Duke Energy's planned $13.7 billion purchase of Progress Energy Inc

is the biggest test yet of whether regulators will allow utilities to merge and fortify their finances for huge new investments.

The deal, announced on Monday, would create the largest U.S. power company, if it wins approval from regulators, with 7.1 million electricity customers in North Carolina, South Carolina, Florida, Indiana, Kentucky and Ohio, and 57,000 megawatts of generating capacity.

Duke Energy Chief Executive and Chairman Jim Rogers said the combined company would be financially stronger and better able to cope with the huge costs facing the industry, from upgrading the power grid and adding new environmental controls to building a new generation of power plants, including new nuclear reactors.

In North and South Carolina, where regulatory approval is needed, the new company would pass along to customers savings of $600 million to $800 million over five years from combining the two companies' fuel costs and delivery systems.

That's very unique in this day and age to be able to capture these types of savings, Rogers told Reuters. I think that gives us a leg up in the (regulatory) process.

Analysts said even though the merged company would be dominant in both states, it stood a strong chance of winning regulators' backing.

As long as there is assurance and protections in place that will both prove the financial strength of the company and benefit the consumers, then regulators will approve it, said Nathan Judge, an analyst with Atlantic Equities in London.

Edward Finley, Jr, the chairman of the Carolina Utilities Commission, said the regulator was briefed on the proposed buyout earlier on Monday.

Our primary objective ... is to look at this from the consumers' perspective, he told Reuters, especially since both companies were sufficiently profitable.

The companies are hoping to close the sale by the end of the year, although Finley said there was no time line on when the commission would rule.

DOMINION OFFER?

The U.S. power industry has seen a resurgence of deal activity in the past year -- despite high regulatory barriers -- as utility companies consolidate to cut costs and pool funds for investing in new projects, such as nuclear power plants.

On Friday, Dominion Resources Inc tried to put its own offer for Duke or Progress on the table, according to a source familiar with the matter. It sent both companies a letter proposing a deal that would be at a premium of 10 percent to 15 percent, but declined to make the offers public, the source said.

But the Dominion offer is likely to end there unless Duke's bid for Progress falls apart, as hostile deals in the utilities sector are very uncommon and difficult to complete.

Dominion, Duke and Progress declined to comment on the Dominion bid.

A combined company would likely be able to increase its dividend, a key factor in attracting investors to the regulated utility sector.

It really enhances our ability to grow the dividend going forward, Rogers said. Our plans are to grow the dividend at slightly less than the growth in our earnings.

The companies would target earnings-per-share growth of 4 percent to 6 percent annually, the companies said during a conference.

Rogers, who joined Duke when the company bought Cinergy for $9 billion in 2006, said the industry could be set for a new wave of consolidation as companies seek growth in their balance sheets to finance increasing costs expected in the coming years.

Power mergers in the past year include FirstEnergy's $4.7 billion deal for Allegheny Energy ; E.ON's $6.7 billion sale of its U.S. unit to PPL Corp

; and Carl Icahn's recent bid to buy power producer Dynegy .

State regulators have sought drastic concessions from companies planning to merge, such as rate reductions. The deal could increase chances that new U.S. nuclear plants could be built.

In a previous spate of mergers in the middle of the last decade, planned mergers of FPL Group and Constellation Energy Group , as well as Exelon and Public Service Enterprise Group

fell apart after regulatory problems arose.

Even mergers that do succeed can drag on for long periods before closing. FirstEnergy has yet to complete its transaction for Allegheny, which was agreed upon 11 months ago.

Duke last year lost out on a bid for the U.S. assets of German utility E.ON .

Duke said Progress Energy shareholders would receive 2.6125 shares of common stock of Duke Energy for each share held, or $46.48 per share, representing a 4 percent premium to the stock's Friday close on the New York Stock Exchange.

Duke Energy said it will assume about $12.2 billion in Progress Energy's debt. The company also expects to effect a reverse stock split immediately prior to closing.

After the merger is completed, Rogers will become executive chairman of the new company, while Bill Johnson, the chairman and CEO of Progress, will become president and chief executive officer, the companies said.

J.P. Morgan was Duke's lead financial adviser, with Bank of America Merrill Lynch providing a fairness opinion. Lazard served as lead financial adviser to Progress Energy, which also was advised by Barclays Capital.

Duke Energy shares closed down 1.18 percent to $17.58 on the New York Stock Exchange, while Progress Energy finished down 1.63 percent at $43.99.

(Reporting by Matt Daily, additional reporting by Diane Bartz in Washington, and Thyagaraju Adinarayan in Bangalore; editing by Maureen Bavdek, Carol Bishopric and Andre Grenon)

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