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An analysis of Central Illinois Public Service Company.

I. DESCRIPTION OF COMPETITOR

General

Central Illinois Public Service Company (CIPS), a neighboring investor-owned public utility, has been providing electric energy since 1902. CIPS, a utility subsidiary of CIPSCO Incorporated (CIPSCO), supplies electricity which it generates, transmits, and distributes to a 20,000 square mile region of central and southern Illinois. This area includes 66 of 102 counties in Illinois (representing over 557 communities and has an estimated population of 820,000 people which represents about 7% of Illinois' population and 35% of its surface area. CIPS also sells natural gas, which it purchases from producers and suppliers and distributes through its system, and transports customer-owned natural gas.

A second subsidiary, CIPSCO Investment Company (CIC), directs the Company's non-regulated investments, including leases, securities and energy projects. CIC was incorporated on October 2, 1990 for the purpose of managing non-regulated investments and providing investment management services to CIPSCO and its affiliates.

CIPSCO Incorporated is a holding company incorporated under the laws of Illinois. As of February 1, 1997, CIPSCO has 34,069,542 common shares outstanding without par value. CIPSCO's common stock is publicly held and traded on both the New York and Chicago Stock exchanges. CIPS has 25,452,373 shares outstanding of common stock that is all owned by CIPSCO. In addition, CIPS has two subsidiaries: Illinois Steam, Inc. and CIPS Energy Inc. as well as owning 20% of Electric Energy, Inc. (Union Electric company also owns 40%). Electric Energy, Inc. owns and operates a 1,015,000 kilowatt coal-fired power station located in Joppa, Illinois.

CIC has four first tier subsidiaries: CIPSCO Securities Company (invest in marketable securities), CIPSCO Leasing Company (makes long-term investments in leveraged lease transactions), CIPSCO Energy Company (invests in energy-related projects), and CIPSCO Venture Company (makes investments within the CIPS utility service territory).

Merger in Process

On August 11, 1995, CIPSCO entered into an agreement and Plan of Merger providing for a business combination with Union Electric Company (UE) of St. Louis, Missouri. Shareholders of both companies approved the merger agreement on December 20, 1995.

As a result of the merger, a newly formed holding company, Ameren Corporation, will become the parent of UE, CIPS, and CIC. The merged entity is expected to realize over $700 million in net savings over 10 years from combining certain operations of the two companies and is expected to adopt UE's dividend payment level, currently at $2.54 per share.

The Missouri Public Service Commission (MSPC) gave its approval February 21, 1997. They still need approval from the Illinois Commerce Commission and five federal agencies. The MSPC will require that Ameren join a regional electricity transmission group, known as an independent system operator (ISO), to protect the public's interest.

Final approval of the merger is expected to be completed by the end of 1997. Once in place, the new parent company, Ameren will serve 1.5 million electric customers and 300,000 natural gas customers in Missouri and Illinois. Ameren's consolidated assets will total nearly $9 billion, and its generating capacity (11,369 megawatts composed of: UE 8,307 mw and CIPS 3,062 ms) and kilowatt hour sales will place the company among the nation's top 20 investor-owned utilities.
TABLE 1

 CIPS UE NATIONAL ILLINOIS
 COOPS

Residential 8.01 cents 7.13 cents 8.90 cents 10.43 cents
Commercial 6.76 5.90 7.86 8.60
Industrial 4.67 4.29 4.92 5.74

TOTAL RETAIL 6.55 5.92 7.12 9.35




Customer Data and Sales Data

As of 12/31/96, CIPS has 322,000 electric and 169,000 gas customers which produced $554 million (78%) and $155 (22%) million in retail revenue, respectively. The retail electric revenues were derived approximately as follows (% of total electric operating revenue): 31% residential customers, 26% commercial customers, 16% industrial customers, and 3% public authorities and other. The natural gas revenues were approximately: 65% residential, 23% commercial, 7% industrial, and 5% other. In addition, CIPS has $177 million in interchange wholesale sales for total revenues in excess of $886 million for 12/31/96. Total kilowatt hours sold for 1996 amounted to 8,304 megawatts, excluding interchange sales, generating $6.42 retail revenue per kilowatt hours sold for 1996.

According to their 1996 annual report, CIPS has a total of 18 industrial electric customers that have completed or announced projects that will add an additional 40 megawatts of load to the CIPS systems. Included in the projects are WalMart Stores, Inc., who is nearing completion of a new 812,500 square foot distribution center at Olney, IL. Trim Masters, Inc., a Kentucky-based automotive parts manufacturing firm, announced plans to locate a new plant in Lawrenceville, IL at a cost of $12 million. JJ Collins, a Chicago-based printing company founded in 1878, plans to expand by relocating certain printing operations into an existing 24,000 square foot facility in Charleston. These three projects represent about 625 new jobs, also.

Rates

The most recent CIPS retail rate case before the Illinois commission became effective March 20, 1992. The commission allowed rate increases based on a net original cost rate base of 9.77% (electric) which reflects a return on common equity of 12.28%. As a result of this rate increase allowed, a corresponding rate adjustment was granted by the FERC for certain customers who purchase power from CIPS for resale.

Retail Electric Rate comparison shows CIPS with the following average revenue per kilowatt hour by class: (See table 1)

Overall, Illinois Coops' average rate is 2.80 cents per kWh higher or 43% higher than CIPS's rates. In addition, UE's rates are lower than CIPS so once the merger is complete, there will be an even larger disparity. This issue must be addressed quickly in the next 12-18 months.

A Fitch report dated 12/19/94 considered CIPS's current and future rates slightly lower than average. Average rates have declined due to lower coal costs, aggressive use of economic development pricing, and the reduction in the summer rate premium. Rates are well structured across customer segments, and industrial rates are very competitive. Even though this report is outdated, it still appears to be accurate.

Assets

At December 31, 1996, CIPS owned 13,051 miles of overhead electric lines and 997 miles of underground electric lines. They also owned 4,620 miles of natural gas transmission and distribution mains, four underground gas storage fields, and one propane-air gas plant used to supplement the available pipeline supply of natural gas during periods of high demand. A majority of all permanent fixed utility property of CIPS is subject to the lien of the Mortgage Indenture which secures all CIPS first mortgage bonds which amounted to 299 million dollars at the end of 1996.

Utility plant at 12/31/96 totaled $1,458,124,000 reflected at original cost net of accumulated depreciation. This represents 78% of their total assets. CIPS's balance sheet is strong with 54% common equity, 39% long-term debt, and 7% preferred stock. For 1996, 95% of CIPS's total capital requirements were provided from internal sources ($106 million).

CIPS's ability to finance its construction program of about $482 million over the next five years and other capital needs is dependent on its ability to earn a fair return on capital. They have more financial flexibility if they continue to be successful in providing a large percentage of those funds from internal sources. Also, they also have the ability to issue long-term securities and to obtain short-term credit. Their credit rating of AA+ based on the Fitch report from 1994 still appears to be an, (on their first mortgage bonds) excellent indication of their financial strength.

CIPS's service territory has been relatively stagnant since 1980 and there has been no meaningful growth in the number of customers. Management forecasts a low to moderate kWh volume growth rate over the next few years. Business risk is mitigated due to relatively low reliance on industrial sales and absence of customer concentration. The service area economy depends on agriculture, coal mining, petroleum refining, and the service sector. Sales appear to be well diversified.

II. ANALYSIS OF CIPS COMPETITIVE POSITION

Strengths

* Excellent financial condition, with 42.5% total leverage.

* Strong cash flow from operations.

* Competitive rates; limited regulatory risk.

* Conservative management team.

* Low-cost generating capacity available from wholesale transactions.

* Geographically positioned to transmit third party energy.

* Electric business balanced by small gas distribution segment.

* Merger related savings and stronger utility when merger is complete. The combination of the two companies offers greater potential for growth by capitalizing on both companies' financial strengths, low costs, strong customer relationships and expanded market opportunities.

* After merger, UE has Callaway nuclear plant that will provide 10% of their capacity. This plant is consistently ranked by the Nuclear Regulatory Commission as one of the best operating plants in the country.

In summary, as a result of reviewing the many things the CIPS is doing to prepare for deregulation, their competitive position appears to be exceptionally strong. This position is further enhanced by their merger with UE. It appears that CIPS has been posturing itself very well over the past few years to prepare for competition.

Weaknesses

* Slow retail demand growth.

* Seasonality; earnings volatility based on summer load.

* Poor labor-management relations due to an extended lockout of both of their labor unions during 1993. The notes to their consolidated financial statements indicate that management estimates the amount of back pay and other benefits being sought due to an unfair labor practices lawsuit to be less than $16 million. An administrative law judge has ruled the lockout to be unlawful.

The merger will have the impact of taking away a large part of the identity of CIPS since it is really a takeover by UE in substance. The CEO of CIPS has announced that he will retire at the end of 1997. UE has already appointed the heir apparent on January 2, 1997 by promoting a long-tine UE employee to the newly created position of executive vice-president to both CIPSCO and CIPS. (This is my perception of the change.) This may result in some disgruntled CIPS employees as the merger takes full effect and they continue to decrease staffing at local offices as has been the trend.

Exposure to various lawsuits, none of which they feel will have an adverse impact on their financial statements. In addition, the raw size of this new organization after the merger may result in a decrease in the personal touch of local business less ability to respond quickly to customer needs, and a detachment from the local communities.

Summary of this section

CIPS and Ameren will have a tremendous advantage over customers served by Illinois Cooperatives due to the disparity in retail prices, not to the mention the wide array of products and services they have and will have available in the near future. It is imperative that Illinois Cooperatives figure out how to reduce their wholesale power cost substantially within the next 12 months. If this can be accomplished and a strategic plan of reducing costs can be effective, Illinois Cooperatives will be able to find a niche market to serve its customers with an additional supply of services that are needed by its rural customers.

III. CURRENT STRATEGIC INITIATIVES BY CIPS AND AMEREN AND THREATS TO ILLINOIS COOPERATIVES

CIPS strategy is to be the low-cost producer for the long-term and to focus on customer service. Ameren's strategy will be to build value for shareholders, maintain competitive prices for customers, and create opportunities for employees now and into the next century.

CIPS has been working on cost reductions strategies as follows:

1. The merger is probably the most important initiative on the table presently. This will give Ameren tremendous strength within the markets of Illinois and Missouri. The impact as stated before is more than $700 million in savings over 10 years.

2. They recently opened a new statewide customer service call center in Pawnee, Illinois on August 7, 1996 to handle all billing, credit, energy services and other matters.

3. A major coal contract was renegotiated in early 1997 to allow for purchase of out of state low-sulfur coal and for a better price. However, this did cost a prepayment of 70 million which CIPS hopes to be able to collect from ratepayers over a six-year period.

4. Instituted a business process re-engineering program to restructure field operations into regions continued in 1996. The regional concept was developed by employees in field operations and support departments and is replacing a division-based field operating structure. This effectively removes two layers of reporting relationships, in order to move decisionmaking as close to the customer as possible. The regions will use multi-functional employee teams, empowerment, responsibility, accountability and the principles to provide better customer service. Realignment of file operations implementation of self-directed work teams for power station maintenance.

5. CIPS has reduced its workforce through attrition and a voluntary separation program to reduce costs. There were 151 people that took the early separation program.

6. Another cost reduction strategy implemented was to switch fuels in June of 1996 at one of their coal-fired plants and cease scrubber operations. Total net savings are estimated at $100 million over the next 10 years as a result of the switch to low-sulfur coal.

Several new marketing initiatives were developed and enhanced in 1996

CIPS has taken a bold presence on the internet and now is beginning to describe themselves as "America's Powerhouse". CIPS initiated a new marketing function on January 1, 1995 to prepare for increasing competition and to reduce costs and increase sales. These efforts are being directed at product and service development programs, customer retention, and economic development:

1. CIPSSTART, a new marketing initiative began in November, 1996, was designed to promote economic growth and development. This program allows CIPS to partner with local communities to allow for help in luring new customers and maintaining current commercial and industrial businesses. CIPSSTART provides qualifying communities with an exciting new development tool that can substantially assist their business prospecting, expansion, and attraction efforts. They will provide an industrial prospect with blueprints, building specifications, and a color architectural rendering of a 60,000 square foot industrial building that is expandable to 200,000 square feet. "In short, the program features a 'ready-to-go' site with a 'ready-to-go' building.

2. Illinois Advantage is a new program sponsored by by CIPS which addresses major national and local economic issues for key economic allies throughout their region.

3. Turn-Key Leasing program is a new-equipment financing network which allows CIPS to connect customers with a funding source for their expansion or project.

4. Obtained a tariff rider in July 1995 to allow CIPS to negotiate contractual rates with certain commercial and industrial customers at rates equal to or greater than the incremental costs of serving that customer. New rate making paradigms are already at work.

CIPS must create benefits for all parties and must not disadvantage any class of customer which may lead to a strategy that could backfire. CIPS has taken an anti-residential position with respect to proposed regulation what would allow Illinois' electric customers to choose their electric energy provider. CIPS has joined the Illinois Coalition for Responsible Electricity Choice. CIPS is favoring a proposal that would allow for customer choice to begin in the year 2000 of the largest utility users. Between 2001 and 2004, direct access would be phased in for smaller industrial commercial customers Residential customers would be allowed free choice in the year 2005. Illinois Cooperatives may choose to exploit this strategy and propose that the residential customer should be given the choice first to ensure that residential customers will realize a savings as well.

Summary

The strategic initiatives being pursued by CIPS are of serious consequence to Illinois Cooperatives. They are becoming larger and more efficient especially with the merger. However, there are a few kinks in their armor, such as their proposed position on retail wheeling. Illinois Cooperative could promote customer choice for residential customers first. This may be deemed a poor strategy for electric cooperatives, but it would force us to restructure our wholesale power costs quicker and may lead to faster corporate restructuring which in the end will help us if we can accomplish our objectives faster.

The primary focus for cooperatives must be to give our customers the best possible service at the lowest cost and as quickly as possible if we are to prepare adequately for competition However, in order to achieve this goal, we must work fast. Coops must consider the impact of the following strategies now:

1. Reduce wholesale power costs significantly in the next 18 months. (Consider strongly the possibility of restructuring contracts with G&T); and consider other alternatives.

2. Seek aggressively mergers or acquisitions with neighboring cooperatives.

3. Develop strategic alliances with a natural gas partner.

4. Outsource billing functions to our data processor.

5. Consider outsourcing payroll or develop a shared human resource departments with other cooperatives.

6. Consider an early retirement program, being careful not to lose too much experience too fast, which would impact the ability to service customers and maintain the system.

7. Continue to aggressively reduce operating costs.

The strategies that decrease rates the fastest must be given top consideration. A definite "sense of urgency" must be taken.

IV. FUTURE STRATEGIC INITIATIVES OF CIPS/AMEREN

CIPS and Ameren will continue to try to be the ultimate low-cost provider of energy services in their service area. However, customer service will suffer due to their size, but they will be much more aggressive toward the municipalities and surrounding areas along with the industrial and commercial loads. They will try to overcome their lack of service to the residential customer by bragging about their ability to help the local business community.

In regards to the lowest rates in town, Coops must maintain their focus on what they do best and try to do it better and more often - excellent service and quality with a very local flavor. In addition, Coop's need to seek out opportunities to provide services that customers need and want such as: home security services, propane, internet service provider, electrical maintenance contracts for wiring in their homes, appliance sales and service. Wherever partnerships or alliances are available they must be considered. Coops must do a better job of working together with everyone if they are to succeed. Coops must not try to beat them at their game, but play their game in a niche market, and play it better than anyone else.

Brian P. Stagen is an accountant for Eastern Illini Electric Cooperative (EIEC) in Paxton, Illinois. He joined Eastern Illini in 1994, after working as an Internal Auditor for the First National Bank in Paxton for seven years. Brian began his career with Arthur Andersen & Co. working in Management Consulting for two years and then spent three years with a local public accounting firm in Urbana, Illinois.

Current responsibilities include preparing financial and tax reports for the Cooperative and subsidiaries, overseeing accounts payable, payroll reporting, and analysis of financial and tax issues that are of importance to Eastern Illini. Currently, Brian is implementing an Activity based Costing System at the Coop. In September he will become the Accounting Supervisor for EIEC.

Brian graduated summa cum laude from Eureka College in 1982, with a Bachelor of Arts in Economics & Business. He holds a Certified Public Accountant (CPA) certificate and is licensed to practice in the State of Illinois. He is a member of the Illinois CPA Society, American Institute of Certified Public Accountants, and the Electric Cooperatives Accounting Association. In addition, Brian is a 1997 graduate of the NRECA Management Internship Program (MIP).

Stagen serves on the Deacon board, Building Committee, and is Co-Chairman of Faithful Men Ministries at the Gibson City Bible Church, Treasurer of the Paxton Park District, and is involved with the Fellowship of Christian Athletes locally. Brian and his wife Julie have four girls and reside in Paxton, Illinois.
COPYRIGHT 1997 National Rural Electric Cooperative Association
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1997 Gale, Cengage Learning. All rights reserved.

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Author:Stagen, Brian P.
Publication:Management Quarterly
Article Type:Company Profile
Date:Jun 22, 1997
Words:3332
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