As filed with the SEC on March 27, 2002
File No. 70-09913
United States Securities and Exchange Commission
Washington, D.C. 20549
----------------------------------------
Pre-effective Amendment No. 2 to
Form U-1
Application/Declaration
Under the
Public Utility Holding Company Act of 1935
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Pepco Holdings, Inc. Conectiv
701 Ninth Street, N.W. 800 King Street
Washington, DC 20068. Wilmington, DE 19899
(Names of companies filing this statement
and addresses of principal executive offices)
----------------------------------------
Pepco Holdings, Inc.
(Name of top registered holding company)
----------------------------------------
Dennis R Wraase William T. Torgerson Peter F. Clark
President General Counsel Vice President, General
Pepco Holdings, Inc. Potomac Electric Power Company Counsel and Secretary
701 Ninth Street, N.W. 701 Ninth Street, N.W. Conectiv
Washington, DC 20068. Washington, DC 20068. 800 King Street
Wilmington, DE 19801
(Names and addresses of agents for service)
The Commission is also requested to send copies
of any communication in connection with this matter to:
Sheri E. Bloomberg Judith A. Center
Sonia Mendonca William C. Weeden
LeBoeuf, Lamb, Greene & MacRae, L.L.P. Skadden, Arps, Slate, Meagher &
125 West 55th Street Flom, L.L.P.
New York, NY 10019-5389 1440 New York Avenue, NW
(212) 424-8000 Washington, D.C. 20005
Facsimile: (212) 424-8500 (202) 371-7000
Facsimile: (202) 371-5760
TABLE OF CONTENTS
Page
Item 1. Description of the Proposed Transaction...............................1
A. Introduction...........................................................1
B. General Request........................................................2
C. The Companies..........................................................4
1. Pepco System.......................................................4
2. Conectiv System....................................................6
3. Pepco Holdings....................................................10
4. Regulatory Environment............................................11
D. Description of the Transaction........................................15
1. The Mergers.......................................................15
2. Conditions to the Transaction.....................................18
3. Background of the Transaction.....................................20
4. Financing the Transaction.........................................30
5. Management and Operations of Pepco and Conectiv Following the
Transaction....................................................30
6. Benefits of the Transaction.......................................31
Item 2. Fees, Commissions and Expenses.......................................33
Item 3. Applicable Statutory Provisions......................................34
A. Applicable Provisions.................................................34
B. Legal Analysis........................................................34
1. Section 10(b).....................................................34
2. Section 10(c).....................................................45
3. Section 10(f).....................................................55
4. Section 11(b)(2)..................................................55
5. Section 13 - Intra-system Provision of Services...................57
6. Nonutility Reorganizations........................................66
7. Authorization to Engage in Energy-Related Activities Outside
of the United States............................................67
8. Tax Allocation Agreement..........................................68
Item 4. Regulatory Approvals.................................................70
Item 5. Procedure............................................................74
Item 6. Exhibits and Financial Statements....................................74
Item 7. Information as to Environmental Effects..............................79
i
This pre-effective Amendment No. 2 replaces and revises the Form U-1
Application-Declaration in this proceeding, originally filed in File No.
70-09913 on July 20, 2001 and Amendment No. 1 filed on January 9, 2002, in their
entireties, except that it does not replace exhibits previously filed.
Item 1. Description of the Proposed Transaction
A. Introduction
This Application-Declaration ("Application") seeks approvals relating to
the proposed acquisition of Potomac Electric Power Company ("Pepco"), a public
utility company, and Conectiv, a registered public utility holding company.
Applicants propose that upon the satisfaction of certain conditions, including
receipt of all necessary regulatory approvals, Pepco and Conectiv will become
subsidiaries of Pepco Holdings, Inc. ("Pepco Holdings"), formerly referred to as
New RC, Inc., headquartered in Washington, DC (the "Transaction").
Pepco Holdings was recently created as a direct wholly owned subsidiary of
Pepco, and after the completion of the Transaction, as described below, will be
the parent of both Pepco and Conectiv. After completion of the Transaction,
Pepco and Conectiv stockholders will own the common stock of Pepco Holdings.
The Transaction is conditioned upon, among other things, the approvals of
Pepco and Conectiv stockholders (which were received on July 18, 2001 and July
17, 2001 respectively) and various state and federal regulatory agencies, as
described below. Applicants believe that the necessary approvals can be obtained
by the first quarter of 2002. Upon consummation of the Transaction, Pepco
Holdings will register with the Commission under the Public Utility Holding
Company Act of 1935 (the "Act").
The Transaction will create a stronger combined company, yielding
significant benefits for customers, communities, shareholders, employees and the
region. The combined company will become the largest electricity delivery
company in the mid-Atlantic region in terms of both MW load and kWh sales. It
will also be the largest owner of transmission facilities within the PJM
Interconnection, L.L.C. ("PJM"). The combined company will serve 1.8 million
customers in New Jersey, Delaware, Maryland, Virginia, and the District of
Columbia.
The combined company will have the size and scope needed to compete more
effectively in the energy delivery and related retail markets.
Each of Pepco and Conectiv will continue to operate under their existing
names and each is committed to maintaining management teams in their current
headquarters. Applicants do not expect significant workforce reductions other
than limited common corporate level functions, and any workforce reductions will
not affect reliability or the quality of customer service.
B. General Request
Applicants request authorization under Sections 9(a)(2) and 10 of the Act
to effect the Transaction. To implement the Transaction, Pepco Holdings proposes
to form two wholly owned subsidiaries that will merge with and into
respectively, Pepco and Conectiv ("Mergers"). Pepco stockholders will receive
one share of Pepco Holdings' common stock for each share of Pepco common stock
they hold prior to the Mergers. Conectiv common stockholders and Class A common
stockholders/1 will receive either cash or Pepco Holdings common stock, subject
to proration, such that the aggregate consideration paid to all Conectiv
stockholders will be 50 percent cash and 50 percent stock. As a result of the
Transaction, all of the outstanding shares of common stock of Pepco Holdings
will be held by the former stockholders of Conectiv and Pepco
----------------------------
1/ Conectiv has the following securities registered pursuant to Section 12(b) of
Securities Exchange Act of 1934: Common stock, $0.01 par value, and Class A
common stock, $ 0.01 par value. Both classes of stock are listed on the New York
Stock Exchange. As of December 31, 2001, the authorized capital stock of
Conectiv consisted of (a) 150,000,000 shares of Conectiv Common Stock, of which
82,957,613 shares were outstanding, (b) 10,000,000 shares of Class A Stock, of
which 5,742,315 were outstanding, and (c) 20,000,000 shares of Preferred Stock,
of which no shares were outstanding but of which 1,200,000 shares have been
designated as Series One Junior Preferred Stock and 65,606 shares have been
designated as Series Two Junior Preferred Stock, in each case reserved for
issuance upon exercise of the Preferred Stock Purchase Rights distributed to the
holders of Conectiv stock pursuant to the Stockholders Rights Agreement, dated
as of April 23, 1998 between Conectiv and Conectiv Resource Partners, Inc.
2
and each share of each other class of capital stock of Conectiv and Pepco/2
shall be unaffected and remain outstanding./3
In addition, the following authorizations with respect to the Pepco
Holdings system are requested in this application:
o To retain the non-utility businesses and subsidiaries of Pepco and
Conectiv.
o To retain Conectiv's gas operations.
o To either (a) extend the role of Conectiv Resource Partners, Inc.
("CRP") as a system service company to provide services to all
associate companies in the Pepco Holdings system or (b) form a new
system service company as a direct subsidiary of Pepco Holdings, in
each case following a transition period. Applicants request that during
a transition period both CRP and Pepco will provide services to system
companies to the extent described in Item 3.B.5 herein. The Applicants
also request certain exemptions from the "at cost" standards of the Act
with respect to services provided to specified subsidiaries.
o To reorganize Pepco Holdings' direct and indirect nonutility
subsidiaries without the need to seek further Commission authorization,
including, without limitation, reorganizing certain of Pepco's current
second and third tier non-utility subsidiaries, Potomac Capital
Investment Corporation ("PCI"), Pepco Energy Services, Inc. ("PES" or
"Energy Services"), and Pepco Communications, Inc. ("PepCom") as first
tier subsidiaries of Pepco Holdings shortly after consummation of the
Transaction. Pepco's current first tier non-utility holding company,
POM Holdings, Inc. ("POM") (formerly known as
----------------------------
2/ Pepco has the following securities registered pursuant to Section 12(b) of
the Securities Exchange Act of 1934: Common stock, $1 par value and Guarantee by
Pepco of the 7-3/8% Trust Originated Preferred Securities issued by Potomac
Electric Power Company Trust I. Both are listed on the New York Stock Exchange.
As of December 31, 2001, the authorized capital stock of Pepco consisted of (a)
200,000,000 shares of Pepco Common Stock, par value $1.00 per share, of which
107,221,176 shares were outstanding, (b) 8,800,000 shares of Preference Stock,
par value $25 per share, of which no shares were outstanding, and 7,750,000
shares of preferred stock, par value $50 per share, of which 1,695,312 shares
were outstanding.
3/ See Agreement and Plan of Merger, dated as of February 9, 2001 among Potomac
Electric Power Company, Pepco Holdings, Inc. and Conectiv ("Merger Agreement"),
Exhibit B-1 herein.
3
Pepco Holdings, Inc.) is expected to remain in existence after
consummation of the Transaction but will not have any subsidiaries
following the non-utility reorganization previously discussed.
o To engage in energy-related activities outside of the United States.
o To allocate consolidated tax among the companies within the Pepco
Holdings system pursuant to a Tax Allocation Agreement.
C. The Companies
1. Pepco System
Pepco is a public utility company within the meaning of the Act. Pepco is
engaged in the transmission and distribution of electric energy in the
Washington, D.C. metropolitan area. Pepco delivers electricity at regulated
rates to 1.9 million people in the District of Columbia ("D.C."), and major
portions of Prince George's and Montgomery counties in suburban Maryland. During
the transition to customer choice, the utility also is selling electricity at
regulated rates within its service area.
Pepco is regulated as a public utility in D.C., the State of Maryland, and,
to a limited extent, in the Commonwealths of Pennsylvania (as a result of
ownership of a 27% interest in the Conemaugh-Conestone EHV transmission line,
which is used to transmit energy from the Conemaugh Generating Station to
Pepco's facilities in other states, and 9.72% undivided tenant-in-common
interest in an electric transmission switching station and related facilities at
the Conemaugh Station) and Virginia (as a result ownership of 55 circuit power
lines in Virginia that interconnect generation and transmission facilities owned
by unaffiliated third parties with Pepco's transmission facilities in other
states).
In 2000, the generating segment of the electric utility industry continued
to transition from a regulatory to a competitive environment, and in response to
this transition, Pepco executed its business plan to exit the electricity
generating business by completing the divestiture of substantially all of its
generation assets in December 2000./4 Additionally, Pepco's comprehensive plans
to implement customer choice were completed as Maryland and D.C.
----------------------------
4/ The generation assets retained are all Exempt Wholesale Generators ("EWGs").
4
customers began to have their choice of electricity suppliers on July 1, 2000,
and January 1, 2001, respectively.
Pepco's transmission facilities are interconnected with those of other
transmission owners that are members of PJM, an Independent System Operator
("ISO") approved by the Federal Energy Regulatory Commission ("FERC")./5 The
interconnected facilities provide economic energy and reliability benefits by
facilitating Pepco's participation in the federally regulated wholesale energy
and capacity market. PJM administers all transmission service within the PJM
region. PJM is the largest centrally dispatched electric control area in North
America, with generating capacity resources of over 58,000 megawatts. The PJM
staff centrally forecasts, schedules, and coordinates the operation of
generating units, bilateral transactions, and the spot energy market to meet
load requirements and administers a capacity market. PJM also monitors,
evaluates and directs the operation of its members' transmission lines. The PJM
Open Access Same Time Information System ("OASIS") is used to reserve
transmission service. In addition, the PJM staff, working with transmission
owners, coordinates the planning of new generator interconnections in the
control area as well as the planning of the interconnected bulk power
transmission system to deliver energy reliably and economically to customers.
Pepco has an investment in the Keystone-Conemaugh 500kV system ("EHV") that
traverses most of Pennsylvania.
Pepco is also engaged in the sale of electricity, natural gas, and
telecommunications in markets throughout the mid-Atlantic region through its
wholly owned non-regulated subsidiary, POM. In May 1999, Pepco reorganized its
non-regulated subsidiaries into two major operating groups to compete for market
share in deregulated markets. As part of the reorganization, POM was created as
the parent company of its two wholly owned subsidiaries, PCI and Energy
Services.
Potomac Electric Power Company Trust I (the "Trust"), a Delaware statutory
business trust, and Edison Capital Reserves Corporation ("Edison"), a Delaware
Investment Holding Company, are also wholly owned subsidiaries of Pepco. The
Trust was established in April 1998 and exists for the exclusive purposes of (i)
issuing Trust securities representing
----------------------------
5/ On July 12, 2001 the FERC conditionally granted RTO status to PJM. PJM
Interconnection, LLC et al., 96 FERCP. 61,061 (2001)("PJM RTO Order").
5
undivided beneficial interests in the assets of the Trust, (ii) investing the
gross proceeds from the sale of Trust Securities in Junior Subordinated
Deferrable Interest Debentures issued by Pepco, and (iii) engaging only in other
activities as necessary or incidental to the foregoing./6 Edison was established
in 2000 and exists for the purposes of managing and investing a significant
portion of the proceeds received from the divestiture of certain Pepco's
generation assets.
For its utility operations, Pepco reported total assets of $5,010.0
million, utility operating revenues of $1,723.5 million (excluding $29.3 million
gain on divestiture of generation assets during the year) and net income of
$194.2 million for the year ended December 31, 2001. PCI reported total assets
of $1,298.8 million, operating revenues of $112.2 million and net loss of
$(36.1) million for the year ended December 31, 2001. PES reported total assets
of $211.8 million, operating revenues of $643.9 million and net income of $10.3
million for the year ended December 31, 2001.
Pepco's existing public utility subsidiaries and nonutility companies are
described in further detail in Exhibit K-1 to this Application.
2. Conectiv System
Conectiv was formed on March 1, 1998, through a series of merger
transactions and an exchange of common stock with Delmarva Power & Light Company
("Delmarva") and Atlantic Energy, Inc./7 Conectiv is a registered holding
company under the Act and a Delaware corporation. Conectiv owns all of the
outstanding common stock of Delmarva, a Delaware and Virginia corporation, and
of Atlantic City Electric Company ("ACE"), a New Jersey corporation and formerly
the wholly owned subsidiary of Atlantic Energy, Inc., which was merged into
Conectiv upon the consummation of the merger transactions that resulted in
Conectiv becoming a registered holding company. Conectiv also owns a number of
other subsidiaries discussed below.
Delmarva and ACE are Conectiv's largest subsidiaries. Delmarva and ACE are
public utilities that supply and deliver electricity to their customers under
the trade name
----------------------------
6/ The securities issued by the Trust are reflected on the capitalization table
set forth herein as $125 million company obligated mandatorily redeemable
preferred securities of subsidiary trust which holds solely parent junior
subordinated debentures.
7/ See Conectiv, Inc., Holding Co. Act Release No. 26832 (Feb. 25, 1998) (the
"Conectiv Merger Order").
6
Conectiv Power Delivery. Delmarva provides electric service in Delaware,
Maryland and Virginia and natural gas service in northern Delaware. ACE provides
electric service in New Jersey./8 Delmarva and ACE deliver electricity within
their service areas to approximately 973,600 customers through their respective
transmission and distribution systems and also supply electricity to most of
their electricity delivery customers. Delmarva has about 472,600 customers in
its service area and ACE has about 501,000 customers in its service area.
Delmarva's regulated electric service area has a population of approximately 1.2
million and covers an area of about 6,000 square miles on the Delmarva Peninsula
(Delaware and portions of Maryland and Virginia). ACE's regulated service area
is located in the southern one-third of New Jersey, covers an area of about
2,700 square miles, and has a population of approximately 900,000. Delmarva
delivers natural gas through its gas transmission and distribution systems to
approximately 110,800 customers in a service territory that covers about 275
square miles in northern Delaware and has a population of approximately 500,000.
ACE is subject to regulation as a public utility in the State of New Jersey
and Delmarva is subject to regulation as a public utility in the States of
Delaware, and Maryland, and the Commonwealth of Virginia. Both ACE and Delmarva
are subject, to a limited extent, to regulation by the Commonwealth of
Pennsylvania.
A transition to market pricing and terms of service for supplying
electricity to customers in the regulated service areas of Delmarva and ACE
began in 1999. Substantially all of the customers of Delmarva and ACE can now
elect to choose an alternative electricity supplier. In response to these
changes, Conectiv formed Conectiv Energy Holding Company ("CEH") in 2000. CEH
and its subsidiaries are engaged in electricity production and sales, energy
trading and marketing.
In addition to the power delivery conducted by Delmarva and ACE, Conectiv,
through its subsidiaries, is engaged in the generation, purchase, trading, and
sale of electricity,
----------------------------
8/ The electricity delivered by Delmarva and ACE may be supplied to customers by
alternative suppliers, Delmarva or ACE. Gas delivered may be supplied to
customers by alternative suppliers or Delmarva.
7
including the obligations of Delmarva and ACE as default suppliers, gas and
other energy supply trading activities./9
CEH owns 100% of the stock of ACE REIT, Inc. ("ACE REIT"), CESI,/10
Conectiv Delmarva Generation, Inc. ("CDG") and Conectiv Pennsylvania Generation,
Inc. ("CPGI"). ACE REIT owns 100% of the interests in Conectiv Atlantic
Generation, LLC ("CAG"), a merchant generation company,/11 and CESI owns 100% of
the stock of Conectiv Operating Services Company ("COSC"), a company that
operates and maintains power plants./12 CDG, CAG and CPGI are utilities within
the meaning of the Act.
In addition, Conectiv is changing the types of electric generation plants
its owns by selling the majority of its baseload plants and increasing its
mid-merit generation portfolio. Based on megawatts of generating capacity,
approximately 25% (739.70 MW) of the electric generating plants owned by
Conectiv as of December 31, 2001 (2,963.70 MW) were under agreements for
sale./13 Conectiv is building new mid-merit electric generating plants, which
Conectiv's management expects will provide a better strategic fit with
Conectiv's energy trading activities and have more profitable operating
characteristics than the plants to be sold.
The capacity provided by the electric generating plants of Conectiv's
subsidiaries as of December 31, 2001 is summarized below:
----------------------------
9/ See order authorizing the restructuring of the Conectiv nonutility operations
and the merger into Conectiv Energy Supply, Inc. ("CESI") of Petron Oil
Corporation and the acquisition of stock of Delmarva Operating Services Company
(now Conectiv Operating Services Company) during phase 1 of the restructuring
and of Atlantic Generation, Inc. during phase 2 of the restructuring (Conectiv,
Holding Co. Act Release No. 26953 (Dec. 16, 1998). Also within the Conectiv
system is Conectiv Energy, Inc. ("CEI"), the assets of which CDG expects to
acquire pursuant to authority previously granted by the Commission in Conectiv,
Holding Co. Act Release No. 27192 (June 29, 2000).
10/ Named Delmarva Energy Company at the time of the Conectiv Merger Order and
later renamed.
11/ In the context of restructuring the market for electricity, merchant
generation is often used to describe a specialized "marketer" for the generating
plants formerly owned by a vertically-integrated utility.
12/ COSC's activities fall within the scope of Rule 58.
13/ Including the ownership interests of ACE in nuclear electric generating
plants. Delmarva's ownership interests in nuclear electric generating plants
were sold on December 29, 2000. As noted below, the sale of 1,081 MW of
Delmarva's baseload coal-fired plans, under contract on December 31, 2000, was
completed in June 2001.
8
As of 12/31/01 Expected to be Expected to be
sold retained *
(MW) (MW) (MW)
-------------- -------------- ---------------
Coal-fired generating units 731 471 260
Oil-fired generating units 686 241 445
Combustion turbines/combined cycle
generating units 1,516 19 1,497
Diesel units 30.7 8.7 22
Electric generating capacity 2,963.7 739.7 2,224
* Represents the electric generating units as of December 31, 2001, less the
units expected to be sold during 2002.
In addition, as of December 31, 2001, Conectiv's subsidiaries had long-term
purchased power contracts which provided 3,100 MW of capacity and varying
amounts of firm electricity per hour during each month of a given year. Also,
Delmarva agreed to purchase back 500 MW/hr of firm electricity per hour from the
buyer of its generating plants beginning upon completion of the sale and
continuing through December 31, 2005.
As a member of PJM, the generation and transmission facilities of Conectiv
are operated on an integrated basis with other electricity suppliers and
transmission owners in Pennsylvania, New Jersey, Maryland and the District of
Columbia, and are interconnected with other major utilities in the eastern half
of the United States. In addition to having an investment in EHV, ACE and
Delmarva each have investments in two other 500kV systems in the PJM region
("LDV" and "SE")./14
Conectiv also holds direct and indirect interests in various nonutility
businesses. Conectiv engages in power plant operation services through COSC, and
district heating and cooling systems operation and construction services,
through Conectiv Thermal Systems, Inc. ("CTS"), and in telecommunications
services, including local and long distance telephone service and Internet
services, through Conectiv Communications, Inc. ("CCI")./15
----------------------------
14/ The EHV, LDV and SE systems interconnect and form the "backbone" of the PJM.
15/ In 2000, Conectiv sold its heating, ventilation and air conditioning
("HVAC") business and portions of CTS, which constructs and operates district
heating and cooling systems. Conectiv also began exiting from the competitive
retail energy business. In addition, on November 14, 2001, Conectiv sold
substantially all of the assets of CCI. The retained assets are being used to
provide telecommunication services to Conectiv and its affiliates. Conectiv
Communications of Virginia, Inc., a Delaware corporation, formerly wholly owned
by CCI was dissolved in June 2001. CCI is an exempt telecommunications company
("ETC") within the meaning of Section 34 of the Act.
9
In addition, Conectiv formed a subsidiary service company, Conectiv
Resource Partners, Inc., to provide a variety of support services to Conectiv
subsidiaries. The costs of Conectiv Resource Partners, Inc. are directly
assigned or allocated to the Conectiv subsidiaries.
The sources of Conectiv's consolidated revenues on a percentage basis are
shown below:
2000 1999 1998
---- ---- ----
Regulated electric revenues* 39.8% 57.4% 62.4%
Competitive electric revenues 18.0% 8.3% 9.3%
Regulated gas revenues 2.2% 3.1% 3.5%
Competitive gas revenues 28.2% 18.7% 13.9%
Other services** 11.8% 12.5% 10.9%
*Regulated electric and gas revenues include the supply and delivery of these
commodities within the service areas of Delmarva and ACE.
**Other services include telecommunications, HVAC, petroleum sales, and other
activities.
All of Conectiv's direct and indirect nonutility subsidiaries are further
described in Exhibit K-1.
3. Pepco Holdings
Pepco Holdings was incorporated under the laws of Delaware on February 9,
2001, as a direct wholly owned subsidiary of Pepco. Pepco Holdings has issued
100 shares of common stock (with a par value of $.01 per share), all of which
are owned by Pepco. Pepco Holdings was created to become the parent company of
Pepco and Conectiv after the consummation of the Transaction. After consummation
of the Transaction, Pepco Holdings will register as a public utility holding
company under the Act.
For the year ended December 31, 2001, Pepco and Conectiv had the following
financial results individually, and on a pro forma combined basis:
10
Pepco Conectiv Pro Forma Combined
------------------ ------------------ ------------------
($ millions) ($ millions) ($ millions)
Total assets 5,285.9 6,280.7 12,289.8
Total operating revenues 2,502.9 5,790.0 8,292.9
Operating income 366.4 759.2 1,125.6
Income from continuing operations(a) 168.4 382.9 551.3
(a) Excludes Conectiv's discontinued telecommunications operations and
extraordinary item.
The tables below show the capitalization of Pepco and Conectiv on a pro
forma combined basis as of December 31, 2001.
Pepco % of Conectiv % of
($ mm) capitalization ($ mm) capitalization
----------------- ----------------- ----------------- --------------
Long-term debt 1,602.1 39 1,356.0 31
Short-term debt 458.2 11 1,596.2 36
Company obligated mandatorily
redeemable preferred securities of
subsidiary trust which holds solely
parent junior subordinated debentures 125.0 3 165.0 3
Preferred stock 84.8 2 48.3 1
Shareholders' equity 1,823.2 45 1,270.9 29
Total capitalization 4,093.3 100 4,436.4 100
Pro Forma Combined
($ mm) % of capitalization
--------------------------------------------------- ------------------ -------------------
Long-term debt 3,658.1(b) 40
Short-term debt 2,054.4 23
Company obligated mandatorily redeemable preferred
securities of subsidiary trust which holds solely
parent junior subordinated debentures 290.0 3
Preferred stock 133.1 2
Shareholders' equity 2,921.2 32
Total capitalization 9,056.8 100
(b) Includes $700 million of borrowings by Pepco Holdings to finance the
Transaction.
4. Regulatory Environment
Federal level
In December 1999 and February 2000, the FERC issued its landmark Orders No.
2000 and 2000-A. Order 2000 requires all public utilities to join or form a
regional transmission organization ("RTO") in furtherance of the FERC's goal to
increase competition in the wholesale
11
generation market. The qualifications to become certified by FERC as an RTO
expand on the independence, scope, transmission service, ratemaking, and
expansion planning elements needed to achieve approval as an ISO. As noted
above, the FERC has conditionally granted RTO status to PJM./16
Since 1927, PJM has provided economically efficient transmission and
generation services throughout the mid-Atlantic region,/17 and has achieved for
its members, including the Applicants, significant cost savings through shared
generating reserves and integrated operations. The PJM members have transformed
the previous coordinated cost-based pool dispatch into a bid-based regional
energy market. With the implementation of the PJM Open Access Transmission
Tariff ("OATT") on April 1, 1997, PJM began operating the nation's first
regional, bid-based energy market. PJM has become the most liquid and active
energy market in the country. PJM enables participants to buy and sell energy,
capacity and ancillary services, schedule bilateral transactions or rely on a
spot market and reserve transmission service throughout the entire PJM region.
PJM provides accounting and billing services for these transactions. Applicants
expect to continue to be transmission-owning members of PJM after consummation
of the Transaction.
As a result of Applicants' membership in PJM, PJM (rather than the
Applicants) directs and administers significant aspects of the Applicants'
transmission business. PJM directs the operation of the electric transmission
facilities owned by the Applicants, as well as those of other PJM transmission
owners. PJM provides the Applicants and all other transmission customers in PJM
with non-discriminatory open access transmission service and all required
ancillary services over the electric transmission facilities owned by the PJM
transmission owners. PJM determines Available Transmission Capacity ("ATC") and
operates an OASIS, processes requests for new transmission service, and receives
and acts upon schedules from transmission customers. PJM also has the
responsibility of preparing a regional plan for the
----------------------------
16/ The FERC has also directed PJM "to continue its current efforts at expanding
Westward and to work with NYISO [the New York ISO] and ISO New England to
develop a regional transmission organization that encompasses the entire
Northeast." PJM RTO Order, supra.
17/ The PJM service area presently includes all or part of Pennsylvania, New
Jersey, Maryland, Delaware, Virginia, and the District of Columbia.
12
enhancement and expansion of transmission facilities to meet the demands for
firm transmission service in the PJM control area.
Further, under the zonal rate structure used by PJM, each PJM "zone"
includes the service area of one of the original ten PJM transmission owners
(including the Applicants). Network transmission customers pay a single rate
based on their pro rata share of the costs of the transmission facilities
comprising the zone in which their load is located. Non-zonal load (load located
outside of the PJM control area) is charged as a single rate based on the
weighted average costs of all of the PJM transmission owners. Point-to-point
transmission service customers pay a single rate for any service to load in a
particular zone, or a single border rate (for non-zone load) that is based on
the weighted average of all of the PJM transmission owners' zonal point-to-point
rates.
In essence, through the PJM OATT, the Applicants have open access to
transmission service over the entire PJM area, regardless of the ownership of
the lines and are able to transmit power paying a single, non-pancaked rate for
firm service throughout PJM.
Pepco
In accordance with the terms of agreements approved by the Maryland Public
Service Commission ("Maryland Commission") in 1999, retail access to a
competitive market for generation services was made available to all Maryland
customers on July 1, 2000. Also under these agreements, Maryland customers who
are unable to receive generation services from another supplier, or who do not
select another supplier, are entitled to receive services (default services)
from Pepco until July 1, 2004, at a rate for the applicable customer class that
is no higher than the bundled rate in effect on June 30, 2000, but subject to
adjustment for tax law changes enacted by the Maryland General Assembly relating
to its authorization of electric industry restructuring. Thereafter, Pepco will
provide default services using power obtained through a competitive bidding
process at regulated tariff rates determined on a pass-through basis and
including an allowance for the costs incurred by Pepco in providing the
services. In December 1999, the Maryland Commission approved rate reductions for
all of Pepco's customers in Maryland. Although the amount of the reduction will
vary somewhat by class of customer, the estimated overall net effect will be
reductions for all customers equivalent to approximately 4% of base rates, or
approximately $29 million in revenue per year. The Maryland arrangements
13
permit Pepco to recover certain revenue lost as a result of the rate reductions
through future generation procurement savings discussed below. A surcharge has
been implemented to assist low-income customers in paying energy bills.
In D.C., customers began to have their choice of electricity suppliers on
January 1, 2001, with Pepco required to provide default service through February
8, 2005, except for default service for low income residential customers which
Pepco is required to provide until February 8, 2007. On November 8, 1999, Pepco
filed a Non-Unanimous Agreement of Stipulation and Full Settlement (the "D.C.
Agreement"), which was approved by the D.C. Public Service Commission ("D.C.
Commission") on December 22, 1999. Under the terms of the D.C. Agreement, the
rates for service to residential customers in D.C. would be reduced by a total
of 7% as follows: 2% effective January 1, 2000, an additional 1 1/2 % effective
July 1, 2000, and an additional 3 1/2 % effective one month after the closing of
the sale of the generation assets. The corresponding rate reductions for
commercial customers in D.C. total 6 1/2 % as follows: 3 1/2 % on January 1,
2000, 1 1/2 % on July 1, 2000, and 1 1/2 % one month after the closing of the
sale of the generation assets. The post-generation divestiture rate reductions
of approximately $15 million annually represent the reductions through the
operation of the generation procurement credit discussed below and are
guaranteed, but may be recouped by Pepco if it is able to purchase electricity
at a lower cost than its frozen production rate during the period Pepco's rates
are capped. Pepco's rates will be capped at the levels in effect one month after
the closing of the sale of the assets for a period of six years for certain
low-income residential customers and four years for other customers. The period
during which the caps will be in effect began one month following the date of
the closing on the sale of the assets.
In order to fulfill its default service obligations, Pepco entered into a
full requirements contract with Mirant, formerly Southern Energy, at the time
Pepco sold its generation assets to Mirant. Under that contract, Pepco has the
option of acquiring all of the energy and capacity that is needed for default
services from Mirant at prices that are below Pepco's current cost-based billing
rates for default service, thereby providing Pepco with a built-in profit margin
on all default service sales that Pepco acquires from Mirant. Under the
settlement agreements mentioned above, Pepco will share such profit amounts with
customers on an annual cycle basis, beginning with the period from July 1, 2000
to June 30, 2001, in Maryland and from February 9, 2001 to February 8, 2002, in
D.C. (the "Generation Procurement Credit" or
14
"GPC"). In both jurisdictions, amounts shared with customers each year are
determined only after Pepco recovers certain guaranteed annual reductions to
customer rates.
Conectiv
The electric utility businesses of Delmarva and ACE were restructured in
1999 pursuant to legislation enacted in Delaware, Maryland, and New Jersey, and
orders issued by the Delaware Public Service Commission ("Delaware Commission"),
the Maryland Commission, and the New Jersey Board of Public Utilities ("NJBPU").
Among other things, the electric restructuring orders provide for the choice of
alternative electricity suppliers by customers, decreases in customer electric
rates, recovery of stranded costs (which are the uneconomic portion of assets
and long-term contracts that resulted from electric utility industry
restructuring), securitization of ACE's stranded costs, and the regulatory
treatment of any gain or loss arising from the divestiture of electric power
plants. All customers in ACE's service area could choose an alternative
electricity supplier, effective August 1, 1999. All of Delmarva's Delaware and
Maryland customers, or about 95% of Delmarva's customers, could choose an
alternative electricity supplier by October 1, 2000. Customers representing
approximately 4% of the combined peak loads of Delmarva and ACE were purchasing
electricity from alternative suppliers as of December 31, 2000.
Under New Jersey's Basic Generation Service ("BGS"), ACE is obligated,
through July 31, 2002, to supply electricity to customers who do not choose an
alternative electricity supplier. Delmarva is obligated to supply electricity to
customers who do not choose an alternative electricity supplier for three years
for non-residential customers and four years for residential customers during
the transition periods that began on October 1, 1999, in Delaware, and July 1,
2000, in Maryland. Conectiv forecasts peak loads in 2002 of 2,622 MW for
Delmarva's default service and 2,243 MW for ACE's BGS.
D. Description of the Transaction
1. The Mergers
Pursuant to the Merger Agreement, Pepco Holdings will form two wholly owned
subsidiaries ("Merger Sub A" and "Merger Sub B," collectively, the "Merger
Subs"). Merger Sub A will be a corporation organized under the laws of the
District of Columbia and Virginia.
15
Merger Sub B will be a corporation organized under the laws of Delaware. Pepco
Holdings will designate the officers of Merger Sub A and Merger Sub B.
Subsequent to formation, the Merger Subs will become parties to the Merger
Agreement.
Merger Sub A will merge with and into Pepco, in accordance with the
applicable provisions of the laws of Virginia and the District of Columbia
("Pepco Merger"). Pepco will be the surviving corporation and will continue its
existence under the laws of the District of Columbia and Virginia. As a result
of the Pepco Merger, Pepco will become a subsidiary of Pepco Holdings. The
parties currently intend that shortly after the consummation of the Transaction,
PHI will become a first tier subsidiary of Pepco Holdings.
Merger Sub B will merge with and into Conectiv, in accordance with the laws
of Delaware ("Conectiv Merger"). Conectiv will be the surviving corporation in
the Conectiv Merger and will continue its existence under the laws of Delaware.
As a result of the Conectiv Merger, Conectiv will become a subsidiary of Pepco
Holdings.
As a consequence of the Mergers, all property, rights, privileges, powers
and franchises of Pepco and Merger Sub A will be vested in Pepco as the
surviving corporation. All the debts, liabilities and duties of Pepco and Merger
Sub A will also become debts, liabilities and duties of Pepco as the surviving
corporation. Similarly, all property, rights, privileges, powers and franchises
of Conectiv and Merger Sub B will be vested in Conectiv, as the surviving
corporation. All the debts, liabilities and duties of Conectiv and Merger Sub B
will also become debts, liabilities and duties of Conectiv as the surviving
corporation. The officers of Merger Sub A and Merger Sub B will become,
respectively, the officers of Pepco and Conectiv.
By virtue of the Mergers, each share of common stock, par value $1.00 per
share of Pepco ("Pepco Common Stock"), each share of common stock, par value
$.01 per share, of Conectiv ("Conectiv Common Stock"), and each share of Class A
common stock, par value $.01 per share of Conectiv ("Conectiv Class A Stock" and
together with the Conectiv Common Stock, "Conectiv Stock") that are owned by
Pepco, Conectiv or any of their subsidiaries, will be cancelled and no
consideration will be delivered in exchange therefor ("Cancelled Stock").
Shares of Pepco Common Stock (other than the Cancelled Stock and shares
with respect to which the owner duly exercises the right to dissent under
applicable law) will be
16
converted into the right to receive one share of common stock, par value $.01
per share, of Pepco Holdings ("Pepco Holdings Common Stock") (the "Pepco Merger
Consideration").
Shares of Conectiv Common Stock (other than the Cancelled Stock and shares
with respect to which the owner duly exercises the right to dissent under
applicable law) will be converted into the right to receive: (a) $25.00 in cash
(the "Conectiv Common Stock Cash Consideration") or (b) the number of validly
issued, fully paid and nonassessable shares of Pepco Holdings Common Stock (the
"Conectiv Common Stock Share Consideration") determined by dividing $25.00 by
the Average Final Price/18 (the "Conectiv Common Stock Exchange Ratio"). The
Conectiv Common Stock Exchange Ratio may vary in accordance with the Average
Final Price within minimum and maximum exchange ratios established in Section
1.8 of the Merger Agreement.
Shares of Conectiv Class A Stock other than Cancelled Stock and shares with
respect to which the owner duly exercises the right to dissent under applicable
law will be converted into the right to receive (a) $21.69 in cash (the "Class A
Cash Consideration" and together with the Conectiv Common Stock Cash
Consideration, the "Conectiv Cash Consideration") or (b) the number of validly
issued, fully paid and nonassesseable shares of Pepco Holdings Common Stock (the
"Class A Share Consideration" and together with the Conectiv Common Stock Share
Consideration, the "Conectiv Share Consideration") determined by dividing $21.69
by the Average Final Price (the "Class A Stock Exchange Ratio"). The Class A
Stock Exchange Ratio may vary in accordance with the Average Final Price within
minimum and maximum exchange ratios established in Section 1.8 of the Merger
Agreement.
Each record holder of Conectiv Stock immediately prior to the consummation
of the Transaction will be entitled to elect to receive shares of Pepco Holdings
Common Stock or cash for all or any part of such holder's shares of Conectiv
Stock. As described in Section 1.8 of the Merger Agreement, such election is
subject to the requirement that, in the aggregate, 50% of the consideration to
be paid to Conectiv stockholders consists of cash and 50% consists of Pepco
Holdings common stock.
----------------------------
18/ The calculation of the Average Final Price is more fully described in the
Merger Agreement and consists of a volume-weighted average of the closing
trading prices of Pepco common stock during a certain period of time prior to
the closing of the Transaction.
17
Each share of common stock, without par value, of Merger Sub A that is
issued and outstanding immediately prior to the consummation of the Transaction
will be converted into one share of common stock, without par value, of Pepco.
Each share of common stock, par value $.01 per share, of Merger Sub B that is
issued and outstanding immediately prior to the consummation of the Transaction
will be converted into one share of common stock, par value $.01 per share, of
Conectiv.
The Transaction will be accounted for by Pepco Holdings as an acquisition
of Conectiv by Pepco using the purchase method of accounting for a business
combination in accordance with generally accepted accounting principles. Under
this method of accounting, the assets and liabilities of Conectiv will be
recorded at their fair values and, if necessary, any excess of the merger
consideration over those amounts will be recorded as goodwill. The results of
operations and cash flows of Conectiv will be included in Pepco Holdings'
financial statements prospectively as of the effective time of the transaction.
Staff Accounting Bulletin No. 54, or SAB 54, generally requires that the premium
paid in an acquisition using the purchase method of accounting be "pushed down"
to the books of the acquired company, which in this case would be Conectiv.
However, the Applicants have determined that, under applicable exceptions to the
general rule, the premium paid in the Transaction will not be "pushed down" to
Conectiv. Specifically, under SAB 54 application of push down accounting is not
required when the acquired company will continue to have public debt, and
Conectiv has and will have after the merger, publicly held debt (medium-term
notes).
2. Conditions to the Transaction
The Transaction will not be completed unless customary conditions, fully
described in the Merger Agreement, are satisfied or waived by Pepco and
Conectiv. The required conditions include stockholder approval, receipt of the
regulatory approvals described in Item 4 herein, and the absence of governmental
action to block the transaction. The required stockholder approvals were
obtained on July 18, 2001 (Pepco) and July 17, 2001 (Conectiv). In addition, the
following conditions must be satisfied or waived: the regulatory approvals do
not contain materially adverse terms, the Pepco Holdings shares to be issued in
the Transaction must be listed on the New York Stock Exchange, the
representations and warranties contained in the Merger Agreement must be
accurate, the material agreements in the Merger Agreement must be
18
performed, the applicable tax opinions must be received, and a material adverse
effect on either company must not have occurred.
Pepco and Conectiv have the right to terminate the Merger Agreement by
mutual written consent in the event that the Transaction has not been completed
by August 9, 2002, or, if the only remaining condition at August 9, 2002 is the
receipt of required regulatory approvals, by February 9, 2003. The companies
also have the right to terminate the Merger Agreement if the Transaction is
prohibited by a governmental entity, if the stockholders of Pepco or Conectiv do
not adopt or approve the Merger Agreement, or if any of the companies materially
violates, and does not cure, any of its representations, warranties or
covenants.
In addition, Pepco has the right to terminate the Merger Agreement if the
Conectiv Board withdraws or adversely modifies its approval of the Merger
Agreement, approves or recommends another acquisition proposal or resolves to
take any of those actions. Conectiv also has the right to terminate the Merger
Agreement if (i) the Conectiv Board approves a superior acquisition proposal, as
long as Pepco has had an opportunity to propose revised transaction terms, (ii)
the Pepco Board withdraws or adversely modifies its approval of the Merger
Agreement or resolves to take any of those actions, or (iii) the Average Final
Price is less than $16.50, subject to Pepco's right to supplement the value of
the Conectiv Share Consideration to a value of $21.15 per share of Conectiv
Common Stock (and $18.35 per share of Conectiv Class A Common Stock).
Under the Merger Agreement, termination fees of $60 million are payable
under the following circumstances:
o By Conectiv to Pepco, in the event (a) Conectiv terminates the Merger
Agreement due to the Conectiv Board's approval of a superior
combination proposal, (b) Conectiv or Pepco terminates the Merger
Agreement due to the failure of Conectiv's stockholders to adopt the
Merger Agreement, at any time after February 9, 2001 and at or before
the time of the Conectiv's stockholders' meeting, a bona fide
acquisition proposal has been made public and has not been withdrawn
and, within 12 months of the termination of the Merger Agreement,
Conectiv enters into a definitive agreement with a third party with
respect to an acquisition
19
proposal (which is subsequently consummated), or (c) Pepco terminates
the Merger Agreement as a result of the Conectiv Board withdrawing or
modifying its approval of the Merger Agreement and the Transaction,
approving or recommending another acquisition proposal, or resolving
to do any of those things, so long as this action by the Conectiv
Board giving rise to Pepco's termination right was not caused by Pepco
entering into a definitive agreement with respect to a business
combination involving Pepco that could reasonably be expected to
materially delay or impede the consummation of the Transaction.
o By Pepco to Conectiv, in the event (a) Conectiv or Pepco terminates the
Merger Agreement due to the failure of Pepco's stockholders to adopt
the Merger Agreement, at any time after February 9, 2001 and at or
before the time of the Pepco stockholders' meeting, a bona fide
proposal with respect to a business combination involving Pepco has
been made public and not withdrawn and, within 12 months of the
termination of the Merger Agreement, Pepco enters into a definitive
agreement with a third party with respect to a business combination
(which is subsequently consummated), or (b) Conectiv terminates the
Merger Agreement as a result of the Pepco Board's withdrawing or
modifying its approval of the Merger Agreement and the Transaction, or
resolving to do any of those things.
3. Background of the Transaction
Over the past several years, Pepco has carefully monitored market and
regulatory developments in the electric utility industry that have substantially
increased competition in all sectors of the industry and analyzed how best to
position itself in this changing environment. In 1999, Pepco announced a
strategy of being an electricity delivery company with growing energy and
telecommunications retail businesses. Pepco determined that it was not big
enough to achieve the economies of scale that would be needed in the long term
to compete effectively in the rapidly consolidating nationwide generation
business. As a result, Pepco decided to sell the bulk of the generation
facilities it then owned in an auction process, which was completed in late
20
2000 and early 2001. The strategy announced by Pepco involves the continued
operation and expansion of an electric distribution system in the mid-Atlantic
region as well as the development of energy and telecommunications retail
operations, in each case through both internal growth and acquisitions.
Since the commencement of operations of Conectiv in 1998, the Conectiv
Board has carefully followed the developments in the electric and natural gas
industries. The Conectiv Board, with the assistance of management, has regularly
reviewed the ongoing restructuring of the energy industry and has evaluated
Conectiv's strategy in this context. After much consideration and review, and
taking into account the legislative developments in Delaware, Maryland and New
Jersey, the Conectiv Board adopted a strategy of disposing of Conectiv's
interests in nuclear generating plants and baseload fossil fuel-fired generating
plants and developing new mid-merit generation plants in the PJM region.
Between January and July 2000, in the course of several meetings, the
Conectiv Board, together with Conectiv's management and financial advisor,
Credit Suisse First Boston Corporation, continued to evaluate the potential
impact of the mid-merit strategy, including its significant capital
requirements, on Conectiv and possible alternatives to implementing this
strategy. As the Conectiv Board weighed the potential risks and benefits of the
mid-merit strategy, the Conectiv Board determined that it should begin to
consider the risks and benefits of potential strategic alternatives, including a
possible business combination. In this regard, Credit Suisse First Boston
outlined for the Conectiv Board the process for soliciting proposals from
potentially interested parties if the Conectiv Board decided to explore a
possible business combination, and management and Credit Suisse First Boston
discussed with the Conectiv Board potential strategic and financial parties who
might have an interest in such a transaction. During these months, the Conectiv
Board did not take any formal action relating to any potential strategic
alternatives and determined that remaining independent and continuing to pursue
the mid-merit strategy and existing long-term plans remained an alternative that
was available depending on the results of further evaluation.
During the spring of 2000, an ad hoc committee consisting of independent
outside directors met several times to review in greater detail the possible
acceleration of the mid-merit strategy. In June 2000, based on the
recommendation of this ad hoc committee, the Conectiv
21
Board instructed management to preserve the option of accelerating the
implementation of the mid-merit strategy. At that time, the Conectiv Board also
appointed another ad hoc committee of three independent outside directors to
evaluate other strategic alternatives and authorized the retention by the ad hoc
committee of outside advisors to assist in this evaluation. This second
committee selected Credit Suisse First Boston as financial advisor and Simpson
Thacher & Bartlett as special legal counsel on behalf of the Conectiv Board in
connection with the evaluation of potential strategic alternatives.
In August 2000, following several meetings with Credit Suisse First Boston
and Simpson Thacher & Bartlett, the second ad hoc committee authorized Credit
Suisse First Boston, with the consent of the Conectiv Board, to make preliminary
contact with likely possible transaction candidates. In August, Credit Suisse
First Boston contacted 10 potential domestic bidders, including Pepco, and 5
potential foreign bidders. Thereafter, several additional parties were
contacted.
When contacted in August 2000 in connection with the process established by
Conectiv, Pepco's management determined that a business combination with
Conectiv was consistent with Pepco's announced regionally-based strategy and, in
October 2000, entered into a confidentiality agreement with Conectiv in order to
participate in the process. At that time, Pepco engaged LeBoeuf, Lamb, Greene &
MacRae, L.L.P. to act as its legal counsel and Merrill Lynch, Pierce Fenner &
Smith Incorporated ("Merrill Lynch") to act as its financial advisor in the
process.
On September 8, 2000, the Conectiv Board convened to review, among other
matters, a report of the ad hoc committee relating to its evaluation of
potential strategic alternatives. Representatives of Credit Suisse First Boston
reviewed for the Conectiv Board the recent performance of utility stocks and
recent mergers and acquisitions activity in the utility industry and reported
that 10 parties had expressed interest in participating in a business
combination with Conectiv. Credit Suisse First Boston also reviewed a potential
timeline for the process of soliciting transaction bids. Representatives of
Simpson Thacher & Bartlett then reviewed for the Conectiv Board its fiduciary
duties in the context of commencing a process which could lead to a merger or
acquisition transaction. After discussion, the Conectiv Board
22
approved the recommendation of the ad hoc committee to commence a process for
soliciting transaction proposals.
Beginning in October 2000, with the assistance of Simpson Thacher &
Bartlett and Potter Anderson & Corroon LLP, Conectiv's legal counsel, Conectiv
negotiated and entered into confidentiality and standstill agreements with 13
parties, including Pepco, for the purpose of facilitating the delivery of
confidential information regarding Conectiv to the parties who had expressed an
interest in receiving such information. Beginning on October 14, 2000, each
party that had entered into a confidentiality and standstill agreement received
a confidential information memorandum relating to Conectiv and a letter inviting
submission of preliminary indications of interest by November 13, 2000.
On October 26, 2000, the Pepco Board met to review the potential
transaction. John M. Derrick, Jr., Chairman and Chief Executive Officer, Dennis
R. Wraase, at that time President and Chief Financial Officer, and William T.
Torgerson, at that time Senior Vice President, External Affairs and General
Counsel, together with representatives from Merrill Lynch and LeBoeuf, Lamb,
Greene & MacRae, L.L.P. reported to the Pepco Board on the process established
by Conectiv and the status of due diligence review of Conectiv's operations.
The Pepco Board discussed the terms of a potential indication of interest
to be submitted by Pepco to Conectiv and authorized management to proceed with
the indication of interest, with the understanding that any final offer would be
subject to satisfactory completion of due diligence, negotiation of a definitive
merger agreement and approval by the Pepco Board.
On November 13, 2000, Conectiv received preliminary indications of interest
from six parties for the acquisition of Conectiv. Among the parties expressing
an interest was Pepco.
On November 17, 2000, at a regularly scheduled meeting of the Conectiv
Board, representatives of Credit Suisse First Boston discussed with the Conectiv
Board the preliminary indications of interest received. The Conectiv Board
decided to continue discussions with five of the initial bidders whose
preliminary proposals offered the highest consideration for the Conectiv
stockholders. The Conectiv Board authorized the process to continue but noted
that it was preserving the option to remain independent, including the option to
continue to implement the mid-merit business plan on an accelerated basis.
23
On November 27, 2000, additional confidential materials were distributed to
the five bidders who were invited to continue participating in the process.
Thereafter, in December 2000 and January 2001, Conectiv's management made
presentations to such parties concerning Conectiv and its business operations
and responded to detailed due diligence inquiries.
On December 5, 2000, the Conectiv Board, at its regularly scheduled
meeting, continued its strategic review process and discussed with management
and representatives of Credit Suisse First Boston the bidders remaining in the
process. Since many of the remaining bidders, including Pepco, had indicated a
desire to pay for the transaction at least partly in stock, Credit Suisse First
Boston also gave an overview of potential "collar" structures and related
issues. Simpson Thacher & Bartlett informed the directors of the material terms
of the draft merger agreement which would be distributed to bidders. Simpson
Thacher & Bartlett explained to the Conectiv Board that the draft merger
agreement would provide for a part cash and part stock consideration and a fixed
value formula without a collar for determining the amount of stock
consideration. Simpson Thacher & Bartlett also explained that the draft merger
agreement would provide that the merger consideration payable to the holders of
the Conectiv Class A Common Stock would be determined in accordance with
Conectiv's certificate of incorporation.
On separate occasions between December 2000 and the time the Merger
Agreement was executed, the Audit Committee of the Conectiv Board met to consult
with Conectiv's legal and financial advisors and to discuss the Conectiv Board's
fiduciary duties, the provisions of Conectiv's certificate of incorporation and
the anticipated terms of the Merger Agreement, the financial implications of a
business combination and other matters, in each case as they related to the
Conectiv Class A Common Stock.
On January 12, 2001, the remaining transaction candidates were sent a
letter outlining the procedures for submitting a final bid for Conectiv,
accompanied by a draft merger agreement prepared by Simpson Thacher & Bartlett.
On January 23, 2001, a meeting of the Conectiv Board was convened to update
the Conectiv Board on the process for soliciting transaction proposals.
Representatives of Credit Suisse First Boston informed the Conectiv Board that
two of the five parties invited to continue in the process had elected to
withdraw from the process. Credit Suisse First Boston then provided the Conectiv
Board with additional information relating to the three parties, including
24
Pepco, remaining in the process. Credit Suisse First Boston reported that one of
the three remaining bidders had indicated that it was not prepared to bid for
the entire company alone and accordingly was exploring an on-sale disposition of
Conectiv's generation assets to another party in order to make a bid.
Representatives of Simpson Thacher & Bartlett then provided a review of the
material legal issues that might arise in negotiations with any of the three
remaining bidders, including potential proposals containing collars. Howard
Cosgrove, Chairman of the Board and Chief Executive Officer of Conectiv, and
other members of management provided the Conectiv Board with a regulatory
assessment of a potential transaction with each of the remaining parties. Potter
Anderson & Corroon LLP and Simpson Thacher & Bartlett further informed the
Conectiv Board of its fiduciary duties in the context of this process and
discussed with the Conectiv Board the provisions of the certificate of
incorporation regarding the treatment of Conectiv Class A Common Stock.
On January 24, 2001, Conectiv received an unsolicited letter from a party
expressing interest in acquiring Conectiv. On January 26, 2001, Conectiv's legal
and financial advisors met with this party and its financial and legal advisors
to explore whether a transaction was feasible and the potential timing of any
such transaction. The preliminary price level expressed by this party was in the
high range of the remaining three parties' indications of interest. This party,
however, had not performed due diligence and informed Conectiv's advisors that
it had not yet obtained commitments for the equity or debt financing required to
complete a transaction. This party further advised that it would require at
least another month to complete due diligence and be in a position to make a
definitive proposal and begin to negotiate a definitive agreement.
At the Pepco Board's regularly scheduled meeting on January 25, 2001,
following conclusion of the Pepco Board's regularly scheduled business,
representatives of LeBoeuf, Lamb, Greene & MacRae, L.L.P. discussed the duties
of the Pepco Board in considering the submission of a bid to Conectiv as well as
the terms of the proposed merger agreement to be included as part of the bid
package. Representatives of Merrill Lynch discussed the proposed bid to be
submitted to Conectiv. In addition, Messrs. Derrick and Wraase (who in the
interim had been promoted to President and Chief Operating Officer) discussed
the financial and strategic benefits and risks of the proposed transaction in
the context of Pepco's business plans and the results of Pepco's due diligence
review. After considering these discussions as well as the
25
recommendation of Pepco's management, the Pepco Board authorized management to
submit a bid and, if successful, to enter into a transaction with Conectiv
substantially in the form provided in the bid. The Pepco Board authorized
management to negotiate final terms for a transaction with Conectiv, but
required further consultation with the Pepco Board regarding any material
changes from the bid proposal. The Pepco Board also discussed the rationale
behind a potential common stock dividend reduction and share repurchase program
which was then under consideration and its relationship to the proposed
acquisition of Conectiv should the bid be successful.
On January 29, 2001, the deadline for all proposals under Conectiv's
process, Pepco submitted a final bid to acquire Conectiv at a price of $24.00
per share of Conectiv Common Stock. Under Pepco's proposal, half of the
consideration would consist of cash and the other half would consist of stock,
with the stock consideration subject to a collar. The Pepco bid also stated that
Pepco would, simultaneously with the execution of the merger agreement, announce
a reduction of its dividend and a share repurchase program.
Conectiv did not receive final proposals from the two other remaining
participants in the process. One such participant indicated that its efforts to
collaborate on a bid with a third- party purchaser of generation assets were not
successful and thus it would be prepared, with additional due diligence, to make
an offer to purchase only Conectiv's transmission and distribution assets. The
proposed third-party purchaser of the generation assets also submitted a
separate letter expressing interest in acquiring the generation assets with an
indicated pricing level that was not considered attractive. The other
participant in this process, a foreign utility company, indicated that it was
not yet prepared to make a final bid because aspects of the transaction were
continuing to be reviewed by its senior executives and that it could not provide
a definitive timeframe for submitting a proposal.
On January 31, 2001, a telephonic meeting of the Conectiv Board was
convened. At this meeting, the Conectiv Board was briefed by Conectiv's
management and legal and financial advisors on the material aspects of Pepco's
bid, the status of the other two participants and the recent unsolicited
inquiry. After this discussion, the Conectiv Board determined that, in light of
the unattractiveness of selling only a portion of Conectiv and the preliminary
and conditional nature of the unsolicited inquiry, the time and resources it
would take to explore a
26
transaction with either of such parties would delay or hinder Conectiv's ability
to negotiate with Pepco and could jeopardize negotiation of a transaction with
Pepco. The Conectiv Board authorized management and its advisors to commence
negotiations with Pepco, particularly with respect to increasing the
consideration for Conectiv's stockholders, and also directed Credit Suisse First
Boston to ascertain whether a definitive bid would be forthcoming from the
potential foreign bidder. The Conectiv Board requested that it be kept informed
of these negotiations as well as developments with respect to any other
potential bidders.
On February 2, 2001, at the direction of the Conectiv Board,
representatives of Credit Suisse First Boston contacted representatives of
Merrill Lynch, to convey that a price of $24.00 per share of Conectiv Common
Stock was not sufficient and to identify other aspects of Pepco's proposal that
raised material issues for Conectiv. Later that day, Merrill Lynch indicated
that Pepco was prepared to pay $24.50 per share of Conectiv Common Stock in cash
and stock. Over the next few days, representatives of Credit Suisse First Boston
and Merrill Lynch continued to hold discussions on price, the proposed collar
and other material business and financial terms of the proposed transaction.
Prior to the end of that week, in accordance with the instructions of the
Conectiv Board, Credit Suisse First Boston attempted to ascertain from the
potential foreign bidder and its financial advisors whether it would eventually
submit a definitive bid, but was unable to obtain any assurances as to the
timing or likelihood of any such bid being made.
On February 5, 2001, Mr. Cosgrove contacted Mr. Derrick and stated that
Conectiv was not prepared to negotiate and execute a merger agreement with Pepco
at a price below $25.00 per share of Conectiv Common Stock. Mr. Cosgrove and Mr.
Derrick also discussed, among other matters, the status of negotiations,
regulatory risks and the number of directors from the Conectiv Board that should
serve on Pepco Holdings' Board to increase representation by directors resident
in or otherwise familiar with the service territories of Conectiv's utility
subsidiaries. Later that evening, Mr. Derrick called Mr. Cosgrove to convey that
Pepco would agree to the $25.00 per share price requested by Conectiv subject to
satisfactory resolution of the other remaining open issues.
On February 6, 2001, Simpson Thacher & Bartlett sent to LeBoeuf, Lamb,
Greene & MacRae, L.L.P. a revised draft of the merger agreement reflecting the
prior conversations
27
between the chief executive officers and financial advisors as well as revisions
reflecting Conectiv's response to certain aspects of Pepco's proposal. Between
the evenings of February 6 and February 9, 2001, representatives of Simpson
Thacher & Bartlett, Potter Anderson & Corroon LLP and LeBoeuf, Lamb, Greene &
MacRae, L.L.P., along with Conectiv's and Pepco's management and financial
advisors, met at the offices of Simpson Thacher & Bartlett to negotiate the
merger agreement. During the same period, Conectiv's management and financial
advisors received additional information with respect to Pepco's dividend
reduction and share repurchase program and completed their due diligence of
Pepco.
On February 8, 2001, the Conectiv Board met to consider and review the
terms of the proposed transaction with Pepco. Representatives of Simpson Thacher
& Bartlett and Potter Anderson & Corroon LLP reviewed for the Conectiv Board its
fiduciary and other legal duties, including duties with respect to the Conectiv
Class A common stock. Mr. Cosgrove reviewed the status of discussions with Pepco
and made a presentation with respect to management's recommendation that the
Conectiv Board approve the proposed transaction with Pepco if the remaining
issues could be resolved in a manner satisfactory to Conectiv. Conectiv
Management then provided a regulatory assessment of the proposed transaction.
Credit Suisse First Boston then reviewed with the Conectiv Board its financial
analysis of the merger consideration payable in the transaction. Conectiv
Management and Credit Suisse First Boston also reported on the due diligence
that had been conducted on Pepco. Credit Suisse First Boston also reported that
there were no further developments with respect to other potential bidders.
Representatives of Simpson Thacher & Bartlett then reviewed in detail for the
Conectiv Board the terms of the proposed Merger Agreement and the other legal
aspects of the Pepco transaction.
At this meeting, the Conectiv Board discussed, among other matters, the
risks and benefits of the Pepco proposal, taking into account the matters
described above. The Conectiv Board also considered the alternative of remaining
independent and implementing the mid-merit strategy in that context, along with
the execution risks relating to such strategy in light of the significant
investments required by Conectiv going forward in the deregulated energy
markets. After additional discussion and deliberation, the Conectiv Board
authorized management and the advisors to complete the negotiation of the Merger
Agreement.
28
On February 9, 2001, the parties reached agreement on all of the remaining
terms of the merger agreement.
On February 9, 2001, the Pepco Board held a special meeting by telephone at
which the board was provided updates by management, LeBoeuf, Lamb, Greene &
MacRae, L.L.P. and Merrill Lynch on the final terms of the proposed transaction
with Conectiv. Pepco Management also discussed with the Pepco Board the terms of
the proposed dividend cut and share repurchase program. At that time, Merrill
Lynch delivered its oral opinion to the Pepco Board (which was subsequently
confirmed in writing) that, as of that date and based on the assumptions made,
matters considered and limitations reviewed with the Pepco Board, the Pepco
exchange ratio was fair from a financial point of view to the holders of Pepco
Common Stock, taking into account the Conectiv Merger, and the consideration to
be paid by Pepco in connection with the Conectiv Merger was fair from a
financial point of view to Pepco. After considering and discussing these matters
as well as the recommendation of management, the Pepco Board, by a unanimous
vote, approved the Merger Agreement and the transactions contemplated thereby
and authorized the execution of the Merger Agreement. The Pepco Board also
approved a dividend cut, effective with the June 30 dividend to a rate of $1.00
per share annually and a share repurchase program not to exceed $450 million in
the aggregate. On February 9, 2001, Pepco caused Pepco Holdings to be formed in
the State of Delaware and the Pepco Holdings Board approved the Merger
Agreement.
On the evening of February 9, 2001, a telephonic meeting of the Conectiv
Board was convened. Mr. Cosgrove reported on the progress of the final
negotiations with Pepco and reaffirmed management's recommendation of the
proposed transaction on the terms that had been negotiated. At this meeting,
Credit Suisse First Boston rendered to the Conectiv Board an oral opinion, which
opinion was confirmed by delivery of a written opinion dated February 9, 2001,
to the effect that, as of that date and based on and subject to the matters
described in the opinion, the Conectiv common stock consideration was fair, from
a financial point of view, to the holders of Conectiv Common Stock and the
Conectiv Class A Common Stock consideration was fair, from a financial point of
view, to the holders of Conectiv Class A Common Stock. The Audit Committee
reported to the Conectiv Board that, at a telephonic meeting convened earlier
that evening, it had determined that the consideration for the Conectiv Class A
Common Stock under the Merger Agreement was determined in accordance with
Conectiv's certificate of
29
incorporation and decided to recommend the transaction to the Conectiv Board.
After additional discussion and deliberation, the Conectiv Board approved the
Transaction and the Merger Agreement and decided to recommend to Conectiv
stockholders that they adopt the Merger Agreement. One of the nine directors,
citing concerns over the number of Conectiv directors to be appointed to the
Pepco Holdings Board, voted against approval of the Transaction.
Later that evening, the Merger Agreement was executed by Pepco, Conectiv
and Pepco Holdings.
4. Financing the Transaction
Before completing the Transaction, the management of Pepco and Pepco
Holdings will evaluate various sources and methods of financing the amount
necessary to fund a portion of the cash consideration to be paid in the
transaction (the total amount of cash consideration is approximately $1.098
billion). Applicants intend to use approximately $400 million of the proceeds
that Pepco has received from the recent sale of its generation assets to fund a
portion of the Conectiv Cash Consideration, and intend to raise the remaining
approximately $700 million of other funds required for the Transaction at the
Pepco Holdings level through external sources. Such financings, however, will be
offset by reductions since the date of its generation asset sale in a like
amount of Pepco's borrowings. Sources of financing that Pepco Holdings is
arranging include commercial and investment banks, institutional lenders and
public securities markets. Methods of financing initially will include
commercial paper and bank lines of credit, which will be refinanced following
completion of the Transaction in the public and/or private markets with debt and
preferred securities of various maturities and types to be determined after the
closing of the Transaction. The management of Pepco and Pepco Holdings believe
that Pepco Holdings will have access to many sources and types of short-term and
long-term capital sources at market rates. The financing for the Transaction by
Pepco Holdings will not be recourse to any system companies other than Pepco
Holdings.
5. Management and Operations of Pepco and Conectiv Following the
Transaction
Following the Transaction, the Pepco Holdings board will consist of 12
persons, at least two of whom will come from the current Conectiv Board. It is
expected that John M. Derrick, Jr., chairman and chief executive
30
officer of Pepco will be chairman and chief executive officer of Pepco Holdings.
It is also expected that all members of the Pepco Board of Directors immediately
prior to the closing of the Transaction will be named as directors of Pepco
Holdings.
Pepco Holdings will operate from and have its headquarters in Washington,
D.C. Pepco will continue its operations from its headquarters in Washington,
D.C., substantially as currently operated. Conectiv will continue to maintain
its headquarters in Wilmington, Delaware, and will continue to have significant
operations in New Jersey and on the Delmarva Peninsula.
Pepco Holdings will adopt Pepco's dividend policy and expects (but can give
no assurances) that the annual dividend at the effective time will be $1.00 per
share of Pepco Holdings common stock.
6. Benefits of the Transaction
Pepco and Conectiv continually evaluate business and strategic
opportunities to enhance shareholder and customer value. Pepco has had the
opportunity to develop a strong working relationship with Conectiv over the
years as neighbors, partners and members of PJM. The companies have
complementary business strategies and similar corporate values.
The Transaction elevates the combined company to the leading position among
the mid-Atlantic delivery companies. The Transaction will double Pepco's
customer base and expand its service territory by nine times. The strategic
combination will improve the two companies' ability to grow earnings in the
changing energy marketplace and give the combined company the size and scope
needed to compete more effectively in the energy delivery and related retail
services markets.
The Transaction will create a stronger combined company, yielding
significant benefits for customers, communities, shareholders, employees and the
region. The combined company will become the largest electricity delivery
company in the mid-Atlantic region in terms of both MW load and kWh sales with a
secure energy supply based on Conectiv's mid-merit generation capabilities and
Pepco's favorable supply contracts. It will also be the largest owner of
transmission facilities within PJM. The combined company will serve 1.8 million
customers in New Jersey, Delaware, Maryland, Virginia, and the District of
Columbia.
31
The combined company is expected to have a solid investment grade balance
sheet, which will facilitate future growth through acquisitions or external
investments.
Customers will benefit as the system's utilities are able to support rates
lower than they would otherwise, resulting from increased efficiencies that will
be reflected in any new rate schedules put into effect following expiration of
the restructuring transition periods currently in place./19 The efficiencies
expected to result from the Transaction include the implementation of new
technologies to enhance reliability and customer service at a lower cost, due to
the increase in kWh sales and the number of customers in the combined company;
the elimination of redundant administrative functions; the enhanced financial
strength of the combined company; and the increased purchasing power of the
combined company.
While the parties believe the primary benefits of the Transaction relate to
strategic growth opportunities for the combined company, the parties have
identified and estimated potential cost savings as a result of the Transaction.
These costs have been categorized as either "redundant" (meaning that both
companies do something now but only one company will perform that activity after
the merger), or "leveraged" (resulting from opportunities to take advantage of
experience, capacity, and third party or vendor relationships across common
support-type areas). The identified cost savings estimates are summarized
below:/20
Total Estimated Savings, by Category and Year (In Thousands):
Year of Annual One-Time Cumulative
Redundant Costs: Savings Savings Avoided Cost through 2005
--------------- ------- ------- ------------ ------------
Executives 2002 $3000 - $12,000
Shareholder Records 2002 1000 - 4,000
Annual Meetings/Report 2002 300 - 1,200
Board of Directors 2002 200 - 800
Support Services 2005 3500 - 3,500
PJM 2002 400 - 1,600
------ ------ -------
Total Redundant Costs: $8,400 $23,100
------ -------
----------------------------
19/ As previously discussed, most of the retail rates of the combined company
are subject to rate caps or freezes for the next several years. Applicants will
reflect efficiencies achieved through the Transaction in any new rates once the
rate cap or freeze ends to the extent required by the relevant state regulatory
commissions.
20/ The estimates on this chart do not include the cost to achieve savings.
32
Year of Annual One-Time Cumulative
Leveraged Costs: Savings Savings Avoided Cost through 2005
--------------- ------- ------- ------------ ------------
Mainframe/Output Services 2004 $3,000 - $6000
Remittance Processing 2004 500 - 1000
Supply Chain 2004 4,200 - 8400
Legal 2003 1,000 - 3000
IT Contractors/Licenses 2003 2,50 - 750
Insurance 2002 300 - 1200
IT Systems:
SAP 2002/04 - $1,850 1850
Itron 2002 - 250 250
Constr. Mgmt. 2002 - 250 250
------- ------ -------
Total Leveraged Costs $9,250 $2,350 $22,700
------- ------ -------
Total (Redundant &
Leveraged Costs) $17,650 $2,350 $45,800
======= ====== =======
Pepco and Conectiv will continue to operate under their existing names and
are committed to maintaining management teams where they are currently
headquartered. This structure will preserve the benefits of localized management
and the system, as a whole, will facilitate efficient operations.
Item 2. Fees, Commissions and Expenses
Commission registration fees $ 959,650
Financial advisors' fees (Pepco Holdings) $ 9,100,000
Financial advisor's fees (Conectiv) $ 19,800,000
Accountant fees $ 600,000
Legal fees $ 7,000,000
Stockholder communication and proxy solicitation expenses $ 4,336,919
Miscellaneous $ 4,000,000
Total $ 45,796,569
===========
33
Item 3. Applicable Statutory Provisions
A. Applicable Provisions
The proposed transactions are subject to Sections 5, 6(a), 7, 9(a), 10, 11,
12 and 13 of the Act and Rules 42, 43, 45, 53, 54, 80-88 and 90-91 thereunder.
B. Legal Analysis
Section 9(a)(2) of the Act makes it unlawful, without approval of the
Commission under Section 10, "for any person . . . to acquire, directly or
indirectly, any security of any public utility company, if such person is an
affiliate . . . of such company and of any other public utility or holding
company, or will by virtue of such acquisition become such an affiliate." Under
the definition set forth in Section 2(a)(11)(A) of the Act, an "affiliate" of a
specified company means "any person that directly or indirectly owns, controls,
or holds with power to vote, 5 per centum or more of the outstanding voting
securities of such specified company."
Pepco is directly engaged in utility operations and is engaged in
diversified, competitive energy and telecommunications businesses through a
wholly owned non-regulated subsidiary. Conectiv is the owner of 100% of the
outstanding common stock of four public utility companies, including Delmarva,
ACE, CDG and CAG. As a result of the Transaction, Pepco Holdings will indirectly
own more than five percent of the outstanding voting securities of Pepco and of
the public utility company subsidiaries of Conectiv. As a consequence, Pepco
Holdings must obtain the approval of the Commission for the acquisition under
Sections 9(a)(2) and 10 of the Act. The statutory standards to be considered by
the Commission in determining whether to approve the proposed acquisition are
set forth in Sections 10(b), 10(c) and 10(f) of the Act.
As described below, the acquisition complies with all of the applicable
provisions of Section 10 of the Act.
1. Section 10(b)
Section 10(b) provides that if the requirements of Section 10(f) are
satisfied, the Commission shall approve an acquisition under Section 9(a)(2)
unless the Commission finds that:
34
o such acquisition will tend towards interlocking relations or the
concentration of control of public utility companies, of a kind or to
an extent detrimental to the public interest or the interests of
investors, or consumers;
o in case of the acquisition of securities or utility assets, the
consideration, including all fees, commissions, and other remuneration,
to whomsoever paid, to be given, directly or indirectly, in connection
with such acquisition is not reasonable or does not bear a fair
relation to the sums invested in or the earning capacity of the utility
assets to be acquired or the utility assets underlying the securities
to be acquired; or
o such acquisition will unduly complicate the capital structure of the
holding company system of the applicant or will be detrimental to the
public interest or the interest of investors or consumers or the proper
functioning of such holding-company system.
a. Section 10(b)(1)
i. Interlocking Relations
Under Section 10(b)(1), the Commission shall approve an acquisition unless
the Commission finds that "such acquisition will tend towards interlocking
relations. . . ." By its nature, any merger of previously unrelated companies
results in new links and relations between the companies./21 These links,
however, are not the types of interlocking relations targeted by Section
10(b)(1), which was primarily aimed at preventing business combinations
unrelated to operating efficiencies./22
Pepco Holdings' purchase of Pepco and Conectiv does not create the type of
interlocking relations prohibited by Section 10(b)(1). Following the Merger,
Pepco's current
----------------------------
21/ Northeast Utilities, Holding Co. Act Release No. 25221 (Dec. 21, 1990), as
modified, Holding Co. Act Release No. 25273 (Mar. 15, 1991), aff'd sub nom. City
of Holyoke v. SEC, 972 F.2d 358 (D.C. Cir. 1992) ("interlocking relationships
are necessary to integrate [the two merging entities]").
22/ See Section 1(b)(4) of the Act (finding that the public interests of
consumers are adversely affected "when the growth and extension of holding
companies bears no relation to economy of management and operation or the
integration and coordination of related operating properties . . .").
35
Chairman and CEO, John Derrick, will serve as Chairman of Pepco Holdings. In
addition, two current directors of Conectiv will serve on the board of directors
of Pepco Holdings.
These arrangements and the representation of Conectiv on Pepco Holdings'
board are necessary to integrate Conectiv fully into the Pepco Holdings System
and to promote group-wide policies and practices for the efficient operation of
the combined system. Such overlap is, therefore, in the public interest and in
the interest of investors and consumers.
ii. Concentration of Control
Section 10(b)(1) is intended to prevent utility acquisitions that would
result in "huge, complex and irrational holding company systems," and to avoid
"an excess of concentration and bigness" while preserving opportunities for the
"economies of scale, the elimination of duplicate facilities and activities, the
sharing of production capacity and reserves and generally more efficient
operations" afforded by the coordination of local utilities into an integrated
system./23 In applying Section 10(b)(1) to utility acquisitions, the Commission
must determine whether the acquisition will create "the type of structures and
combinations at which the Act was specifically directed [to prohibit]."/24 Pepco
Holdings' acquisition of Conectiv will not result in a "huge system" and will
avoid the "excess of concentration and bigness" which Section 10(b)(1) seeks to
prevent. The Pepco Holdings System will be smaller than many other systems that
have been approved by the Commission.
The Commission has approved acquisitions involving registered holding
companies with much larger public utility systems./25 As the table below shows,
after the Merger, Pepco Holdings will be smaller than several other registered
holding companies. The table compares Pepco and Conectiv combined on a pro forma
basis to Southern Company, American Electric Power Company ("AEP"), Exelon
Corp., Entergy, and Xcel Energy Inc. - all large registered holding companies.
----------------------------
23/ American Elec. Power Co., Inc., Holding Co. Act Release No. 20633 (July 21,
1978).
24/ Vermont Yankee Nuclear Corp., Holding Co. Act Release No. 15958 (Feb. 6,
1968).
25/ See American Elec. Power Co., Inc. and Central and South West Corp., Holding
Co. Act Release No. 27186 (June 14, 2000) ("AEP Merger Order"); and Exelon
Corp., Holding Co. Act Release No. 27256 (Oct. 19, 2000).
36
Customers
Total Assets Operating Revenues
Company/26 (million) (million) (000s)
---------------------------- ------------------------- -------------------------- -------------------------
Pepco Holdings $12,396.1 $8,006 1,800,000
(Pepco/Conectiv) (at 9/30/01) (at 12/31/00) (at 12/31/00)
Southern Company 31,362 10,066 3,944,000
AEP 54,548 13,694 4,893,000
Exelon Corp 34,597 7,499 4,661,405*
Entergy 25,565 10,016 2,500,000*
Xcel Energy Inc. 21,769 11,591 4,679,000*
* 1999 data. Source: U.S. Securities and Exchange Commission, Financial and
Corporate Report, Holding Companies Registered under the Public Utility Holding
Company Act of 1935 as of August 1, 2000 (data provided is as of Dec. 31, 1999).
Overall, Pepco Holdings' acquisition of Conectiv will not create a "complex
and irrational system", but will create a company focused on reliability,
competitive pricing and high quality customer service in the mid-Atlantic
region. The larger size of the combined company will provide strategic scale and
expertise needed to compete in changing markets.
Finally, Section 10(b)(1) also requires the Commission to consider possible
anticompetitive effects of a proposed combination. As the Commission noted in
Northeast Utilities, Holding Co. Act Release No. 25221 (Dec. 21, 1990), the
"antitrust ramifications of an acquisition must be considered in light of the
fact that public utilities are regulated monopolies and that federal and state
administrative agencies regulate the rates charged to customers." Pepco
Holdings, Pepco, and Conectiv have filed Notification and Report Forms with the
Department of Justice and the Federal Trade Commission under the
Hart-Scott-Rodino Antitrust Improvements Act ("HSR Act") describing the effects
of the acquisition on competition in the relevant market. The waiting period has
terminated and the merger has been cleared for closing under the HSR Act.
The competitive impact of the acquisition was also fully considered by FERC
in proceedings under Section 203 of the Federal Power Act. As described in its
Merger Policy Statement, the FERC evaluates the competitive effects of a
proposed merger before deciding whether to approve the merger as "consistent
with the public interest," the applicable standard of
----------------------------
26/ As of December 31, 2000. Source: Individual companies' 2000 Annual Reports,
except as stated otherwise.
37
review./27 In particular, under the Merger Policy Statement, the FERC considers
whether a merger has an adverse effect on (1) competition in any market, (2)
customer rates, and (3) the effectiveness of regulation.
The Applicants have submitted an application to the FERC that demonstrates
that all the tests in the Merger Policy Statement are satisfied and that the
acquisition is in the public interest./28 Included in the FERC application is
the testimony of Dr. Joe D. Pace, demonstrating that the Transaction will not
have an adverse effect on competition./29 As Dr. Pace's testimony shows,
Conectiv and Pepco are not business rivals in the generation market. Pepco has
effectively exited the generation business and owns only 806 MW of generating
capacity./30 Conectiv is greatly reducing its presence in that business. The
Applicants have submitted market concentration analysis showing two potential
scenarios: the first assumes that Conectiv's post-Transaction ownership of
generating capacity will be 5,080 MW; the second assumes that the nuclear and
NRG sales are completed and that Conectiv's post-Transaction ownership of
generating capacity will be 2,878 MW./31 Total PJM capacity (exclusive of
imports) is forecast to be about 63,797 MW in 2002. Under either scenario, the
market concentration analysis demonstrates that the Transaction has no adverse
competitive effect as it will not result in a material increase in market
concentration within PJM (either considered as a whole or within the three
distinct markets considered to reflect the presence, from time to time, of
internal PJM transmission constraints.)/32
----------------------------
27/ 16 U.S.C.ss.824b(a). The factors that FERC focuses on in making this public
interest determination are set out in its Inquiry Concerning the Commission's
Merger Policy Under the Federal Power Act: Policy Statement, Order No. 592, 61
Fed. Reg. 68,595 (1996), reconsideration denied, Order No. 592-A, 62 Fed. Reg.
33,341 (1997) ("Merger Policy Statement").
28/ The FERC application is attached hereto as Exhibit G-1.
29/ Dr. Pace's testimony is attached hereto as Exhibit G-2.
30/ This generation capacity is oil-fired and operates only during very limited
hours of the year.
31/ Dr. Pace's analysis also treats all of Conectiv's purchased capacity, as
well as its minority-owned capacity as part of Conectiv's market share. As more
fully discussed in the FERC application and Dr. Pace's testimony, Pepco has no
control over the capacity associated with its purchased power.
32/ The Applicants own immaterial amounts of non-PJM generating capacity, which
was not deemed to be relevant to Dr. Pace's market concentration analysis.
38
The acquisition also does not have a significant effect on vertical market
power as a result of control over transmission, the siting of new generation, or
fuel supplies and delivery systems. Since the Applicants participate in the PJM
RTO, that is guided by FERC-approved market monitoring rules, they cannot
exercise market power through control of their bulk power transmission systems.
Transmission access to new generators is assured through the independent control
by PJM of the Applicants' transmission systems and the Commission's open access
policies.
The Applicants' FERC application also shows that the acquisition will not
adversely impact customer rates. The Applicants commit to hold wholesale
requirements and transmission customers harmless from the effects of the
Transaction by pledging not to charge those customers for any Transaction costs
that exceed any Merger savings. In addition, due to the rate freezes or caps
currently in place, the rates of the Applicants' retail customers cannot be
affected by the Transaction except to the extent permitted by state regulatory
commissions.
Lastly, the acquisition will not impair effective regulation. The
regulation of Pepco Holdings' utility subsidiaries will not be affected. The
acquisition does not alter the corporate form of Pepco Holdings' public utility
subsidiaries, which will continue to be subject to FERC regulation and (with the
exception of CAG and CDG, which are subject only to FERC regulation) state
regulation, in particular, as to its rates, operations and services. The FERC
approved the application on September 26, 2001.
For all these reasons, the acquisition does not result in the concentration
of control of public utility companies to an extent detrimental to the public
interest or the interest of investors or consumers and the Commission should
find the standards of Section 10(b)(1) satisfied.
b. Section 10(b)(2)
i. Fairness of Consideration
Section 10(b)(2) precludes approval of the acquisition if the Commission
finds that the consideration paid by Pepco Holdings for Conectiv is not
reasonable or does not bear a fair relation to the sums invested in or the
earning capacity of the utility assets underlying the securities to be acquired.
Pepco Holdings' registration statement on Form S-4 includes an
39
extensive discussion of the analysis conducted by Merrill Lynch and Credit
Suisse First Boston in arriving at their opinions./33
As explained in the registration statement, Merrill Lynch delivered to the
Pepco Board its opinion that, as of that date and based on the assumptions made,
matters considered and limitations reviewed with the Pepco Board, the Pepco
exchange ratio was fair from a financial point of view to the holders of Pepco
Common Stock, taking into account the Conectiv Merger, and the consideration to
be paid by Pepco in connection with the Conectiv Merger was fair from a
financial point of view to Pepco. In addition, Credit Suisse First Boston
delivered to the Conectiv Board an opinion to the effect that, as of that date,
and based on and subject to the matters described in the opinion, the Conectiv
Common Stock consideration was fair, from a financial point of view, to the
holders of Conectiv Common Stock and the Conectiv Class A Common Stock
consideration was fair, from a financial point of view, to the holders of
Conectiv Class A Common Stock.
Market prices at which securities are traded have always been strong
indicators as to values. As shown in the table below, the quarterly price data,
high and low, for Conectiv common stock and Conectiv Class A Common Stock (prior
to, and therefore unaffected by, announcement of the Transaction) provides
support that the consideration of approximately $25.00 and $21.69 per share
(depending on the operation of the exchange ratio) for each share of Conectiv
Common Stock or Class A Common Stock, respectively, is fair./34
----------------------------
33/ Pepco Holdings' registration statement on Form S-4 is included as Exhibit
B-2 hereto. The Merrill Lynch and Credit Suisse First Boston fairness opinions
are found in Appendices D and E to the registration statement.
34/ Because Pepco Common stock will be exchanged on a one-for-one basis for
Pepco Holdings Common Stock, the Applicants treat those shares as equivalent.
40
Pepco Common Stock Conectiv Common Stock Conectiv Class A C/S
Price Dividend Price Dividend Price Dividend
High Low Declared High Low Declared High Low Declared
1999
First $26.50 $23.00 $0.415 $24.38 $19.38 $0.385 $40.00 $34.88 $0.800
Quarter
Second $31.75 $23.13 $0.415 $25.50 $19.38 $0.220 $42.25 $34.38 $0.800
Quarter
Third $31.31 $25.06 $0.415 $25.25 $19.00 $0.220 $43.00 $37.31 $0.800
Quarter
Fourth $28.06 $21.25 $0.415 $20.75 $16.25 $0.220 $40.81 $26.50 $0.800
Quarter
2000
First $27.69 $19.06 $0.415 $18.25 $13.44 $0.220 $21.75 $23.13 $0.800
Quarter
Second $27.88 $20.94 $0.415 $18.81 $15.00 $0.220 $24.63 $19.38 $0.800
Quarter
Third $27.44 $23.63 $0.415 $19.19 $15.50 $0.220 $25.56 $17.75 $0.800
Quarter
Fourth $25.56 $21.50 $0.415 $20.75 $15.81 $0.220 $20.25 $8.50 $0.800
Quarter
2001
First $24.90 $20.20 $0.415 $22.50 $17.19 $0.220 $22.80 $12.63 $0.800
Quarter
February $21.39 $20.60 (Closing) $21.34 $20.92 (Closing) $22.05 $20.50 (Closing)
9, 2001* $21.35 $21.00 $22.00
* Last full trading day before the public announcement of the execution of the
Merger Agreement.
More importantly, however, the consideration agreed to by the parties was
the product of arm's-length negotiation. See the summary of the companies'
preliminary discussions in Item 1.D.2, supra. The Commission has found
"persuasive evidence" that the standards of Section 10(b)(2) are satisfied
where, as here, the agreed consideration for an acquisition is the result of
arm's-length negotiations between the managements of the companies involved,
supported by the opinions of financial advisors./35
Finally, the acquisition has been submitted to and approved by the affected
public shareholders, i.e., the common and preferred stockholders of Pepco and
common and Class A common stockholders of Conectiv.
ii. Reasonableness of Fees
The Applicants believe that the estimated overall fees, commissions and
expenses incurred and to be incurred in connection with the Transaction are
reasonable and fair in light of the size and complexity of the transaction
relative to other transactions and the anticipated benefits of the acquisition
to the public, investors and consumers; that they are consistent with recent
precedent; and that they meet the standards of Section 10(b)(2).
----------------------------
35/ See Southern Co., Holding Co. Act Release No. 24579 (Feb. 12, 1988).
41
The fees and expenses that the Applicants expect to incur in connection
with the Transaction total approximately $45.8 million. This amount represents
2.1% (based on a purchase price of $2.2 billion) of the value of the
consideration to be paid by Pepco Holdings to Conectiv's stockholders. This
percentage is consistent with percentages previously approved by the
Commission./36
c. Section 10(b)(3)
Section 10(b)(3) requires the Commission to determine whether the
acquisition will unduly complicate Pepco Holdings' capital structure or be
detrimental to the public interest, the interest of investors or consumers or
the proper functioning of the Pepco Holdings system.
The proposed Transaction will not unduly complicate the capital structure
of Pepco Holdings or its subsidiaries. The financing of the Transaction will not
affect the priorities, preferences, voting power, or other rights of the holders
of the outstanding securities of Pepco Holdings or its subsidiaries. The
proposed transactions do not involve the creation of any minority interests. As
a result of the Transaction, Conectiv's common stock will become wholly owned by
Pepco Holdings and its publicly held debt will remain outstanding, unaffected by
the Transaction. Moreover, neither Conectiv nor Pepco Holdings will have
classified common stock following the Transaction. Similarly, Pepco Common Stock
will be wholly owned by Pepco Holdings and Pepco preferred stock and publicly
held debt will remain unaffected.
Post-Transaction, the Applicants will fall within the seventy-to-thirty
percent debt-to-common equity ratio generally prescribed by the Commission./37
On a pro forma basis, as the following table shows, assuming the Transaction was
consummated on December 31, 2001, common shareholders' equity would have been
32% of Pepco Holdings' total capitalization.
----------------------------
36/ See, e.g., New Century Energies, Inc., Holding Co. Act Release No. 27212
(Aug. 16, 2000) ("New Century Energies") (fees and expenses of approximately $52
million represented approximately 1.4% of the value of the consideration to be
paid for New Century Energies, Inc.); AEP Merger Order (fees and expenses of
approximately $73 million represented approximately 1.1% of the value of the
consideration to be paid for Central and South West Corporation); Entergy Corp.,
Holding Co. Act Release No. 25952 (Dec. 17, 1993) ("Entergy")(fees and expenses
represented approximately 1.7% of the value of the consideration paid to the
shareholders of Gulf States Utilities); Northeast Utilities, Holding Co. Act
Release No. 25548 (June 3, 1992) (fees and expenses of approximately 2% of the
value of the assets to be acquired).
37/ See, e.g., The National Grid Group plc, Holding Co. Act Release No. 27154
(Mar. 15, 2000) ("National Grid").
42
Pro Forma Capital Structure
(see also Item 1.C.3 for combining information)
($ millions) % of Total Capitalization
Long-term debt (including
Transaction financing) 3,658.1 40
Short term debt 2,054.4 23
Company obligated mandatorily
redeemable preferred securities of
subsidiary trust which holds solely
parent junior subordinated debentures 290.0 3
Preferred stock 133.1 2
Shareholders' equity 2,921.2 32
Total capitalization 9,056.8 100
Section 10(b)(3) also requires that a proposed acquisition not be
detrimental to the public interest, the interest of the investors or consumers
or the proper functioning of the resulting holding company system. As set forth
more fully in the discussion of the standards of Section 10(c)(2), below, and
elsewhere in this Application, the acquisition will benefit shareholders and
consumers. The combination will result in a fully integrated utility system and
will produce savings and benefits to the public, consumers and investors that
would, quite possibly, be otherwise unavailable.
As noted by the Commission in Entergy, "concerns with respect to investors'
interests have been largely addressed by developments in the federal securities
laws and the securities markets themselves." In this regard, following
completion of the Transaction, Pepco Holdings will be a reporting company
subject to the disclosure requirements of the Securities Exchange Act of 1934
that will provide investors with readily available information concerning Pepco
Holdings and its subsidiary companies.
The Transaction is also subject to various other federal and state
regulatory approvals as discussed in Item 4. In particular, FERC's review and
approval of the Transaction
43
assures that there will be no significant effect to competition. The numerous
regulatory reviews provide adequate protection for the public interest and the
interest of customers.
Finally, the Applicants note that the incurrence of acquisition
indebtedness is not detrimental to investor's interests. As the Commission has
previously recognized in the Conectiv Merger Order, under Section 7(c)(2)(A) of
the Act, a registered holding company can issue other than plain vanilla
securities "solely . . . for the purpose of effecting a merger, consolidation,
or other reorganization." Indeed, the issue for purposes of Section 10(b)(3) is
not the existence of parent-level debt per se. Rather, the question is whether
it is permissible for a registered system to have debt at more than one level.
The Commission has answered this question in the affirmative. In the 1992
amendments to Rule 52, the Commission eliminated the requirement that a
public-utility subsidiary company could issue debt to nonassociates only if its
parent holding company had issued no securities other than common stock and
short-term debt. The rule release explains:
Condition (6) provides that a public-utility subsidiary company may issue
and sell securities to nonassociates only if its parent holding company has
issued no securities other than common stock and short-term debt. All eight
commenters that considered this condition recommended that it be
eliminated. They noted that it may be appropriate for a holding company to
issue and sell long-term debt and that such a transaction is subject to
prior Commission approval. They further observed that other controls, that
did not exist when the statute was enacted, provide assurance that such
financings will not lead to abuse. These include the likely adverse
reaction of rating agencies to excessive amounts of debt at the parent
holding company level and the disclosure required of companies seeking
public capital. The Commission agrees with these observations and also
noted the power of many state utility commissions to limit the ability of
utility subsidiaries to service holding company debt by restricting the
payment of dividends to the parent company. The Commission concludes that
this provision should be eliminated.
Exemption of Issuance and Sale of Certain Securities by Public-Utility
Subsidiary Companies of Registered Public-Utility Holding Companies, Holding Co.
Act Release No. 25573 (July 7, 1992).
For these reasons, the Applicants submit that investors' interests in Pepco
and Conectiv will continue to be protected and that the Commission has no basis
for making a negative finding under Section 10(b)(3). The acquisition of Pepco
and Conectiv by Pepco
44
Holdings will be in the public interest and in the interest of investors and
consumers, and will not be detrimental to the proper functioning of the
resulting holding company system.
2. Section 10(c)
i. Section 10(c)(1)
Section 10(c)(1) prohibits the Commission from approving an acquisition if
it would be unlawful under the provisions of Section 8 or detrimental to
carrying out the provisions of Section 11.
Section 8 prohibits Commission approval of an acquisition by a registered
holding company of an interest in an electric utility and a gas utility serving
substantially the same territory without the express approval of the state
commission when the state's law prohibits or requires the approval of the
acquisition. In this case, the acquisition will not cause the overlap of an
electric and gas utility systems and, therefore Section 8 is not applicable./38
In addition, as explained below, the acquisition will not be detrimental to
carrying out the provisions of Section 11. The primary electric operations of
Conectiv and Pepco will result in a single integrated electric utility system.
Integration will result primarily from the companies' membership in PJM, which
is highly interconnected and coordinated, and will be accomplished by the
functioning of the open, competitive markets administered by the PJM RTO.
Sellers and purchasers within PJM's control area may engage in transactions
among themselves through readily-accessible, OASIS-based transmission access. In
addition, coordination will be further achieved through the utilization by Pepco
Holdings' subsidiaries of the services of the Service Company.
The Delmarva gas system will also result in a separate integrated gas
utility system and is a permissible additional system under Section 11(b)(1)A-C
(the "ABC clauses") and the Commission's order in the Conectiv Merger Order.
(a) Section 11, Integrated Utility System
Section 11 (b)(1) directs the Commission to require each registered holding
company system to limit its utility operations to "a single integrated
public-utility system" and
----------------------------
38/ Further, the only electric and gas utilities in the combined system that
serve substantially the same territory already do so in compliance with
applicable state law. See Conectiv Merger Order.
45
"such other businesses as are reasonably incidental, or economically necessary
or appropriate to the operations of such integrated public utility system."
Section 2(a)(29)(A) defines an integrated public utility system with respect to
electric utility companies as:
a system consisting of one or more units of generating plants and/or
transmission lines and/or distributing facilities, whose utility assets,
whether owned by one or more electric utility companies, are physically
interconnected or capable of physical interconnection and which under
normal conditions may be economically operated as a single interconnected
and coordinated system confined in its operations to a single area or
region, in one or more states, not so large as to impair (considering the
state of the art and the area or region affected) the advantages of
localized management, efficient operation, and the effectiveness of
regulation.
The Commission has established four standards that must be met before it
will find that a proposed combination of utilities will result in an integrated
electric system:
1. the combined utility assets must be physically interconnected or
capable of physical interconnection ("interconnection requirement");
2. the combined utility assets, under normal conditions, must be
economically operated as a single interconnected and coordinated
system ("economic and coordinated operation requirement");
3. the system must be confined in its operations to a single area or
region ("single area or region requirement"); and
4. the system must not be so large as to impair (considering the state of
the art and the area or region affected) the advantages of localized
management, efficient operation, and the effectiveness of regulation
("no impairment requirement").
In its review of the merger of Delmarva and ACE (which resulted in the
formation of Conectiv), the Commission found that the merger of two companies
interconnected through the PJM ISO and operated on an integrated basis with
those of other PJM members did result in an integrated system under the Act. The
Commission also held that the additional gas system of Delmarva could be
retained. See Conectiv Merger Order. In addition, the Commission found
46
that, although the electric service territories of ACE and Delmarva were not
contiguous, and the companies were not directly interconnected, the combined
electric properties satisfied each of the four requirements for integration by
virtue of their membership in the PJM ISO. Id. As described below, the electric
systems of Pepco and Conectiv also constitute an integrated system.
The PJM RTO
Pursuant to a FERC Order issued in 1997, PJM was authorized, as an
Independent System Operator, to administer transmission service under a poolwide
transmission tariff and provide open access transmission service on a poolwide
basis. The ISO began operation in January 1998 and is responsible for system
operations and regional transmission planning. In addition, FERC decided that
the independent body that operates the ISO may also operate the PJM power
exchange. FERC approved the power pool's use of single, non-pancaked
transmission rates to access the ten transmission systems that make up PJM.
Pursuant to a rate design in effect since April 1997, each transmission owner
within PJM has its own transmission rate, whereby the transmission customer will
pay a single rate based on the cost of the transmission system where the
generating capacity is delivered. FERC also approved, effective April 1998,
locational marginal pricing for managing scarce transmission capability. This
method is based on price differences in energy at the various locations on the
transmission system. In March 1999, FERC approved market-based rates for pricing
sales through the PJM energy market and a market monitoring plan. On July 12,
2001 the FERC conditionally granted RTO status to PJM.
The Interconnection Requirement
The electric transmission facilities of Conectiv and Pepco are
interconnected through their investment in jointly owned transmission lines in
the PJM system and through the facilities of other members of the PJM RTO. Pepco
and Conectiv each have investments in and are, directly or indirectly,
interconnected with the EHV that traverses most of Pennsylvania. Pepco connects
to the EHV directly at its Brighton substation, and Conectiv connects indirectly
to EHV through a direct connection to LDV (which interconnects with EHV) at the
Keeney and Red Lion substations owned by Delmarva and the New Freedom
substation, in which ACE has an ownership interest. Delmarva and ACE, together
with PJM, serve as the means of interconnecting the facilities of CEH's
generation subsidiaries. The PJM transmission owning
47
members, including Pepco, ACE and Delmarva, own part of the transmission lines
that connect them. Going forward, pending FERC approval, new transmission lines
in PJM will be jointly owned by the transmission owning members as a tenancy in
common, creating a "virtual transco."
The Commission has previously found the interconnection requirement
satisfied on the basis of contractual rights to use a third-party's transmission
lines./39 In several of these cases, holding companies had secured firm
contracts to use third-party lines, and in other cases holding companies relied
on participation in power pools to satisfy the physical interconnection
requirement. In such situations, the Commission has focused on the actual
ability of the holding company systems to access third-party transmission lines
and has found that so long as there is an ability to use third-party lines,
those paths are sufficient to satisfy the physical interconnection requirement.
The Commission has also found that the interconnection requirement was
satisfied through participation in a tight power pool, where the companies were
indirectly interconnected through the pool transmission facilities./40 This
understanding was recently reiterated by the United States Court of Appeals for
the District of Columbia Circuit in its review of the Commission's order in the
AEP/CSW merger case./41
The Applicants will use a collection of transmission access rights
representing current standard techniques for operating a single interconnected
and coordinated system economically under normal conditions. The interconnecting
transmission paths between the Applicants will be accessible pursuant to the PJM
OATT. Under the PJM OATT, PJM is required to provide open access to the PJM
members' transmission lines to all parties requesting service so long as
capacity is available.
As a matter of right under Order No. 888, two utilities can arrange
contractually for transmission to achieve interconnection solely by relying on
an OATT. All parties, including
----------------------------
39/ See Unitil Corp., Holding Co. Act Release No. 25524 (Apr. 24, 1992)
("Unitil"); Conectiv Merger Order; C&T Enterprises, Inc., Holding Co. Act
Release No. 26973 (Feb. 5, 1999).
40/ See Unitil and Conectiv Merger Order.
41/ Nat'l Rural Elec. Coop. Ass'n, v. SEC, 2002 U.S. App. LEXIS 777 (D.C. Cir.
Jan. 18, 2002).
48
transmission facility owners, reserve transmission services electronically
through the owner's OASIS. Service is reserved for a specific amount of power
and for a specific period of time, which may be as short as one hour or as long
as several years. Service can also be reserved on a firm or non-firm basis. In
all cases, a party will reserve service on the basis of terms and conditions
that, in its business judgment, represent the economically and operationally
preferable alternative. In addition, OATTs establish a hierarchy of service and
a corresponding variation in cost. "Firm" service is the most reliable. It is
available on a long-term (i.e., one year or more), monthly, weekly or daily
basis. A transmission provider may "cut" (i.e., refuse to initiate or curtail
use of the transmission for energy deliveries notwithstanding the firm
reservation) only when a threat to system reliability appears, i.e., in
emergency situations. All users of firm service, including the transmission
facility owner with respect to its "native load," must receive equal treatment
when service is cut.
The Economic and Coordinated Operation Requirement
Where previously vertically integrated companies combined generation,
transmission and distribution functions to provide a "bundled" product,
delivered electricity, to retail customers within franchised service areas,
under the new functionally, or operationally separated industry structure,
separate companies, or separate functional/operational components of companies,
perform the generation, merchant, transmission and distribution functions, with
the goal of fostering competition in the generation sector.
Among other things, these structural changes have resulted in the rapid
development of wholesale markets through which load-serving utilities, retail
aggregators, and individual retail customers are able to obtain needed
electricity products. Many states, including the states in which Pepco and
Conectiv operate, have implemented or are considering open access at the retail
level. Where retail open access is provided, retail customers have the ability
to "shop" for their electric power from a power supplier other than their
traditional distribution utility. The distributor is obligated to deliver the
third-party power supplies to the customer.
The FERC has recognized that the efficient functioning of the transmission
grid is critical to connecting buyers with the competitive generation markets
and has promoted the formation of Regional Transmission Organizations to reduce
the barriers to the free flow of
49
power and increase reliability and transmission efficiency./42 Having evolved
from a tight power pool with a history of coordinated operations, PJM is a good
example of the trend towards the regionalization of electric transmission
operations. Similar to what the Commission found in the Conectiv Merger Order,
with regard to ACE and Delmarva, the transmission and distribution systems of
Pepco and Conectiv are now used, and in the future will increasingly be used in
a coordinated manner, to accomplish transfers of power between generation and
load within the PJM region, because of their membership in the PJM RTO. In sum,
the coordination of transmission operations within the PJM RTO effectively
coordinates the operations of Pepco, ACE, Delmarva and CEH's generation
subsidiaries in satisfaction of the economic and coordinated operations
requirement./43
The PJM RTO engages in coordinated activities so that its members may
participate in a single market, with free-flowing inter-ties that are available,
on an open-access basis, to purchasers and sellers of electric energy and
related energy products. Also, PJM and its individual members, including ACE,
Delmarva and Pepco, participate in joint pool and regional transmission planning
and reliability studies. PJM operates as a non-profit organization and includes
over 200 investor-owned utility ("IOU") and non-IOU members, and operates
centralized power markets. In addition, PJM performs congestion management to
free up transmission capacity for the most economic uses of the system.
Although coordination between merging utilities has traditionally been
shown by using joint operating agreements to dispatch generating plants on a
coordinated basis,/44 as the Commission found in the Energy East/45 matter, "the
fact that [the Energy East Applicants] are now essentially transmission and
distribution companies does not preclude a finding that the
----------------------------
42/ Regional Transmission Organizations, Order No. 2000, III FERC Stats. & Regs.
[Regs. Preambles]P. 31,089 (1999), on reh'g, rder No. 2000-A, III FERC Stats. &
Regs.P. 31,092 (2000), petitions for review pending sub nom., Pub. Util. Dist.
No. 1 of Snohomish County. v. FERC, Case No. 00-1174 (D.C. Cir. Apr. 24, 2000).
43/ See Energy East Corp., Holding Co. Act Release No. 27224 (Aug. 31, 2000)
("Energy East") (finding integration and coordination requirements satisfied
through the combined companies' participation in NY ISO and ISO-NE). See also,
Unitil (the combined electric utility assets of the companies may be operated as
a single interconnected and coordinated system through their participation in
NEPOOL).
44/ See AEP Merger Order (applicants implemented a joint operating agreement to
coordinate the efficient use of generating resources).
45/ Energy East.
50
combined electric properties are an integrated system." In addition to the
coordination of their transmission systems, Pepco, ACE, Delmarva and the
generation subsidiaries will also be economically operated as a single
interconnected and coordinated system through (1) coordinated power purchasing
to satisfy their standard offer service (provider of last resort) obligations,
(2) coordinated disaster response programs, (3) the sharing of utility supplies
inventories, and (4) the integration of a range of central and corporate
functions. The utilities' combined purchasing power can provide efficiencies in
their ability to obtain economies of scale and will provide a ready market for
power supplies that turn out to be in excess of one of the individual utility's
needs.
Single Area or Region Requirement
The third requirement for integration; the single area or region
requirement, is also satisfied. The combined post-Transaction system will extend
from New Jersey to Virginia. This service area, substantially in the
mid-Atlantic U.S., is essentially the same as the area found to be a single area
or region in the Conectiv Merger Order. The Commission has made clear that the
"single area or region" requirement does not mandate that a system's operations
be confined to a small geographic area or a single state. In considering size,
the Commission has consistently found that utility systems spanning multiple
states satisfy the single area or region requirement of the Act./46 In addition,
the high degree of operational coordination and energy trading that occurs
within the PJM RTO demonstrate that the mid-Atlantic U.S. is a single area or
region in both operational and economic terms.
The No Impairment Requirement
Lastly, the combined Conectiv and Pepco system will not be so large as to
impair (considering the state of the art and the area or region affected) the
advantages of localized management, efficient operation, and the effectiveness
of regulation. Pepco Holdings will adopt a local management structure to
efficiently operate and manage the combined system. ACE and Delmarva will stay
responsive to customer needs on the local level. Conectiv's operational
decisions will continue to be made by Conectiv's management team, headquartered,
as they are
----------------------------
46/ See, e.g., Southern Co. Holding Co. Act Release No. 24579 (Feb. 12, 1988)
(approving an electric utility system covering portions of four states) and New
Century Energies, Inc., Holding Co. Act Release No. 26748 (Aug. 1, 1997)
(approving a utility system covering portions of five states.)
51
now, in Wilmington, Delaware. There will be at least two Conectiv directors on
Pepco Holdings' board of directors. Pepco and Conectiv, and Conectiv's public
utility subsidiaries will continue to be subject to the regulation of FERC and
(with the exception of CAG and CDG) their respective state commissions. In sum,
Pepco and Conectiv will preserve all the benefits of localized management that
they currently enjoy while coordinating their management so as to achieve the
economies and efficiencies of operation from the Transaction.
(b) Section 11, Retention of the Additional Gas System
As the Commission found in the Conectiv Merger Order, under New Jersey,
Virginia, Delaware and Pennsylvania law, Conectiv was permitted to own both the
gas and electric properties that constitute the Conectiv system. Thus, the
requirements of Section 8 of the Act are satisfied.
Under Section 10(c)(1) of the Act, the Commission may not approve an
acquisition that would be "detrimental to the carrying out of the provisions of
Section 11." Section 11(b)(1) of the Act generally confines the utility
properties of a registered holding company to a "single integrated
public-utility system," either gas or electric. An exception to the requirement
of a "single system" is provided in the ABC clauses./47 A registered holding
company may own one or more additional integrated public utility systems, i.e.,
gas as well as electric, if each system meets the criteria set forth in these
clauses.
The acquisition of the Delmarva gas system by Pepco Holdings meets the
criteria contained in the ABC clauses, for the same reasons that the acquisition
of the Delmarva gas system by Conectiv did. See Conectiv Merger Order. As the
Commission found in the Conectiv Merger Order, after reviewing the studies
submitted by Conectiv, the loss of economies resulting from the divestiture of
the gas system would be significantly higher than the thresholds established in
Commission precedent, thus satisfying the requirements under clause A. In
addition, the Commission found that the acquisition of the Delmarva gas system
by Conectiv did not raise issues under clauses B or C. The principal electric
system of Conectiv and Delmarva were located in adjoining states and the
combination of systems was not "so large as to impair ... the advantages of
localized management, efficient operations, or the effectiveness of regulation."
----------------------------
47/ See, generally, NIPSCO Industries, Inc., Holding Co. Act Release No. 26975
(Feb. 10, 1999).
52
The same analysis applies to the acquisition of the Delmarva gas system by Pepco
Holdings. Neither the relevant facts nor the applicable law changed since then.
(c) Non-Utility Subsidiaries
The acquisition of Pepco and Conectiv introduces several new non-utility
subsidiaries into the Pepco Holdings System, but the Applicants believe that all
of Pepco and Conectiv's non-utility businesses are energy-related or otherwise
retainable under the Commission's rules and precedent.
Section 11(b)(1) limits the non-utility interests of a registered holding
company to those that are "reasonably incidental, or economically necessary or
appropriate to the operations of such integrated public-utility system," on a
finding by the Commission that such interests are "necessary or appropriate in
the public interest or for the protection of investors or consumers and not
detrimental to the proper functioning" of the integrated system. The Commission
has interpreted these provisions to require: (i) the existence of an operating
or functional relationship between the utility operations of the registered
holding company and the non-utility activities sought to be retained,/48 and
(ii) that the retention is in the public interest./49 A non-utility business may
also be retained if it evolved out of the system's utility business, the
investment is not significant in relation to the system's total financial
resources and the investment has the potential to produce benefits for investors
and/or consumers./50
Rule 58 under the Act codifies the types of permissible non-utility
activities retainable by registered systems by exempting from Section 9(a) of
the Act acquisitions by registered holding companies of the securities of
energy-related companies or gas-related companies. With respect to
energy-related companies, a holding company's aggregate investment in such
energy-related companies may not exceed the greater of $50 million or 15% of the
consolidated capitalization of the registered holding company. Rule
58(a)(1)(i)-(ii). Rule 58
----------------------------
48/ See generally, Michigan Consolidated Gas Co., Holding Co. Act Release No.
16763 (June 22, 1970), aff'd, 444 F.2d 913 (D.C. Cir. 1971).
49/ See, e.g., id. quoting General Public Utilities Corp., Holding Co. Act
Release No. 10982 (Dec. 28, 1951); United Light and Railways Co., Holding Co.
Act Release No. 12317 (Jan. 22, 1954).
50/ CSW Credit, Inc., Holding Co. Act Release No. 25995 (Mar. 2, 1994); Jersey
Central Power and Light Co., Holding Co. Act Release No. 24348 (Mar. 18, 1987).
53
defines "energy-related company" as a company that, directly or indirectly,
derives substantially all of its revenues from certain enumerated activities
such as rendering energy management services, the sale of electric and gas
appliances and the development of certain energy-related technologies./51
As discussed in Exhibit K-1 herein, each of Pepco and Conectiv's active
non-utility businesses is retainable.
ii. Section 10(c)(2)
Section 10(c)(2) requires the Commission to examine whether a proposed
acquisition will serve the public interest by tending towards the economical and
efficient development of an integrated public utility system. The Transaction
will result in benefits to investors, consumers and the public interest and
represents an opportunity for growth.
The Transaction allows Pepco Holdings to build on the platform Pepco and
Conectiv have created in PJM and reinforce the combined company's position as a
leading player in the mid-Atlantic region, which is at the forefront of the
electric industry's restructuring in the U.S. The addition of Conectiv's
experience with gas operations strengthen Pepco Holdings' ability to provide
services that will benefit customers in today's rapidly changing U.S. energy
markets. Pepco Holdings intends to continue to contribute to the current debate
on the restructuring of the U.S. transmission sector.
Finally, as previously discussed, the strategic combination will improve
the two companies' ability to grow earnings in the changing energy marketplace
and give the combined company the size and scope needed to compete more
effectively in the energy delivery and related retail services market.
Although some of the anticipated benefits are strategic and will be fully
realizable only in the longer term, they are properly considered in determining
whether the standards of Section 10(c)(2) are met./52 The Commission has
recognized that potential benefits are entitled to be considered, regardless of
whether they can be precisely estimated: "[S]pecific dollar forecasts
----------------------------
51/ The Act also allows registered holding companies to acquire and maintain
interests in the following exempt entities: exempt telecommunications companies
(Section 34), foreign utility companies (Section 33) and exempt wholesale
generators (Section 32).
52/ See National Grid.
54
of future savings are not necessarily required; a demonstrated potential for
economies will suffice even where these are not precisely quantifiable."/53
3. Section 10(f)
Section 10(f) prohibits the Commission from approving an acquisition unless
the Commission is satisfied that the acquisition will be undertaken in
compliance with applicable state laws. As described in Item 4, the acquisition
will be consummated in compliance with all applicable state laws.
4. Section 11(b)(2)
Section 11(b)(2) of the Act requires that "the corporate structure or
continued existence of any company in the holding company system does not unduly
or unnecessarily complicate the structure, or unfairly or inequitably distribute
voting power among security holders, of such holding-company system." Section
11(b)(2) also requires each registered system company "to take such action as
the Commission shall find necessary in order that such holding company shall
cease to be a holding company with respect to each of its subsidiary companies
which itself has a subsidiary company which is a holding company," in other
words, to eliminate "great-grandfather" holding companies.
After the consummation of the Transaction, Conectiv will become a
subsidiary company of Pepco Holdings and will be a holding company with respect
to CEH. Conectiv will be a great-grandfather company with respect to one of
CEH's utility subsidiaries. This structure, which results from the superposition
of Pepco Holdings over the existing and previously approved Conectiv holding
company structure, cannot be altered without a substantial tax burden./54 The
creation of CEH precedes the combination of Pepco and Conectiv and occurred in
----------------------------
53/ Centerior Energy Corp., Holding Co. Act Release No. 24073 (Apr. 29, 1986)
(citation omitted). See also Energy East Corp., Holding Co. Act Release No.
26976 (Feb. 12, 1999) (authorizing acquisition based on strategic benefits and
potential, but unquantifiable, savings).
54/ Because of the structure of the Transaction and the cash consideration to be
paid to Conectiv stockholders, under Section 355(b)(2)(D) of the Internal
Revenue Code, the restructuring of any Conectiv subsidiaries as part of the
Transaction and for a five year "seasoning" period thereafter in order to make
the Conectiv subsidiary a direct Pepco Holdings subsidiary would be treated as a
taxable distribution and would result in an immediate taxable event on the state
level and a deferred taxable event on the federal level. The resulting loss that
the Pepco Holdings system would experience if CEH were to be restructured as a
direct subsidiary of Pepco Holdings is currently estimated to be a minimum of
$36 million after taxes.
55
response to the changes in the regulatory environment in which Conectiv conducts
its electric utility business./55
As discussed in the CEH Order, CEH was formed as a wholly owned
intermediate holding company to hold ownership interests previously held by
Delmarva and ACE in mid-merit generating facilities. CEH owns 100% of the stock
of ACE REIT, CESI/56, CDG and CPGI. In addition, ACE REIT owns 100% of the
interests in CAG, a merchant generation company. CEH's subsidiaries CDG, CAG and
CPGI are utilities within the meaning of the Act. Thus, at the creation of CEH,
Conectiv was already a great-grandfather company with regard to ACE-REIT's
subsidiary CAG. The Commission in the CEH Order expressly approved this
structure./57
In this respect, the CEH Order simply follows the precedent established in
a number of recent cases in which the Commission has permitted the existence of
holding company structures containing three or more layers (i.e., a
"great-grandfather holding company"). Generally, the Commission found that under
the facts of each case, the corporate structure did not implicate the abuses
that section 11(b)(2) was designed to address, i.e., the pyramiding of holding
company groups with the interposition of one or more holding companies between
the ultimate parent holding company and the operating companies, and the
issuance, at each level of the structure, of different classes of debt or stock
with unequal voting rights./58 In addition, as described in more detail in the
separate Application-Declaration on Form U-1 filed by the Pepco Holdings system
companies with respect to post-Transaction financing activities
----------------------------
55 See Conectiv, Holding Co. Act Release No. 27192 (June 29, 2000) ("CEH Order")
(authorizing the creation of CEH). In connection with the issuance of Release
No. 35-27415 in File No. 70-9095 (June 7, 2001), CEH and ACE REIT agreed to
register under the Act and are in fact now deemed to be so registered. All
reporting requirements under the Act for CEH and ACE REIT are subsumed in the
reporting requirements for Conectiv. After the Transaction, all reporting
requirements under the Act for Conectiv, CEH and ACE REIT will be subsumed in
the reporting requirements for Pepco Holdings.
56 Named Delmarva Energy Company at the time of the Conectiv Merger Order and
later renamed.
57 In the CEH Order, the Commission observed that it would not, under certain
circumstances, deem intermediate holding companies to be holding companies for
the purposes of Section 11(b)(2) of the Act, where the intermediate holding
company was a special purpose entity designed for the sole purpose of capturing
economic efficiencies that might otherwise be lost.
58 National Grid, Energy East, Exelon Corp., Holding Co. Act Release No. 27256
(Oct. 19, 2000), KeySpan Corp., Holding Co. Act Release No. 27271 (Nov. 7,
2000).
56
(File No. 70-9947), the Applicants are in the process of seeking the necessary
approvals to obtain exempt wholesale generator status for the utility
subsidiaries of CEH and ACE REIT, which, once obtained, will result in CEH and
ACE REIT ceasing to be holding companies within the meaning of the Act.
The Transaction will not result in a change in the corporate structure of
the Conectiv and CEH subsidiaries (other than the superposition of Pepco
Holdings as the holding company of Conectiv). Neither Conectiv nor CEH or their
subsidiaries will borrow or issue any security or pledge any assets to finance
the Transaction./59 Thus, implementation of the proposed Transaction structure
will not result in an unduly complicated capital structure of the Conectiv
system, to the detriment of protected interests. Consequently, it is appropriate
to "look through" the intermediate holding companies (or to treat the
intermediate holding companies and Conectiv as a single company) for purposes of
the analysis under Section 11(b)(2) of the Act. Additionally, in this case, the
economic benefits associated with the retention of the additional corporate
layers outweighs the potential for harm and the possibility that there could be
a recurrence of the financial abuses that the Act was intended to eliminate.
These circumstances support a finding that the corporate structure
resulting from the proposed Transaction will not unduly or unnecessarily
complicate the corporate structure, or unfairly or inequitably distribute voting
power among security holders of the holding company system.
5. Section 13 - Intra-system Provision of Services
After consummation of the Transaction, and during the transition period
described herein, both CRP (which may be renamed after the Transaction is
completed) and Pepco will provide Pepco Holdings, Conectiv, Pepco and other
system companies with certain system wide administrative, management and support
services such as, for example, executive management, financial services and
human resources. All services provided to Pepco Holdings or to both Pepco or any
of its current subsidiaries ("Pepco companies") and Conectiv or any of its
current subsidiaries ("Conectiv companies") by either CRP or Pepco will be
billed and allocated through
----------------------------
59/ Conectiv's existing medium term notes, $250 million aggregate principle
amount outstanding at March 31, 2001, are not redeemable at the option of
Conectiv without prepayment of the present value of all future interest
payments, and will remain outstanding at the closing of the Transaction. These
debt securities were issued prior to, and are not related to, the Transaction.
57
CRP in accordance with a Revised CRP Service Agreement submitted herein as
Exhibit J-1. In addition to these services that are immediately provided on a
system wide basis, during the transition period the parties intend to maintain
many of their currently existing internal service relationships. As a result,
during the transition period not all services will be provided on a system-wide
basis and CRP will continue to provide certain services solely to Conectiv
companies, while Pepco companies will continue to provide services solely to
Pepco companies. The Applicants have not yet completed their analysis of how
best to accomplish the goal of centralizing the service functions in the
combined company. The Applicants believe that this task is not capable of being
completed until after the companies are in fact merged. Therefore, the
Applicants propose certain interim arrangements described below. Once this
analysis is completed, Pepco Holdings will consolidate the provision of services
in a first tier system service company/60 as appropriate and subject to
Commission approval.
Transition Period
During a transition period, defined below, the Applicants propose to have
CRP function as an interim service company through which system wide services
are allocated and billed. CRP will provide services to Pepco Holdings as well as
both Pepco companies and Conectiv companies and these services will be allocated
and billed in accordance with the revised CRP service company agreement. In
addition, some Pepco employees will provide services to Pepco Holdings and Pepco
companies and Conectiv companies. Pepco will bill these services to CRP at cost
determined in accordance with Rules 90 and 91 of the Act, and CRP will then
allocate and bill the costs to the appropriate system companies in accordance
with the revised CRP service company agreement. During the transition period,
CRP will either be a direct or indirect subsidiary of Pepco Holdings. Applicants
note that there are tax implications involved in moving CRP to a direct
subsidiary of Pepco Holdings/61 as well as both management and regulatory
implications of having a system service company that is a subsidiary of an
intermediate holding company, which they are in the process of analyzing the
full impact of.
----------------------------
60/ To accomplish this, Applicants will either expand CRP's operations such that
it will serve as the system service company; provided that CRP has or will
become a direct subsidiary of Pepco Holdings, or alternatively form a new
company as a direct subsidiary of Pepco Holdings to serve as the system service
company.
61/ See Note 54 for a discussion of the tax implications of moving Conectiv
subsidiaries.
58
In addition to providing system wide services, during the transition
period, CRP will continue to provide certain services solely to Conectiv
companies, while Pepco companies will continue to provide certain services
solely to Pepco companies. All such services provided by either CRP or Pepco
companies for which an exemption is not requested herein under the caption
"Other Services" would be charged at cost as determined by Rules 90 and 91 of
the Act. If allocation is appropriate, charges for services provided by Pepco
companies to other Pepco companies, and charges for services provided by CRP to
Conectiv companies, will be allocated using an approved allocation formula from
the Revised CRP service company agreement.
Exhibit J-1 and J-2 herein consist of a revised service company agreement,
which is based on the existing and approved CRP service company agreement and
CRP's service company policy and procedures that will govern intra-system
provision of services during the transition period.
The services to be provided during the transition period may include the
following:
(a) Executive Management, including the services of the Chairman, CEO,
President, COO, Corporate Secretary and supporting staff;
(b) Financial Services, including corporate planning; strategic planning;
budgeting; treasury and finance including risk management, cash management,
financing, and funded plans administration; investor relations; shareholder
services, accounting services including general ledger, corporate accounting,
accounts payable, payroll, asset and project accounting; tax accounting
services; regulatory affairs; insurance and claims processing; and insurance and
claims administration;
(c) Human Resource Services, including compensation and benefit services;
personnel, employment and staffing; employee/labor relations; skills training
and management development; performance improvement; and organizational
development;
(d) Legal and Internal Audit Services, including internal audit services
and legal counsel related to general corporate issues;
(e) Procurement and Administrative Services, including security, asset
protection and investigative services; purchasing and storeroom management;
procurement and materials
59
management; vehicle resource management, including company vehicle maintenance;
general services including mail, graphics, records management and other office
services; building services including facilities management and building
maintenance; and real estate services, including rights-of-way;
(f) Customer Services, including customer service centers, billing, credit
and collections, cash remittance processing, administrative & technical support,
quality assurance and training, as well as a separate group that provides
billing of non-energy materials and services;
(g) Marketing Services, including sales; market product and sales planning;
market and customer research; direct response marketing; marketing
communication; and general corporate advertising/branding;
(h) Information Technology Services, including employee labor, contractors,
and other operating support of voice and information technology services, which
currently include the following: solutions management, including applications
delivery and support; information management, including data administration and
security; operations management mainframe support; help desk; desktop support;
network support; consulting services, including business technology management;
mid- range operations, support for non-mainframe, non-network systems; general
management and administration;
(i) Communications Services, including general corporate communications;
governmental affairs; community relations; sponsorships & contributions; and
employee communications;
(j) Environmental and Safety Services, including oversight of environmental
concerns related to air, water, land and waste, as well as compliance with
relevant regulations; reporting and compliance with safety regulations, and
oversight of corporate safety awareness programs;
(k) Regulated Electric and Gas Delivery Services, including the following
electric and gas delivery services: delivery senior management; delivery
business planning including, asset management, business planning, financial
analysis, distribution planning, engineering standards, interconnection planning
and arrangements, transmission planning, and value added
60
services; engineering services including distribution, substation and
transmission engineering, system protection, drafting and construction
management; system operations services including senior management, finance
director and administrative support, electric and energy system operations,
distribution operations, and operations planning and analysis; electric
maintenance services including non-regional management and administrative
support; forestry supervision; meter shop; other delivery services including
process improvement, training, safety, performance analysis, benchmarking, and
enabling systems;
(l) Energy Business Services, including energy senior management, financial
analysis and generation, as well as non-regulated operations and management;
merchant functions including marketing, portfolio management, risk management,
and strategic planning; and supply engineering and support including technical
support and project management; and
(m) Internal Consulting Services, including consulting in areas such as the
alignment of people, processes and technologies with a goal of improving
productivity and reducing costs for a business line or shared service
department.
The services provided by CRP will be billed under the Revised CRP Service
Company Agreement. The system wide services provided by Pepco will also be
billed under the Revised CRP Service Company Agreement.
As noted above, Applicants intend to restructure CRP as a direct subsidiary
of Pepco Holdings and following the transition period further expand CRP's role
to provide more centralized services (or alternatively form a new service
company as a first tier subsidiary of Pepco Holdings to provide such centralized
services) and request that they be allowed to maintain their interim service
company arrangements until the later of January 1, 2003 or approval of new
service company arrangements by the Commission (the "transition period").
Applicants commit to file, within six months of the consummation of the
Transaction, a revised service agreement and service company policy and
procedures that address the final service company arrangements to be proposed.
At such time, any new service company will have been formed. Consistent with
CRP's current operations, the headquarters of the service company will be in the
same location as Pepco Holdings' headquarters (currently in Washington, D.C.)
while system company personnel may be located at various system locations as
appropriate for the service provided.
61
Applicants believe that their approach to service company arrangements
provides them with the appropriate degree of flexibility to integrate their
operations in a manner consistent with applicable laws and regulations./62
Accordingly, the Applicants request authorization to implement their
transitional services proposal, as described herein.
Restriction on Amendments
During the transition period, no change in the organization of CRP, the
type and character of the companies to be serviced, the methods of allocating
costs to associate companies, or in the scope or character of the services to be
rendered subject to Section 13 of the Act, or any rule, regulation or order
thereunder shall be made unless and until CRP shall first have given the
Commission written notice of the proposed change not less than 60 days prior to
the proposed effectiveness of any such change. If, upon the receipt of any such
notice, the Commission shall notify CRP within the 60-day period that a question
exists as to whether the proposed change is consistent with the provisions of
Section 13 of the Act, or of any rule, regulation or order thereunder, then the
proposed change shall not become effective unless and until CRP shall have filed
with the Commission an appropriate declaration regarding such proposed change
and the Commission shall have permitted such declaration to become effective.
Interaction with FERC Policy
All services provided by Pepco Holdings system companies to other Pepco
Holdings system companies will be in accordance with the requirements of Section
13 of the Act and the rules promulgated thereunder. Pepco Holdings is aware that
questions concerning the FERC's policy in this area are likely to arise with
respect to affiliate transactions with system companies that are public
utilities under the Federal Power Act. In connection with the FERC
authorization, the applicants in that matter represented that they would abide
by FERC policy with respect to any transaction between any member company of the
Pepco Holdings system and
----------------------------
62/ See New Century Energies (authorizing delay in implementation of services
company arrangements to accommodate the need to develop systems to implement
fully the desired accounting requirements or for other reasons). See also First
Energy Corp., GPU, Inc. et al., Holding Co. Act Release No. 27459 (Oct. 29,
2001); Emera Incorporated, Holding Co. Act Release No. 27445 (Oct. 1, 2001);
Kansas City Power & Light Company, Holding Co. Act Release No. 27436 (Sep. 7,
2001); KeySpan Corporation et al., Holding Co. Act Release No. 27272 (Nov. 8,
2000); NiSource, Inc., Holding Co. Act Release No. 27263 (Oct. 30, 2000); Exelon
Corporation, Holding Co. Act Release No. 27256 (Oct. 19, 2000); Energy East
Corp. et al., Holding Co. Act Release No. 27248 (Oct. 13, 2000); Dominion
Resources, Inc., Holding Co. Act Release No. 27113 (Dec. 15, 1999).
62
any of its subsidiary or affiliated companies. The FERC intra-corporate
transactions policy, with respect to non-power goods and services, generally
requires that affiliates or associates of a public utility not sell non-power
goods and services to the public utility at a price above market; and sales of
non-power goods and services by a public utility to its affiliates or associates
be at the public utility's cost for such goods and services or market value for
such goods and services, whichever is higher.
The Applicants recognize that affiliate transactions among the member
companies of Pepco Holdings will be subject of the jurisdiction of the
Commission under Section 13(b) of the Act and the rules and regulations
thereunder. That section generally requires that affiliate transactions
involving system utilities be "at cost, fairly and equitably allocated among
such companies." See also Rule 90. Nonetheless, Pepco Holdings believes that, as
a practical matter, there should not be any irreconcilable inconsistency between
the application of the Commission's "at cost" standard and the FERC's policies
with respect to intra-system transactions as applied to Pepco Holdings.
On this basis, the Applicants believe that Pepco Holdings will be able to
comply with the requirements of both the FERC and the "at cost" and fair and
equitable allocation of cost requirements of Section 13, including Rules 87, 90
and 91 thereunder, for all services, sales and construction contracts between
associate companies and with the holding company parent unless otherwise
permitted by the Commission by rule or order./63
Other Services
The Applicants hereby request an exemption from the at-cost requirements of
rules 90 and 91 for services rendered by Pepco Holdings nonutility subsidiaries
to certain other Pepco Holdings nonutility subsidiaries, if one or more of the
following conditions apply:
(i) the purchasing nonutility subsidiary is a FUCO or an EWG that derives
no part of its income, directly or indirectly, from the generation and sale of
electric energy within the United States;
----------------------------
63/ Under circumstances of divergent cost and market prices such that both the
FERC and SEC pricing standards could not be reconciled if the transaction was
performed, Service Company will comply by refraining from performing the
affected service, sales or construction contract.
63
(ii) the purchasing nonutility subsidiary is an EWG that sells electricity
at market-based rates that have been approved by the FERC or the relevant state
public utility commission, provided that the purchaser is not one of Pepco
Holdings' regulated public utility subsidiaries;
(iii) the purchasing nonutility subsidiary is a "qualifying facility"
("QF") under the Public Utility Regulatory Policies Act of 1978, as amended
("PURPA"), that sells electricity exclusively at rates negotiated at arm's
length to one or more industrial or commercial customers purchasing the
electricity for their own use and not for resale, or to a electric utility
company (other than one of Pepco Holdings' regulated public utility
subsidiaries) at the purchaser's "avoided costs" as determined under the
regulations under PURPA; and
(iv) the purchasing nonutility subsidiary is an EWG or QF that sells
electricity at rates based upon its cost of service, as approved by the FERC or
any state public utility commission having jurisdiction, provided that the
purchaser of the electricity is not one of Pepco Holdings' regulated public
utility subsidiaries.
The nonutility subsidiaries described in clauses (i)-(iv) are referred to
collectively below as "Exempt Nonutility Companies." To the extent not exempt or
otherwise authorized, Applicants request an exemption from the at-cost
requirements of rules 90 and 91 for services rendered to any Exempt Nonutility
Company that (a) is partially owned, provided that the ultimate purchaser of the
services is not a regulated public utility subsidiary of Pepco Holdings, (b) is
engaged solely in the business of developing, owning, operating and/or providing
services to Exempt Nonutility Companies, or (c) does not derive, directly or
indirectly, any material part of its income from sources within the United
States and is not a public-utility company operating within the United States.
The Commission has granted exemptions from the at-cost requirement
transactions that "involve special or unusual circumstances or are not in the
ordinary course of business."/64 In addition, the Commission has previously
granted exemptions under section 13(b) in circumstances where a market rate
would not adversely affect consumers. Orders granting an exemption from the
at-cost requirement involve power projects that (1) do not derive their
----------------------------
64/ Section 13(b) further provides an exception for transactions with an
associate company that does not derive, directly or indirectly, any material
part of its income from sources within the United States and which is not a
public-utility company operating within the United States.
64
income from sales of electricity within the United States, (2) sell electricity
at rates that have been approved by federal or state regulators, (3) sell
electricity to industrial or commercial customers at arms-length negotiated
rates, or (4) sell electricity, but not to associate companies that are retail
public-utility companies, at rates based upon cost of service and approved by
federal or state regulators./65 Applicants submit that this request for
exemption is similar to those that have been previously granted, where
structural protections to protect consumers against any adverse effect of
pricing at market rates were in place./66
Pepco's indirect wholly owned subsidiaries W. A. Chester LLC and W. A.
Chester Corporation are in the business of installing and maintaining utility
cable systems. These companies currently provide services to Pepco at market
rates under contracts entered into before they became part of a registered
system and will continue to operate under these contracts for the existing term
of the contracts. Upon consummation of the Transaction, any new service
arrangements between these companies and Pepco will be priced at cost, as
required under Rules 90 and 91 of the Act.
In conjunction with its sale to Edison Place, LLC of the property on which
the new headquarters building was built, Pepco entered into a lease arrangement
with Edison Place, LLC pursuant to which Pepco rents office space in the new
headquarters building from Edison Place. This 15 year lease was entered into
before Pepco and Edison Place were part of a registered system and contains rent
arrangements that Pepco believes are more favorable to it than other available
options in the market. The rent arrangements were not determined in accordance
with the provisions of Rules 90 and 91 of the Act but were an integral part of
the property sale between Pepco and Edison Place. Pepco and Edison Place request
authorization to leave the existing lease in place until the expiration of its
term.
In its Application before the Commission relating to securitization bonds
to be issued by a subsidiary of ACE (File No. 70-9899), Conectiv has requested
an exception from the
----------------------------
65/ See, e.g., Entergy Corp., Holding Co. Act Release No. 26322 (June 30, 1995);
Southern Co., Holding Co. Act Release No. 26212 (Dec. 30, 1994); Central and
South West Corp., Holding Co. Act Release No. 26887 (June 19, 1998).
66/ See Progress Energy, et al., Holding Co. Act Release No. 27297 (Dec. 12.
2000); Entergy Corporation, et al., Holding Co. Act Release No. 27039 (June 22,
1999)
65
"at cost" standards for fees relating to the servicing of such bonds. Any such
authorization granted pursuant thereto shall continue following consummation of
the Transaction.
6. Nonutility Reorganizations
Applicants propose to restructure the nonutility subsidiaries from time to
time as may be necessary or appropriate in the furtherance of the Pepco Holdings
authorized non-utility activities. To that end, Pepco Holdings requests
authorization to acquire, directly or indirectly, the equity securities of one
or more intermediate subsidiaries ("Intermediate Subsidiaries") organized
exclusively for the purpose of acquiring, financing, and holding the securities
of one or more existing or future non-utility subsidiaries. Intermediate
Subsidiaries may also provide management, administrative, project development,
and operating services to such entities.
Reorganizations could involve the acquisition of one or more new
subsidiaries to acquire and hold direct or indirect interests in any or all of
Pepco Holdings' existing or future authorized non-utility businesses.
Restructuring could also involve the transfer of existing subsidiaries, or
portions of existing businesses, to Pepco Holdings or among the Pepco Holdings
non-utility subsidiaries and/or the re-incorporation of existing subsidiaries in
a different jurisdiction. Following any such reorganization, Pepco Holdings will
continue to hold, directly or indirectly, the same interest in the voting
securities of the non-utility subsidiary as immediately prior to the
reorganization. This would enable Pepco Holdings to consolidate similar
businesses and to participate effectively in authorized non-utility activities,
without the need to apply for or receive additional Commission approval.
The direct or indirect newly created non-utility holding company
subsidiaries referred to above might be corporations, partnerships, limited
liability companies or other entities in which Pepco Holdings, directly or
indirectly, will have a 100% voting equity interest. These subsidiaries would
engage only in businesses to the extent Pepco Holdings is authorized, whether by
statute, rule, regulation or order, to engage in those businesses. Pepco
Holdings does not seek authorization to acquire an interest in any nonassociate
company as part of the authority requested in this application and states that
the reorganization will not result in the entry by Pepco Holdings into a new,
unauthorized line of business.
As previously noted, the first such reorganization is expected to occur
shortly after the consummation of the Transaction, when Pepco and Pepco Holdings
will effect
66
transactions by which PCI, PES and PepCom will become first tier subsidiaries of
Pepco Holdings.
7. Authorization to Engage in Energy-Related Activities Outside of the
United States
Pepco Holdings, on behalf of any current or future non-utility
subsidiaries, requests authority for such non-utility subsidiaries to engage in
certain "energy-related" activities outside the United States.
Such activities may include:
(i) the brokering and marketing of electricity, natural gas and other
energy commodities ("Energy Marketing");
(ii) energy management services ("Energy Management Services"), including
the marketing, sale, installation, operation and maintenance of various
products and services related to energy management and demand-side
management, including energy and efficiency audits; facility design and
process control and enhancements; construction, installation, testing,
sales and maintenance of (and training client personnel to operate) energy
conservation equipment; design, implementation, monitoring and evaluation
of energy conservation programs; development and review of architectural,
structural and engineering drawings for energy efficiencies, design and
specification of energy consuming equipment; and general advice on
programs; the design, construction, installation, testing, sales and
maintenance of new and retrofit heating, ventilating, and air conditioning
("HVAC"), electrical and power systems, alarm and warning systems, motors,
pumps, lighting, water, water-purification and plumbing systems, and
related structures, in connection with energy-related needs; and the
provision of services and products designed to prevent, control, or
mitigate adverse effects of power disturbances on a customer's electrical
systems; and
(iii) engineering, consulting and other technical support services
("Consulting Services") with respect to energy-related businesses, as well
as for individuals. Such Consulting Services would include technology
assessments, power factor
67
correction and harmonics mitigation analysis, meter reading and repair,
rate schedule design and analysis, environmental services, engineering
services, billing services (including consolidation billing and bill
disaggregation tools), risk management services, communications systems,
information systems/data processing, system planning, strategic planning,
finance, feasibility studies, and other similar services.
The Applicants request that the Commission (i) authorize non-utility
subsidiaries to engage in Energy Marketing activities in Canada and reserve
jurisdiction over Energy Marketing activities outside of Canada pending
completion of the record in this proceeding,/67 (ii) authorize non-utility
subsidiaries to provide Energy Management Services and Consulting Services
anywhere outside the United States,/68 and (iii) reserve jurisdiction over other
activities of non-utility subsidiaries outside the United States, pending
completion of the record.
The Applicants note that Conectiv's non-utility subsidiaries already have
authorization from the Commission to provide the services referred to in this
Application through its Rule 58 subsidiaries (Holding Co. Act Release No. 27464
(Nov. 8, 2001). Pepco Holdings requests that this authorization be extended to
its other non-utility subsidiaries.
8. Tax Allocation Agreement
The Applicants ask the Commission to approve an agreement for the
allocation of consolidated tax among the companies within the Pepco Holdings
system (the "Tax Allocation Agreement"). Approval is necessary because the Tax
Allocation Agreement provides for the retention by Pepco Holdings of payments
for tax losses that it has incurred in connection with financing or refinancing
approximately $700 million of the cash consideration to be paid in the
Transaction, rather than the allocation of such losses to its subsidiaries
without payment as
----------------------------
67/ See NiSource Inc. et al., Holding Co. Act Release No. 27265 (Nov. 1, 2000);
Southern Energy, Inc., Holding Co. Act Release No. 27020 (May 13, 1999)
(supplemental order amending prior order to permit registered holding company
subsidiary to engage in power and gas marketing activities in Canada and
reserving jurisdiction over such activities outside the United States and
Canada); Interstate Energy Corp., Holding Co. Act Release No. 27069 (Aug. 26,
1999). See also National Fuel Gas Co., Holding Co. Act Release No. 27114 (Dec.
16, 1999).
68/ The Commission has authorized non-utility subsidiaries of a registered
holding company to sell similarly-defined energy management services and
technical consulting services to customers outside the United States. See
NiSource Inc. et al., Holding Co. Act Release No. 27265 (Nov. 1, 2000); Columbia
Gas System, Inc., Holding Co. Act Release No. 26498 (Mar. 25, 1996); Cinergy
Corp., Holding Co. Act Release No. 26662 (Feb. 7, 1997); and Interstate Energy
Corporation, Holding Co. Act Release No. 27069 (Aug. 26, 1999).
68
would otherwise be required by Rule 45(c)(5). A copy of the proposed Tax
Allocation Agreement will be filed as Exhibit J-3.
Provisions in a tax allocation agreement between a registered holding
company and its subsidiaries must comply with Section 12 of the Act and Rule 45
thereunder. Rule 45(a) of the Act generally prohibits any registered holding
company or subsidiary company from, directly or indirectly, lending or in any
manner extending its credit to or indemnifying, or making any donation or
capital contribution to, any company in the same holding company system, except
pursuant to a Commission order. Rule 45(c) provides that no approval is required
for a tax allocation agreement between eligible associate companies in
registered holding company system, that "provides for allocation among such
associate companies of the liabilities and benefits arising from such
consolidated tax return for each tax year in a manner not inconsistent with" the
conditions of the rule. Of interest here, Rule 45(c)(5) provides that:
The agreement may, instead of excluding members as provided in paragraph
(c)(4), include all members of the group in the tax allocation, recognizing
negative corporate taxable income or a negative corporate tax, according to
the allocation method chosen. An agreement under this paragraph shall
provide that those associate companies with a positive allocation will pay
the amount allocated and those subsidiary companies with a negative
allocation will receive current payment of their corporate tax credits. The
agreement shall provide a method for apportioning such payments, and for
carrying over uncompensated benefits, if the consolidated loss is too large
to be used in full. Such method may assign priorities to specified kinds of
benefits.
Under the rule, only "subsidiary companies," as opposed to "associate
companies" (which includes the holding company in a holding company system), are
entitled to be paid for corporate tax credits. However, if a tax allocation
agreement does not fully comply with the provisions of Rule 45(c), it may
nonetheless be approved by the Commission under Section 12(b) and Rule 45(a). In
connection with the 1981 amendments to Rule 45, the Commission explained that
the distinction between associate companies, on the one hand, and subsidiary
companies, on the other, represented a policy decision to preclude the holding
company from sharing in consolidated return savings. The Commission noted that
exploitation of utility companies by holding companies through the misallocation
of consolidated tax return benefits was among the abuses examined in the
investigations underlying the enactment of the
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1935 Act. Holding Co. Act Release No. 21968 (Mar. 18, 1981), citing Sen. Doc.
92, Part 72A, 70th Congress, 1st Sess. at 477-482.
It must be noted, however, that the result in Rule 45(c)(5) is not dictated
by the statute and, as the Commission has recognized, there is discretion on the
part of the agency to approve tax allocation agreements that do not, by their
terms, comply with Rule 45(c) so long as the policies and provisions of the Act
are otherwise satisfied. In this matter, where the holding company is seeking
only to receive payment for tax losses that have been generated by it, the
proposed arrangement will not give rise to the types of problems (e.g., upstream
loans) that the Act was intended to address. Compare Section 12(a) of the Act.
As a result of financing or refinancing a portion of the cash consideration
for the Transaction, Pepco Holdings will be creating tax credits that are
non-recourse to its subsidiaries. As a result, Pepco Holdings should retain the
benefits of those tax credits. Accordingly, the Applicants request that the
Commission approve the Tax Allocation Agreement./69
Item 4. Regulatory Approvals
The federal and state regulatory requirements described below must be
complied with before the Applicants can complete the Transaction. The Applicants
currently believe that the necessary approvals can be obtained by the first
quarter of 2002.
State Approvals
Delaware
Delmarva is subject to the jurisdiction of the Delaware Commission as a
public utility. The approval of the Delaware Commission is required before a
Delaware public utility may directly or indirectly merge or consolidate with any
other person or company. Delaware Commission approval is also required before
any person may directly or indirectly acquire control of a Delaware public
utility. To grant its approval, the Delaware Commission must find that the
Transaction is to be made in accordance with law, for a proper purpose and is
consistent with the public interest. Pepco Holdings and Delmarva have filed an
application seeking the
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69/ See, National Grid.
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approval of the Delaware Commission consistent with these requirements. On March
19, 2002, the Delaware Commission voted to approve this application.
Maryland
The Maryland Commission is granted general authority to supervise and
regulate public utilities with operations in the State of Maryland. Both Pepco
and Delmarva have utility operations in the State of Maryland. Pepco and
Conectiv have filed an application with the Maryland Commission under the
Commission's general authority to determine whether the Transaction will have an
adverse effect on the relevant Maryland franchises.
New Jersey
ACE is subject to the jurisdiction of the NJBPU as a public utility. The
approval of the NJBPU is required before any person may directly or indirectly
acquire control of a New Jersey public utility. In considering a request to
acquire control of a public utility, the NJBPU evaluates the impact of the
acquisition on competition, on the ratepayers affected by the acquisition of
control, on the employees of the affected public utility or utilities, and on
the provision of safe and adequate utility service at just and reasonable rates.
Pepco Holdings and ACE have filed an application seeking the approval of the
NJBPU consistent with these requirements.
ACE has operations that are considered "industrial establishments" under
New Jersey's Industrial Site Recovery Act. Under that Act, filings with and
clearances from the New Jersey Department of Environmental Protection are
required for any direct or indirect change of ownership of an industrial
establishment. However, if a transaction involves only the indirect owner of an
industrial establishment with another owner and the indirect owner's assets
would have been unavailable for remediation under the Industrial Site Recovery
Act, the transaction is not subject to the requirements of that Act. While we do
not believe that any filings or clearances are required for the Transaction,
Pepco Holdings, Conectiv and ACE may make filings with the New Jersey Department
of Environmental Protection as deemed appropriate, including seeking a letter of
non- applicability for the Transaction with respect to the Industrial Site
Recovery Act.
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Pennsylvania
Delmarva and ACE each own minority interests in electric generating
stations and related transmission lines located in Pennsylvania and thus are
considered Pennsylvania public utilities. The approval of the Pennsylvania
Public Utility Commission ("Pennsylvania Commission") is required for a
Pennsylvania public utility to directly or indirectly transfer any public
utility property located in Pennsylvania. To grant its approval, the
Pennsylvania Commission must find that the Transaction is necessary or proper
for the service, accommodation, convenience or safety of the public. Pepco
Holdings, Delmarva and ACE have filed an application seeking the approval of the
Pennsylvania Commission consistent with these requirements. The Pennsylvania
Commission issued an order, on October 15, 2001, approving the joint
application.
Virginia
Delmarva provides utility service in Virginia and is subject to the
jurisdiction of the Virginia State Corporation Commission ("Virginia
Commission") as a public service company and a public utility. Because of its
ownership of transmission lines in Virginia, Pepco is subject to the
jurisdiction of the Virginia Commission as a public utility for limited
purposes. The Virginia Commission must approve the acquisition of any Virginia
public utility and the disposition of any utility assets located in Virginia.
The applicants must show that the provision of adequate service at just and
reasonable rates will not be threatened or impaired by the Transaction. Delmarva
and Pepco have filed an application seeking the approvals of the Virginia
Commission consistent with these requirements. The Virginia Commission has
issued an order on November 1, 2001, approving the application.
District of Columbia
Pepco is subject to the jurisdiction of the DC Commission. Pepco Holdings
will not become a public utility as a result of the Transaction. However, in
view of the DC Commission's plenary authority over the operations of Pepco,
Pepco has filed an application for approval of the Transaction with the DC
Commission.
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Federal Approvals
Antitrust
Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended
(the "HSR Act"), and the rules promulgated thereunder by the Federal Trade
Commission ("FTC"), the Transaction may not be consummated until Pepco Holdings,
Pepco and Conectiv file notifications and provide specified information to the
FTC and the Antitrust Division of the Department of Justice and specified
waiting period requirements are satisfied. A review process under the HSR Act is
undertaken for the purpose of determining whether a proposed transaction will
have an adverse effect on competition in the marketplace in which the companies
involved in that transaction currently operate. Since the Transaction falls
within the scope of the transactions to which the HSR Act is applicable, the
companies must file notifications with, and present information to, the
Department of Justice and the FTC so as to provide an opportunity for the
Department of Justice, the FTC and the public to evaluate whether the proposed
Transaction might have any such anti-competitive effects. Even after the HSR Act
waiting period expires or terminates, the FTC or the Antitrust Division of the
Department of Justice may later challenge the Transaction on antitrust grounds.
If the transaction is not completed within 12 months after the expiration or
earlier termination of the initial HSR Act waiting period, the parties would be
required to submit new information under the HSR Act and a new waiting period
would begin. On July 6, 2001, the parties filed their notification and report
forms under the HSR Act with the FTC and the Antitrust Division of the
Department of Justice.
Federal Power Act
The FERC must approve the Transaction. Under Section 203 of the Federal
Power Act, the FERC is directed to approve a merger if it finds such merger
consistent with the public interest. In reviewing a merger, the FERC generally
evaluates:
o whether the merger will adversely affect competition;
o whether the merger will adversely affect rates; and
o whether the merger will impair the effectiveness of regulation.
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The parties have filed an application with the FERC requesting approval of
the Transaction under the Federal Power Act. FERC issued an order approving the
Transaction on September 26, 2001.
The Communications Act
The Communications Act of 1934 prohibits the transfer, assignment or
disposal in any manner of any construction permit or station license or any
related rights, to any person without approval from the Federal Communications
Commission. The Federal Communications Commission will approve a transfer of
control if it serves the public convenience, interest and necessity. We will
seek the necessary approval from the Federal Communications Commission for the
transfer of control of licenses held by Pepco, Starpower Communications, L.L.C.,
Delmarva, ACE, and CCI.
No other federal regulatory approvals, other than the approval of this
Commission, are required with respect to the Merger.
Item 5. Procedure
The Applicants expect to close the proposed Transaction in the second
quarter of 2002. The Applicants respectfully request that the Commission issue
and publish, not later than March 26, 2002, the requisite notice under Rule 23
with respect to the filing of this Application-Declaration, such notice to
specify a date not later than April 16, 2002 by which comments may be entered
and a date not later than April 17, 2002 as the date after which an order of the
Commission granting and permitting this Application to become effective may be
entered by the Commission.
The Applicants waive a recommended decision by a hearing or other
responsible officer of the Commission for approval of the Transaction and
consent to the Division of Investment Management's assistance in the preparation
of the Commission's decision. There should not be a waiting period between the
issuance of the Commission's order and the date on which it is to become
effective.
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Item 6. Exhibits and Financial Statements
Exhibits
A-1 Form of Amended and Restated Certificate of Incorporation of Pepco
Holdings, Inc., incorporated by reference to Annex B to Pepco Holdings,
Inc.'s Registration Statement in Exhibit B-2, hereto.
A-2 Form of Amended and Restated Bylaws of Pepco Holdings, Inc., incorporated
by reference to Annex C to Pepco Holdings, Inc.'s Registration Statement `s
Registration Statement in Exhibit B-2, hereto.
A-3 Charter of Pepco, incorporated by reference to Pepco's Annual Report on
Form 10-K, filed on March 27, 2000, SEC File No. 1-1072.
A-4 Bylaws of Potomac Electric Power Company, as amended through January 25,
2001, incorporated by reference to Pepco's 2000 Annual Report on Form 10-K,
filed on March 23, 2001, SEC File No. 1-1072.
A-5 Restated Certificate of Incorporation of Conectiv, incorporated by
reference to Conectiv's Current Report on Form 8-K, filed on March 6, 1998,
SEC File No. 1-13895.
A-6 Conectiv's Bylaws as amended October 26, 1999, incorporated by reference to
Conectiv's 2000 Annual Report on Form 10-K filed on March 15, 2001, SEC
File No. 1-13895.
B-1 Agreement and Plan of Merger, dated as of February 9, 2001 among Potomac
Electric Power Company, Pepco Holdings, Inc. and Conectiv, incorporated by
reference to Annex A to Pepco Holdings, Inc.'s Registration Statement in
Exhibit B-2, hereto.
B-2 Pepco Holdings, Inc. Registration Statement on Form S-4, filed on May 30,
2001, incorporated by reference to SEC File No. 333-57042.
C-1 Application to the Delaware Public Service Commission (previously filed).
C-2 Application to the Maryland Public Service Commission (previously filed).
C-3 Application to the New Jersey Board of Public Utilities (previously filed).
C-4 Application to the Pennsylvania Public Utility Commission (previously
filed).
C-5 Application to the Virginia State Corporation Commission (previously
filed).
C-6 Application to the District of Columbia Public Service Commission
(previously filed).
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C-7 Order of the Delaware Public Service Commission (to be filed by amendment).
C-8 Order of the Maryland Public Service Commission (to be filed by amendment).
C-9 Order of the New Jersey Board of Public Utilities (to be filed by
amendment).
C-10 Order of the Pennsylvania Public Utility Commission (previously filed).
C-11 Order of the Virginia State Corporation Commission (previously filed).
C-12 Order of the District of Columbia Public Service Commission (to be filed by
amendment).
D-1 Map of Pepco's service territory (previously filed on Form SE).
D-2 Map of ACE and Delmarva's service territory (previously filed on Form SE).
D-3 Map of PJM Interconnection Transmission Owners (previously filed on Form
SE).
E-1 Opinion of Counsel - Pepco (to be filed by amendment).
E-2 Opinion of Counsel - Conectiv (to be filed by amendment).
F-2 Past tense opinion of counsel - Pepco (to be filed by amendment).
F-3 Past tense opinion of counsel - Conectiv (to be filed by amendment).
G-1 Application to the Federal Energy Regulatory Commission (previously filed).
G-2 Testimony of Joe D. Pace as filed with the Federal Energy Regulatory
Commission (previously filed).
G-3 Order of the Federal Energy Regulatory Commission (previously filed).
H-1 Pepco's 2000 Annual Report on Form 10-K, filed on March 23, 2001,
incorporated by reference to SEC File No. 1-1072.
H-2 Conectiv's 2001 Annual Report on Form 10-K filed on March 19, 2002,
incorporated by reference to SEC File No. 1-13895.
H-3 Pepco's Quarterly Report on Form 10-Q, filed on May 2, 2001, incorporated
by reference to SEC File No. 1-1072.
H-4 Pepco's Quarterly Report on Form 10-Q, filed on August 10, 2001,
incorporated by reference to SEC File No. 1-1072.
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H-5 Pepco's Quarterly Report on Form 10-Q, filed on November 9, 2001,
incorporated by reference to SEC File No. 1-1072.
I-1 Proposed Form of Notice (previously filed).
J-1 Revised CRP Service Agreement (previously filed).
J-2 CRP Policy and Procedures (included in Exhibit J-1) (previously filed).
J-3 Form of Tax Allocation Agreement (previously filed).
K-1 Description of Pepco and Conectiv Subsidiaries (previously filed).
M-1 Post-Transaction Corporate Chart (previously filed on Form SE)
M-2 Supplemental Information regarding the Edison Place lease (filed pursuant
to a request for confidential treatment)
N-1 Opinion of Merrill Lynch, Pierce, Fenner & Smith Incorporated (included as
Annex D to Pepco Holdings' Registration Statement in Exhibit B-2, hereto).
N-2 Opinion of Credit Suisse First Boston Corporation (included as Annex E to
Pepco Holdings' Registration Statement in Exhibit B-2, hereto).
Financial Statements
FS-1 Pepco's Consolidated Balance Sheet as of December 31, 2000, incorporated
by reference to Pepco's Annual Report on Form 10-K, SEC File No. 1-1072,
filed on March 23, 2001.
FS-2 Pepco's Consolidated Statement of Earnings for the year ended December 31,
2000, incorporated by reference to Pepco's Annual Report on Form 10-K, SEC
File No. 1-1072, filed on March 23, 2001.
FS-3 Pepco's Consolidated Statements of Shareholders' Equity and Comprehensive
Income for the year ended December 31, 2000, incorporated by reference to
Pepco's Annual Report on Form 10-K, SEC File No. 1-1072, filed on March
23, 2001.
FS-4 Pepco's Consolidated Statement of Cash Flows for the year ended December
31, 2000, incorporated by reference to Pepco's Annual Report on Form 10-K,
SEC File No. 1-1072, filed on March 23, 2001.
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FS-5 Notes to Consolidated Financial Statements, incorporated by reference to
Pepco's Annual Report on Form 10-K, SEC File No. 1-1072, filed on March
23, 2001.
FS-6 Conectiv's Consolidated Statement of Income for the year ended December
31, 2001, incorporated by reference to Conectiv's 2001 Annual Report on
Form 10-K filed on March 19, 2002, SEC File No. 1-13895.
FS-7 Conectiv's Consolidated Statement of Cash Flows for the year ended
December 31, 2001, incorporated by reference to Conectiv's 2001 Annual
Report on Form 10-K filed on March 19, 2002, SEC File No. 1-13895.
FS-8 Conectiv's Consolidated Balance Sheets as of December 31, 2001,
incorporated by reference to Conectiv's 2001 Annual Report on Form 10-K
filed on March 19, 2002, SEC File No. 1-13895.
FS-9 Conectiv's Consolidated Statement of Changes in Common Stockholders'
Equity for the year ended December 31, 2001, incorporated by reference to
Conectiv's 2001 Annual Report on Form 10-K filed on March 19, 2002, SEC
File No. 1-13895.
FS-10 Notes to Consolidated Financial Statements, Conectiv's 2001 Annual Report
on Form 10-K filed on March 19, 2002, incorporated by reference to SEC
File No. 1-13895.
FS-11 Pepco Holdings Unaudited Pro Forma Combined Statement of Earnings for the
three months ending March 31, 2001, incorporated by reference to Pepco
Holdings, Inc. Registration Statement in Exhibit B-2, hereto.
FS-12 Pepco Holdings Unaudited Pro Forma Combined Statement of Earnings for the
year ended December 31, 2000, incorporated by reference to Pepco Holdings,
Inc.'s Registration Statement in Exhibit B-2.
FS-14 Pepco Holdings Unaudited Pro Forma Combined Balance Sheet as of March 31,
2001, incorporated by reference to Pepco Holdings, Inc.'s Registration
Statement in Exhibit B-2, hereto.
FS-15 Notes to Unaudited Pro Forma Combined Financial Statements of Pepco
Holdings, incorporated by reference to Pepco Holdings, Inc.'s Registration
Statement in Exhibit B-2.
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Item 7. Information as to Environmental Effects.
The proposed Transaction involves neither a "major federal action" nor
"significantly affects the quality of the human environment" as those terms are
used in Section 102(2)(C) of the National Environmental Policy Act, 42 U.S.C.
Sec. 4321 et seq. No federal agency is preparing an environmental impact
statement with respect to this matter.
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SIGNATURE
Pursuant to the requirements of the Public Utility Holding Company Act of
1935, Applicants have duly caused this pre-effective Amendment to an
Application-Declaration to be signed on their behalf by the undersigned
thereunto duly authorized.
Date: March 27, 2002
PEPCO HOLDINGS, INC.
By: /s/ Dennis R. Wraase
----------------------------
Name: Dennis R. Wraase
Title: President
CONECTIV
By: /s/ Peter F. Clark
------------------------------
Name: Peter F. Clark
Title: Vice President, General
Counsel & Secretary