Tag Archives: merger

Pair Trading Opportunity – AGL Resources And Piedmont Natural Gas

Summary Two deals in the same sector with similar conditions and similar payment methods — the perfect situation for implementing a pair trading strategy. Because of regulation, this will be a very long process. So the pair trading strategy is more profitable than a classic merger arbitrage. In my opinion, if the authorities block one of the transactions the other merger will automatically have a lot problems. This risk should be hedged. I have to admit it: I hate mergers with a lot of regulatory conditions and economic intervention . I’m not a lawyer, so I’m not an expert in terms and conditions and I avoid these transactions. However, we can sometimes see very good opportunities in the M&A markets because of similar deals pursuant to the same antitrust approvals. On Aug. 24, 2015, Southern Company (NYSE: SO ) and AGL Resources (NYSE: GAS ) announced a merger agreement. Sometime later, on Oct. 26, 2015, Duke Energy (NYSE: DUK ) and Piedmont Natural Gas (NYSE: PNY ) approved another merger agreement with similar terms and conditions. Both transactions will be paid in cash, and their size is comparable: $12 billion and $6.7 billion, respectively. In this article, I will only assess the terms and conditions of both mergers. If you want to understand more about the financial performance of the companies, check our these articles: Buyers Duke is the largest electric utility in the United States. It serves 7.3 million customers, located in the Southeast and Midwest. It has an enterprise value of $88.01 billion and $1.38 billion cash on the balance sheet; its ROA is 2.83%. You can check some more numbers here. Source: I nvestor Presentation . It is a mature company, with an interesting dividend yield as well as a high payout ratio: Source: Investor Presentation. You can only see this type of payout ratio in mature industries. Merger arbitrage analysts might say that they like this transaction or not, but the fact is that the sector is in a phase of consolidation and mergers will occur. Southern serves more than 4.5 million customers, and it is the leader in the southeast portion of the United States. It has an enterprise value of $67.48 billion and $1.12 billion in cash; its ROA is 3.74%. You can check some more numbers here. Source: Investor Presentation . I would like to mention that the buyers are very big players. Their size is comparable, and the only difference is that they operate in different areas. The negotiation process with the authorities will be the same. Because of this fact, the merger spread should be similar. Targets and Transitions Benefits Piedmont has one million customers in portions of North Carolina, South Carolina, and Tennessee. It has a better ROA than its acquirer (3.54%), and it is also more than 10 times smaller than Duke. The transaction is an interesting move. Duke’s objective is to enhance its regulated business mix. What’s more, this merger creates a strong platform for future growth. AGL is based in Atlanta. It provides energy services to 5.5 million utility customers (including over one million retail customers served by the SouthStar Energy Services joint venture). Its ROA is 3.84%, which is better than that of the buyer. This transaction is a little better than the other one. It is accretive to ongoing EPS in the first full year, and it will create a strong credit profile. Source: Investor Presentation . Overall, the targets are very similar. It looks like a copied transaction, both in size (“same customer base”) and in value. As mentioned earlier, because of this fact the merger spread should be approximately the same. Terms, Conditions and Timing If you are interested, you can read the merger agreement of Duke’s transaction here and that of Southern here . Both mergers are pursuant to the shareholders’ approval. I did not read about any shareholders complaining about the price paid. So, I’m not worried about these conditions. It is more important, in this case, to assess the regulatory conditions. Southern’s transaction is subject to the following regulatory conditions: – The receipt of antitrust clearance in the United States (Hart-Scott-Rodino Act) – The approval of the FCC – The approval of the California Public Utilities Commission, Georgia Public Service Commission, Illinois Commerce Commission, Maryland Public Service Commission, New Jersey Board of Public Utilities and Virginia State Corporation Commission and other approvals required under applicable state laws. Source: Merger Agreement. Duke’s transaction is subject to the following antitrust conditions: – The receipt of antitrust clearance in the United States (Hart-Scott-Rodino Act) – “The merger is subject to the approval of the NCUC. The Company and Duke Energy expect to file in or around January 2016 a joint application for approval by the NCUC of the merger. Section 62-111(a) of the North Carolina General Statutes provides that no merger or combination affecting a public utility may be made through acquisition or control by stock purchase or otherwise without written approval from the NCUC. Under this statute, such approval shall be given if justified by the public convenience and necessity. The Company is a public utility under North Carolina law and two of Duke Energy’s subsidiaries are also public utilities under North Carolina law. Source: Merger Agreement. I do not think that any merger arbitrageur will tell you the outcome of these mergers. It is a very technical question that you might only be able to answer if you have worked approving mergers for a while. So I would not implement a classic merger arbitrage strategy here. I do not like gambling. The pair trading strategy that I will explain below reduces the exposure to these regulatory risks. Overall, the mergers will take a long time because of these regulatory conditions. Both transactions are said to close in the second quarter of 2016. Pair Trading Strategy and Conclusion Duke will pay $60 per share in cash, so the merger arbitrage spread is 5.24% ($60/$57.01 (close on Dec. 11, 2015) – 1). What’s more, we have to include four quarterly dividends paid by Piedmont (0.33 per share; I included the fourth quarterly dividend of 2015 but not that of 2016). So, the merger contribution is $61.32, and the calculated spread is 7.56% ($61.32/$57.01 – 1). Southern will pay an amount of $66.00 per share in cash, so the merger arbitrage spread is 5.21% ($66/$62.73 (close on Dec. 11, 2015) – 1). However, if we include the four quarterly dividends that AGL distributes (0.51 per shares), the merger contribution becomes $68.04, and the calculated spread is 8.46%($68.04/$62.73 – 1). The most recent evolution of the calculated spread can be seen in the following figure: Source: Maudes Capital. I would like to mention that the spread of both companies is somewhat correlated. It makes sense because of the facts explained above. In the future, the evolution will be similar so that you can perfectly implement a pair trading strategy. Today, I would buy PNY shares, and use the same amount of money to short sell GAS. You can make more than 1% return in a short period of time. The best thing in this idea is that you eliminate the regulatory risk included in both transactions. If one merger does not close, the other merger will have a lot of issues as well, and the spread will be enlarged. This means that you hedge the loss in one merger with the gains in the other transaction. To make a long story short, these transactions have a lot of regulatory conditions, and the classic merger arbitrage strategy is not a good idea. The pair trading strategy provides a better risk/return ratio. What’s more, both mergers are necessary moves in the same sector, and therefore good M&A ideas. I believe that both transactions will close, but I do not like playing with regulatory conditions. So, I prefer to hedge the risk. Note: At the moment there are some other merger arbitrage and pair trading investments like this one — you can read about them here , here , and here .

Exelon Presents Mixed Picture As Investors Are Advised To Wait

Company’s management seems committed to appealing against PSC judgment. Management continues to consider Pepco merger as key in achieving Exelon’s goal of re-balancing asset portfolio. Recent PSC decision to reject proposed merger has adversely affected Exelon’s plans to grow regulated operations. Exelon has to make important decision regarding capital deployment. Company’s risk profile has also increased. U.S. utility companies have been making aggressive efforts to increase their regulated business operations exposure, as forward power prices remain weak. Exelon Corp. (NYSE: EXC ) has also been working to expand its regulated operations, in an attempt to provide stability to its revenues and earnings. Consistent with its efforts to increase regulated operations, the company has been directing capital investments towards regulated operations. However, the company’s plans to increase regulated operations are adversely affected, as the Public Service Commission (PSC) of the District of Columbia rejected the proposed $6.8 billion Exelon-Pepco merger; Exelon does have a right to appeal against the judgment. However, Exelon’s future growth prospects will be seriously affected if the proposed merger is not completed. Therefore, I recommend investors to stay on the sideline until some clarity appears on the merger. Overhang Prevails Exelon’s financial performance in recent years has been volatile mainly because of weak and volatile forward power prices. However, the company has been undertaking prudent strategic decisions in recent years by focusing on increasing its regulated operations, which remains an important source for the future earnings growth. Exelon is known as the largest operator of nuclear power plants in the country; however, cheap coal and natural gas have rendered nuclear power uneconomical. The company has been making capital investments to strengthen and develop its regulated operations, where regulators guarantee investment returns. Moreover, in the recent past, the company was working on the proposed $6.8 billion Exelon-Pepco merger to provide stability and growth for its future earnings. Exelon’s management expects that the proposed merger will increase Exelon’s regulated utility earnings contribution to 65%-70% up from the current level of almost 55%. However, recently, the PSC rejected the planned merger, stating that it is not in the ‘public interest’; the decision has weighed on stock prices of both Exelon and Pepco, and I think Exelon’s stock price will stay under pressure in the near term. Exelon plans to appeal against the judgment, as it has a right to appeal against the decision in 30 days. The rehearing process is expected to take 6 months. However, the merger rejection has increased Exelon’s business risk. I think the merger now has 50% probability of being completed, and the main reason for pessimism is that the PSC has outrightly rejected the proposal rather than offering conditional approval. The company can push for the merger by settling with key stakeholders and presenting a case that the merger will bring notable benefits to customers. Moreover, in anticipation of finalizing the merger, the company has already raised almost $6 billion in long-term financing, including $1.9 billion raised through equity issuance and $4.2 billion through senior note issuance. If the company’s merger efforts are not successful, Exelon will face earnings dilution from the financing. Also, capital allocations have now become a key question for the company. I think if the merger does not materialize, the company can opt to allocate $3-$4 billion for share buybacks. Therefore, going forward, the company has to make important decisions regarding wealth maximization for its shareholders, therefore, I recommend investors to keep an eye on the management’s future decisions, which could have a notable impact on Exelon’s stock price. Separately, the company has to make another important decision, whether it will continue to operate its nuclear power plants or close them. Electricity generation by Exelon’s nuclear power plant has been uneconomical because of cheap natural gas and coal. The company spends nearly $1 billion per annum on its nuclear plants to keep them operational reliably and safely. In my opinion, if the proposed merger is not completed, the company should continue to look for other options to expand its regulated operations, as regulated operations will augur well for its earnings stability and risk profile. Summation The company’s management seems committed to appealing against the PSC judgment. The company’s management continues to consider the Pepco merger as key in achieving Exelon’s goal of re-balancing its asset portfolio away from volatile unregulated business, with weak growth outlook, towards a more stable and growing regulated operations. However, the recent PSC decision to reject the proposed merger has adversely affected the company’s plans to grow its regulated operations and will weigh on its future earnings growth and stability. If the merger deal does not close, the company has to make an important decision regarding capital deployment and its future growth will be negatively affected. Also, the company’s risk profile has increased. Therefore, I recommend investors to stay on the sidelines and wait for clarity on the matter. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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.

Cleco Merger Arbitrage Offers Low-Risk 13% Annualized Return

Summary Investors can earn a low-risk 13% annualized return by purchasing the stock at today’s price and waiting for the transaction to close. Mr. Market doesn’t appear to be properly accounting for the merger agreement, which calls for CNL to continue to pay its sizable dividend while shareholders wait for closing. CNL shareholders have already voted on and approved the transaction by a wide margin. Anyone who follows our work knows our typical modus operandi focuses on finding undervalued contrarian investments that offer asymmetric risk/reward opportunities. While we firmly plan to “stick to our knitting,” we occasionally look to supplement our returns with low-risk, high-return (relatively speaking) merger arbitrage opportunities. As Warren Buffett once said: “Give a man a fish, and you feed him for a day. Teach him how to arbitrage and you feed him forever.” We see a compelling risk/reward profile for a merger arbitrage trade of Cleco Inc. (NYSE: CNL ). We believe an investor can earn a low-risk 13% annualized return by purchasing the stock at today’s price and waiting for the transaction to close. Our analysis suggests there is a low probability of the deal not consummating. This outsized return opportunity exists because Mr. Market does not appear to be properly accounting for the merger agreement, which calls for CNL to continue to pay its sizable dividend while shareholders wait for the deal to close. Company overview Cleco Corporation is a regulated electric utility company headquartered in Pineville, Louisiana. CNL is engaged principally in the generation, transmission, distribution, and sale of electricity, primarily in Louisiana. Cleco Power owns 11 generating units with a total nameplate capacity of 3,340 megawatts. Cleco Power serves approximately 286,000 customers in Louisiana through its retail business, and it supplies wholesale power in Louisiana and Mississippi. The Deal On October 20, 2014, CNL announced that it had entered into an agreement to be acquired by an investor group led by Macquarie Infrastructure and Real Assets, British Columbia Investment Management Corporation, and John Hancock Financial. Under the terms of the definitive merger agreement , the investor group will acquire all outstanding shares of CNL for $55.37 per share in cash. The merger agreement also calls for CNL shareholders to continue to receive the sizeable dividend payments until the deal closes. CNL pays a quarterly dividend of $0.40 per share, which equates to a 3.00% yield based on today’s closing price. 10/20/2014 merger press release: “Prior to closing, the transaction is expected to have no impact on Cleco’s dividend. Cleco shareholders will continue to receive dividends at an annualized rate of $1.60 per share until closing.” The Payout We believe an investor can earn a 13% annualized return by purchasing the stock at today’s price and waiting for the transaction to close. With the stock currently trading at $53.70, the relatively large deal spread combined with an attractive dividend payout presents a compelling risk/reward opportunity for a merger arbitrage trade. This outsized return opportunity exists because Mr. Market does not appear to be properly accounting for the merger agreement, which calls for CNL to continue to pay its sizable dividend while shareholders wait for the deal to close. The table below shows that CNL will pay a dividend in August and November if the transaction has not closed by then. The column titled “Total Profit” shows the cumulative profit that will accrue to an investor under the different closing dates. Our estimated annualized return is based on our expectation that the transaction will close by the end of August 2015. We think this is a reasonable estimate based on our research (details below). Keep in mind that the longer the deal takes to close, the lower the annualized return will be because of the time component of the calculation. Low-risk Transaction We believe the CNL transaction has a high probability of closing for the following reasons: – Modest deal size, all cash deal: This transaction is of average size and it calls for the Investor Group to pay CNL shareholders in cash. Given today’s accommodative lending environment, we believe the Investor Group will easily be able to raise the necessary funds. – Shareholder support: CNL shareholders have already voted on and approved the transaction by a wide margin. The merger proposal passed with more than 94% of the votes cast. – Termination fee: The merger agreement calls for the Investor Group to pay CNL $180m if they fail to close the transaction. – Fair valuation for the deal: Regulated utility assets are attractive in a world with extremely low interest rates. Furthermore, M&A activity has led to regulated utility assets becoming increasingly scarce. We analyzed the CNL transaction versus recent comparable deals and found the valuation multiples to be consistent with what investors have been willing to pay for similar assets. (click to enlarge) Source: FactSet Should the deal fail to close, we believe CNL could be sold to a different party for a similar price. This view is based on the recent history of CNL and how the current merger agreement came about. In June 2014, CNL received an unsolicited bid from the Canadian investment group, Borealis Infrastructure. In response, CNL retained Goldman Sachs to run a formal sale process. At the time, press reports said the company was seeking a deal in the range of $61-62 per share. Our research indicates that four different parties made serious overtures for CNL: Macquarie Group, Iberdrola, Borealis Infrastructure, and CenterPoint Energy. Regulatory Approvals Needed CNL still needs to receive the following regulatory approvals before the transaction can close: 1) Hart-Scott-Rodino Antitrust approval: We view this approval as a formality. The Investor Group acquiring CNL is a financial buyer and has no other competing businesses in the operating footprint. The application has already been filed. 2) Federal Communications Commission approval: We think approval of license transfers is a formality. CNL expects to file the application this quarter. 3) Foreign Investment in the United States approval: We think this approval is a formality. The financial buyers are from Canada and Australia. CNL expects to file the application this quarter. 4) Federal Energy Regulatory Commission approval: We expect a timely approval by FERC given the Commission’s stance on similar M&A transactions over the years. The application has already been filed. 5) Louisiana Public Services Commission approval: We expect this approval to take the longest but we believe the LPSC will grant an approval given the accommodative concessions made by the acquiring Investor Group. These concessions include promises to maintain employment levels and employee compensation, a commitment to appoint individuals from Louisiana to the board of directors, and a vow to remain operated by local management and headquartered in Pineville, Louisiana. The merger application was filed with the LPSC in February with a status hearing last month. We analyzed past utility deals that have occurred in Louisiana and found that historically the LPSC has approved these types of transactions (despite the occasional saber rattling). Perryville Energy Partners LLC, Dolet Hills Power Plant Operations, and Cajun Electric Power Cooperative Inc. are all examples of utility transactions that have been allowed to proceed. Utility Transactions Historically Take ~250 Days to Close We analyzed the group of comparable utility transactions cited above and found that average “days to close” was 258 days. It has been 204 days since the definitive agreement was announced. If the transaction closes at the end of August, like we expect, it will be 314 days, which seems reasonable compared to industry history. (click to enlarge) Source: FactSet Conclusion We see a compelling risk/reward profile for a merger arbitrage trade of CNL. We believe an investor can earn a low-risk 13% annualized return by purchasing the stock at today’s price and waiting for the transaction to close. Our analysis suggests there is a low probability of the deal not consummating. This outsized return opportunity exists because Mr. Market does not appear to be properly accounting for the merger agreement, which calls for CNL to continue to pay its sizable dividend while shareholders wait for the deal to close. Should this transaction fail to close, we don’t think investors would suffer a permanent impairment of capital as CNL could likely sell itself for a similar price to a different party. Disclosure: The author is long CNL. (More…) 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. Additional disclosure: The author and/or employer may buy or sell shares in any company mentioned, at any time, without notice. The information contained herein is believed to be accurate as of the posting date. Readers should conduct their own verification of any information or analyses contained in this report. The author undertakes no obligation to update this report based on any future events or information. This article represents best efforts to convey a fact-based opinion. Our conclusions may be incorrect. This is not a recommendation to buy or sell any securities. This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein or of any of the affiliates of the Author.