Aqua America (WTR) is closing in on its proposed acquisition of Peoples Gas, filing a settlement agreement with Pennsylvania regulators earlier this month. That positions the merger squarely for a late third quarter close.
Initially viewed skeptically, this deal is now seen more favorably by investors, and for good reason. Regulated water, wastewater and natural gas distribution have much in common, and therefore opportunity for improved efficiency and cost cutting.
Advanced metering and big data applications, for example, are still vastly underutilized by all three sectors. And while territories served by Aqua and Peoples are mostly complementary rather than overlapping, there’s potential to utilize the same personnel to provide services, particularly in Pennsylvania.
Metallic pipeline outdoors with a valve of control
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Following a wave of mergers over the past decade, ownership of natural gas utilities is now even more concentrated than electricity. Water and wastewater, however, are still widely dispersed industries, with thousands of municipal and privately held systems operating independently.
Last year, Aqua acquired three muni-owned water and wastewater systems adding more than 12,000 accounts, as well as privately held utilities with roughly 21,000 customers. So far in 2019, it’s completed three deals, and expects to close on 19,000 municipal customers by the end of the year.
Buying Peoples adds customers in Kentucky and West Virginia, two states Aqua doesn’t currently serve. More important, however, the deal also greatly increases coverage in Pennsylvania, which starts out at 77 percent of the total $7.2 billion in post-deal rate base and 1.74 million accounts.
Aqua expects 7 percent annual rate base growth from water, fueled by infrastructure investment, customer growth and acquisitions. Gas figures to grow 8 to 10 percent a year by the same factors, augmented by switching from oil to natural gas heat.
Added scale from this merger positions Aqua to make even more moves. That should sustain upper single digit earnings and dividend growth for the foreseeable future. It also increases the company’s appeal as a takeover target, from a still relatively modest market capitalization of around $10 billion.
Initially a Philadelphia-environs based company like Aqua, Exelon actually shares managerial DNA. That includes former Aqua CEO Nick DeBenedictis, who had one time was also an Exelon board member. Both companies also do business in Illinois and Texas.
An offer for Aqua would likely require PPL to sell its UK operations. That’s not a route management would prefer to take, as the regulated utility distribution system it owns is rapidly growing rate base to improve efficiency, absorb more renewable energy and spur government-mandated adoption of electric vehicles.
But should the opposition Labour Party take power in the UK, there’s a high probability a sale would be forced upon them. Labour recently reaffirmed plans to renationalize regulated electric, natural gas distribution and water systems, using funds from the government’s giant pensions.
The ultimate asking price would be negotiated. But at the end of the day, PPL would have a pile of cash to re-invest, potentially as a special dividend but very likely acquiring regulated US utility assets. And few would offer as great a potential benefit for synergy as Aqua, especially in Pennsylvania.
The biggest hurdle to investing in Aqua now is valuation. Shares slipped below my recommended mid-30s entry point following the Peoples merger announcement. Now that the merits of the deal are better known, the price is well above that level. That means would-be buyers should be patient and focus on potential for other utility convergence mergers, including gas and electric utilities buying up regulated water systems.
Northwestern Natural Gas (NWN) a natural gas distribution utility, has $70 million of acquisitions pending for water companies in Oregon, Idaho and Washington state. When closed later this year, they’ll add 18,000 connections serving approximately 45,000 people, and management plans more.
Much larger EverSource Inc (ES) is doing the same with small systems in New England. It’s also waiting in the wings as a potential suitor for Connecticut Water Service’ (CTWS) roughly $500 million rate base, should state regulators again reject that company’s merger with California-based SJW Corp (SJW).
The pair has again filed for approval in Connecticut and Maine after answering questions raised by the officials in their first failed attempt. Rulings are due this summer. But even if merger succeeds this time, the combination will still have a market capitalization south of $3 billion, making it an eventual target for a convergence merger.
As a prospective builder of offshore wind in New England, EverSource is incented to increase its regulated rate base to offset the higher risk of these contracted generation projects. And it has successfully absorbed its $1.7 billion acquisition of the former Aquarion Water. That’s particularly important with offshore wind since the economics are still uncertain in the US, one reason sector leader
Avangrid Inc (AGR) also may attempt to offset prospective offshore wind project risk with a regulated US utility acquisition. The company’s 82 percent owner
Of course, the largest impediment to utility mergers of any stripe now is high valuation. But because the likely acquirers too are high priced, their cost of equity capital has rarely been lower. So is their cost of debt, as investment grade corporate borrowing rates remain near historic lows.
Our cardinal rule is always to stick to takeover targets you’d want to own if there were never a deal. Look for candidates in the upcoming July issue of Conrad’s Utility Investor, highlighting our picks and pans for the rest of 2019.
