Tag Archives: holdings

ITC Holdings To Join Utility Industry M&A Wave

ITC Holdings announces strategic review that includes a sale of company; stock soars 12.8%. We believe transaction is likely at $44-$47 per share, as strategic bidders National Grid, Iberdrola, and Berkshire Hathaway participate in competitive bidding. ITC Holdings is attractive target with $120-$160 billion capital investment opportunity, unique regulatory structure; Merger approval process may be shorter than other industry M&A deals. Shareholders in ITC Holdings (NYSE: ITC ), a leader in electric transmission in the US, saw its stock soar 12.8% from Friday’s close to $38.04 per share following an announcement that the board is reviewing its strategic options. The possibilities under consideration include a sale of the company, and we believe, for several reasons, that an outright sale of ITC Holdings to a strategic bidder is a highly probable outcome. We are currently in the middle of a significant M&A boom in the power and utility industry: Over $45.4 billion in deals were announced in the third quarter of 2015. This quarterly total exceeds the total transaction value of announced deals in the prior four quarters combined by over $7 billion ($38.3 billion in total from Q3 2014 to Q2 2015). Among the largest announced deals were the acquisition of Oncor Electric Delivery from the bankrupt Energy Future Holdings for $12.6 billion, Southern Company’s (NYSE: SO ) $12 billion acquisition of AGL Resources (NYSE: GAS ) ( as discussed here ), and the $10.4 billion acquisition of TECO Energy (NYSE: TE ) by Emera ( OTCPK:EMRAF ). (click to enlarge) Source: PwC report on Power and Utility Industry, October 2015. The recent wave in M&A activity in the regulated power industry is precipitated by a change in market dynamics from higher operating and maintenance costs and increased capital investment requirements. The costs of new utility construction and facility improvements continue to march upwards, as expense for labor and building materials rise. While allowed rate increases have been able to offset a considerable portion of these costs, rate increases for customers have been under pressure from a lower cost of capital in a low interest rate environment. With this underlying shift in the market taking place across the industry combined with stagnant demand for many utilities in their existing territories, several companies are looking beyond their own market to expand their customer base and generate economies of scale through operating efficiencies. These factors have served as the catalyst for several strategic acquisitions over the past twelve months including the larger deals announced in the third quarter as well as transactions as Exelon’s (NYSE: EXC ) $6.8 billion purchase of Pepco Holdings (NYSE: POM ). We anticipate that these industry factors will continue to drive consolidation and M&A activity is likely to remain robust through 2016. (click to enlarge) Source: ITC Holdings investor presentation, Edison Electric Institute 50th financial conference, November 8, 2015. With this industry backdrop, we believe the Board of ITC Holdings is making a shareholder-friendly decision in reviewing all of its strategic alternatives at this time and the Board appears to be taking the first steps in fulfilling its obligation to pursue value-enhancing action when the opportunity arises. Over the past three months, ITC Holdings’ stock has traded in the $31-$33 per share range and as much as 31% below its 52-week high trading price of $44 per share. This underperformance is very discouraging for long-term shareholders and many patient investors may be ready to cash out of their holdings at the right price. (click to enlarge) Source: ITC Holdings investor presentation, Edison Electric Institute 50th financial conference, November 8, 2015. It is our view that putting the company up for sale now would deliver the greatest value for ITC Holding shareholders. We believe that a sale of ITC Holdings would result in an all-cash transaction with consideration worth between $39 to $47 per share. Our valuation is based on a PE multiple of 18.5x to 22.5x on projected 2016 earnings per share of $2.10. This PE multiple range is consistent with multiples seen on recent transactions in the regulated power industry. Furthermore, the typical premium over the unaffected stock price we have seen is 20% to 40% which would imply a transaction value of $39 to $45 per share. In our view, the high end of these ranges would represent tremendous value for shareholders and exceed the all-time high trading price for ITC Holdings. From the standpoint of the strategic bidders believed to be interested in ITC Holdings, there are many compelling reasons to acquire the company and pay top dollar. One of the most attractive aspects of ITC Holdings is the significant future infrastructure requirements. Management estimates an investment in upgrades of $120 – $160 billion will be required through 2030 driven by an aging infrastructure and regulatory and compliance investments. The opportunity to put well over a hundred billion in capital to work and earn a decent return on the invested capital for the foreseeable future will appeal to the larger strategic acquirers such as National Grid (NYSE: NGG ), Iberdrola ( OTCPK:IBDSF , OTCPK:IBDRY ), Berkshire Hathaway ( BRK.A , BRK.B ) Energy, and NextEra Energy (NYSE: NEE ). Additionally, the unique regulatory structure that ITC Holdings is subject to is a very attractive characteristic of the company and provides ITC Holdings with an advantage over other potential acquisition targets in the regulated power industry. ITC Holdings is regulated at the federal level by the Federal Energy Regulatory Commission and the agency acts in setting the rates for the company’s vast electric transmission assets that span the U.S. Midwest. As a result of this regulatory structure, the regulated return on equity for ITC Holdings has consistently exceeded that of its state-regulated peers by as much as 200 basis points. We believe there is also a transaction-specific benefit of the unique regulatory structure The downside risk for ITC Holdings shareholders (and any shareholder of a utility company that is acquired) is the complex regulatory approval process of an acquisition. The unpredictable and often politically-charged process has delayed some transactions for several months. The average length from announcement to completion of an acquisition in the power and utilities industry is nearly 8 months between 2009 and 2013. As many investors in recent M&A deals will attest, the figures for 2014 and through the third quarter of 2015 are likely higher. For example, the proposed Exelon-Pepco transaction has been pending for over 19 months and may finally be approved as we approach the two-year anniversary of the April 2014 acquisition announcement. (click to enlarge) Source: Deloitte Center for Energy Solutions. Understandably, this burdensome process may deter a potential acquirer from pursuing a negotiated agreement. However, for ITC Holdings, we do not believe this will hold true. In our view, a proposed transaction may not have to receive the approval of each state jurisdiction in which ITC Holdings’ electric transmission subsidiaries operate. We believe approval of the Federal Energy Regulatory Commission and the Federal Antitrust authorities would satisfy the company’s statutory requirements. According to ITC Holdings’ most recent 10-K filing, state regulators’ authority and scope of oversight is quite limited: “The regulatory agencies in the states where our Regulated Operating Subsidiaries’ assets are located do not have jurisdiction over rates or terms and conditions of service. However, they typically have jurisdiction over siting of transmission facilities and related matters as described below. Additionally, we are subject to the regulatory oversight of various state environmental quality departments for compliance with any state environmental standards and regulations.” In our view, the FERC will have jurisdiction, from a power and utility industry standpoint, over the approval of any proposed transaction and would make the determination of the competitive effects of a merger and the long-term impact on the ratepayers. While the state jurisdictions may be involved in a regulatory review, we do not expect a state agency within the power industry to be in a position to make a binding decision as to the competitive effects of a proposed transaction. This unique regulatory structure therefore avoids a potential “DC Public Service Commission”-type disruption to a merger approval process where a small, activist group minimally impacted by a large multi-jurisdictional merger has the ability to delay the process or extract additional financial benefits from the parties. In conclusion, we believe a sale of ITC Holdings in the range of $39-$47 per share is in the best interests of shareholders and is a very likely outcome of the Board’s current strategic review. Based on the attractive characteristics and prospects of ITC Holding, we believe there will be active and competitive bidding by large strategic players in the regulated power industry and the results will be a final transaction price in the $44-$47 per share range. As such, we expect the power and utility industry consolidation will show no signs of slowing in 2016. And importantly, in contrast to several of the current prolonged transactions, we believe a proposed acquisition involving ITC Holdings will navigate the complex regulatory process successfully and in a more appropriate timeframe. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

The Market Doesn’t Matter: Vanguard Dividend Appreciation ETF

Summary Investors need to avoid decision risk. While many individual stocks can be attractive, I’ve seen to many people feel handcuffed (or married) to particular companies. Investors that held VIG and didn’t watch TV could have ignored the financial crisis. If there is one thing investors often struggle with, it is being able to pick a winner and stick with it. While picking winners in the stock market can be very difficult, I believe picking winners in the ETF market is easier. Rather than understanding every business, the fundamentals of the ETF can be used to determine the risk level and risk factors. In my opinion, there are a few ETFs that are simply born winners. It isn’t a case of looking at their performance of an arbitrary time period; it is a matter of some ETFs being designed to serve investors while other ETFs are designed to serve managers. In my opinion, the Vanguard Dividend Appreciation ETF (NYSEARCA: VIG ) is one of those born winners. The very nature of the Vanguard Dividend Appreciation ETF is what makes it such a solid choice. I’ve been asked on occasion: “If you could only invest in one ticker and had to hold it for 50 years, which ticker would you buy?” While I haven’t nailed down the answer to that question, because the premise is mildly absurd, I do believe it is important for investors to know their long term goals and to find investments that match those goals. VIG is an ETF that matches my long term goals, so it would be an extremely strong contender for that question. What does VIG do? VIG attempts to track the investment results of the NASDAQ US Dividend Achievers Select Index. The general methodology is to focus on stocks that have a history of increasing dividends over time. The ETF falls under the category of “Large Blend” and has a very high correlation with the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). Overall the ETF has been slightly less volatile than SPY and performed slightly better during the last crash as demonstrated in the following chart: (click to enlarge) Getting married I often cover Freeport-McMoRan (NYSE: FCX ) and one of the common themes I hear from investors is that they don’t like the company anymore but after holding it while it fell so far, they feel “married” to it. They resent the investment in which they lost so much money, but they don’t want to just walk away either. That isn’t the way I like to think of marriage, but I can understand how they feel. As investors we may become attached to the investments we have selected and that emotional attachment can complicate our decision making. Since it is very difficult to mitigate emotional biases through training clients, I would rather see people select an investment that will work to protect them. While I am long FCX, I certainly don’t think that it belongs in every investor’s portfolio. On the other hand, there are very few investors that wouldn’t be well served to hold VIG over the next several decades. The risk VIG solves for investors One of the major issues investors face is decision risk. While there are plenty of other kinds of risk in the market, decision risk is one of the nastiest ones. One reason that the S&P 500 regularly beats out most investors (and even money managers) is that a comparison of SPY to actual performance is that money simply stays in SPY while people trade at the wrong time, pay more commissions because of the trading, and cross the bid-ask spread. These issues all add up and stack the deck against many investors. VIG solves a substantial portion of the decision risk problem by offering investors a different way to look at part of their portfolio. Instead of deciding what they should do with their holdings in VIG, investors need simply to turn off dividend reinvestment when they are ready for an income stream. After that, there is no need to touch the investment again. My suggestion on this would be to hold VIG in a different brokerage from other holdings. Hold VIG in an account you never log into, that way there is no temptation to kill the goose that lays the golden egg. If you were holding VIG during the financial crisis As all readers should know, we had a bit of an issue in the financial markets. We saw the economy tank, stock prices plummet, and interest rates go to 0%. On the other hand, if an investor was simply holding VIG and enjoying a nice beach, they had no need to know or care. Their dividends didn’t go away. They still had a similar payment to live on. Just look at the chart below: Investors should know about a couple issues I came across preparing the chart. The fund inception date was in April of 2006, so there are only 3 dividends included for the year. It is only may of 2015, there is only one dividend included for 2015. Yahoo Finance has incorrect information on dividend history. I verified the dividend payouts through Google and Schwab. Yahoo was missing the December 2014 payout. Holdings I put together the following chart showing the top 10 holdings in VIG: (click to enlarge) Conclusion If an investor was only picking one investment, VIG should be a strong contender. If the investor wants to build a more diversified portfolio, it makes sense to put VIG in a separate account and just leave it alone. While rebalancing accounts is very useful in maintaining the optimal risk exposures, the decision risk of accessing the golden goose offsets the benefits of rebalancing. I’m not currently holding any VIG, but my long term plan will have me buying into VIG or the very similar Schwab U.S. Dividend Equity ETF (NYSEARCA: SCHD ). I’ll probably start acquiring the position later this year or early next year. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

VWINX Is The Only Retirement Fund You Need, Unless You Expect Solid Returns

Summary VWINX has great historical performance as it invested heavily in high quality debt issues that appreciate when yields drop. Unless yields go negative, it shouldn’t be possible to duplicate that portion of performance. I would prefer to keep my bonds in tax deferred accounts. The dividend-paying stocks can reasonably be held in a taxable account. The result is a mismatch of styles. VWINX has had fairly low levels of volatility, but even low levels of volatility require meaningful expected returns. VWINX is a great fit for investors that are not knowledgeable about investing, but not such a great fit for the kind of people that read about investments. I saw a piece on Vanguard Wellesley® Income Fund Investor Shares (MUTF: VWINX ) this weekend that got me curious about the fund. It was good introduction to the fund that left me wanting to know more about the primary question. Was VWINX satisfactory for retirement as a singular investment? If you look at some of the basic facts laid out, I think it would be reasonable for investors to think that this fund might be enough by itself. I humbly disagree. After reading the piece I started doing more research because VWINX was delivering very solid returns given how stable the results were. However, as all readers should know, past performance is no guarantee of future performance. In my opinion, it would be nearly impossible for VWINX to duplicate its performance from the last decade under any modern understanding of economics. How does VWINX invest? The fund holds 60 to 65% of resources in government securities and corporate investment grade bonds. Ironically, that may even include MBS. I frequently cover the REIT sector and my preferred part of that sector is mREITs. In my opinion, MBS have very little in common with investment grade corporate bonds. When we look more specifically at what bonds the firm is holding, I see a disturbing trend. The top holdings are all US treasury notes or bonds. These are either yielding under 2% or have a maturity past 2040. The short-term performance of the fund includes appreciation in the price of government bonds as yields are at absurdly low levels. Unless we see interest rates go negative, it won’t be possible for these bonds to appreciate that way over the next decade. By mixing in short-term securities the portfolio is able to limit its duration (interest rate risk) from becoming absurdly high, but the short-term securities just don’t offer enough yield. If an investor is hoping for substantial returns, buying bonds near par with a 1% coupon rate just doesn’t cut it. The rest of the resources go into companies that pay solid dividends or are expected to pay solid dividends. Companies like Wells Fargo (NYSE: WFC ) and Microsoft (NASDAQ: MSFT ) are at the top of the holdings. I think it’s a very reasonable idea for a mutual fund designed to produce income for retirees (yield = 3%) to include a substantial allocation to dividend stocks that will pay qualified dividends. However, that brings us to part of the challenge here. Taxes and turnover The portfolio turnover is 109%. The fund is heavily invested in bonds and there may be some substantial tax disadvantages to holding the mutual fund in a taxable account. I’m not a CPA, so I won’t try to predict the exact implications, but if I wanted to get diversified exposure in a taxable account, this isn’t how I would do it. I would use the tax deferred accounts to hold my bonds and REITs and I would use my taxable account to buy and hold large dividend paying stocks or ETFs. As long as possible, I would attempt to defer recognizing gains. Volatility reduction isn’t enough I’m often one of the first analysts to point to the volatility of an ETF or mutual fund as an indication that it is or is not providing too much risk for the expected return. In this regard, VWINX is very steady. However, without any reasonable expectations for long-term capital appreciation on the bond portfolio, the expected future return should be substantially less than the historical return. That doesn’t mean that I think the fund is a “bad” investment. However, I do believe that investors can find better options from Vanguard. While the fund sports an expense ratio of .25%, which is dramatically below the category average (1.28% by my sources), I think investors can still find better. If an investor would like to use Vanguard products like VWINX, I’m a big of the Vanguard Total Stock Market Index (NYSEARCA: VTI ). I recently invested heavily in another mutual fund, (MUTF: FSTVX ), because it has an extremely high correlation with VTI and was available in a Fidelity account. I put together a great piece explaining my reasoning . The real benefit of VWINX In my opinion, the biggest advantage to VWINX is simply that combining the bonds and stocks into a single account under a single Vanguard manager allows the stocks and bonds to be rebalanced without the investor being emotionally involved in reallocating between the investments. That may help the portfolio continue to resemble the intended asset mix. However, the benefit of having a professional manager rebalance the portfolio is substantially smaller for the kinds of investors that enjoy reading up on their holdings. In my opinion, VWINX is a better fit for the 401k of a worker that doesn’t know the first thing about stocks or bonds and is planning to retire within the next several years. For investors that are able to do it themselves, I’d rather take VTI and combine it with holdings in another bond portfolio. There are numerous bond ETFs or mutual funds to choose from, but I’d focus on low expense ratios and solid diversification among the holdings. Disclosure: The author is long (FSTVX) (VTI). (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. The analyst holds a diversified portfolio including mutual funds or index funds which may include a small long exposure to the stock.