FOOL ON THE HILL
An Investment Opinion

A High Tech Company You Never Heard Of

By Bill Mann (TMF Otter)
September 29, 1999

I'm thinking of a company. It has one of the largest fiber optic telecommunications networks in the United States with over 10,000 miles of installed fiber optic cable plant and an additional 8,000 miles to be operational soon. It has been providing telecom services since 1983, primarily private data lines and Internet connectivity, though it also has significant long distance, wireless, and local multipoint distribution components.

Did you guess Qwest Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: QWST)") else Response.Write("(Nasdaq: QWST)") end if %>? Not bad, but it's not right. A few more details about the company: It transports, resells, and brokers natural gas and energy commodities through its own network to utilities, distributors, and its own retail customer base.

No, Williams Companies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WMB)") else Response.Write("(NYSE: WMB)") end if %> is not right either, though it is another company serving in both the natural gas and telecommunications industries.

The company I'm talking about is Montana Power Company <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MTP)") else Response.Write("(NYSE: MTP)") end if %>, the monopoly electric utility for two-thirds of the state of Montana. This company has quietly reinvented itself over the past five years and is, in my opinion, uniquely situated to participate in some of the highest growth industries in the next decade.

Power Company, you say? Isn't that what old ladies invest in so they can keep their principal safe and get periodic dividends for cat food money? Well, don't blink, because electricity generation and distribution is in as much flux as long distance or any other industry. And Montana Power is one of the first movers to put itself ahead of the curve.

Yes, the days of the guaranteed returns on investment are history for investor-owned utilities. Traditionally these companies exchanged the burden of universal service (providing power to everyone) with being granted an exclusive service territory. This concept began to change only in the past 15 years, with the federal and state governments each enacting their own competitive electricity projects. The utilities, protected from competition for the better part of a century, have been thrown back into the open market, and the ones that don't react properly will be doomed long before they realize it. You know, existing just out of habit.

So let's take a look at Montana Power, shall we? And for those of you whose toes don't tingle at the sound of the words "coal-fired power generation facility," don't worry; this is a company that has left that realm far behind. In fact, within the past month, Montana Power sold its electricity generating capacity, while retaining its higher-margin transmission and distribution facilities. The combination of the company's power line plant, its natural gas pipelines, and its communications network give it a potentially strong synergy between energy and communication services products on a wholesale and retail basis.

Power companies operate similarly to other dispersed-facility industries such as railroads. They are very dependent on communications between components for efficient operations. Several of the larger companies' internal communication networks span several thousand miles. Montana Power began updating its own network in the early 1980s and took an unusual step -- it laid high-capacity fiber optic cables along its electricity and pipeline right-of-ways. These cables gave the company exponentially more bandwidth than it needed for its internal communications. As the majority of the capital cost for fiber optic cable is in the installation process, Montana Power's strategy allowed them to combine the development of a communications business while passing much of the costs of the network through to its natural gas customer base.

This is an old story, where a company needs an integrated service to provide its main product but then realizes that significant revenues can be derived from the sale of that service. In telecommunications alone there are some enormous examples: MCI, now part of MCI Worldcom <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WCOM)") else Response.Write("(Nasdaq: WCOM)") end if %>, began as an internal communications network for long-haul truckers. Sprint <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FON)") else Response.Write("(NYSE: FON)") end if %> was initially the communications arm of Southern Pacific Railroad. And Enron <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ENE)") else Response.Write("(NYSE: ENE)") end if %>, the staid natural gas operator and service contractor of old, has transitioned into a commodity broker, realizing that the information about the commodities was more valuable to its customers than the products themselves.

But there is a difference. Note the difference in P/E for the companies listed above:

Sprint:            30
Enron:             36
Qwest:             85
Williams:         256
Montana Power:     19

Perhaps the name throws people off? But Montana Power is not your run-of-the mill electric utility, a point reinforced by its yearly gains of 48% and 78% in 1997 and 1998. This year has been quite turbulent, though the company currently trades almost flat with its price in January.

In some ways the lower P/E is justified. After all, Montana Power has averaged 13% revenue growth over the last two years, compared with 52% for Enron, 212% for Qwest, and 50% for Williams. But remember, these metrics are based on future earnings, and Montana Power is only now moving away from its power generation base, a low-margin drag on the company's comparables. Although each is further along in its metamorphosis, Williams and Enron provide a good indication for where Montana Power is going as it concentrates more and more of its resources on telecommunications services. Qwest, which was from its founding an independent communications company, does not have any mature business components to depress its rate of growth.

But as much as Montana Power seems to be trailing these companies in the transition to the "new economy," it has a few things going for it. First, it is miles ahead of other electric utilities in its response to open competition pressures. Second, it carries a debt load ($671 million) one-fifth the size of Qwest's and one-tenth that of Williams. Third, Montana Power's standing as a regulated carrier gives it built-in access to the "last mile" for its incumbent customers, something other bandwidth providers lack but sorely need. Fourth, Montana Power's regulated electricity transmission and distribution facilities give it a guaranteed revenue base as an incumbent wholesale electricity provider, with predetermined profit margins for its energy services business.

Finally, the company is using its communications network -- which it originally needed to operate its own power plants -- to broker transactions between other utilities. For example, let's say a utility in Washington state is shopping for a natural gas contract. A transaction is brokered with a provider in North Dakota by Montana Power through its communications facilities, and the natural gas is routed to Washington through its pipeline network. Montana Power takes a piece of the deal and never carries any inventory.

Isn't the free market great?

Montana Power may not be the sleekest racehorse in the bandwidth stable. Compared to the Global Crossings and Broadcoms of the world, it looks more like an old plow horse. But, in a realm where those companies burning brightest may end up crashing the hardest, Montana Power is quietly building a world-class fiber optic network that rivals them all.

Related links:
A map of Montana Power's fiber optic network
Edison Electric Institute's Competition and Regulation site