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ITC Holdings To Join Utility Industry M&A Wave

ITC Holdings announces strategic review that includes a sale of company; stock soars 12.8%. We believe transaction is likely at $44-$47 per share, as strategic bidders National Grid, Iberdrola, and Berkshire Hathaway participate in competitive bidding. ITC Holdings is attractive target with $120-$160 billion capital investment opportunity, unique regulatory structure; Merger approval process may be shorter than other industry M&A deals. Shareholders in ITC Holdings (NYSE: ITC ), a leader in electric transmission in the US, saw its stock soar 12.8% from Friday’s close to $38.04 per share following an announcement that the board is reviewing its strategic options. The possibilities under consideration include a sale of the company, and we believe, for several reasons, that an outright sale of ITC Holdings to a strategic bidder is a highly probable outcome. We are currently in the middle of a significant M&A boom in the power and utility industry: Over $45.4 billion in deals were announced in the third quarter of 2015. This quarterly total exceeds the total transaction value of announced deals in the prior four quarters combined by over $7 billion ($38.3 billion in total from Q3 2014 to Q2 2015). Among the largest announced deals were the acquisition of Oncor Electric Delivery from the bankrupt Energy Future Holdings for $12.6 billion, Southern Company’s (NYSE: SO ) $12 billion acquisition of AGL Resources (NYSE: GAS ) ( as discussed here ), and the $10.4 billion acquisition of TECO Energy (NYSE: TE ) by Emera ( OTCPK:EMRAF ). (click to enlarge) Source: PwC report on Power and Utility Industry, October 2015. The recent wave in M&A activity in the regulated power industry is precipitated by a change in market dynamics from higher operating and maintenance costs and increased capital investment requirements. The costs of new utility construction and facility improvements continue to march upwards, as expense for labor and building materials rise. While allowed rate increases have been able to offset a considerable portion of these costs, rate increases for customers have been under pressure from a lower cost of capital in a low interest rate environment. With this underlying shift in the market taking place across the industry combined with stagnant demand for many utilities in their existing territories, several companies are looking beyond their own market to expand their customer base and generate economies of scale through operating efficiencies. These factors have served as the catalyst for several strategic acquisitions over the past twelve months including the larger deals announced in the third quarter as well as transactions as Exelon’s (NYSE: EXC ) $6.8 billion purchase of Pepco Holdings (NYSE: POM ). We anticipate that these industry factors will continue to drive consolidation and M&A activity is likely to remain robust through 2016. (click to enlarge) Source: ITC Holdings investor presentation, Edison Electric Institute 50th financial conference, November 8, 2015. With this industry backdrop, we believe the Board of ITC Holdings is making a shareholder-friendly decision in reviewing all of its strategic alternatives at this time and the Board appears to be taking the first steps in fulfilling its obligation to pursue value-enhancing action when the opportunity arises. Over the past three months, ITC Holdings’ stock has traded in the $31-$33 per share range and as much as 31% below its 52-week high trading price of $44 per share. This underperformance is very discouraging for long-term shareholders and many patient investors may be ready to cash out of their holdings at the right price. (click to enlarge) Source: ITC Holdings investor presentation, Edison Electric Institute 50th financial conference, November 8, 2015. It is our view that putting the company up for sale now would deliver the greatest value for ITC Holding shareholders. We believe that a sale of ITC Holdings would result in an all-cash transaction with consideration worth between $39 to $47 per share. Our valuation is based on a PE multiple of 18.5x to 22.5x on projected 2016 earnings per share of $2.10. This PE multiple range is consistent with multiples seen on recent transactions in the regulated power industry. Furthermore, the typical premium over the unaffected stock price we have seen is 20% to 40% which would imply a transaction value of $39 to $45 per share. In our view, the high end of these ranges would represent tremendous value for shareholders and exceed the all-time high trading price for ITC Holdings. From the standpoint of the strategic bidders believed to be interested in ITC Holdings, there are many compelling reasons to acquire the company and pay top dollar. One of the most attractive aspects of ITC Holdings is the significant future infrastructure requirements. Management estimates an investment in upgrades of $120 – $160 billion will be required through 2030 driven by an aging infrastructure and regulatory and compliance investments. The opportunity to put well over a hundred billion in capital to work and earn a decent return on the invested capital for the foreseeable future will appeal to the larger strategic acquirers such as National Grid (NYSE: NGG ), Iberdrola ( OTCPK:IBDSF , OTCPK:IBDRY ), Berkshire Hathaway ( BRK.A , BRK.B ) Energy, and NextEra Energy (NYSE: NEE ). Additionally, the unique regulatory structure that ITC Holdings is subject to is a very attractive characteristic of the company and provides ITC Holdings with an advantage over other potential acquisition targets in the regulated power industry. ITC Holdings is regulated at the federal level by the Federal Energy Regulatory Commission and the agency acts in setting the rates for the company’s vast electric transmission assets that span the U.S. Midwest. As a result of this regulatory structure, the regulated return on equity for ITC Holdings has consistently exceeded that of its state-regulated peers by as much as 200 basis points. We believe there is also a transaction-specific benefit of the unique regulatory structure The downside risk for ITC Holdings shareholders (and any shareholder of a utility company that is acquired) is the complex regulatory approval process of an acquisition. The unpredictable and often politically-charged process has delayed some transactions for several months. The average length from announcement to completion of an acquisition in the power and utilities industry is nearly 8 months between 2009 and 2013. As many investors in recent M&A deals will attest, the figures for 2014 and through the third quarter of 2015 are likely higher. For example, the proposed Exelon-Pepco transaction has been pending for over 19 months and may finally be approved as we approach the two-year anniversary of the April 2014 acquisition announcement. (click to enlarge) Source: Deloitte Center for Energy Solutions. Understandably, this burdensome process may deter a potential acquirer from pursuing a negotiated agreement. However, for ITC Holdings, we do not believe this will hold true. In our view, a proposed transaction may not have to receive the approval of each state jurisdiction in which ITC Holdings’ electric transmission subsidiaries operate. We believe approval of the Federal Energy Regulatory Commission and the Federal Antitrust authorities would satisfy the company’s statutory requirements. According to ITC Holdings’ most recent 10-K filing, state regulators’ authority and scope of oversight is quite limited: “The regulatory agencies in the states where our Regulated Operating Subsidiaries’ assets are located do not have jurisdiction over rates or terms and conditions of service. However, they typically have jurisdiction over siting of transmission facilities and related matters as described below. Additionally, we are subject to the regulatory oversight of various state environmental quality departments for compliance with any state environmental standards and regulations.” In our view, the FERC will have jurisdiction, from a power and utility industry standpoint, over the approval of any proposed transaction and would make the determination of the competitive effects of a merger and the long-term impact on the ratepayers. While the state jurisdictions may be involved in a regulatory review, we do not expect a state agency within the power industry to be in a position to make a binding decision as to the competitive effects of a proposed transaction. This unique regulatory structure therefore avoids a potential “DC Public Service Commission”-type disruption to a merger approval process where a small, activist group minimally impacted by a large multi-jurisdictional merger has the ability to delay the process or extract additional financial benefits from the parties. In conclusion, we believe a sale of ITC Holdings in the range of $39-$47 per share is in the best interests of shareholders and is a very likely outcome of the Board’s current strategic review. Based on the attractive characteristics and prospects of ITC Holding, we believe there will be active and competitive bidding by large strategic players in the regulated power industry and the results will be a final transaction price in the $44-$47 per share range. As such, we expect the power and utility industry consolidation will show no signs of slowing in 2016. And importantly, in contrast to several of the current prolonged transactions, we believe a proposed acquisition involving ITC Holdings will navigate the complex regulatory process successfully and in a more appropriate timeframe. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Tracking The Sequoia Fund: Q3 2015 Update

Summary Year-to-date, the fund is up 1.97%, versus -5.29% for the S&P 500. Top 10 holdings (65.2% of the fund): Valeant Pharmaceuticals, Berkshire Hathaway, TJX Companies, O’Reilly Automotive, Fastenal, Precision Castparts, MasterCard, Idexx Laboratories, Mohawk Industries, and Google. During the third quarter, the fund was adding to its positions in Rolls-Royce, Constellation Software, and Jacobs Engineering. An update on Valeant Pharmaceuticals. Since its inception on 7/15/1970 an investment in the Sequoia Fund (MUTF: SEQUX ) has returned 14.34% annually versus 10.65% for the S&P 500. The fund is noted for its long-term value investing style, portfolio concentration, and outperforming in down years. For more background on the fund you can check out my original article here . The big news for the Sequoia Fund is the Valeant Pharmaceuticals controversy. The fund started accumulating shares in the second quarter of 2010 and by the end of the year held 11.3 million shares. The stock price during this period ranged from $14 to $30. You can find the fund’s reasoning for getting into the company in the 2010 annual report, which you can find here . Valeant quickly became the fund’s largest position. It said at the time: Valeant and Biovail merged during the year, and on December 31 the combined company, called Valeant, was our second largest holding. In recent weeks, rapid appreciation in Valeant shares caused it to surpass Berkshire and become Sequoia’s largest holding. It is the first time in nearly 20 years that Berkshire has not been the largest investment in the Fund. Speaking of Berkshire, it was Charlie Munger that first sounded the alarm that all might not be up to snuff. Munger is Chairman of the Daily Journal Corporation and was asked about Valeant at the last annual meeting. He responded: Valeant is like ITT and Harold Geneen come back to life, only the guy is worse this time. For those unfamiliar with the ITT story you can check out this article , which gives a nice summary. Basically, like Valeant, ITT was built up on acquisitions and debt. And what was once a growth story turned into a mish mash of debt laden businesses. Despite Munger’s warnings Valeant’s stock continued its upward trajectory, reaching a high of $263.81 on August 6th. Munger wasn’t the only one suspicious of the stock. On August 13 blog AZ Value Investing published an article on Valeant, calling it a dangerous story told well. You can find the article here . Trouble for Valeant was just around the corner. On September 17th infectious disease website Healio reported that Turing Pharmaceuticals raised the price of its Daraprim drug from $13.50 per tablet to $750. The USA Today followed up with its own article the next day and did the math for us, noting the price hike was 5,000%. Then Hillary Clinton jumped on board, tweeting on September 21st: Price gouging like this in the specialty drug market is outrageous. Tomorrow I’ll lay out a plan to take it on. That put all specialty pharma companies in the crosshairs, including Valeant. In a week the stock dropped from $245 to $155. But the pain wasn’t over. On September 28 Citron Research, a specialist in unearthing frauds and terminal business models, published a report saying a congressional subpoena to Valeant on price gouging should be granted. Plus it gave a short term price target of $130 with the stock in the $170-$180 range at the time. The initial report didn’t move the stock much. But sure enough on October 14 subpoenas were issued. And then Citron wrote another report detailing the whole Philidor RX issue. By the time the dust had settled Valeant had dropped 50%, from $180 to $90, in just a few days. On October 28 the Sequoia Fund addressed the issue in a letter to shareholders which you can find here . Key comments: The short seller Andrew Left (of Citron Research), writing as Citron Research, exploited the negative sentiment surrounding Valeant. Our consultations with lawyers who specialize in the pharmaceutical industry lead us to believe there is no legal reason Valeant can’t advise, control or own Philidor. We work hard to understand Valeant and its business model. Our belief has always been that Pearson is honest and extremely driven. He does everything legally permissible to maximize Valeant’s earnings. At a recent price of $110, Valeant trades for about seven times the consensus estimate of 2016 cash earnings, which does not strike us as a rational price for a company with a diverse collection of product lines and strong earnings growth. So it appears the Sequoia Fund is sticking with Valeant. As of 6/30/15 Valeant was a $2.5 billion position in the fund, and its largest, accounting for 28.7% of the fund. As of 9/30/15 Valeant was a $2.0 billion position in the fund, and its largest, accounting for 24.8% of the fund. Based on my numbers, assuming the fund didn’t sell any shares, the position is now worth about $1 billion at a price of $90. It will be interesting, to say the least, to see the fund’s activity in Valeant during the fourth quarter of 2015. Here’s the fund activity for the third quarter of 2015. New Stakes: None. Stake Disposals: None. Stake Increases: Rolls-Royce ( OTCPK:RYCEY ) designs, develops, manufactures, and services integrated power systems worldwide. The company is known for its expertise in making engines for wide body jets. The fund has been in Rolls-Royce since 2007. It built up the position to over 12 million shares by the end of 2008. Since then it’s held, save very minor selling. Despite continuing to hold, the fund is very concerned over the position. While it admires its jet engine business, it questions the board of directors recent decisions to diversify into marine engine and power generation businesses. It’s also concerned the company is abandoning its Total Care service contract selling model which was very successful under the former CEO. As for the current CEO, John Rishton, the fund says, “… in our meetings with him, has shown minimal awareness of the returns on capital his acquisitions have generated.” The fund was selling in the second quarter of 2015, trimming the position by 437k shares when prices traded between $13.75 and $16.00. Rolls Royce announced in April that John Rishton was retiring and be replaced by John Rishton. The fund must like East’s plan as they did an about face in the third quarter of 2015, adding just over 7 million shares as prices ranged from $9.75 to $13. Constellation Software ( OTCPK:CNSWF ): Constellation Software, based out of Toronto, acquires, manages, and builds vertical market software (VMS) businesses. The fund likes the company because the software they provide tend to be essential to the customers’ operations. It also likes Constellation for being an adept acquirer and then increasing the cash flow of acquisitions. During the fourth quarter of 2014 the fund acquired 257k shares for a 1.09% position. Prices for the fourth quarter of 2014ranged from $240 to $300 for the ADR. During the third quarter of 2015 the fund added another 165k shares boosting its position by 64%. Prices ranged from $380 to $460. This is now a 2.19% position in the portfolio. Jacob’s Engineering (NYSE: JEC ) provides technical, professional, and construction services to industrial and government clients. The fund first established a position in the fourth quarter of 2013, picking up 743k shares when prices ranged from $56 to $64. That turned out to be near the high point for the stock which has been falling since January of 2014. The fund added another 716k shares in the second quarter of 2014 when prices traded between $53 and $65. This past quarter the fund added another 764k shares. Prices traded between $36.50 and $44.50. This stock is a 1% position in the portfolio. Stake Decreases: None. Kept Steady : Omnicom (NYSE: OMC ), Precision Castparts (NYSE: PCP ), Compaignie Financiere Richemont SA ( OTCPK:CFRUY ), O’Reilly Automotive (NASDAQ: ORLY ), Canadian Natural Resources (NYSE: CNQ ), Sirona Dental Systems (SRIO), Berkshire Hathaway (BRK.A & BRK.B), Danaher (NYSE: DHR ), EMCOR Group (NYSE: EME ), Trimble Navigation (NASDAQ: TRMB ), Mohawk Industries (NYSE: MHK ), Expeditors International (NASDAQ: EXPD ), Perrigo Company (NYSE: PRGO ), Valeant Pharmaceuticals (NYSE: VRX ), West Pharmaceuticals (NYSE: WST ), Zoetis (NYSE: ZTS ), Fastenal Company (NASDAQ: FAST ), Praxair (NYSE: PX ), IMI plc ( OTCQX:IMIAY ), MasterCard (NYSE: MA ), Brown & Brown (NYSE: BRO ), Google (NASDAQ: GOOGL ) and (NASDAQ: GOOG ), Goldman Sachs (NYSE: GS ), International Business Machines (NYSE: IBM ), Waters Corporation (NYSE: WAT ), Admiral Group ( OTCPK:AMIGY ), Hiscox Ltd. ( OTC:HCXLY ), Verisk Analytics (NASDAQ: VRSK ), Costco Wholesale (NASDAQ: COST ), Tiffany & Co. (NYSE: TIF ), TJX Companies (NYSE: TJX ), Walmart (NYSE: WMT ), Croda International ( OTCPK:COIHY ), Cabela’s (NYSE: CAB ), and Idexx Laboratories (NASDAQ: IDXX ) saw no changes from the second quarter of 2015 to third quarter of 2015. Here’s a snapshot of the activity from the second quarter of 2015 to the third quarter of 2015: (click to enlarge) Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

5 More Dividend ETFs For Your Consideration

Summary These five dividend ETFs have similar expense ratios but very different yields. Sector analysis shows that the portfolios have some very material differences. SPHD, SDY, and NOBL all work for investors that want to handle their investing in the technology sector on their own. The one that catches my eye for high yield and utility allocations that may go on sale during December is SPHD. One of the areas I frequently cover is ETFs. I’ve been a large proponent of investors holding the core of their portfolio in high quality ETFs with very low expense ratios. The same argument can be made for passive mutual funds with very low expense ratios, though there are fewer of those. In this argument I’m doing a quick comparison of several of the ETFs I have covered and explaining what I like and don’t like about each in the current environment. The Five ETFs Ticker Name Index DLN WisdomTree LargeCap Dividend ETF WisdomTree LargeCap Dividend Index DGRW WisdomTree U.S. Dividend Growth ETF WisdomTree U.S. Quality Dividend Growth Index SPHD PowerShares S&P 500 High Dividend Portfolio ETF S&P 500® Low Volatility High Dividend Index SDY SDPR Dividend ETF S&P High Yield Dividend Aristocrats Index NOBL ProShares S&P 500 Dividend Aristocrats ETF S&P 500® Dividend Aristocrats® Index By covering several of these ETFs in the same article I hope to provide some clarity on the relative attractiveness of the ETFs. One reason investors may struggle to reconcile positions is that investments must be compared on a relative basis and the market is constantly changing which will increase and decrease the relative attractiveness. For investors that want to see precisely which assets I’m holding, I opened my portfolio earlier in November. Dividend Yields I charted the dividend yields from Yahoo Finance for each portfolio. You may notice that despite each of these portfolios being named for dividends, the yields on the ETFs are significantly different. Expense Ratios These funds are all very comparable on expense ratios which is nice for creating a more direct comparison. (click to enlarge) Sector Assuming your decision isn’t based strictly on yields, the next area to look into is the sector allocations. There were clearly no big differences in expense ratios, so this race should really come down to getting a strong enough yield and getting a great sector allocation. I built a fairly nice table for comparing the sector allocations across dividend ETFs to make it substantially easier to get a quick feel for the risk factors: (click to enlarge) First Glance The first thing I would expect investors to notice is that there are a few areas where one or two of the ETFs have vastly different allocations from their peers. The most obvious standouts in this regard are NOBL allocating nearly 28% to the consumer defensive sector and SPHD allocating over 24% to the utility sector. NOBL Since I see a fairly expensive market, I find the heavier allocation to the consumer defensive sector to be appealing. If the market undergoes a severe correction then I would want to be more aggressive with the portfolio when it appeared the worst had passed. In the later stages of a bull market or entering a bear market I’d rather focus on the consumer defensive sector. It is interesting to note that the technology allocation here is zero. If investors feel very confident in analyzing technology companies, it could make NOBL a great fit for them since the lack of technology companies within the fund would work out well for an investor that was managing their own investments in the sector. SPHD SPHD uses a very heavy allocation to utilities. For investors that already build their own utility positions in their portfolio, this wouldn’t be a great fit since it would double up on the exposure. On the other hand, for the investor that does not have utility exposure in their portfolio, the ETF could be a great fit. The utility sector often demonstrates some correlation with bonds because investors treat it as an alternative source of income. This may be a fairly volatile sector going into December because investors are expecting the Federal Reserve to raise rates and if a rate increase is confirmed it could send bond yields higher and utility stocks would be expected to fall at the same time so that the dividend yields would increase. For investors willing to take the exposure on utilities if the stocks go on sale, the middle of December could bring Christmas a little early with sales in the sector. SPHD also offers the highest yield which may be very attractive for investors seeking to grow more income immediately. Similar to NOBL, SPHD has a very low weight for the technology sector. The combination of high yield, utility exposure, and no technology makes it ideal for the dividend growth investor that focuses their research time on technology. What do You Think? Which dividend ETF makes the most sense for you? Do you want to overweight consumer staples for more safety in a downturn or would you rather have more upside in a prolonged bull market? Do you want to own the oil companies, or do you foresee gas as being in a long term downtrend that makes the business model much weaker?