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With investment fund takeout, El Paso gains new access to capital


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With investment fund takeout, El Paso gains new access to capital

While analysts were somewhat surprised by an investment firm's steep price to acquire Texas investor-owned utility El Paso Electric Co., the deal likely makes financial sense for both parties and may face little resistance from tough state regulators.

The El Paso, Texas-headquartered electric utility announced June 3 that it reached an agreement to be acquired by Infrastructure Investments Fund, an investment vehicle advised by J.P. Morgan Investment Management Inc., for $68.25 per share in an all-cash deal.

The purchase price represents a 17% premium to El Paso Electric's $58.20 closing price on May 31, the last trading prior to the announcement. The enterprise value of the transaction is about $4.3 billion, including $2.8 billion in cash and the assumption of about $1.5 billion in El Paso Electric's net debt.

"The 27x [price-to-earnings] ratio is a steep price to pay for a financial buyer where O&M savings are harder to achieve and the 27x compares to the group trading at 18x," CreditSights analyst Andrew DeVries wrote in a June 3 report. DeVries noted that Vectren Corp.'s buyout by CenterPoint Energy Inc. involved a purchase price of 25 times earnings.

El Paso Electric's market capitalization was about $2.4 billion as of May 31 with the company's total enterprise value set at $3.9 billion, according to S&P Global Market Intelligence data.

El Paso Electric's stock jumped more than 14% on June 3 before closing at $66.08.

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"It was a pretty healthy price," Jay Rhame, portfolio manager and research analyst at Reaves Asset Management, said in a June 3 phone interview. "I think company [earnings] guidance is up to $2.45 in 2019 and they are paying something like 27 and a change, almost 28, times earnings."

Still, Rhame said El Paso likely presented an attractive opportunity for Infrastructure Investments Fund, or IIF.

"Looking at it over the whole investment landscape, there is something nice about investing in a regulated utility with growth prospects for kind of mid-, single-digit growth for a while," Rhame said. "It's a nice counterbalance to have something with a little bit less volatility, relatively predictable earnings and cash flow stream that either can be reinvested [in the utility itself] or elsewhere."

The $11.3 billion investment vehicle committed a bridge financing facility led by Bank of America Merrill Lynch to support the deal.

The transaction is subject to approval by the New Mexico Public Regulation Commission, the Public Utility Commission of Texas and presumably the Federal Energy Regulatory Commission. Texas regulators have presented roadblocks for utility mergers and large-scale investments in recent years in order to protect ratepayers and the financial health of the state's utilities.

"If [IIF's] plan is to take cash out of the company and lever it up, I think that's harder to get past the regulatory approvals," Rhame said. "But if they plan to just run it like a utility ... reinvest all of the cash flow every year back into the utility infrastructure, something like that has a much better chance of being approved."

"From the PUCT standpoint, this is certainly an easier transaction to figure out the pros and cons on," the analyst added.

Rhame noted that New Mexico regulators also have been tough on utilities. Still, the analyst believes the deal can survive scrutiny if IIF can convince regulators it is committed to holding the utility.

"I think one wouldn't go into a utility transaction without an idea for holding it for at least several years," Rhame said. "I think it would be hard to get approval if you're planning for an exit. It's such a relationship business."

Under the deal, El Paso Electric will remain an independently operated, regulated utility headquartered in El Paso, Texas, and its current workforce will remain in place. As part of the deal, customers will receive $21 million in credits on bills over 36 months, the companies said in a news release.

El Paso Electric provides generation, transmission and distribution service to about 428,000 retail and wholesale customers in West Texas and southern New Mexico.

From the utility's standpoint, it was going to have to "outspend cash flow" to build generation and infrastructure to support strong load and customer growth.

"There's kind of a continual need to keep building new power plants every five or 10 years or so," Rhame said. "In a way, this (acquisition) probably serves a lot of the capital market potential issues that they would have had."

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Analysts do not see the El Paso acquisition as indicative of an emerging trend as the utility sector has been relatively quiet from an M&A standpoint.

"We are hard pressed to see the next takeout target among U.S. utilities given there are so few single-state utilities left and multi-state deals are much tougher to approve for financial buyers," CreditSights analyst DeVries wrote. "CreditSights therefore views this deal as much more of a one-off than a sign of future M&A trends in the U.S. utility sector."

"I think most utilities actually have pretty good organic growth opportunities without having to do any M&A," Rhame said. "I think if the right deal comes up, no utility would turn it down ... but there is no real need to go out and do it."

Rhame, however, said "it will be interesting" to see if more infrastructure funds do decide to bolt on utilities. "Because I think it does make sense for a fund like that to look at."