A Gulf Power lineman from Pensacola, Fla., helps repair a power line in Virginia following summer storms that swept through the state in 2012. |
Recent transactions by NextEra Energy Inc. and Southern Co. demonstrate the immediate focus by the two integrated utility giants on re-calibrating strategic priorities to achieve longer-term balance sheet flexibility.
NextEra's $6.48 billion acquisition of Southern's Gulf Power Co., Florida City Gas and a pair of contracted generating assets offers evidence that after foiled utility acquisition attempts in Hawaii and Texas, the company is doubling down strategically on its home turf in the Sunshine State. For Southern, the sale announced May 21 highlights management's aversion to share dilution through additional equity issuance, and a belief that within its portfolio, no assets are off the table when it comes to addressing remaining equity needs to shore up credit quality in light of tax reform impacts.
"We did spend a lot of time thinking about the sale of Gulf Power, it's a wonderful company, and in fact, I was CEO there," Southern Chairman, President and CEO Tom Fanning told analysts on May 21, reflecting on the lineage of Southern executives who worked at the Florida subsidiary on their rise through the ranks. He added that Southern may continue to shed assets at value, saying, "If there's anything else that makes sense, certainly we'll evaluate it both on the buy- and the sell-side."
Deploying 'smart capital'
For NextEra, expanding its position in Florida should offer regulatory and operational advantages with its Florida Power & Light Co. utility that may have been absent from previous M&A campaigns. That notion has helped partially offset concerns that NextEra may be overpaying for the Southern assets, in exchange for a higher level of certainty that the deal will close and a promise to double the earnings per share growth rate of Gulf Power relative to NextEra's 6% to 8% corporate target by 2021.
"We see an opportunity to essentially run the playbook that we've been running in Florida for the last 15 years," NextEra Chairman, President and CEO Jim Robo said May 21, "and so that would include investing smart capital that would benefit customers and will also, I think, benefit shareholders."
Those opportunities could manifest in accelerated rate-base investments in combined-cycle gas-fired projects, wind, solar and energy storage, Deutsche Bank analysts noted May 22, adding that an,"improvement on the cost front would allow Gulf Power to earn the high end of its authorized ROE band of 11.25%."
"To that end, Gulf Power's generation fleet is over [two-thirds] coal, with about one third of its capacity located out-of-state, two areas NextEra is likely to target for improvement," Deutsche Bank added.

Balancing act
The transaction critically gives NextEra a pathway to increasing its business profile to approximately 70% regulated earnings, a prospect the company raised earlier in May. The greater degree of certainty afforded by more regulated earnings confers additional balance sheet capacity for NextEra, helping maintain the $5 billion to $7 billion of excess balance sheet latitude the company had prior to the deal, resulting from presumed adjustments to credit rating metrics. In light of its balance sheet firepower, the company did not rule out subsequent acquisitions, instead suggesting the expanded platform could allow additional deals given the expectation of few regulatory hurdles.
"Not only would these acquisitions expand NextEra's growth platforms, in our view, they leave room for more growth by way of M&A, and management noted they remain open to opportunities that make sense," Guggenheim Securities analysts observed May 21.
For Southern, however, the deal was about more than simply securing cash outside equity markets, It was also carving off assets with higher risk and cost exposure. Analysts calculated that NextEra's premium was paid largely for Gulf Power and Florida City Gas, whereas the acquisition of interests in the Oleander and Stanton plants appears to be a bargain, particularly if NextEra looks to re-contract and re-market the assets in the future.
"You should almost think about Oleander and Stanton as risk trades as opposed to earnings trades," Fanning said. "Having short coverage relative to our typical [Southern Power Co.] asset, we were able to have our friend from NextEra take those assets rather than have us retain those assets and try and remarket them."
Southern has cut its equity need to $3 billion overall, from $7 billion as of May 2, a target the utility says it can meet internally with its planned annual issuance in coming years. Taken together with the sale of a 33% interest in Southern Power's solar portfolio for some $1.18 billion, announced May 23, Southern has given analysts a credible baseline for achieving a 4% to 6% annual earnings target, while securing its credit quality.
"Southern can accommodate the majority of the remaining planned equity issuance via internal plans rather than block equity that may have otherwise been used," Deutsche analysts wrote. "From [a funds from operations to debt] perspective, [Southern] expects the deal to be supportive of their FFO:Debt targets of 15-15.5% with [the Vogtle Nuclear Plant] or 16-16.5% without."

