A deal blows up

The Duke–Progress Energy merger

By on / Business Negotiations

When negotiating a new business partnership, what should you do if you begin to believe that your partner is less attractive than he (or it) first appeared? Duke Energy faced this question during the course of its nearly two years of merger negotiations with Progress Energy.

In July 2012, the two North Carolina– based companies closed their deal, becoming the largest utility in the United States. Duke’s handling of the situation suggests some novel advice for those considering new business relationships, as described in a recent Harvard Business School case written by Harvard Business School and Harvard Law School professor Guhan Subramanian and Harvard Business School research associate Charlotte Krontiris.

Cracks and more cracks
During its negotiations with Progress, one of Duke’s primary concerns was Crystal River 3, an aging nuclear pressurized-water reactor in Florida owned by Progress. CR3, as it was known, had been offline since a crack in the concrete wall of its containment building was found in 2009—a significant safety concern.

Rejecting pricey repair bids from experienced contractors, Progress hired a less experienced engineering firm that used an unorthodox approach to the repair. In 2011,another crack was found in the wall—and then another.

As its merger talks with Duke unfolded, Progress was also engaged in tense negotiations with its insurer, Nuclear Electric Insurance Limited (NEIL). NEIL had paid Progress about $298 million for repairs claims and replacement power for CR3 but was reluctant to pay more. The insurer believed that the recent damage to the reactor had been caused by Progress’s repair work in 2009.

Moreover, the Duke-Progress merger agreement explicitly limited Progress’s ability to negotiate with NEIL. The agreement also stipulated that Duke could withdraw from the merger if it learned that the CR3 damage constituted a “material adverse change.” As a result, negotiations between NEIL and Progress over insurance payouts were at a standstill during the Duke-Progress talks.

Floridians served by CR3 were displeased by Progress’s high electric rates, which were expected to rise after the anticipated repairs. Yet Progress CEO Bill Johnson expressed optimism that the reactor could be repaired at a reasonable cost and be back online soon.

A sudden switch
On July 2, Duke and Progress officially merged to become the newly formed Duke Energy in a stock-for-stock transaction. Per the agreement, Johnson was appointed the new company’s CEO. But in a shocking twist, just two hours later, the Duke-dominated board fired Johnson and replaced him with former Duke CEO Jim Rogers.

The North Carolina Utilities Commission (NCUC), which had approved the merger, launched an investigation into the boardroom coup. In testimony to the NCUC, Rogers explained that Duke had experienced “a loss of confidence” in Johnson.

Johnson’s decisions regarding CR3 may have played a significant role in his ouster. Johnson had incentives to downplay the repair costs of CR3 in order to close the deal.

A marriage gone awry
In an interview with Bloomberg Businessweek, Rogers described the integration and planning process of the merger negotiation: “You’re not quite married, but you’re living together, and you’re learning a hell of a lot about each other.” To carry the analogy forward, when the wedding day arrived, Duke decided to leave Johnson at the altar. Due diligence had persuaded Duke that repairing CR3 would be a much more uncertain and costly enterprise than Johnson had claimed.

The NCUC and Duke reached a settlement in November 2012 that gave Progress executives a stronger role in the new company’s operations. Meanwhile, following a nonbinding mediation with Duke, insurer NEIL agreed to pay another $530 million toward CR3 repairs. The same day, Duke announced that it had decided to close CR3 permanently: An engineering study had estimated that repairs could cost $3.4 billion and take eight years. Duke’s market capitalization rose by $1 billion following the news.

Avoiding your own deal meltdown

  • Trust, but verify. Wisely, Duke Energy thoroughly investigated Progress’s
    optimistic predictions of CR3’s future. Due diligence uncovered
    ample evidence that the reactor might not be worth repairing.
  • Manage incentives. Progress CEO Johnson faced strong personal
    incentives to get his deal over the finish line. When appointing and
    managing negotiators, take steps to improve the odds that the
    organization’s interests will be paramount in their minds.

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