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South Jersey Industries deal promises growth, but Wall Street wary of details

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South Jersey Industries deal promises growth, but Wall Street wary of details

South Jersey Industries Inc.'s planned acquisition of two gas utilities for $1.7 billion prompted mixed reactions from industry analysts while shares were pummeled.

South Jersey Industries, or SJI, would increase its scale by 45% to 80% by buying Southern Co. Gas subsidiary Pivotal Utility Holdings Inc.'s Elizabethtown Gas Company Inc. and Elkton Gas Company, according to Williams Capital Group analysts. By adding 294,000 customers and increasing its natural gas distribution rate base by almost 46% to over $2.3 billion, they said in an Oct. 17 note to clients, the acquisition would make SJI New Jersey's second-largest natural gas utility once the transaction closes in mid-2018. The deal would also grow SJI's utility capital investment plans to $1.5 billion from 2018 through 2021.

During an Oct. 16 conference call, SJI executives said the transaction would provide an opportunity to grow SJI's earnings potential through infrastructure modernization investments that would increase the utilities' rate bases.

Morgan Stanley analysts emphasized that SJI's entry into Maryland through Elkton Gas de-risks its portfolio by expanding regulatory exposure.

"The deal helps increase the percentage of SJI's earnings coming from regulated businesses and diversifies SJI's utility exposure into a new state and regulatory jurisdiction, with Elkton gas operating in Maryland, which helps reduce exposure to single US state-level regulatory outcomes," they wrote in an Oct. 17 research note. "SJI's strong existing relationships within the state of New Jersey could also help to decrease the risk of regulatory resistance during the approval process and longer-term after the transaction has closed."

SJI stock fell 9.3% to close Oct. 16 at $32 following the deal's announcement. "This [stock sell-off] is most likely a result of what might appear to be a rich acquisition multiple," Williams Capital Group analysts said. "While management quoted a 23.4x acquisition multiple of 2018 expected earnings adjusted to exclude $300 million of acquisition tax basis step-up tax benefits anticipated, some interpretations of the acquisition multiple are much higher and the tax benefits are poorly understood at this point."

Morgan Stanley, however, cautioned against interpreting the market move as an accurate response to the deal. "While we see the potential for limited accretion and earnings dilution, we view Monday's ~9% negative move as overblown," the analysts wrote. SJI stock had recovered by 3.75% as of mid-afternoon ET on Oct. 17, trading at 33.20.

Analysts at Hilliard Lyons said in an Oct. 17 note that they expect SJI to sell Elkton Gas and that the regional M&A activity was unexpected.

"We were surprised ... as we were totally unaware that M&A was a potential growth driver for South Jersey," they wrote. "More broadly, uncertainty surrounding the corporate tax code had seemingly been a deterrent to additional deal flow in the gas space. In our estimation, management seemed to downplay the importance of this tax item in evaluating this particular transaction."

S&P Global Ratings downgraded its outlook on SJI and subsidiary South Jersey Gas Co. to negative from stable but affirmed both entities' investment-grade BBB+ credit ratings.

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.