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Scale, emissions limit Canadian private equity's appetite for gas infrastructure

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Scale, emissions limit Canadian private equity's appetite for gas infrastructure

Canadian private equity's recent billion-dollar bets on North American gas infrastructure reflect a low-risk strategy focused on contracted assets, industry analysts said recently, but they cautioned that activity will likely remain sparse as funds shift toward avoiding greenhouse gas-emitting investments even when they have sufficient buying power.

Public Sector Pension Investment Board and Alberta Teachers' Retirement Fund Board agreed to buy out AltaGas Canada Inc. for C$1.7 billion in cash Oct. 21, the first take-private transaction for a North American gas utility since a fund managed by BlackRock Real Assets' Global Energy & Power Infrastructure group merged with Gas Natural Inc. in 2017.

Similar to that deal, which came about due to company-specific struggles that tainted relationships with regulators, the AltaGas Canada transaction was announced to help parent company AltaGas Ltd. unload the crippling debt it incurred from acquiring WGL Holdings Inc. in 2018, utility equities analysts at Mizuho Securities and Veritas Investment Research Corp. said.

"Private equity involvement in gas utilities has been infrequent. … I think you need some degree of special situations to arise where a bigger company is maybe hiving off some assets," Mizuho's Gabriel Moreen said in an interview. "With gas utility valuations where they are today … I think it's a bit of a stretch for private equity to be interested."

With the transaction's premium of approximately 31% to AltaGas Canada's closing share price on the Toronto Stock Exchange on Oct. 18, the offer was effectively too good to refuse, according to Canadian equity research company Veritas Investment's Darryl McCoubrey.

"Given the valuation they got, they almost just had to do the transaction because [AltaGas is] really up against the wall," McCoubrey said in an interview, noting that the company's target 5.5x debt/EBITDA for the end of 2019 is not an investment-grade balance sheet. "They may not be done selling [assets] even yet."

McCoubrey added that there are not many companies like AltaGas Canada that pension funds can afford to buy out entirely without being overly extended in one asset class since "usually scale is everything" for utilities.

Canadian private equity giant Brookfield Asset Management Inc. can afford higher price tags and plans to buy a 25% equity interest in Dominion Energy Inc.'s Cove Point LNG export facility for over $2 billion, in line with a low-carbon strategy that prioritizes port infrastructure over pipeline assets that are closer to the wellhead, emit more CO2 and are more likely to have un-contracted capacity.

"This particular LNG export facility has cash flow that is not going to go up or down. It is essentially a bond tied to high-quality counterparties for the life of the contracts that last a couple decades," CBRE Clarion Securities portfolio manager Hinds Howard said in an email. "LNG is a logical place for the mega-infrastructure funds to get involved, because the capital needs are so big and the assets are heavily contracted."

Dominion had planned to sell Cove Point to its pipeline master limited partnership but chose instead to roll up the MLP in 2018 as its stock price tanked.

When it comes to gas infrastructure M&A, McCoubrey sees Canada's big pension funds "adopting" Brookfield's investment model and sidestepping traditional midstream opportunities.

"They're looking for a combination of real assets that don't have a huge CO2 footprint that they can lever up with a lot of debt … to direct to more asset acquisitions going forward," McCoubrey said.