Avista (NYSE:AVA) announced that it has reached an agreement to sell its subsidiary Ecova to the French giant, GDF Suez (GDFZY). Investors applauded the deal given the fact that proceeds of the deal will be used to repurchase shares.
That being said, the sale will dilute earnings to some degree before considering the offsetting impact of share repurchases. The company has a full valuation, as I believe investors are largely attracted to the stock for its generous dividends. I remain on the sidelines.
The Deal Highlights
Avista announced that it has reached an agreement that its subsidiary Avista Capital sold Ecova to Cofely USA, which is a subsidiary of French-based GDF Suez.
Avista is selling the unit for $335 million in cash after adjusting for debt payments and closing conditions. Ecova provides sustainability and management services to more than 50 utility companies. The unit reported revenues of $176.8 million last year, while earning $7.1 million. The reported price tag values the unit at 1.9 times annual revenues and 47 times earnings.
Net of debt, taxes and transaction costs, the sale will fetch some $136 million in cash for Avista, which is expected to report a net gain of $62 million related to the deal.
The transaction is expected to close by July 1, 2014, and is subject to various normal closing conditions.
Avista is a company which is not on every investor's radar. The company has been around for a long time, being incorporated back in 1889. It produces, transmits and distributes energy, providing electricity in a regulated environment to 367,000 customers and natural gas to another 326,000 consumers.
The company operates in eastern Washington, northern parts of Idaho and parts of Oregon, in which some 1.6 million people reside. At a recent presentation, Avista projects 5% to 6% rate base growth going forward, while providing an attractive dividend growth rate of 4% to 5%. These assumptions are based on a projected customer growth of a percent per annum.
The company is already quite advanced in its generation methods. 48% of electricity is being generated through hydro power, placing the company far ahead of the 15% renewable portfolio standard rate as set by the state of Washington.
The business excluding Ecova reported revenues of roughly $1.45 billion, on which it earned a little over $100 million. At $33 per share, Avista is valued at $2 billion, while holding $1.4 billion in debt, giving the company a $3.4 billion enterprise valuation.
CEO Scott Morris anticipates that the company will use the majority of the proceeds to buy back common stock, as well as reinvest funds back into the business, without specifying investment targets or opportunities. The company continues to seek growth opportunities next to the core utility business.
As discussed below, significant repurchases are required to offset dilution from the deal.
Takeaway For Investors
Avista is making a sizable deal, with the reported deal tag coming in around 17%-18% of its current equity market valuation. That being said, repurchases are required to offset the anticipated earnings dilution resulting from the sale. Ecova is set to earn $0.12-$0.16 per share this year, while Avista anticipates annual earnings of $1.77 to $1.97 overall.
As such, investors should realize that the vast majority of sales proceeds will need to be targeted to repurchases to offset dilution, with net proceeds of the sale coming in far below the reported deal tag.
At $33 per share, Avista trades at 17-18 times earnings, assuming the company will maintain its mid-point target for earnings of $1.87 per share. This is not cheap given the significant debt load and capital expenditure requirements anticipated around $350 million per annum through 2016.
While the quarterly $0.3175 per share dividend is appealing, as it provides investors with a 4.0% dividend yield, the valuation leaves little room upwards, in my opinion. Of course, the large contribution of hydropower in the generation mix is very beneficial from an environmental and sustainability standpoint, making the company very resilient for the future.
I remain on the sidelines.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.