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Energy Services

Industry Review

Overview

The electric power industry is estimated to be a $300 billion market representing 3% of U.S. GNP. Demand for electricity is driven by increased usage, population growth and population migration. Despite increasing efficiency and higher prices, consump- tion of electricity in kilowatt hours is projected to increase by over 30% by the year 2030.

Expenditures on new generation capacity to meet this increased demand is expected to approach $1 trillion over this same time period. In addition to the need for increased generation capacity, the transmission and distribution infrastructure will need to be expanded and upgraded. It is estimated that the cost to build new transmission and distribution infrastructure, and to maintain and upgrade the existing infrastructure, will be in excess of $900 billion through the year 2030. Along with the significant ex- penditures that will be required to produce and deliver electricity, utilities continue to invest heavily in advanced metering systems in order to improve efficiencies.

Investment in the infrastructure will also be driven by the economic stimulus package being proposed by the new administration, of which a key component includes the creation of a “smart grid”, comprised of a combination of advanced metering, ad- vanced grid automation and meter data management, in order to improve the reliabil- ity, efficiency and affordability of electric power. The recently proposed package would include $49 billion for all energy related projects, of which $11 billion would be dedi- cated to the electricity grid.

Overall, the total investment in electricity infrastructure and related services will be in excess of $2 trillion over the next 20 years.

This projected capital spending will create significant opportunities for companies in many sectors, principally in those that provide products and business services to sup- port the growth and maintenance of the electricity generation, transmission and distri- bution and metering infrastructure. Although the market for the generation, delivery and metering of electricity is highly consolidated and represented by large companies, the universe of companies supporting the electric industry is highly fragmented and comprised of thousands of middle-market businesses representing an attractive oppor- tunity for acquisition and consolidation.

Generation

The U.S. economy, and thus economic growth, relies on an available supply of reliable and affordable electricity. Electricity usage has grown historically at approximately the same rate as Real GDP although projected consumption is expected to slow due to slower economic growth, increased efficiency standards and rising prices.

Efficiency improvements are expected to continue to make a major contribution to- wards meeting the country’s electricity requirements, however as electricity demand grows, new power generation capacity will be needed to ensure an adequate supply of electricity into the future.

The last major build-out of generation capacity in the United States occurred in the 1970’s and 1980’s averaging $31 billion per year between 1970 and 1988. This major build-out resulted in significant excess capacity that, in conjunction with deferred con- struction due to increasing construction costs and regulatory uncertainty, caused new plant construction to slow to approximately $11 billion per year between 1989 and 2006. New generation capacity can no longer be deferred and various industry sources estimate the cost for new capacity to meet anticipated demand at $35 billion per year through the year 2030 and as much as $55 billion per year should potential carbon emission regulations be put in place.

The high construction costs of a new generation plant combined with the increased risks associated with potential environmental regulation and the volatile prices for the various fuels used for generating electricity create a very challenging environment in which to build new generation capacity.

The new construction of generation plants, combined with the maintenance and up- grading of existing plants and the increased outsourcing by the utilities, creates an en- vironment whereby the various providers of products and services supporting the needs of utilities will be well positioned to experience significant growth over the next several years. Sub-sectors that are likely to benefit will include companies that manu- facture the required equipment and devices as well as providers of consulting, mainte- nance and repair and facilities management services.

Transmission and Distribution

The U.S. transmission and distribution (“T&D”) infrastructure is comprised of hun- dreds-of-thousands miles of overhead and underground lines and the associated equip- ment and devices that deliver electricity to the end user. In addition to the need to ex- pand the T&D network to support the anticipated growth in demand, substantial in- vestment is required to replace and maintain the existing infrastructure as well as to upgrade the system in order to improve reliability, improve power quality and to install the equipment and devices necessary to support the deployment of advanced metering.

Transmission expenditures have begun to increase in recent years, averaging $8.6 bil- lion per year for 2007 and 2008E as compared to $5.4 billion per year during the pe- riod from 2000 through 2006. Expenditures on transmission infrastructure are pro- jected to be approximately $320 billion through 2030, averaging $15 billion per year.

As with transmission expenditures, investment related to the distribution infrastruc- ture has increased significantly in recent years averaging, $17 billion per year for 2007 and 2008E compared to approximately $13 billion per year during the period from 2000 through 2006. Expenditures on distribution infrastructure are projected to be approximately $580 billion through 2030, averaging $27 billion per year.

Although the T&D infrastructure is “owned” principally by very large companies, there are tremendous opportunities for middle market companies to grow by providing products and services to build, upgrade and maintain the T&D infrastructure. Sub- sectors such as maintenance and repair, construction, locating, equipment rental, asset management, and vegetation management as well as other ancillary providers of prod- ucts and services are likely to be beneficiaries of the expected increase in T&D spending over the next several years.

Metering

Metering, or the measurement of electricity usage, is evolving as utilities are beginning to invest in advanced metering infrastructure (“AMI”) systems which not only allow for automated meter reading (“AMR”) but also provide the capability to implement vari- ous demand management / demand response (“DR”) initiatives such as time-of-day pricing and load control, which can help utilities balance their peak load requirements and ultimately reduce the need for additional generation capacity.

Despite the obvious benefits of AMI systems, as well as 2005 legislation which man- dated public utilities to investigate such smart metering technology, deployment has been relatively slow due to the cost, regulatory uncertainty and the technology risk as- sociated with such systems. A 2008 Federal Energy Regulatory Commission (“FERC”) study estimates that fixed-network AMI penetration in the U.S. for commercial and industrial (“C&I”) customers is approximately 4.2% (up from 1.0% in 2006) and 4.7% for residential customers (up from 0.6% in 2006).

The deployment of these systems is expected to increase considerably over the next few years as many utilities have completed, or are undergoing, RFP processes to select equipment and technology vendors. It is estimated that by 2030, 50% of all C&I me- ters and 60% of all residential meters will be equipped with AMR / DR capabilities.

The current economic slowdown is not likely to hinder deployment as the “smart grid” is a key initiative of the new administration and AMR and DR systems are key to achieving the anticipated benefits.

As the utilities begin to commit to and roll out new AMI systems, there are a number of products and services required to deploy and maintain the system that are not pro- vided by the utility or the large providers of AMR-enabled meters and technology. Op- portunities exist in services such as consulting, retrofitting of meters, meter installa- tion and system maintenance, as well as for a myriad of equipment and devices re- quired for the deployment and efficient operation of an AMI system. In addition, pro- viders of software that facilitate meter data management and customer care needs such as time-of-day pricing, load management, outage detection and remote connect/ disconnect will serve a critical role in delivering the benefits of an AMI system.

Financing Market

Naturally, the financial health of the utilities is a critical component in funding this significant level of projected infrastructure spending. Funding has not been an issue to date, even with the market turmoil of 2008. As the equity market became unattractive and the commercial paper market became unavailable, utilities were able to secure funding through the issuance of bonds in record amounts. In 2008, utilities with in- vestment grade ratings issued $47 billion of bonds which represented a 34% increase over 2007, and this was against a back-drop of a 35% decline in issuance in the overall bond market.

Funding is expected to continue to be available to the utility sector as it serves a critical role in realizing the benefits from the economic-stimulus plan through the moderniza- tion of the nation’s electric infrastructure.

Public Market

Although the values of publicly-traded companies participating in the electric power industry have traded down significantly over the past few months, most have outper- formed the market as a whole.

Since 2000, the VRA Electricity Composite has outperformed the overall market de- spite the recent decline which was sharper than that of the overall market. Metering companies have exhibited the strongest market performance as investors value the in- dustry’s future growth based on expected AMI penetration. These companies have also fetched the highest trading multiples as the mean enterprise value to estimated 2009 EBITDA is 12.8x. Transmission companies have maintained the most stable trading patterns during this time period. Overall, the electric power industry has represented an attractive investment opportunity versus broad market indices.

M&A Market

U.S. merger and acquisition activity in the electric power industry has been strong rela- tive to the overall market with the number of transactions flat in 2008 versus a 30%+ drop in the overall market. The dollar value of transactions was off over 50%, primar- ily due to absence of any “mega” transactions in 2008 whereas 2007 numbers included the $45 billion acquisition of TXU Corp. by an investor group including Kohlberg Kravis Roberts & Co. and TPG.

The dollar value of transactions is expected to go up considerably in 2009 as evidenced by three large pending acquisitions in the generation section (Constellation Energy, NRG Energy, and Puget Energy) which total over $30 billion in deal value.

Looking behind the overall industry numbers, M&A activity in the transmission and distribution sector increased in 2008. Some of this activity was driven by acquisitions by private equity firms as many have recognized the attractiveness of the sector and have been aggressively looking for investment opportunities, principally in support services such as line locating, right-of-way management, line maintenance, equipment rental, staffing services and logistics services.

The metering sector has also been a hot-bed of M&A activity over the past several years as the large meter companies have been vying to own the best products and technolo- gies available to effectively compete for the large number of upcoming AMI projects. Although the meter and AMI providers are primarily large multi-national companies, there are significant opportunities for middle-market companies that provide products and services in support of the deployment and maintenance of these systems. In addi- tion, technology and software companies with the “better mousetrap” will be attractive acquisition candidates for large companies looking to enhance their current capabili- ties.

Acquisition multiples have historically been high relative to the overall market as most M&A activity has been strategic in nature.

Merger and acquisition activity in the industry is likely to be strong going forward as we expect to see continued strategic consolidation as well as increased interest in the sector from the private equity community. Of the approximately $233 billion raised by buyout funds in 2008, approximately $24.5 billion, or 10%, are funds dedicated to in- vestments in the energy sector. Many firms have recognized the opportunity in the industry and have acquired platform companies in sectors such as locating (Kohlberg & Co.), right-of-way consulting (Hammond Kennedy Whitney) and traffic control (Blue Point Capital Partners).

Conclusion

Overall, the electric power industry represents an attractive market for investment over the next several years as industry participants are well positioned to benefit from the expected increase in infrastructure spending.