FirstEnergy Corp. (FE) has agreed to a $4.7 billion takeover of utility Allegheny Energy Inc. (AYE). The $4.7 billion acquisition is an all-stock deal rather than a cash deal, and the reason the premium does not appear higher is because shares of First Energy are trading down over 6% on the dilution that will occur in its current $12 billion market capitalization. The question now is: Will this deal finally create a wave of power utility mergers among the dozens of small-cap and mid-cap players out there? If so, this could be a rather important development for dividend investors.

Finding a blueprint is not as easy as it sounds, but generally the idea is to pursue geographic overlap or geographic expansions next to or within current customer bases.  The other point is to avoid deals that are highly dilutive to earnings and deals that will kill dividends.  After all, it is those prized dividends that investors seek in many of their utility investments. The yield for FirstEnergy after the dilution today is 5.3%, while the dividend for Allegheny holders, even after the gain, is only 2.8%.

This merger gives customers from Ohio to New York with sales of what look to be almost $16 billion on a combined basis. The company will also now serve over 6 million customers in Ohio, Pennsylvania, New York, New Jersey, Maryland, Virginia and West Virginia.  If you pull out your Atlas, you will see that these are all tied together, and that allows for use of the same power generation lines and a combination of geographic overlaps.

The trick is in finding which companies want to be the acquirer. For years before Berkshire Hathaway (BRK-B) made its Burlington Northern Santa Fe (BNI) deal, it was believed that Buffett wanted a utility for one of his huge deals. After all, Berkshire’s MidAmerican was trying to acquire Constellation Energy Group (CEG) before a stake was taken for a better deal by the French. Buffett won’t compete in deals.

Both Calpine (CPN) and Edison International (EIX) had been thought of as long-standing targets and/or partners in a merger, but the big issue here is regulatory risks that are specific to California. That being said, you can pass on those as candidates for the time being. But there are other smaller players with niche fits, and you can’t ever rule out the private equity firm buyers when it comes to power companies.

If you want to consider one company that is close by the same geographies in the PJM -Power grid, you have Pepco Holdings (POM). This utility delivers electricity to approximately 1.8 million customers in the mid-Atlantic region; it also distributes natural gas to approximately 122,000 customers in Delaware. The yield is high, and some buyers may not want to be on the hook here at 6.7%. But its market cap is about $3.6 billion, and it trades at an estimated 12.5-times 2010 earnings estimates.

Portland General Electric Company (PGE) served approximately 814,000 residential, commercial and industrial customers as of summer-2009 throughout Oregon. The company’s market cap is a mere $1.4 billion. It trades at 11.6-times expected 2010 earnings and offers investors a 5.4% dividend yield.

NSTAR (NST) is another one of the regional players that fits some of the general regional bolt-on themes in the Massachusetts area. It serves approximately 1.4 million customers, broken down (approximately) as 1.1 million electric distribution customers in 81 communities and 300,000 natural gas distribution customers in 51 communities. The market cap here is $3.5 billion, it trades at about 13-times 2010 earnings, and the dividend yield is 4.8%.

What are the big risks? For starters, the cap-and-trade or emissions taxes represent huge risks for the sector. But most market pundits feel this will be passed straight down to the consumers immediately. There are also local regulatory risks, as well as geographic risks. Many operators prefer to be away from troubled hurricane or earthquake zones, although that is often just considered a cost of business in many areas. Many utilities operate with high debt-to-equity ratios as well, and many buyers are leery of leveraging up and up for income. The last risk is the ability for a utility to stay independent. For a merger to occur here, it almost always needs to be a friendly merger.

It is very interesting that today’s merger has very little secondary and tertiary activity in the electric and even in the natural gas utilities. Perhaps it is just the premium not being a mega-premium. But when Buffett said he wanted to own utilities in the early 2000s, that had the sector going. These are just some very simple looks, but in the past, excitement in one caused excitement in the sector.