Gas Natural, Inc (NYSEMKT:EGAS) is the new name for Energy Inc, a small cap (market capitalization of $70 million) natural gas utility that is expanding its customer base by acquiring even smaller local utilities. Through its recently announced secondary offering, EGAS will soon have sufficient cash to increase service customers by 12,000-14,000 and when fully invested could represent a 22% increase in customer count.
Using a roll-up business model, CEO Richard Osborne has been building an intriguing natural gas utility by acquiring small, local natural gas firms and folding them into the growing organization. Initially focused in Montana and Wyoming, EGAS owns additional utilities in Ohio, PA, Maine, and N.C. More background information can be found in my post from April 16.
In January of this year, EGAS acquired three utilities in OH and PA that expanded its service client count by 60%, to a current 61,000. The acquisition cost per hook-up was $1,648 and the total cost was $37 million, structured as debt assumption of $20 million and 1.6 million new shares. The most recent quarter‘s financials, the first to include the higher customer count, were quite strong given the dilution and higher interest expense from the acquisition.
Net income for the first quarter 2010 was up 89%, and earnings per share rose 32% to $0.61 from $0.46 last year. Nice performance, especially considering 30% of the increase in net income was organic growth, fueled by higher gross margins.
However, like many small companies, EGAS has an interesting history with its CEO. The utilities purchased in January were privately owned by Mr. Osborne, and he was the recipient of the 1.6 million new shares. With the addition of these shares, Mr. Osborne owns 2.4 million shares, or 40% of the almost 6 million shares outstanding.
The company recently announced a secondary of 2.8 million shares at $11.77, 1.8 million from the company and 1.0 million from Mr. Osborne. After the offering, there will be 7.6 million out and Osborne will have reduced his stake to 19%. Effectively, Osborne is cashing out of most of the shares received for his privately-held utilities – his personal goal for the past 18 months.
Reviewing the latest balance sheet, a few items have changes since the January acquisition, with the most obvious being goodwill. As of the end of 2009, the book value of goodwill was $0, but after the merger, increased to $13 million or $1.71 a share. Current book value is $9.12, including the goodwill. Deducting goodwill, book value drops to $7.41.
Although the company assumed $20M in added debt in January, the percentage of operating income that goes for interest has remained the same at 9.6%. The added shares issued for both the merger and secondary offering will increase quarterly dividend expenses from $705,000 to $1.06 million, more than offset by an increase in net income.
EGAS share price has done quite well since January, rising 15%. Shares carry a yield of 4.6% with a monthly dividend of $0.045.
Some may think the sale of insider shares indicates a lack of confidence by Osborne. However, based on the concentration and large percentage of Osborne’s wealth in EGAS, it would seem prudent for him to diversify. As it is said, “There are many reasons for an insider to sell, but only one for them to buy.” Owning 19% of EGAS should make Osborne sufficiently motivated to increase shareholder value, both his and ours.
If management uses the added funds from the secondary to expand their service territory through further acquisitions or capital expenditures, the increase in share count will not be overly dilutive to EPS. Investor’s belief that this will be the final outcome of the secondary is the reason share prices have not declined commensurately with the percentage share increase of almost 30%.
While no longer looking for a divvy increase this year, higher dividends should be in the cards over time. EGAS could still earn $1.50 a share over the next 24 months, making an original price target of $14 still valid. At today’s price, that would equate to a 20% capital gain and a 4.6% yield, more than acceptable for a utility selection. Buying on market weakness or a potential share- dilutive sell-off would provide better returns.
As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.
Disclosure: Long EGAS and have been a shareholder since 2007