Exhaustive reviews, impossible public interest standards and no guarantee of eventual success: That’s the consensus outlook for mergers and acquisitions activity under the Biden Administration.
Nonetheless, M&A is alive and well among the 190 essential services companies I track in the Conrad’s Utility Investor coverage universe.
Seven have accepted takeover offers and regulatory approvals are well underway. Another is negotiating a better price from a hostile acquirer. Eight companies are trying to close what would be transforming acquisitions. And seven are divesting assets in deals that will dramatically change their outlook.
As heavily regulated businesses, utility M&A often draws heavy scrutiny from government officials, businesses and the general public. And not every proposed union has been able to successfully jump through all the needed hoops.
One possible reason for currently elevated activity is that former president Trump’s appointees dominate the five-member Federal Communications Commission and Federal Energy Regulatory Commission. President Biden’s picks will eventually as staggered terms on the FCC and FERC expire. And he will have a 3-2 Democrat majority on both, once the Senate approves enough choices. But for now both commissions may be more inclined to approve deals than they will be in a couple years.
The more important reason for so many mergers is the industrial logic of building scale has never been as strong. For the power business, it’s enormous ongoing spending on America’s ongoing energy transition, and the need for access to low-cost capital.
Communications companies need equally massive financing to keep networks competitive in the emerging era of 5G. And water companies face an escalating cost to deliver safe drinking supplies and to treat rising levels of waste.
These imperatives are driving asset divestitures as well, as companies refocus resources on their prime directives. Centerpoint Energy (CNP), for example, plans a massive ramp-up of renewable energy once it sells its 50 percent general partner and 53.69% limited partner interest in Enable Midstream Partners (ENBL) to Energy Transfer LP (ET). It also plans to divest natural gas distribution utilities in Arkansas and Oklahoma.
The history of U.S. utilities is basically continuous M&A. In more than 120 years, not one merger closing between regulated utilities has ever failed to create a financially stronger, more durable company. That’s an irresistible incentive to keep trying to join forces even if regulators resist.
Reflection of a stock trader viewing the performance of a company share price on screen.
There are three main ways to bet on utility M&A. The most lucrative is buying stocks of prospective targets before they’re in play. The second is picking up companies that trade at discounts to takeover offers already received, largely because they’re still chasing regulatory approvals. Finally, investors can buy companies divesting assets, as a bet the transactions will earn them a higher share price.
I’ll be highlighting all of the best bets in each category in the upcoming issue of Conrad’s Utility Investor. Here are three for starters.
PPL Corp (PPL) shares are basically flat since management announced a pair of transforming deals with National Grid Plc (NG, NGG). PPL is selling its UK electricity unit to National Grid in a GBP14.4 billion deal including assumed debt. And it’s buying Grid’s Rhode Island utility for $3.8 billion. The remaining cash will pay off an additional $3.5 billion in debt, with the rest available for further acquisitions and stock buybacks.
The muted market response to the deal so far likely reflects concerns about PPL’s execution, particularly regulatory approvals in the US and UK and the need to hedge against a drop in the British pound. That means investors are all but ignoring the real appeal of PPL’s moves: Creating a focused, financially strong, small utility that will be a prime takeover candidate. Trading at the discounted valuation of less than 14 times expected 2021 earnings, PPL is a buy up to $36 for patient investors.
Looking north, Canadian cable television and wireless services provider Shaw Communications (SJR/B, SJR) currently trades at the largest discount to a cash offer price, CAD40.50 per share from Rogers Communications (RCI/B, RCE).
The reason is rampant skepticism about passing muster with Canadian federal communications sector and anti-trust regulators. Shaw’s wireless business doesn’t overlap much geographically with Rogers’. Nor would the combination do much to alter the competitive landscape with Rogers, BCE Inc (BCE) and Telus Inc (T, TU) already serving an estimated 90 percent of the Canadian market.
Approving this merger would mark a change in long-standing Canadian government policy that four national companies are necessary to assure a competitive market.
That’s a position already abandoned by the US in allowing the T-Mobile US (TMUS) to join with the former Sprint. It was never adopted in major Asian countries like China, the world’s first country to massively deploy 5G. Furthermore, the premise is now being questioned throughout Europe as well, as a hindrance to needed network investment.
It’s still early days with regulatory approvals, and some believe it may take up to a year to complete. But trading more than 20 percent below Rogers’ offer, Shaw’s upside far outweighs risk of deal failure. US investors would also get a lift from more strength in the Canadian dollar. Buy Shaw up to $28.
Last month, Exelon Corp (EXC) announced a one-year process to spin off America’s largest fleet of nuclear power plants. Shares initially dropped following the announcement, as management simultaneously revealed a potential $710 million loss from its power plants in Texas due to the state’s February deep freeze.
Exelon shares have since rebounded but still trade at a discounted 15.5 times expected next 12 months earnings. With CO2-free electricity a top priority for the Biden administration, the nuclear assets should command solid value once the shape of the spinoff becomes clear. Exelon is a buy up to $48.