A series of equity issuances by utilities in 2019, characterized by a unique structure of pairing a subordinated bond with a three-year equity purchase obligation, has become an increasingly common offering by big names in the sector.
Issuances of these convertibles have totaled more than $5.5 billion so far in 2019, with NextEra Energy Inc. the most recent utility to go this route. Foregoing a traditional debt or equity issuance, the Juno Beach, Fla.-headquartered company announced a $1.5 billion equity issuance of units worth $5 on Sept. 4. The upside of such an issuance is that it "locks in cash proceeds of an equity offering today while avoiding the dilution from the offering for a few years," wrote Andrew DeVries, a senior analyst and co-head of U.S. investment grade credit at CreditSights, in a Sept. 5 note.
The offering consists of a subordinated bond due to mature approximately two years after the three-year equity purchase obligation, with utilities usually opting to remarket the subordinated note, according to DeVries. "Since the note that could remain outstanding is subordinated we still view these units as great for credit quality," he added.

This NextEra offering is similar to issuances from American Electric Power Co. Inc. in March, from Dominion Energy Inc. in June and Southern Co. in August.
"The most commonly used mandatory convertible structure among the issuances from companies under our coverage has been the equity unit structure," wrote Scotia Capital analyst Andrew Weisel in an Aug. 19 research report. "A truly synthetic security, the equity unit combines a mandatory forward equity purchase contract with a medium-term note or preferred stock. In exchange for the high yield, investors face an unfavorable asymmetry in terms of participating in stock price appreciation."
Weisel added, "With ultra-low interest rates and dividend yields, we expect to see more" of such offerings.
There are merits to these types of equity issuances, DeVries told S&P Global Market Intelligence, especially for companies with fairly weak credit metrics. While NextEra does not fit that profile, their offering could provide dry powder for future acquisitions, said DeVries.
"I think it is pretty straightforward in that all of these utilities have significant and increasing [capital expenditure] programs, but they are reluctant to issue dilutive equity here," said DeVries. "The equity units give them the ability to get equity from the agencies without near-term dilution, then on top of that they lock in the high share price without exposure to big fall in the shares. Then the icing on the cake is the interest payments on the equity units are tax deductible for tax purposes, unlike the dividends on a straight equity offering."
In Southern's case, the issuance will allow the company to fulfill its approximately $2.4 billion in equity needs and scrap its $600 million dividend reinvestment plan, Mizuho equity analyst Paul Fremont said in a Sept. 12 research report. "We believe the mandatory convertible transaction announced in mid-August provides an attractive alternative for Southern to remove any overhang associated with future equity needs," wrote Fremont, adding that the issuance provides the company with downside protection.
As for what's next in this trend, Weisel noted these convert offerings have been previously used in the utility sector to finance acquisitions, so DTE Energy Co. could issue a convertible if it makes another midstream acquisition or Eversource Energy could do so to fund offshore wind construction. With municipal utilities JEA and Santee Cooper potentially up for sale, the mandatory convertible offering could be one tool to finance an acquisition with potential buyers including NextEra, Dominion and Duke Energy Corp.
