Two U.S. Utility Giants Just Got Even Larger
Two major electricity industry takeovers were announced within a few days of each other. Energy Capital Partners, a private equity firm, announced its planned acquisition of Calpine, the nation’s largest generator of electricity using natural gas as a fuel. The acquisition valued Calpine at $17.3 billion ($5.6 billion for the common stock plus assumption of $11.7 billion of debt).
Days later, Sempra, a California-based utility, outbid Warren Buffet’s Berkshire Hathaway to buy Oncor, a Texas utility spin off from a disastrous private equity acquisition of TXU (the old Dallas-based Texas Utilities). Sempra’s bid values Oncor at $18.8 billion ($9.8 billion for equity and $9 billion to take responsibility for ex-isting debt).
In the case of Oncor, both final bidders had clear motives. Berkshire Hathaway has cash to invest and Mr. Buffett and Co. have targeted U.S. electric utilities for investment As a relatively large financial player, his investments have to be of a size to make a positive impact. In this case that means making relatively large acquisitions. Small ones barely register at Berkshire Hathaway.
But big electric utilities don’t hit the auction block too often.
Sempra may lack Berkshire’s investable cash, but is nevertheless a solidly credit worthy utility. Its stock sells at an impressive price. If it wants to go shopping for say an electric utility in Texas, it can raise the money.
But let’s take a step back. Why all this seemingly frenetic M&A activity recently? If the U.S. electric utility industry was a river we’d say it sits at the confluence of three troublesome tributaries; the No Growth, the Looming Competitive Threat and the High ROE (great name for a ranch). And so the utility industry consoli-dates.
Power generators, fearing the wrath of rating agencies and competitive markets have been acquiring lower risk regulated electric utility businesses whenever possible.
The power generators, especially the non-regulated ones, haven’t so much consolidated as engaged in a business form of serial reorganization and bankruptcies starting about 15 years ago. Low natural gas prices and competition from wind power have recently combined to deny profitability to this industry. As a result, like the old boll weevil in the song, these financially precarious power generating assets are as a result “just a lookin’ for a home”.
Like other utilities, Sempra requires new asset acquisitions to maintain its earnings growth. And as noted not many “Buffett-class” opportunities arise. Oncor comes to market in a way that’s unusual for an electric utili-ty. A supposedly extremely savvy leveraged buyout firm saddled the entity with so much debt it collapsed. And here we are. But it’s all good. A lot of former management and private investors made a lot of money.
If Oncor is about greed and a rather loose attitude towards regulatory supervision, Calpine is a story of con-tinually unmet aspirations. Formed in 1984 by California engineers and a Swiss holding company (hence the name Calpine), assets grew to $21 billion by 1992. The company went public in 1996 and bankrupt in 2005, one more victim of too much borrowing and not enough revenue.
In 2008, Calpine emerged from bankruptcy, still with a heavy burden of debt (83 percent of capitalization vs the 50 percent typical of regulated utilities.) In the ensuing decade, Calpine’s earnings gyrated wildly. Return on equity averaged a paltry 8 percent–barely higher than the interest and other financial charges paid on debt.
The company did run power plants efficiently. But given its bloated balance sheet and reliance on natural gas as a boiler fuel, it has become remarkably and to a degree inversely affected by the vicissitudes of wind power. Average capacity factor was around 49 percent, meaning that the facilities produced less than half of the theoretical output–not out of line with other gas-fired generators. The news stories said that Energy Capital Partners valued Calpine’s ”stable cash flow”. Stability appears to be in the eye of the beholder.
We are still left with the question. Why would supposedly clever, ex-Goldman guys like Energy Capital Part-ners pay $5.6 billion for Calpine’s assets, a 51 percent premium over the previous day’s closing price? And an 82 percent premium over book value of the stock.