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El Paso deal underscores 2019's otherwise slow utility consolidation

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El Paso deal underscores 2019's otherwise slow utility consolidation

El Paso Electric Co.'s June 3 announcement that it would be acquired by a J.P. Morgan Investment Management Inc.-advised investment fund underscored a key trend in the utility sector for 2019 so far: There is not a lot of corporate M&A happening.

El Paso's buyout marked the third utility deal so far in 2019, following Canada-headquartered ENMAX Corp.'s purchase of Emera Maine and Irving, Texas-headquartered Vistra Energy Corp.'s acquisition of Canada's Crius Energy Trust.

This latest transaction, in which J.P. Morgan-advised Infrastructure Investments Fund, or IIF, plans to purchase El Paso for $4.3 billion, including its net debt, is not a utility acquisition driven by traditional considerations like expanding a service territory, capitalizing on corporate synergies and strategically moving into high-growth markets. Instead, IIF, an $11.3 billion private investment vehicle, appears to be looking for a safe place to invest some of its 40 million retirement funds.

A low-interest-rate environment has contributed to the lack of pure utility M&A play in 2019, according to some analysts and sector observers. Companies have seen clarity on rates shift in the past six to nine months, which affects their valuations, said Brian Boufarah, an accounting and deal management partner at Deloitte Risk and Financial Advisory. Without that certainty, utilities are taking a wait-and-see approach.

"Those things do matter to potential buyers and sellers of corporate assets," Boufarah said in an interview. "It doesn't surprise me that impacted the pace and pattern around getting some deals transacted."

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If a company is trading at 19x its price-to-earnings ratio thanks to low interest rates, it creates a high valuation, said Andrew DeVries, a senior analyst for CreditSights. Once a 20% premium is added on top of that valuation, purchasing another utility becomes a less efficient option for a company's capital.

"I think there is still room for M&A down the road, just not at the current interest rate and earnings growth environment we're in now," DeVries said in an interview. "The interest rates have P/E's of 19x, so it makes it tough to pay for M&A. With earnings growth, everyone is growing 5% or 6%, so there's not that overwhelming need to do M&A."

Consolidation among utilities in recent years has been limited mainly to diversified names purchasing more regulated companies, DeVries added. Dominion Energy Inc.'s purchase of SCANA Corp. and Sempra Energy's acquisition of Oncor Electric Delivery Co. LLC represent some of the biggest deals of late, but it appears unlikely the sector will see much more large-scale M&A since many of those players are still digesting those deals. And it's worth noting the acquisition of Oncor and SCANA were driven by somewhat unique circumstances of financial distress: in Oncor's case from the bankruptcy of its corporate parent and in SCANA's case the fallout from an abandoned nuclear project.

Recent utility M&A waves have tended to produce similar deals, like the debt-heavy acquisitions of gas utilities in 2015 and 2016 by electric utility giants Southern Co., Duke Energy Corp. and Dominion. Beginning during roughly the second half of 2016, a buying spree by Canadian utility and midstream companies saw acquisitions by Emera Inc., Fortis Inc. and an ultimately unsuccessful attempt by Hydro One Ltd.

Aggressive transformations such as mega-deals have consolidated the industry, meaning fewer players to continue those large purchases, said Paul Patterson, an analyst with Glenrock Associates LLC. But more subtle changes have pushed sector changes, like the focus by many large utilities on rate-based growth within their regulated businesses.

"As a result, that means they grow that way or they may purchase another utility or they may buy regulatory-like assets, which would be an asset with a long-term contract with a utility or something like that. That's the trend we've seen a lot of," Patterson said in an interview.

Utilities with merchant generation exposure have also taken steps to reduce their exposure over the years, such as PPL Corp.'s spinoff of its competitive power generation business now known as Talen Energy Supply LLC in 2014. "There are less utilities in a position to do that, simply because so many ones have done that," Patterson added.

That does not mean the utilities have completely consolidated, but there are fewer parties now who can make those acquisitions, Deloitte's Boufarah said. "I don't know if the economic incentive is yet there for those companies to be more compelled that they have to do those consolidations."

Another factor discouraging utility consolidation is the arduous regulatory proceedings necessary to gain approval in many states, hurdles that foiled: Hydro One's play for Avista Corp., numerous attempts by other companies to acquire Oncor, and which ultimately forced Great Plains Energy Inc.'s takeover of Westar Energy Inc. to restructure into a "merger of equals" forming Evergy Inc.

The 2019 M&A playbook

Although conditions may not currently be conducive to multibillion-dollar utility deals, DeVries sees room for diversified utilities to scoop up more regulated assets.

"The one diversified utility name that hasn't is Public Service Enterprise Group Inc.," he said. "If I had to pick one name that goes to make an acquisition of assets, it would be PSEG. Who or what they would buy, that's a much tougher question. They're the diversified name that hasn't pulled the trigger yet."

In the meantime, the steady flow of asset transactions, particularly for renewable projects and portfolios, is likely to continue as big electric utilities execute on carbon reduction goals. Boufarah noted renewable assets have grown such that deals now involve existing projects, not just new development.

"Ultimately, those things don't have the scale or size for what you're going to see if someone does one $20 billion regulated utility deal," Boufarah said. "But certainly, there are a number of those deals that are going to continue happen."