Wisconsin Energy - Implications Of The Latest Big Energy Deal

Jun.24.14 | About: Wisconsin Energy (WEC)

Summary

Wisconsin Energy acquires Integrys Energy Group in a $9.1 billion deal.

Investors react very cautious, as the deal is driven by the need for capital, scale and diversification. The primary objective are not synergies, although they can be reasonably expected.

Solid projected earnings growth and anticipated dividend hikes should comfort investors.

Wisconsin Energy (NYSE:WEC) announced the largest deal of the latest version of Merger Monday. In a $9.1 billion deal it seeks to acquire Integrys Energy Group (NYSE:TEG). Investors are not applauding the deal yet as synergies are not the prime motivation behind the transaction.

Yet I believe shareholders should be pleased with the guided earnings per share growth and anticipated dividend hikes in the future. I am cautiously optimistic about the deal, yet shun the utility sector overall given the interest rate exposure and the impact of the energy transformation on their business.

The Deal Highlights

Wisconsin Energy announced that it has entered into a definitive agreement to acquire Integrys Energy Group.

Under terms of the deal, Wisconsin will pay a total of $9.1 billion for Integrys. The new combination will be named WEC Energy Group and creates a larger and more diverse Midwest electric and natural gas delivery company.

Under terms of the deal, investors in Integrys will receive 1.128 Wisconsin Energy shares as well as $18.58 per share in cash for each share in Integrys they are currently holding. Based on Friday's closing prices, this values shares of Integrys at $71.47 per share, a 17.3% premium over Friday's closing price.

The deal has already been unanimously approved by the boards of directors of both companies. The deal is anticipated to close in the summer of 2015.

Strategic Rationale

The main reason behind the deal is of course an increase in scale. Both strong independent operations have complementary geographic footprints, but together will have more scale and financial resources to provide energy to their markets in the future.

Combined both firms serve more than 4.3 million gas and electric consumers in the states of Wisconsin, Illinois, Michigan and Minnesota. The company operates 71,000 miles of electric distribution lines and over 44,000 miles of gas distribution lines.

At the same time, Integrys announced it is in the late stages to divest its services business, the non-regulated marketing subsidiary.

Another complication of the deal is that the new pro-forma business will gain a majority ownership in privately held American Transmission Company. Wisconsin holds a 26% equity ownership in the business while Integrys holds a 34% stake in American Transmission, giving the new group a 60% ownership stake.

The company will have greater financial firepower to finance the original plans of Integrys which calls for $3.5 billion in investments in the coming five years. These investments are targeted to invest in infrastructure and operational initiatives to maintain reliability and improve customer service.

Financial Implications

For the calendar year of 2013, Integrys reported revenues of $5.63 billion on which it net earned $354.9 million. In its latest quarterly filing, Integrys operates with $3.32 billion in net debt.

At $68.35 per share equity is valued at $5.47 billion, putting the total price tag to roughly $8.8 billion as shares of Wisconsin Energy fell on the back of the announcement, lowering the equity valuation of the deal.

Wisconsin Energy reported revenues of $4.52 billion over the past year, yet it was much more profitable as it posted earnings of $577.4 million. Total net debt stands at $5.09 billion while equity is valued at $10.21 billion based on Monday's closing price of $45.27

Combined, both companies post annual revenues of $10.15 billion on which it earned $932 million in 2013. The sum of the net debt position stands at $8.41 billion before the deal took place. Given the exchange ratio, about 90 million new shares of Wisconsin Energy will be issued, bringing the total count to 315 million.

This values equity at the pro-forma business at roughly $14.2 billion. Total debt of $8.41 billion will increase by nearly another $1.5 billion as a result of the cash component of the deal, resulting in a pro-forma net debt position of almost $10 billion.

All About The Dividends

For investors in utilities it is of course all about the dividend, although lower interest rates have resulted in solid capital gains as well in recent years.

Wisconsin Energy currently pays a quarterly dividend of $0.39 per share, thereby providing investors with a 3.5% yield. The $0.68 quarterly dividend of Integrys yields 4.0% per annum, even after the acquisition premium.

Before the deal closes which is anticipated in the summer of next year, Wisconsin aims to maintain its current dividend policy which aims for a 7-8% annual increase in the dividend. At closing, a further hike is anticipated to reflect the dividend policy of the combined companies, with investors in Integrys currently receiving a yield which is roughly 50 basis point higher.

Thereafter, a combined payout ratio of 65-70% of net earnings is targeted. Based on combined earnings of $932 million for 2013 and a share count of 315 million shares, Wisconsin might target an annual dividend between $1.92 and $2.06 per annum, compared to $1.56 at the moment.

Takeaway For The New Wisconsin Company

The new $14.2 billion equity valuation, values the company at 15-16 times 2013's earnings, while the net debt position of $10 billion is rather steep. The company is targeting a roughly $2 per share annual dividend one or two year's down the road, providing investors with a nearly 4.5% dividend yield at current prices.

Investors are not really enthusiastic about the deal yet. Shares of Integrys rose by 12.1% on Monday, resulting in a $590 million boost to its market capitalization. Shares of Wisconsin Energy fell by 3.4%, thereby shedding $355 million in value. Combined the total accretion as judged by the market is just $235 million.

This is as the deal is not driven by anticipated synergies, but rather an increased desire for scale, access to capital and a reduced exposure to volatile wholesale power markets. Of course the companies will focus on the sharing of best practices and some other efficiencies, but Wisconsin's CEO Klappa stresses that the deal is not being driven by synergies.

The prospects for 5-7% long term earnings growth and appealing dividend plans should be comforting to investors in any case. This is as 99% of the combined business will come from regulated businesses, limiting the risks for shareholders according to the company's management. This is very important given the huge energy transformation which is taking place in the US where abundant supply of natural gas is having huge effects on prices.

While I like the deal and believe that investors underestimate the positive impacts of the deal, I avoid utilities as a sector in this low interest rate environment. Besides low interest rates, I am skeptical about the long term outlook for many of these old-fashioned and high-indebted utility names amidst the energy transformation which is taking place.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.