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After activism drives Sempra stock bounce, 'inflated' valuation questions emerge


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After activism drives Sempra stock bounce, 'inflated' valuation questions emerge

Wall Street analysts and Sempra Energy investors are beginning to question the "inflated" valuation inferred by activist shareholders pushing to restructure the company and unlock $11 billion to $16 billion in new equity.

It's also currently unclear how Sempra Energy management will respond to the pitch to revamp the company's board of directors and sell numerous assets, including its non-U.S. businesses and Sempra Renewables LLC, and spin off its Sempra LNG & Midstream segment.

Activist investors Elliott Management Corp. and Bluescape Resources Co. LLC on June 11 announced their two-step plan to unlock value at Sempra Energy and simplify its business structure. In an open letter and presentation to the company's board of directors, Elliott and Bluescape highlighted an opportunity to "refresh the board" with six independent directors and create a strategic review committee to "identify value-creation opportunities for all stakeholders."

They believe their plan could lead to $11 billion to $16 billion in "line-of-sight value creation," driving Sempra's stock price up to $139 per share to $158 per share.

While analysts have largely responded favorably to news of the initiative, several key questions are dampening the near-term excitement.

"We find arguments introduced today by Elliott and Bluescape directionally compelling, and agree that this portfolio has limited justification for existing in its current wide-ranging form and has potential valuation upside from asset sales," J.P. Morgan Securities LLC analyst Christopher Turnure wrote in a June 11 report. "However, we see the proposed valuation as inflated for nearly all businesses and view a base case as closer to $106 [to $109 per share], excluding the benefit from any incremental share buybacks."

The analyst also expressed reservations about the pitch to split Sempra into a pure-play regulated utility and a separately traded LNG and midstream-focused enterprise.

"Despite [Sempra's] recent interest in selling assets, we largely see the idea of divesting/spinning everything but the utilities as the polar opposite of the intended direction of new management," Turnure wrote.

Sempra Energy CEO and Director Jeffrey Martin took the helm at the San Diego-headquartered company on May 1 and is expected to unveil its new business plan at a June 28 analyst day.

Elliott and Bluescape, which together own a $1.3 billion, or 4.9%, economic interest in Sempra Energy, said they are concerned about the complexity of the business and the lack of industry experience among board members.

"Despite the attractive characteristics of its businesses, Sempra shares are deeply undervalued by the market," Elliott Management Portfolio Manager Jeff Rosenbaum and Bluescape Resources Executive Chairman C. John Wilder wrote in their letter to the board. "In our view, this persistent and substantial undervaluation stems from a focus on sheer size that has permeated management and Board thinking. This has led to the creation of a conglomerate structure consisting of disparate businesses grouped together with no compelling strategic or financial rationale."

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News of the letter catapulted Sempra shares more than 15% higher to close at $117.19 on June 11, up from $101.43 on June 8.

Wells Fargo Securities LLC on June 11 downgraded Sempra to "market perform" from "outperform" while raising its price target to $123 from $118 in response to the activist-driven share price spike.

"Given [Sempra's] diverse platform of high quality assets, we do see the potential to unlock value via a full-scale strategic and operational review," Wells Fargo analyst Sarah Akers wrote. "That said, we do not yet know how [Sempra] management will respond to the activist letter and, separately, upside investment opportunities should still be discounted, in our view, given significant uncertainty and execution risk."

The firm noted the new share price target includes $5 of upside tied to incremental value creation from new investment opportunities and potential portfolio optimization.

Wells Fargo said it already expected Sempra to announce the sale of its renewables business at the analyst day and therefore does not believe management will "close the door" on the investors' proposals.

"The key, however, will be timing — and we're not convinced that [Sempra] will be at a point of announcing a full-scale break-up by year-end," Akers wrote.

Weighing the risk

Evercore ISI on June 12 increased its price target to $130 per share from $117 per share, which incorporates some of the upside from the Elliott and Bluescape plan.

"The risk/reward for [Sempra] management appears skewed to us toward engagement with these investors regarding the merits of their proposal, as there is no downside except the consumption of time and some expense to pursue a review of these proposed strategies," Evercore analyst Greg Gordon wrote.

The analyst noted that the investors have previously engaged with NRG Energy Inc. and FirstEnergy Corp. to simplify and restructure their businesses.

"Our experience following the evolution of the NRG and [FirstEnergy] processes has been that engagement with Elliott/Bluescape, and the creation of a formal review process with no 'sacred cows' has generally driven more robust, aggressive and potentially value enhancing strategic decisions than would have occurred in the alternative," Gordon wrote.

FirstEnergy welcomed the $2.5 billion equity infusion from Elliott, Bluescape and other prominent and activist investors, which helped slash holding company debt and propel FirstEnergy's exit from merchant generation.

FirstEnergy Executive Vice President of Finance James Pearson, formerly the company's CFO, downplayed Elliott's past activism and push for operational and governance changes at other investor-owned utilities.

"We will clearly listen to any ideas they have, but from a standpoint of changing the direction of the company, wanting governance or board seat responsibilities, no that has not been a discussion point at all," Pearson told S&P Global Market Intelligence in January.

Sempra, meanwhile, issued a brief statement in response to Elliott and Bluescape's pitch to overhaul the company.

"Our board and management will review their letter and presentation in detail and respond in due course," it said.