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Cleco Merger Arbitrage Offers Low-Risk 13% Annualized Return

Summary Investors can earn a low-risk 13% annualized return by purchasing the stock at today’s price and waiting for the transaction to close. Mr. Market doesn’t appear to be properly accounting for the merger agreement, which calls for CNL to continue to pay its sizable dividend while shareholders wait for closing. CNL shareholders have already voted on and approved the transaction by a wide margin. Anyone who follows our work knows our typical modus operandi focuses on finding undervalued contrarian investments that offer asymmetric risk/reward opportunities. While we firmly plan to “stick to our knitting,” we occasionally look to supplement our returns with low-risk, high-return (relatively speaking) merger arbitrage opportunities. As Warren Buffett once said: “Give a man a fish, and you feed him for a day. Teach him how to arbitrage and you feed him forever.” We see a compelling risk/reward profile for a merger arbitrage trade of Cleco Inc. (NYSE: CNL ). We believe an investor can earn a low-risk 13% annualized return by purchasing the stock at today’s price and waiting for the transaction to close. Our analysis suggests there is a low probability of the deal not consummating. This outsized return opportunity exists because Mr. Market does not appear to be properly accounting for the merger agreement, which calls for CNL to continue to pay its sizable dividend while shareholders wait for the deal to close. Company overview Cleco Corporation is a regulated electric utility company headquartered in Pineville, Louisiana. CNL is engaged principally in the generation, transmission, distribution, and sale of electricity, primarily in Louisiana. Cleco Power owns 11 generating units with a total nameplate capacity of 3,340 megawatts. Cleco Power serves approximately 286,000 customers in Louisiana through its retail business, and it supplies wholesale power in Louisiana and Mississippi. The Deal On October 20, 2014, CNL announced that it had entered into an agreement to be acquired by an investor group led by Macquarie Infrastructure and Real Assets, British Columbia Investment Management Corporation, and John Hancock Financial. Under the terms of the definitive merger agreement , the investor group will acquire all outstanding shares of CNL for $55.37 per share in cash. The merger agreement also calls for CNL shareholders to continue to receive the sizeable dividend payments until the deal closes. CNL pays a quarterly dividend of $0.40 per share, which equates to a 3.00% yield based on today’s closing price. 10/20/2014 merger press release: “Prior to closing, the transaction is expected to have no impact on Cleco’s dividend. Cleco shareholders will continue to receive dividends at an annualized rate of $1.60 per share until closing.” The Payout We believe an investor can earn a 13% annualized return by purchasing the stock at today’s price and waiting for the transaction to close. With the stock currently trading at $53.70, the relatively large deal spread combined with an attractive dividend payout presents a compelling risk/reward opportunity for a merger arbitrage trade. This outsized return opportunity exists because Mr. Market does not appear to be properly accounting for the merger agreement, which calls for CNL to continue to pay its sizable dividend while shareholders wait for the deal to close. The table below shows that CNL will pay a dividend in August and November if the transaction has not closed by then. The column titled “Total Profit” shows the cumulative profit that will accrue to an investor under the different closing dates. Our estimated annualized return is based on our expectation that the transaction will close by the end of August 2015. We think this is a reasonable estimate based on our research (details below). Keep in mind that the longer the deal takes to close, the lower the annualized return will be because of the time component of the calculation. Low-risk Transaction We believe the CNL transaction has a high probability of closing for the following reasons: – Modest deal size, all cash deal: This transaction is of average size and it calls for the Investor Group to pay CNL shareholders in cash. Given today’s accommodative lending environment, we believe the Investor Group will easily be able to raise the necessary funds. – Shareholder support: CNL shareholders have already voted on and approved the transaction by a wide margin. The merger proposal passed with more than 94% of the votes cast. – Termination fee: The merger agreement calls for the Investor Group to pay CNL $180m if they fail to close the transaction. – Fair valuation for the deal: Regulated utility assets are attractive in a world with extremely low interest rates. Furthermore, M&A activity has led to regulated utility assets becoming increasingly scarce. We analyzed the CNL transaction versus recent comparable deals and found the valuation multiples to be consistent with what investors have been willing to pay for similar assets. (click to enlarge) Source: FactSet Should the deal fail to close, we believe CNL could be sold to a different party for a similar price. This view is based on the recent history of CNL and how the current merger agreement came about. In June 2014, CNL received an unsolicited bid from the Canadian investment group, Borealis Infrastructure. In response, CNL retained Goldman Sachs to run a formal sale process. At the time, press reports said the company was seeking a deal in the range of $61-62 per share. Our research indicates that four different parties made serious overtures for CNL: Macquarie Group, Iberdrola, Borealis Infrastructure, and CenterPoint Energy. Regulatory Approvals Needed CNL still needs to receive the following regulatory approvals before the transaction can close: 1) Hart-Scott-Rodino Antitrust approval: We view this approval as a formality. The Investor Group acquiring CNL is a financial buyer and has no other competing businesses in the operating footprint. The application has already been filed. 2) Federal Communications Commission approval: We think approval of license transfers is a formality. CNL expects to file the application this quarter. 3) Foreign Investment in the United States approval: We think this approval is a formality. The financial buyers are from Canada and Australia. CNL expects to file the application this quarter. 4) Federal Energy Regulatory Commission approval: We expect a timely approval by FERC given the Commission’s stance on similar M&A transactions over the years. The application has already been filed. 5) Louisiana Public Services Commission approval: We expect this approval to take the longest but we believe the LPSC will grant an approval given the accommodative concessions made by the acquiring Investor Group. These concessions include promises to maintain employment levels and employee compensation, a commitment to appoint individuals from Louisiana to the board of directors, and a vow to remain operated by local management and headquartered in Pineville, Louisiana. The merger application was filed with the LPSC in February with a status hearing last month. We analyzed past utility deals that have occurred in Louisiana and found that historically the LPSC has approved these types of transactions (despite the occasional saber rattling). Perryville Energy Partners LLC, Dolet Hills Power Plant Operations, and Cajun Electric Power Cooperative Inc. are all examples of utility transactions that have been allowed to proceed. Utility Transactions Historically Take ~250 Days to Close We analyzed the group of comparable utility transactions cited above and found that average “days to close” was 258 days. It has been 204 days since the definitive agreement was announced. If the transaction closes at the end of August, like we expect, it will be 314 days, which seems reasonable compared to industry history. (click to enlarge) Source: FactSet Conclusion We see a compelling risk/reward profile for a merger arbitrage trade of CNL. We believe an investor can earn a low-risk 13% annualized return by purchasing the stock at today’s price and waiting for the transaction to close. Our analysis suggests there is a low probability of the deal not consummating. This outsized return opportunity exists because Mr. Market does not appear to be properly accounting for the merger agreement, which calls for CNL to continue to pay its sizable dividend while shareholders wait for the deal to close. Should this transaction fail to close, we don’t think investors would suffer a permanent impairment of capital as CNL could likely sell itself for a similar price to a different party. Disclosure: The author is long CNL. (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: The author and/or employer may buy or sell shares in any company mentioned, at any time, without notice. The information contained herein is believed to be accurate as of the posting date. Readers should conduct their own verification of any information or analyses contained in this report. The author undertakes no obligation to update this report based on any future events or information. This article represents best efforts to convey a fact-based opinion. Our conclusions may be incorrect. This is not a recommendation to buy or sell any securities. This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein or of any of the affiliates of the Author.

Construction Delayed, Bringing Down Southern Company’s Rating From Buy To Hold

Summary SO’s near-term performance will be pressurized due to construction delays in two main projects. Completion of ongoing construction projects will improve business risk profile and portend well for stock valuation. SO’s ongoing robust investments in several solar projects will also add towards growth of long-term earnings trajectory. Challenges faced by the company due to construction delays and cost overruns will keep pressure on stock valuation. I am downgrading Southern Company (NYSE: SO ) to a ‘hold’ from ‘ buy ‘, due to challenges faced by the company in its construction projects. Despite the fact that the company’s healthy rate base earned from its strong capital investments towards growing operations in a stable and growing industry has been helping its top-line numbers grow, the ongoing construction growth remains a risk to its performance in the near term. I recommend investors to keep track of the ongoing construction projects, as in the near term, ongoing construction delays of the Kemper and Vogtle projects could hurt the company’s stock price performance. Cost overruns and delays in the ongoing projects weighed on the company’s Q4’14 results. Moreover, the ongoing construction challenges will keep pressure on stock valuations, as the company’s business risk profile has inflated due to construction delays and cost overruns. During the Q4’14 conference call, the company introduced its 2015 guidance and lowered its EPS growth range due to construction challenges. Construction Remains a Concern The company’s recent financial performance was adversely affected by cost overruns and delays. In Q4’14, the company registered an after-tax impairment charge of approximately $44 billion. SO reported an EPS of $0.38 for Q4’14, down from $0.48 in Q4’13. The company’s major growth investments in its keynote power plant projects, Kemper and Vogtle, are facing construction delays. The Kemper project is delayed, and is now expected to be in service in 1H’16. Also, the Vogtle project is delayed by 18 months. In fact, the cost overruns on SO’s 582MW coal plant Kemper prevailed in 2014. With a cost increase of $330 million, Kemper’s total construction cost escalated to almost $6.2 billion , as compared to initial estimates of $2.2 billion. As far as the construction of two nuclear plants in Vogtle is concerned, analysts have projected that if the construction of these new nuclear reactors at the Vogtle plant will be delayed just short of three years, the company might spend $8 billion to complete the construction of reactors. Along with the $8 billion construction delay costs, SO might be asked to pay $240 million in damages for falling behind schedule. I believe that in the near term, construction delays on both Kemper and Vogtle projects will weigh on its performance. But in the long run, the completion of these projects will improve SO’s production capacity and will optimize its generation portfolio. Along with its increased investments in competitive business, SO is also investing heavily to expand the generation capacity of its renewable energy generation business. As part of this plan, the company has started building a 131MW solar electricity generating plant in Georgia, which will begin its operation in 2016. This 131MW utility facility will sell electricity to three Georgia Electricity generation companies under a 25-year agreement. Owing to the longevity of the purchase power agreement done by the company, I believe the 131MW facility will deliver a significant upside to the company’s earnings base, upon completion. Moreover, SO has recently acquired two solar projects totaling 99MW from TradeWind Energy in Georgia, which include an 80MW Decatur Parkway Solar Project and a 19MW Decatur Country Solar project. The 80MW generation project, which is planned to commence this month, will sell electricity under the 25-year PPA with Georgia Power. As the projects are covered by long-term contracts, I believe that upon their commencement, both projects will add well towards growing the company’s long-term earnings trajectory. During the Q4’14 conference call, the company’s management provided the 2015 earnings guidance; SO expects the EPS for 2015 to be in a range of $2.72-$2.80/share . Due to cost overruns and delays, the company lowered its earnings growth target range to 3%-4% from 4%-5% for the future. Analysts have anticipated that SO’s earnings will grow by approximately 3.61% over the next 5 years. Along with current investments in long-term growth generating projects, the company will continue to look into all possible opportunities to make more capital investments in several growth generating projects. Also, SO, in the recent Q4’14 conference call, provided its planned 2017 capital expenditures. The company has projected a CAPEX of $16.6 billion for a three-year period from 2015 to 2017, as shown in the chart below. (click to enlarge) Source: Quarterly Earnings Reports Cash Returns SO has a strong history of making healthy cash returns to its shareholders by paying hefty dividends. In fact, due to the company’s hefty dividend payment policy, the stock has earned an attractive dividend yield of 4.60% . Moreover, SO is fully committed to following its healthy dividend payment formula in the years ahead; in the Q4’14 earnings conference call, the company’s Vice President and Chief Financial Officer, Arthur Bettie, said : We feel very confident in our ability to deliver sustainable dividend policy as we have in the past into the future. Owing to the management’s commitment towards making healthy dividend payments and due to its strong strategic growth initiatives directed at improving the company’s cash flow base, I believe that SO’s dividends remain secure. Risks The ongoing increase in construction costs due to delays occurring at both Kemper and Vogtle projects will continue to pressurize the company’s cost base in upcoming years. Moreover, increased environmental expenditure due to regulatory restrictions and decline in power demand due to weather changes are key risks hovering over SO’s future stock price performance. Conclusion I am downgrading SO from a ‘buy’ to ‘hold’ due to ongoing construction challenges. The company’s near-term performance will be pressurized due to construction delays in its two main projects. However, as the company will complete its ongoing construction projects, its business risk profile will improve and portend well for the stock valuation. The company’s ongoing robust investments in several solar projects will also add towards the growth of its long-term earnings trajectory. The ongoing challenges faced by the company due to construction delays and cost overruns will keep pressure on the stock valuation. The stock is currently trading at a lower forward P/E of 15x, as compared to the utility sector’s forward P/E of 16.8x , which I believe is justified due to ongoing construction challenges and an increase in its business risk profile. 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.

Treasury Yields Have Me Shying Away From Buying Some More Dominion Resources

Summary The stock appears to be fairly valued on next year’s earnings estimates. Increasing treasury yields has people investors leaving safe-haven yields plays such as Dominion. The company at least pays a great dividend to help stem the losses on the capital side of things. Dominion Resources (NYSE: D ) is a producer and transporter of energy. It manages its daily operations through three operating segments namely Dominion Virginia Power of DVP, Dominion Energy and Dominion Generation. On February 6, 2015, the company reported fourth quarter earnings of $0.84 per share, which beat the consensus of analysts’ estimates by $0.01. In the past year, the company’s stock is up 2.53% and is losing to the S&P 500, which has gained 14.03% in the same time frame. Since initiating my position in the growth portfolio back on December 23, 2014, I’m down 4%. I’d like to take a moment to evaluate the stock to see if right now is a good time to purchase more for the growth portfolio. Fundamentals The company currently trades at a trailing 12-month P/E ratio of 28.37, which is fairly priced, but I mainly like to purchase a stock based on where the company is going in the future as opposed to what it has done in the past. On that note, the 1-year forward-looking P/E ratio of 18.66 is currently fairly priced for the future in terms of the right here, right now. The 1-year PEG ratio (5.52), which measures the ratio of the price you’re currently paying for the trailing 12-month earnings on the stock while dividing it by the earnings growth of the company for a specified amount of time (I like looking at a 1-year horizon), tells me that the company is expensively priced based on a 1-year EPS growth rate of 5.14%. Financials On a financial basis, the things I look for are the dividend payouts, return on assets, equity and investment. The company pays a dividend of 3.55% with a payout ratio of 101% of trailing 12-month earnings while sporting return on assets, equity and investment values of 2.9%, 12.9% and 7%, respectively, which are all respectable values. Because I believe the market may get a bit choppy here and would like a safety play, I believe the 3.55% yield of this company is good enough alone for me to take shelter in for the time being. The company has been increasing its dividends for the past 11 years at a 5-year dividend growth rate of 6.5%. Technicals (click to enlarge) Looking first at the relative strength index chart [RSI] at the top, I see the stock approaching oversold territory with a current value of 36.65. I will look at the moving average convergence-divergence [MACD] chart next. I see that the black line is below the red line with the divergence bars decreasing in height which tells me bearish momentum may continue in the name. As for the stock price itself ($72.91), I’m looking at $74.85 to act as resistance and the 200-day simple moving average (currently $70.77) to act as support for a risk/reward ratio which plays out to be -2.94% to 2.66%. Wrap Up After taking a look at the stock I think I’ve determined this is not a good place to be buying more of the stock right now. Fundamentally I believe the company to be fairly valued on next year’s earnings estimates and expensive on future earnings growth. Financially, the dividend is great and doesn’t have a lot of room to grow. On a technical basis the risk/reward ratio shows me there is more risk than reward right now. With interest rates on the ten-year treasury beginning to climb these utility names have begun to take a hit. So I’d first like to see the utility stocks decouple first from the treasury yields before I buy some more of this particular name. Disclaimer: This article is in no way a recommendation to buy or sell any stock mentioned. This article is meant to serve as a journal for myself as to the rationale of why I bought/sold this stock when I look back on it in the future. These are only my personal opinions and you should do your own homework. Only you are responsible for what you trade and happy investing! Disclosure: The author is long D. (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.