Research

Herbivores or Carnivores? M&A Pace Alive and Well

James von Riesemann
Managing Director, Power, Utilities and Alternative Energy
March 14, 2016

MIZUHO SECURITIES USA INC.  |  US EQUITY RESEARCH

Summary

M&A doesn't look like it's going away. With two transactions already announced this year, and news reports that another company is considering its "strategic alternatives," the one question investors are asking is what are you: a Herbivore or a Carnivore? If a company has a market cap less than $10B, in all but a few cases, you're a herbivore and your valuation already reflects it. Otherwise, you're a carnivore. So long as there's a low interest rate environment and markets remain open, we expect M&A activity to remain robust.

Key Points

Not much has changed: (a) companies are paying to maintain/enhance underlying growth rates; (b) the purchaser's balance sheet capacity, low financing costs and tax position matter; (c) deals are all cash to the sellers; (d) trend toward more regulated earnings and cash flows remains intact; (e) targeted companies earning full ROEs is not a takeover impediment; (f) convergence mergers, e.g., electric/gas where the buyers look to balance earnings streams and stabilize cash flow, are still relevant; and, (g) never underestimate the power of a regulator. They're underpaid and they listen to those that put them in the regulatory role. If a particular jurisdiction doesn't want an outsider buying the local utility, no matter how penal they've been to that utility, the deal is never going to happen. Mizuho posits that the NEE/HE, EXC/POM, and Macquarie/ CNL deals will all fall through because all underestimated item (g).

Boards, pay attention to the market. As takeout multiples continue to soar - look at the prices and multiples paid for TE, GAS, PNY, EDE, and ITC - our view is that Boards have (i) a fiduciary duty to seriously evaluate proposal(s) or begin a process; (ii) explain why the standalone case exceeds the takeout alternative; and (iii) recognize this is not about job preservation for you or the management of the targeted company.

Who might be the next SMID target? Gas centric: Atmos Energy (ATO); New Jersey Resources (NJR); South Jersey Industries (SJI); Southwest Gas (SWX). The WSJ reported that Columbia Pipeline Group (CPGX) has held talks with TransCanada (TRP). CPGX was split from NiSource (NI) in order to make both companies more transaction-friendly. On the electric side, in addition to NI, our view is the Pacific Northwest and the entire Great Plains is ripe for consolidation. The question is whether the consolidation will be amongst regional strategic's or larger capitalized strategic's and/or infrastructure funds.

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