Tag Archives: power

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.

TerraForm Will Survive, But Needs To Slow Down

Summary TerraForm Power’s stock has plunged 70% year to date. The market value was high due to its aggressive expansion plan. The company will survive, but needs to slow down. If you’ve believed in SunEdison (NYSE: SUNE ) and TerraForm Power Inc.’s (NASDAQ: TERP ) growth story and have been a shareholder of either company, you’ve probably had a hard time falling asleep at night. It’s been devastating for TerraForm’s shareholders, as the shares have plunged over 70% year to date. So, what makes investors worried even when the company has been able to grow its CAFD (cash available for distribution) and raise dividends consistently since it went public in July 2014? (click to enlarge) (Source: TerraForm Power Investor Presentation) TerraForm only had 808 MW in projects generating $107 million in CAFD initially. After only one year, the company now has over 1900 MW in assets, with a projected $225 CAFD in 2015. The project pipeline and cash flow distribution growth are impressive, but not the stock price. Expansion comes at a price. Clearly, the market now focuses on TerraForm’s liquidity and balance sheet, believing the company’s rapid expansion is sustainable. First of all, I would like to estimate how much money the company is obligated to pay (up to December 2016), based on its scheduled debt repayment, projected dividend distribution and committed funds for acquisitions. Current portion of long-term debt and lease obligation: $115 million (to be paid by September 2016) Invenergy acquisition: $2.05 billion Vivint Solar (NYSE: VSLR ) deal: $962 million Payments (2016) on maturities of long-term debt as of September 30: $58 million Dividend payment: $112 million (based on 80 million class A common stock outstanding) Interest payment and some other payments, based on its agreement with SunEdison (IDRs) In total, TerraForm needs to come up with approximately $ 3.3 billion for its acquisitions, debt repayment, lease obligations, dividend payment and other payments in the next 12 months. To put it in perspective, the company generated $105 million cash from operating activities in the first nine months, and it expects to generate $225 million of CAFD for 2015. So, the question is: Has TerraForm addressed funding shortfalls, if there are any? Let’s take a look at the company’s current financing plan: Unrestricted cash: $821 million (including $160 million in UK refinancing proceeds) Revolver: $725 million Project debt (CA Ridge): $174 million TERP Holdco Capital: $388 million Assumed project debt: $358 million (subject to lender consent) Project debt/Term loan/Holdco bonds/Warehouse facilities: $1.27 billion (in progress) Including the $1.27 million financing options in progress, TerraForm has about $3.6 billion available to fund its commitments and fulfill other obligations, if needed. The management is quite confident that all financing will be made available by Q1 2016. This seems quite desperate, as the company plans to deplete all its cash and most likely its revolver for acquisition and debt repayment. TERP’s unrestricted cash on-hand is approximately $800 million and our liquidity available is approximately $1.5 billion. We have earmarked this cash and liquidity to fund our existing commitments, including the pending Invenergy and Vivint acquisitions. – TerraForm Power Q3 Earnings Call Transcript While TerraForm is capable of funding its obligations and acquisitions given listed options, this will further bury the company in heavy debt. Let’s not forget, the company still has about $2.4 billion long-term debt outstanding as of September 30, 2015. Senior debt 2023 – $950 million (Issued for First Wind and previous revolver repayment) Senior debt 2025 – $300 million (issued for Invenergy) Other project debt and construction financing – $1.28 billion After its acquisition of Vivint and Invenergy assets, TerraForm will have over $4 billion in debt, with little cash on hand. It will be difficult for the company to further grow its pipeline given its highly leveraged balance sheet and the current market sentiment. Even if TerraForm can obtain the needed capital in the near future, it will likely pay a much higher interest rate. Debt is usually cheaper than equity, but only to a certain point. Investors may argue that TerraForm will add another 1.4GW to its pipeline once the acquisition is completed. However, for companies like TerraForm, the payback does not happen overnight. If the company grows its CAFD 70% in 2016 (management refuses to provide a guidance for 2016, saying it will focus on closing deals first), it should generate approximately $95 million CAFD each quarter to pay dividend, interest expense and other obligations. Conclusion Financially and strategically, TerraForm Power went too far, too fast (following SunEdison’s path), and it needs to slow down. Corporate governance is another issue given its connection with SunEdison. As I am writing this, David Tepper, the founder of Appaloosa Management, just sent a letter raising concerns regarding conflict of interests between TerraForm and SunEdison. This is another important issue that investors need to pay attention to. TerraForm had financing lined up for its committed acquisitions, and should not have problems paying liabilities in the next few years. But it will have little room to grow in the short term given its highly leveraged balance sheet and depressed stock price. Clearly, investors now focuses more on the company’s financial strength rather than how fast it can grow its dividend and pipeline. Going forward, TerraForm should focus on the profitability of projects rather than blindly expanding by acquiring assets regardless of project quality. Sometimes we need to take a break and slow down, and I hope TerraForm has learnt this lesson.

8 ETFs To Watch In December

Traditional investors may pin hopes on the Santa Claus rally in the most successful month of the year, i.e., December, but they should note that this time Christmas might be a little dull, defying the natural progression of the end-of-season rally. A consensus carried out from 1950 to 2013 has revealed that December has ended up offering positive returns in 49 years and negative returns in 16 years, with an average return of 1.59%, as per Moneychimp , the best of the year. But this year, the Fed is scheduled for a rate hike after a decade, provided the economic momentum remains the same. And though the move now seems well digested by the market, a certain shock is inevitable post lift-off. In any case, 2015 had been quite downbeat so far. Even historically strong months couldn’t live up to investors’ expectations. All these made December a keenly watched month for the investing legion. We thus pinpoint a few ETFs that are highly in focus and could hop or drop in December. iPath U.S. Treasury Flattener ETN (NASDAQ: FLAT ) As the Fed hikes the benchmark interest rate, the initial blow would be at the short-end of the yield curve. The investing world has already started to prepare for the move. As a result, yield on the 6-month Treasury note soared 15 bps, from the 0.27% level seen at the start of November to 0.42% on November 30. In the same time frame, the yield on the 10-year Treasury note rose just 1 basis point to 2.21%. In fact, in the recent sessions, yields on 10-year U.S. Treasuries declined, indicating a flattening of the yield curve. So, a keen watch on the inverse bond ETF FLAT is needed to earn some quick gains from the bond market. This product provides inverse exposure to the Barclays US Treasury 2Y/10Y Yield Curve Index, which delivers returns from the steepening of the yield curve through a notional rolling investment in U.S. Treasury note futures contracts. FLAT was up 1.3% in the last one month. ALPS Barron’s 400 ETF (NYSEARCA: BFOR ) This all-cap U.S. equity ETF could be in watch in December. The fund could be used as a representative of the total stock market performance in a volatile (expectedly) month. It is made up of high-quality U.S. stocks. Since the month of December is likely to stay volatile and large-cap stocks might be hurt by a rising greenback post Fed tightening, an all-cap quality U.S. ETF might be the key to win ahead. ALPS U.S. Equity High Volatility Put Write Index ETF (NYSEARCA: HVPW ) The markets are likely to be wobbly post lift-off, and volatility levels should spike. Going bull on high-beta stocks may lead you to losses then. If this happens, investors can have a look at alternative ETFs like HVPW. The fund looks to take advantage of the stocks with the highest volatility in the U.S. equity markets. As the volatility in a given stock rises, so does the price of the options traded on it. The underlying index of the fund seeks to generate income by selling put options on the most volatile stocks in a given two-month period, along with interest earned on T-bills. HVPW added over 0.6% in the last one month. Vanguard High Dividend Yield ETF (NYSEARCA: VYM ) Since income ETFs underperform when rates rise, this high-income U.S. equities ETF might fall out of investors’ favor in December. However, still-subdued inflation and global growth worries might keep the yields on benchmark 10-year U.S. Treasury from rising fast. If this happens, VYM may not be as hit as it is feared right now. As of November 30, 2015, the fund yielded about 3.09%, while the yield on benchmark 10-year U.S. Treasury is 2.21%. VYM is down about 0.9% in the last one month (as of November 30, 2015). iShares U.S. Preferred Stock ETF (NYSEARCA: PFF ) Even in a rising rate environment, there are ways beat to the benchmark Treasury yield and earn smart income. Preferred stocks are one such option. Preferred stocks are hybrid securities that are characterized by both debt and equity. They have a higher claim on assets and earnings than common stock. These securities are less volatile than stocks, and yield in the range of 5-6%. PFF yields 5.87% as of November 30, 2015, while it charges 47 bps in fees. The fund was up about 3% in the last one month. iShares Russell 2000 ETF (NYSEARCA: IWM ) Small-cap stocks are the barometer of domestic economic health. So, when the U.S. economy shifts gear in December and experiences policy normalization, small-cap stocks should be the most beneficial zone. While small-cap growth ETFs like the PowerShares Fundamental Pure Small Growth Portfolio ETF (NYSEARCA: PXSG ) and the iShares Russell 2000 Growth ETF (NYSEARCA: IWO ) have already started rallying, we believe these could be high-risk choices, as smaller-capitalization and growth stocks are highly volatile in nature and succumb to a slowdown once the Fed hikes rates. So, investors can keep a close watch on small-cap blend ETFs like IWM. This Zacks Rank #2 (Buy) ETF was up over 3.2% in the last one month. WisdomTree International Hedged Dividend Growth ETF (NYSEARCA: IHDG ) While the Fed is preparing for a hike, other developed economies of the world and a few emerging economies are going the opposite direction. Due to growth issues, global superpowers like Europe, Japan and Australia are presently pursuing easy money policies. While stocks of the concerned region are likely to soar, a currency-hedged approach is essential to set off the effect of a surging greenback. IHDG serves both aspects. Moreover, IHDG takes care of investors’ income too, as the fund selects dividend-paying companies with growth features in the developed world ex-U.S. and Canada. This Zacks ETF Rank #3 (Hold) ETF was up over 1.9% in the last one month and yields 1.86%. Market Vectors ChinaAMC SME-ChiNext ETF (NYSEARCA: CNXT ) China, the epicenter of the global chaos in summer, should also be in focus in December. In any case, this segment is exhibiting excessive volatility lately, throwing shocks and surprises now and then. While Chinese stocks and ETFs soared at the start of November on a flurry of economic and demographic policy easing, it suffered its worst decline since summer to conclude the month. News about securities regulators’ probe into brokerages caused a stock market rout in China. On the positive side, the IMF agreed to declare yuan as a reserve currency, which hints at a stable economy. So, Chinese ETFs are on the fence now, with possibilities and perils on either side, and investors may be interested in tracking its course in December. Original Post