliability and customer responsiveness. Entergy decided to change all this in order to be the supplier of choice when their customers are given a choice. In addition, Entergy decided to invest $0.5 billion in its power marketing and trading business because the need for a superior energy- and price-risk management function will increase as the industry restructures and trading in wholesale markets plays a larger role in determining the price that utilities, and ultimately consumers, pay for electricity.

In 1998, Entergy also set a goal of becoming one of the top 10 wholesale generators and traders in Europe, the Americas, and Australia, primarily by developing new merchant power generation plants using gas turbine advanced technology. To realize this goal, Entergy allocated $4.0 billion in investment, and expects the global development business to contribute significantly to earnings beginning in 2000.

Entergy believes that it is one of only a few companies that has the skilled personnel and the scale of operations necessary to successfully operate nuclear power plants in a competitive market. Entergy sees significant expansion opportunities through the purchase and management of additional nuclear plants and through decommissioning plants. As a result, in 1998 Entergy allocated $0.5 billion in investment for expansion of its nuclear power operations.

By the end of 1998, the result of the change in strategy was an increase in earnings per share to $3.00, up from $1.03 in 1997 (Figure D12). The increase did not come from increases in total operating income, which declined from 1997 to 1998, but, at least in part, from the gain on the sale of non-regulated businesses.

Apparently, investors were not as optimistic about the prospects for increased profits from the Entergy/GSU merger or the aggressive acquisition strategy that was being pursued by Entergy over the 1994-1997 period. When indexed to the Dow Jones Utility Average, Entergy's price of common stock fell below the index within six months after the close of the merger, and stayed there through the end of 1998 (Figure D13). Total return on common stock (dividend yield plus percentage price appreciation of the stock) suffered in 1994 as the stock price fell precipitously (Figure D14). The price drop occurred as Entergy reported lower earnings and the Federal Reserve implemented a series of interest rate increases aimed at warding off inflation. The stock price recovered most of the price decline in 1995, a very good year for utility and other stocks in general, but failed to close the gap with the average for all utility stocks over subsequent years. As a result, total returns on common stock were disappointing in the 1994-1998 period, reaching only 8.8 percent in 1998, the year that Entergy's dividend was cut. The arithmetic average of total returns over the 1994 to 1998 period was only 6.6 percent.

Figure D13. Comparison of Entergy Common Stock Price and Dow Jones Utility Average, December 1993 Through December 1998

Figure D14. Entergy's Total Return on Equity, 1993-1998

On the positive side, the price of Entergy's common stock increased almost 10 percent from December 31, 1997 to December 31, 1998, indicating that investors apparently reacted positively to the change in Entergy's management and the new Entergy strategy for growth and profitability.

Assessment of Merger Effects on Ratepayers and Shareholders

Based on the overall growth, efficiency, and profitability measurements discussed in this section, the following preliminary conclusions can be drawn:

• Entergy's merger with GSU in 1993 failed to stimulate growth in total electric operating revenues of the combined company primarily because of customer base rate reductions in subsequent years. Before the merger (1991-1993), growth in total electric operating revenues for the two companies  was  increasing  by  5.8  percent annually; after the merger (1993-1997), annual growth in revenue had slowed to 2.8 percent. The decline in annual growth of operating revenues was experienced in both the retail and wholesale markets.



• Entergy's total kilowatthour sales (including both retail and wholesale sales) were probably stimulated by the merger, primarily due to both customer rate reductions and an increase in the growth of retail customers. Total sales for Entergy and GSU before the merger (1991-1993) were growing at an annual rate of only 0.6 percent, but after the merger (1993-1997), annual growth of 3.3 percent was experienced. Annual growth in the total number of retail customers increased after the merger, to 1.2 percent from 0.5 percent before the merger, but the total number of wholesale customers declined after the merger.



• Retail customer rates were reduced significantly after the merger, when measured in both nominal and inflation-adjusted dollars. In fact, the most certain result of the merger was retail customer rate reductions, particularly at GSU. This could be expected because 95 percent of the merger savings was expected to be attributed to GSU operations. Average rates for the two companies were increasing 2.1 percent annually before the merger, but declined 1.35 percent annually after the merger (in nominal dollars). Retail customers of the four original operating utilities of Entergy experienced a drop in retail rates of 3.2 percent, and 10.9 percent when adjusted for inflation. GSU's customer rates dropped 9.1 percent over the 1993-1997 period, and 16.4 percent when adjusted for inflation.



• Entergy's operational efficiency was somewhat improved after the merger. Real total O&M costs per kilowatthour of net generation declined 13 percent in the post-merger period, while this efficiency measurement increased slightly, by 2.5 percent, in the 1991-1993 period before the merger. Entergy's electric department workforce efficiency improved as measured by both megawatthour sales per employee and customers served per employee, and its real customer expense per customer declined. (Conclusions regarding electric department workforce efficiency gains have to be qualified by the uncertainty in the data derived from the probable transfer of some employee work requirements associated with GSU electric department administrative functions to Entergy Services after the merger.)



• Shareholders of Entergy did not experience increased profits or higher total returns on common stock equity as a result of the merger. This was probably a result of concessions made by Entergy when obtaining merger approval from the various regulatory agencies, that allocated most of the merger savings to ratepayers. In addition, in hindsight, Entergy may have paid too high a price for GSU. The $2.3 billion price tag was some $380 million in excess of the historical cost of the GSU net assets acquired,⁽¹⁰⁹⁾ and GSU had severe financial problems linked to the recovery of costs associated with the River Bend nuclear plant that, to date, were not resolved in GSU's favor. As a result, growth in price of Entergy's common stock lagged growth in the Dow Jones Utility average over the 1994-1998 period, shareholders received a cut in dividends per share in 1998, and average annual total returns on common stock equity were only 6.6 percent over the 1994-1998 post-merger period, about equal to the yield of a long term Treasury Bond that has no risk.



• Entergy itself, as a company, did not appear to benefit strategically from the merger. The stringent cost reduction measures put in place in the 1993-1997 period resulted positively in customer rate reductions, but system reliability and customer service suffered. As a result, corrective measures had to be taken by the new CEO in mid-1998, and, by that time, Entergy realized it had to refocus on core operations, including domestic utility operations, if it were to be prepared for customer choice.

Analysis of Estimated Pre-Merger and Post-Merger Savings and Costs

As described previously, in August of 1992, when Entergy first applied to the FERC for approval of the merger, Entergy estimated merger savings would be approximately $539 million over the first five years following  the  merger, and approximately $1.7 billion over the first 10 years. These savings were to be derived primarily from the fuel cost savings over the decade, nonfuel O&M savings over the decade, and deferred resource capacity expenditures over the 1999-2003 period. (See Table D1 for a summary of estimated pre-merger and post-merger cost savings.) Each of these merger savings categories is analyzed below, followed by an itemization of recorded merger costs.

Fuel Cost Savings

Projected fuel cost savings would be primarily from: (1) greater efficiencies in the purchasing of fossil fuels for steam generation plants due to the consolidation of purchasing operations; and (2) greater use of primarily coal-fired generation plants and less use of oil- and gas- fired generation plants, as a result of coordinated generation dispatch.⁽¹¹⁰⁾ Therefore, a reasonable way to observe whether these savings were achieved, using public data, is to examine changes in steam-power fuel expense per kilowatthour of electricity generation after the merger.

Figure D15. Entergy's Steam Fuel Expense, 1991-1997

Changes in fuel expenses will occur because of market price  changes,  Entergy's  ability  to  obtain better prices relative to the market, attainment of higher average efficiencies  for each type of fossil-fueled generation unit, and changes in the mix of generation plants dispatched. Entergy should be given credit for positive savings from the latter three factors, but should not be credited or penalized for market price changes, which, in a competitive market, are beyond Entergy's control. Entergy's fuel expenses, unadjusted for changes in market prices, decreased in the two years following the merger, but increased to higher levels in 1996 through 1997 (Figure D15). In order to factor out changes in the market price of fuel from the improvements in operation the company made that may lower fuel expenses, a composite market price index was developed.⁽¹¹¹⁾ The composite market price index indicates how the average costs of fossil fuels would have changed at Entergy, GSU, and Entergy/GSU combined, if these entities continued to purchase the same relative quantities of each type of fossil fuel as they did in 1993, and with the same purchasing efficiency as experienced in 1993. The difference between the composite market price index and actual fuel expenses represent the savings in fuel expenses attributable to improved fuel management after the merger. (Table D2 contains the value of the composite market price index and an analysis of fuel cost savings.)

Entergy and GSU together accumulated approximately $199.5 million in fossil fuel savings over the 1994-1997 period. This compares well to the $201.5 million estimated by Entergy for the corresponding period.⁽¹¹²⁾ Fuel savings are not linear; 4-year savings were estimated at $201.5 million while 5-year savings were estimated at $274 million. Since these savings are derived from changes in purchasing practices and the introduction of coordinated dispatch of generation plants, more savings are likely, and Entergy is likely to achieve its estimated $274 million in fossil fuel savings over the first years after the merger, and $849 million over the first 10 years. Also, Entergy's assertion that GSU would accrue nearly all of the fossil fuel savings was accurate. GSU was allocated all of the fossil fuel savings over the first four years after the merger (Table D2). Entergy projected that GSU would accrue about 83 percent of the cumulative fossil fuel savings after four years, 87 percent after 5 years, and 93 percent after 10 years.⁽¹¹³⁾

Savings from Nonfuel Operation and Maintenance Expenses

The merging companies projected that merger savings from nonfuel O&M expenses would amount to $265 million accumulated over the first 5 years after the merger, and $673 million over the first 10. (These nonfuel savings estimates are net of Entergy's estimated $12.4 million of merger costs associated with early retirement costs.) Of these savings, GSU was projected to accrue $234 million over 5 years, and $578 million over 10 years. One way to use public data to determine whether these savings were achieved is to examine nonfuel O&M expenses (minus purchased power expense) per kilowatthour of electricity generation before and after the merger.⁽¹¹⁴⁾

Figure D16. Entergy's Total Nonfuel Expense Minus Purchased Power Expense, 1991-1997

Entergy experienced substantial reductions in nonfuel O&M expenses (Figure D16).⁽¹¹⁵⁾ Associated savings are computed on Table D3. Unfortunately, the savings shown on Table D3 include savings derived from the Entergy/GSU merger, as well as from the restructuring and reorganization that Entergy imposed on all its operating utilities beginning in the third quarter of 1994.⁽¹¹⁶⁾ Isolating the individual effects on nonfuel O&M expenses using public data is not possible. However, from the fact that the estimated savings at GSU for the first four years after the merger, at $280 million, exceed the estimate for merger savings at GSU for five years, at $234 million, and because the reorganization of functions and employees at GSU was an integral component of plans associated with the merger, it is likely that the savings in this overall nonfuel O&M category were realized at GSU. The apparent savings of $647 million over 4 years in this category for Entergy's subsidiaries dwarf the estimated amount associated with the merger, of $31 million over 5 years. It is unlikely that Entergy underestimated the expected cost savings from the merger by such a large amount. Therefore, it is more likely that most of these savings were attributable to the Entergy reorganization and restructuring than the merger.

Thus, based on these findings, it can be concluded that an analysis of public data support Entergy's achievement of estimated merger savings in this category over the 1994-1997 period. Since the efficiency measures associated with the merger are expected to promote permanent changes in Entergy/GSU's organization, it is probable that Entergy will achieve its merger savings estimates associated with nonfuel O&M expenses over both the first five years and the decade after the merger.

This conclusion is further supported by an examination of cost changes in each of the areas targeted by Entergy/GSU for nonfuel O&M merger savings, as described  in  the  remaining paragraphs of this section.

Figure D17. Entergy's Nonfuel Power Production Expenses, 1991-1997

One of the merger goals was to bring the River Bend nuclear power plant, which was 70 percent owned by GSU, closer to the efficiencies achieved by the other Entergy nuclear plants. In 1993, GSU's nonfuel nuclear power production expenses per kilowatthour were more than double (102 percent higher) that of the other Entergy nuclear units. By 1997, GSU's nonfuel power production expenses were only 28.7 percent higher (Figure D17).

Another target for nonfuel O&M merger savings was fossil-fuel power production at GSU. GSU's nonfuel O&M steam power production expense per kilowatthour declined by 4.3 percent in the post-merger period, from 3.02 mills per kWh in 1993 to 2.89 mills per kilowatthour in 1997 (Figure D17). For the fossil fuel plants at the four original operating subsidiaries of Entergy, the reorganization of Entergy which began in the third quarter of 1994 produced even more dramatic reductions in the nonfuel O&M expense per kWh.

Retail distribution cost was another target for merger savings mentioned by Entergy during the FERC application process. Retail distribution expense per kilowatt- hour dropped by 17 percent after the merger for Entergy/GSU, from 2.08 mills per kWh in 1993 to 1.72 mills per kWh in 1997 (Figure D18). For GSU alone, retail distribution expense per kilowatthour dropped by 23 percent; the original operating four utilities of Entergy dropped by 14 percent. Entergy also expected to realize savings by reducing customer  and  administrative  expenses  (Figure  D18). Although the path taken was erratic over the four years in both measures, by 1997 cost savings were apparent in both. Entergy/GSU experienced a drop of 21 percent in customer expense, from $54.97 per customer in 1993, to $43.51 in 1997. Similarly, Entergy/GSU enjoyed a drop of 18 percent in administrative and general expenses, from $198.57 per customer in 1993 to $162.63 per customer in 1997.

Figure D18. Entergy's Other Nonfuel Expenses, 1991-1997

Savings from Deferral of New Resource Capacity

The estimated $184 million associated with deferral of resource capacity additions represented the greatest potential source of merger savings for Entergy. Without the merger, on a stand-alone basis, the Entergy system was projected to incur a resource capacity deficit in 1999; GSU not until 2006. The combined Entergy and GSU system was projected to show a resource capacity deficit not until the year 2001, and a smaller resource capacity deficit than that for Entergy as a stand-alone system.⁽¹¹⁷⁾

Determining whether this deferral of capacity additions will actually occur, based on public data, is made difficult by Entergy's definition of resource capacity. Entergy defines available resource capacity options to include: (1) implementation of demand-side manage-ment programs; (2) installation of new generating capacity; (3) the repowering or delayed retirement of generation plants; and/or (4) the utilization of capacity from independent power producers or qualifying facilities. At any time, the option to be implemented would be determined by least cost planning.⁽¹¹⁸⁾ Thus, in absence of obtaining and reviewing recent Integrated Resource Plans filed with State regulatory commissions, if any, there is no sure way of determining whether new resource capacity additions are being planned as of the end of 1998. Entergy's 1998 SEC 10-K did include estimated construction expenditures for the years 1999-2001 in the range of $1.3 to $1.4 billion per year, but there was no breakdown of these numbers by type of construction. Thus, based the publicly available data reviewed herein, no conclusion can be drawn as to whether the estimated merger savings associated with the deferral of resource capacity in the 1999-2003 timeframe will be realized.

Merger Costs

By the end of 1993, total merger costs were estimated at approximately $111 million. These included: (1) $33.5 million of merger transaction costs; (2) one-time capital costs of $37 million, incurred over the first three years after the merger to add or modify facilities and equipment at GSU's River Bend nuclear plant; (3) one-time capital costs of $28 million, incurred over the first four years after the merger to conform GSU fossil steam generation equipment to Entergy specifications; and (4) one-time O&M expenditures of $12.4 million for the implementation of an early retirement program and directors' and officers' insurance premiums in order to facilitate workforce reductions and administrative cost savings. Only the O&M costs were subtracted from Entergy's estimated merger savings to derive publicly announced net merger savings.

The capital costs associated with the merger were not reported as separate items in Entergy's SEC 10-K reports for 1994 or subsequent years. Because they were targeted to specific construction expenditures at generation plants, however, and these plants did show efficiency gains as described above, it is probable that these capital expenditures (totaling $65 million) were invested as planned. In 1994, GSU recorded expenses totaling $49 million net of tax effects (approximately $70 million on a pre-tax basis) for early retirement and other severance-related plans and the payment to financial consultants involved in merger negotiations.⁽¹¹⁹⁾ Additionally, Entergy recorded $24.3 million in 1994 and $1.6 million in 1996 related to remaining severance and augmented retirement benefits related to the merger. (These accruals were nearly completely expensed in 1995 and 1996.)⁽¹²⁰⁾ Thus, recorded costs associated with the merger aggregated to about $129.4 million ($33.5 + $70 +$24.3 + $1.6). As discussed above, additional capital costs estimated by Entergy and probably incurred as planned were $65 million, yielding total merger costs of about $194 million.

Assessment of Realized Merger Costs and Savings

From the above discussion, the following conclusions can be drawn:

• Over the first four years after the merger, Entergy realized the merger fuel savings it had estimated from consolidating purchasing and coordinating generation dispatch. Since these savings were induced by permanent changes, it is likely that Entergy will realize the $274.5 million in merger-induced fuel savings over the first 5 years, and $849 million over the first 10.
• Entergy is also likely to realize its merger savings in nonfuel O&M expenses, estimated at $265 million over the first 5 years, and $673 million over the first 10 years. At the end of 4 years, GSU, where most of these savings were to occur, had realized more savings ($280 million) than projected for the first 5 years ($234 million). For Entergy subsidiaries, nonfuel O&M savings stem from both the merger and the reorganization and restructuring program Entergy implemented in the third quarter of 1994. However, measured total savings in this category for the original Entergy utilities over the first 4 years after the merger ($647 million) are so much greater than estimated merger savings over the first 5 years ($31 million) that it is probable that the estimated merger savings were achieved. Since the measures implemented to achieve these savings are permanent, it is likely that Entergy will realize total estimated merger savings in this category of $673 million over the first 10 years after the merger.
• Based on the public data reviewed, no conclusion can be made as to whether Entergy will realize its estimated merger savings ($184 million) from the deferral of resource capacity, which was projected to occur over the 1999-2003 timeframe.
• Recorded costs associated with the merger were about $129.4 million, including $33.5 million of merger transaction costs recorded by Entergy in 1993. Entergy probably also incurred planned capital costs of $65 million, yielding total merger costs of $194.4 million.
• Although all categories of merger-related costs were not included in Entergy's net merger savings estimates (e.g., capital costs needed to achieve merger savings were estimated separately and pre-1994 incurred costs were not included), based on observed savings over the first 4 years of the merger, it is likely that Entergy will realize its net merger savings estimates in the categories of fuel savings and nonfuel O&M expenses over the first 5 and first 10 years after the merger. (The higher nonfuel O&M merger savings rate being experienced by GSU itself probably will offset higher merger costs than were recorded.)

Endnotes

120. Source: Entergy Corporation SEC 10-K for 1996, Note 12 to Financial Statements.

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