13% Upside In Sale Of Westar Energy, But Deal Faces Challenges

| About: Westar Energy, (WR)
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Summary

Stock in Westar Energy recently traded $7 below its $60 sale price to Great Plains Energy.

The Kansas Corporation Commission staff recommended against the sale of Westar Energy while Gov. Sam Brownback favors the deal.

The KCC will decide the fate of the merger by April 24.

Stock in Westar Energy (NYSE:WR) recently traded at $53 per share - $7 below its sale price of $60 per share to Great Plains Energy (NYSE:GXP). The stock suffered a 3.6% decline from $55 per share after a seven-day hearing at the Kansas Corporation Commission. The commission heard arguments for and against the merger and is expected to make its decision on the deal by April 24.

Photo of corporate headquarters in Topeka provided by Westar Energy

Staff who work for the KCC recommended against the sale, saying Great Plains is paying a $5 billion acquisition premium that will ultimately hurt the company because of all the debt financing to make the deal happen.

There are three commissioners, Shari Feist Albrecht, Pat Apple and Jay Emler, who will decide whether to support the sale of Westar to Great Plains in a $12.2 billion deal, according to The Topeka Capital-Journal.

Part of the mandate by the Kansas Corporation Commission is to review the merger to see if it meets 22 merger standards. One of the standards is whether the transaction will be beneficial on an overall basis to state and local economies and to communities served by the public utility.

The Topeka Capital-Journal's Morgan Chilson and Tim Hrenchir showed the sale of Westar Energy would result in the loss of 638 jobs.

The loss of the 638 jobs would certainly have a negative impact on the Kansas economy. I estimate those jobs have an annual payroll of at least $32 million if average pay is about $50,000. My estimate is conservative. Jobs at Westar pay well, with good benefits. Kansas can't afford to lose anymore jobs. Kansas lost 6,300 private sector jobs between September 2015 and September 2016, according to the Kansas Department of Labor. Kansas ranks 45th in private sector job growth for the last 12 months, according to an analysis by Arizona State University. Colorado leads the region with the 10th highest rate of private sector job growth, while Missouri and Nebraska rank 31st and 39th, respectively. Oklahoma trails Kansas at 47th, the Kansas City Star reported.

Last fall, the Kansas Corporation Commission's staff recommended against the sale of Westar Energy to Great Plains Energy, saying the deal failed most of the 22 merger standards.

The KCC said "Limited savings do not justify the purchase price or $5 billion acquisition premium."

Adam Gatewood of the KCC says the post-merger utility will be financially weaker than the existing stand-alone entities. He says the merger is not in the public interest because customers will be asked to pay rates that are in excess of the cost of providing services. Finally, the transaction weakens the commission's ability to effectively regulate the post-merger entity.

The proposed transaction would leave ratepayers, the state, and even the post-transaction entity in a worse position moving forward. In fact, this transaction primarily promotes the interests of Westar's shareholders - due to the overcompensation they will receive - to the detriment of the public interest, Gatewood said.

Jeffrey McClanahan, director of the Utilities Division at the Kansas Corporation Commission, said the staff cannot recommend approval of the merger even with conditions. Merger conditions cannot remedy several fundamental flaws within the transaction as proposed. These fundamental flaws are: The purchase price of $12.2 billion is too high because it results in Great Plains and its subsidiary Westar being in a significantly weaker financial position post-acquisition. Even though joint applicants assert they are not explicitly requesting recovery of the acquisition premium, ratepayers will inevitably pay this acquisition premium implicitly through financial engineering. Financial engineering requires the commission to change its current approach to setting a utility's cost of capital by allowing Great Plains to earn equity-level returns on investment financed with lower-cost debt, McClanahan said.

When the sale of Westar Energy was announced last spring, the stock was already trading at a high premium due to merger speculation. Many months before the transaction, it was well known Westar Energy was for sale, so traders got in on the action, pushing the price up 40% from $37 to $52 per share before the deal was announced in spring 2016. I watched the stock jump rapidly in price and speculated there was M&A interest in the stock.

When the deal was announced May 31, 2016, Westar's stock jumped a few more points to $57 per share, but the big gains had already been made before the announcement. Since the announcement, the stock has fallen 8% to $53 per share. I sold our shares in Westar after the deal was announced at $57 per share. I imagine most of the traders sold their shares too. There is 13.2% upside from $53 per share to the $60 per share sale price. Westar shareholders will receive $51.00 in cash and $9.00 in Great Plains Energy common stock, if the deal is approved by the KCC.

Westar Energy was built in Kansas, not Missouri. Kansas and Missouri have been rivals for years, going back to the days of the Civil War. Missouri ruffians burned down Lawrence, Kan., in 1863. Today, they are rivals in football and basketball and economic development. They compete in the bitter divide between Kansas City, Mo., and Johnson County, Kansas. Some companies used to be on the Missouri side, but moved to Kansas for tax breaks and other incentives. If the sale of Westar Energy goes through, Kansas will lose control of one of its best assets. That is one of the reasons the Kansas Corporation Commission staff dislike the deal.

Gov. Sam Brownback favors the merger. Brownback appointed all three KCC members Jay Scott Emler, Shari Feist Albrecht and Pat Apple to the commission. The governor gave his support in a two-page letter Nov. 28 to the KCC commissioners.

In that letter, Brownback said leaders at both companies have assured him the deal is about creating a stronger more efficient utility to serve Kansans while preserving the local jobs and community engagement that have been a hallmark of Westar over the years. He said Kansas needs competitive electric rates to facilitate economic growth.

As a Kansan, I would hate to see our state lose corporate headquarters of Westar Energy in Topeka, the loss of 638 jobs is not good for Kansas. Kansas has a history of losing its best assets, including the Menninger Clinic, which used to be located in Topeka for 77 years, but moved to Houston in 2003.

Conclusion

Initially, I thought this deal would go through with no problem. But after tremendous criticism of the deal by KCC staff, public disclosures in the local press, I'm not so sure. Investors have been selling WR, perhaps worried the deal won't go through. I believe there are 49% odds that this deal goes through. The three KCC commissioners, who will decide the outcome, know that the deal will result in the loss of jobs and the loss of a true corporate headquarters in Topeka, but they also know they were appointed by Brownback and he won't be happy with them if they go against his advice.

Very few politicians in Kansas have the courage to stand up against Brownback; they allowed him to push through a tax plan that gave 330,000 businesses tax breaks, resulting in the loss of state revenue and reductions in state aid to schools, universities and pensions. Brownback's trickle down experiment is failing. I hope the three Kansas Corporation Commissioners will stand up against Brownback and the Missouri ruffians and vote against this deal. Brownback got his assurances from leaders in both corporations. I trust the information from the KCC staff on this deal over the leaders at Westar and Great Plains. Corporations in this case are acting in the best interest of their shareholders. Shareholders in Westar will make out great if this deal goes through, but the state will lose control of one of its best assets and consumers will send their utility dollars to Missouri.

Disclosure: I/we 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.