American Gas - May 2014 - (Page 28)

m&a OPPOrTunITIes wITh smaller uTIlITIes By Gerry yurkevicz T hinking small can produce big results for utility investors. small utilities can offer attractive growth opportunities for larger utilities and infrastructure funds scouting for future earnings growth. Utilities face limits on how much and how quickly they can grow the rate base. new products and services typically do not contribute enough to move the needle. Utilities can pursue mega-mergers, but recent history suggests that the regulatory approval process bogs down these deals and strips away value. companies currently pursuing smaller utility acquisition strategies include Algonquin Power & Utilities, Gaz metro, steelriver infrastructure Partners, and Gas natural. a smaller utility acquisition strategy: Opens the door to more utility opportunities. The market for small utility acquisitions is actually quite big. There are about 175 investor-owned electric and gas utilities in the United states that have net property, plant, and equipment (PPe, a proxy for rate base) of less than $500 million. in addition, there are more than 3,000 municipally and government-owned utilities. Together, these smaller utilities have net PPe greater than $45 billion. Provides utility investments with upside. Big utilities tend to perform reasonably well. in contrast, some utilities are a small part of a larger energy company that is focusing on higher growth or return businesses (e.g., midstream or exploration and production). some smaller utilities represent just a fraction of a parent's utility holdings. in both cases, smaller utilities may not get much management focus or investment dollars. Growth in net PPe is below average for half of smaller utilities, but for only one-quarter of larger utilities. smaller utilities often have opportunities to improve the local customer experience and state regulatory relations. regulators and politicians crave local rela- 28 AmericAn GAs may 2014 tions and local job creation (e.g., offices and call centers). many larger utilities have focused on functional consolidation and standardization. many smaller utilities are natural gas distribution utilities. With sustained lower gas prices expected, gas utilities offer substantial upside for fuel conversion and gas system expansion. allows investors to purchase at a somewhat lower price. investors pursuing a utility acquisition strategy need to be prepared to pay market multiples (e.g., enterprise value as a percentage of net PPe or as a multiple of eBiTDA). However, the purchase price for about 85 percent of smaller utility acquisitions is a bit below the market multiple. For larger utility acquisitions or mergers, only about 33 percent are below the market multiple. Involves fewer management issues to address. We all know the story with big mergers: The senior teams meet, they do the dance, and they negotiate the issues. many cannot reach agreement, and the dance ends. smaller acquisitions involve far fewer issues. many can be winwin asset purchase transactions or offer career growth or cash-out opportunities for senior managers. some argue that smaller transactions are not worth the effort. Bigger transactions may create greater value sooner, while smaller deals often require a similar level of resources (e.g., management time, advisory, and due diligence fees). However, a fresh, focused, and disciplined approach can yield a cost-effective small utility acquisition initiative. Furthermore, utility roll-up opportunities exist in every region of the U.s. over time, a robust strategy coupled with first-class acquisition integration efforts can yield value equal to just one big deal. Gerry Yurkevicz is a partner in Oliver Wyman's energy practice. ability of utilities to deliver natural gas safely, reliably, and affordably, while building their customer base and earning returns on their invested capital. That proposition, of course, starts with having a safe and reliable infrastructure in place." Like Fidell, Strassberg believes that the need to replace and upgrade infrastructure is urgent. With gas prices relatively low, regulators and customers alike are more likely to tolerate rate surcharges aimed at recovering the cost of capital expenditures. "In many jurisdictions, the public utility commissions have allowed for an incentive mechanism known as an accelerated infrastructure replacement rider that incents gas LDCs to replace old pipe at a faster rate than they were doing previously, in a way that is shareholderfriendly," Strassberg says. Positive sentiments aside, Strassberg's one concern is that some utilities may have gotten a late start on replacing their aging infrastructure. "With gas prices low and incentive mechanisms available in many jurisdictions, the window of opportunity to accelerate infrastructure upgrades is now," he says. At a moment when gaining investor and public confidence in natural gas is paramount, missing that window carries several adverse effects. Speed to market being of the essence, the industry can ill-afford any deceleration of pipeline improvement and expansion. Not taking advantage of the favorable economics presently at hand could injure shareholder confidence-maintaining steady dividend returns and EPS growth is critical to the investment equation-to say nothing of rate-hike pain for consumers. And for utilities themselves, the confidence to invest in large-scale capital expenditures goes with having a cost-recovery solution in place. The window to avoid these outcomes is now-and streamlined approvals and

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American Gas - May 2014