A proposal to break up Duke Energy into three separate companies has analysts scratching their heads, and ratepayer advocates on the fence about its merits.

Elliott Management, a top 10 Duke shareholder, on Monday sent a letter to the utility, proposing it split its territories into three separate companies in order to maximize shareholder value, with what Elliott says is the potential to unlock up to $15 billion. Given Duke's share price underperformance over the past decade, and lagging rate base growth relative to its peers, the investor says a more targeted regional focus could better maximize the value of its operations across the Midwest and Southeast.

But analysts question the proposal's timing, given the utility has shed some of its risk and even exceeded analyst projections in the stock market over the past 18 months.

"If Elliott had come out with this when the stock was underperforming … I think they would have gotten a better reception on this than they have now," said Mike Doyle, a senior utilities equity analyst at Edward Jones. But given Duke's multi-billion dollar clean energy investment plan it intends to execute over the next decade, and the promising stock performance that has brought, investors are less likely to be on board with the split-up, he said.

Some see benefits to breaking apart the third largest utility by market value in the U.S. — namely a more targeted regional approach that could shake up entrenched habits and possibly push the power company to transition to clean energy quicker. "Elliott might be onto something with Duke," said Kerwin Olson, executive director of Citizens Action Coalition of Indiana, who regularly engages with Duke's Indiana territory in rate cases in front of regulators.

But Olson and other advocates are also apprehensive about the lack of oversight surrounding Elliott's influence over Duke and other utilities.

"We now have a serious problem where Elliott Management, I would argue, is one of the most powerful investors in the utility industry today," said Tyson Slocum, director of Public Citizen’s energy program. Slocum filed a complaint along with Olson with the Federal Energy Regulatory Commission earlier this year, in response to their concerns the investor was wielding too much influence over power companies without proper oversight.

Elliott: Duke is 'empire building' at the expense of shareholders

In 2012, Duke for a moment was the largest utility in the U.S., having just completed a $32 billion acquisition of Progress Energy, a North Carolina-based power company. But following the purchase, Duke's stock performance quickly began to slide, Elliott found through company disclosures, and the utility consistently performed below its peers until about 2019, lowering its earnings guidance four times during that time period.

Elliott attributes this fall to the utility's preoccupation with growing its footprint and its portfolio rather than execution and "prudent investment." This has led to the perception that Duke is "empire-building" at the expense of shareholder value, Elliott wrote in its Monday letter to management, adding that its current strategy has led to a number of consequential "missteps."

Specific blunders, according to Elliott, include the utility's failed investment in the $8 billion Atlantic Coast pipeline (ACP), the 2014 coal ash spill which led to years of litigation and billions of dollars in clean up costs, its overpriced acquisition of Piedmont Natural Gas in 2016 and the resulting credit pressures.

In March, the utility was downgraded by Moody's Investors Service given the termination of ACP and a settlement Duke reached with North Carolina that will reduce the utility's rate of return on its coal ash cleanup costs.

"Importantly, this series of missteps has distracted management and created balance sheet pressures that have crowded out valuable rate base investment opportunities at Duke's regulated utilities," Elliott wrote.

In order for Duke to maximize its earnings potential, Elliott proposed the "multi-jurisdictional, noncontiguous utility … simplify its footprint to a more manageable and logical service territory."

Currently, Duke is the parent company to nine subsidiaries across the U.S., with territories in Ohio, Indiana, Kentucky, Tennessee, North Carolina, South Carolina and Florida. 

Duke's performance in Indiana and Florida is particularly weak, the investor pointed out: In Florida, the utility's customers have the second-highest power bills in the state and Duke has some of the lowest reliability and customer satisfaction ratings. Its subsidiaries also have low rate base growth compared to other IOUs in Florida and in Indiana.

Elliott's proposal would split the utility into three: A Carolinas-focused Duke presiding over six of its subsidiaries, a Florida entity and a Midwest company with one subsidiary in Indiana and another in Kentucky and Ohio. Such a split could allow the utility to execute more targeted strategies in its service territories, according to the investor, and create better regulatory relationships in those states, ultimately building a market capitalization of $90-93 billion, versus the utility's current $78 billion market cap.

Utility analysts, however, question the activist fund's timing, given Duke's recent performance upswing. 

Analysts: Elliot proposing 'cosmetic' changes at the wrong time

Despite underperforming in recent years, analysts believe Duke is on the rebound, given the utility's aggressive 10 year spending plan and the end of its ACP and coal ash sagas. Duke intends to spend $134 billion over the next decade, and is eyeing regulatory reform in its North Carolina territory to help it follow through on those capital investments. That plan and renewed certainty around its coal ash settlement and the cancellation of the pipeline have Duke well positioned to compete against its peers, according to analysts, and even overperform.

Elliott's "timing is interesting given how much Duke has accomplished over the past 18-24 months, which led to relative outperformance," said Andrew Weisel, a sell-side equity research analyst covering U.S. utilities and power for Scotiabank, in an email.

There are some potential upsides to Elliott's proposal, including the potential for a sale. NextEra Energy has previously put an offer on the table for Duke Energy Florida, and such a sale could create value and benefit for both companies, said Weisel. 

"The small utilities might be more attractive in terms of take-over targets," agreed Paul Patterson, an analyst at Glenrock Associates.

But broadly speaking, such a split up doesn't seem to solve some of the utilities' management issues, and would likely only create redundant costs, the "reverse of economies of scale," said Patterson, adding that the proposal seems largely "cosmetic."

"It is a one plus one equals three equation," he said.

Duke in its response to Elliott's proposal echoed its plans to spend large amounts of capital over the next decade, and deliver 5% to 7% annual earnings growth along the way, noting its stock price has grown 25.2% over the past year. Duke was also critical of Elliott's engagement with its management, charging the investor of demanding to appoint new seats to the utility's board and put in place a non-transparent "strategic review" of the company.

"Elliott's approach to Duke Energy thus far is reminiscent of Elliott's decidedly mixed results in the utility industry, as shown by recent activity with Sempra Energy, FirstEnergy and Evergy," Duke said in a statement. "These utilities' share prices have materially underperformed the sector to date since Elliott became involved, establishing an unenviable track record of shareholder value destruction."

Ratepayer advocates have also raised concerns about the fund's involvement in the power sector, charging it with aggressive tactics and requesting FERC exert more oversight in its involvement with utility companies.

Elliott declined to comment on Duke's response or the charges of ratepayer advocates.

Advocates: Elliott involvement opens 'a dangerous can of worms'

Elliott's involvement in several utilities over the past few years has led to some large scale changes for power companies. 

DTE Energy in October announced a spinoff of its pipeline and storage companies, revealing the decision followed lengthy discussions with Elliott, who had a "significant interest" in the company. In February, Evergy announced it would name two additional directors to its board, as part of its settlement agreement with Elliott, which had owned stakes in the company since January and demanded either a sale of the company or significant changes. And in May, CenterPoint Energy announced Elliott and others had injected $1.4 billion in equity into the power company.

Following the May announcement, Olson and Slocum filed a complaint with FERC against Elliott, asking the commission to deem the fund an affiliate of CenterPoint, despite it not hitting the 10% investment threshold needed to trigger affiliation — and regulatory oversight. 

"If you're giving a private equity firm or a hedge fund access to nonpublic business information of one utility, and then they take an investment position in a competing utility, you are opening up a dangerous can of worms in terms of the anti-competitive impact on markets, and on the utility industry," said Slocum.

Slocum and Olson argue in their filing that Elliott wields an outsized influence on the companies it invests in, consistently resulting in replaced board members or major changes to a company's investment strategy. But because the fund is often not named an affiliate of the companies it engages with, the investor is avoid regulatory scrutiny and pursue its agenda, and the company will often heed the fund's advice in order to avoid a public battle that may make shareholders nervous, according to Slocum. Regardless of the fund's end impact, that lack of transparency is never good for ratepayers, he said.

"The hedge fund engages in a unique form of influence and control of publicly traded companies that evades regulatory review," the advocates wrote in their filing, adding it has become "one of the most influential investors shaping U.S. utility decisions" through "the use of a deliberate strategy designed to evade regulatory oversight under the Federal Power Act."

FERC rejected the filing, citing in part the fact that Elliott does not have a large enough stake in CenterPoint Energy to be deemed an affiliate. But Slocum and Olson say the investor's latest involvement with Duke should be fuel for FERC to revisit their decision, regardless of the merits of Elliott's plan.

"As long as FERC just watches on the sidelines and refuses to step in, Elliott Management is going to be dictating the terms in the U.S. utility industry," said Slocum. "There may be some good things that they're pursuing, there's gonna be some bad things they're pursuing. I don't care. We want them to be subject to FERC regulations like any other entity that is seeking to initiate changes at a utility. It's not good for consumers to have a hedge fund dictating the terms for management of franchised utilities."

Analysts say that Elliott is definitely a major player that could lead to a bit of a shakeup within Duke, though maybe not at the scale the investment fund is proposing.

"Even if a major shakeup or M&A doesn't happen, the firm's investment and involvement no doubt puts a bit of pressure on Duke's management and Board to find some kind of operational or financial improvements," said Weisel. "We give Duke a ton of credit for how well the company has navigated rocky waters over the past 18-24 months. But, in order to assuage pressure from Elliott and possibly other investors, I imagine Duke will likely find some kind of ace up its sleeve to further improve the outlook (which we think is already attractive and meaningfully de-risked)."