(September 2012) Our annual financial ranking shows some remarkable shifts among the industry’s shareholder value leaders. Despite flat demand and low commodity prices, investor-owned...
Going Once ...
The industry has seen more acquisitions in the last 24 months than in the previous six years. Utilities are gaining scale and consolidating territories. Whole company acquisitions are an important part of the strategy of any company to grow and when well executed can provide much more than simple scale. However, it is not the only option to grow earnings. Asset acquisitions can provide another avenue for growth that should not be ignored. There are three main forces that will push the industry back to focusing on asset acquisitions in the next year.
We are approaching a point where there are fewer attractive acquisition prospects available, as the largest utilities become landlocked.
1) the decline of suitable whole company acquisition targets;
2) impending environmental regulations that will have a large impact on generation portfolios; and
3) the increasing difficulty of obtaining regulatory approval for whole company acquisitions.
These factors will turn the tide in favor of acquiring specific assets and pieces of companies in favor of buying companies outright.
Big is Beautiful
The recent upswing in whole company acquisitions vs. asset acquisitions is clearly seen in Figure 1 which shows total deal value by year for each type of acquisition (see all figures on p.2). The reasons for this surge in activity are multi-fold but revolve around the need for utilities to drive earnings-per-share (EPS) growth in a slow economy and the relative value seen in acquiring a whole company rather than individual pieces. However, we are approaching a point where there are fewer attractive acquisition prospects available, as the largest utilities become landlocked against equally large competitors. In fact, this trend of acquiring utilities in neighboring territories is so strong that it can be easily seen by looking at a map of territories of recent acquisitions.
Plant acquisition opportunities will be short-lived, as asset values increase due to planned generation retirements.
For many utilities the lack of these opportunities leaves targeted asset acquisitions as the best option for driving growth. Furthermore, the relative value of acquiring whole companies compared to assets is beginning to shift as utility values are recovering from the low seen in 2009. Earnings multiples are recovering following the recession where they went as low 10x as shown in Figure 2. Furthermore, utilities were reluctant to sell assets during the bottom of the recession due to relatively low valuations. Many of the asset-based transactions that occurred in this period were by companies in need of cash to shore up balance sheets.
The next driver to consider behind asset acquisitions is the need for companies to replace generation assets as a significant portion of the U.S. generation fleet will likely be affected as a result of pending EPA regulations. The reasons for this to favor asset acquisitions are threefold: 1) many companies will need a source of cash to complete required environmental upgrades on their fleets making asset sales attractive; 2) companies retiring large portions of their fleet will want to replace retired generation in their portfolio; and