PURA’s New Draft Decision In The UIL/Iberdrola USA Merger
Summary Last summer, Connecticut regulators ruled against the proposed merger of UIL and Iberdrola USA. The merging parties submitted a new application, and later reached a settlement with intervenors. On November 24, PURA released its draft decision approving the merger. With only a few requirements left, the merger could be completed by the end of the year. Investors now need to think about the value of the new combined company. Investors relying on the February merger announcement presentation in its valuation analysis are likely using stale data. Iberdrola USA’s ( OTCPK:IBDRY ) ( OTCPK:IBDSF ) proposed acquisition of UIL Holdings (NYSE: UIL ) passed a major milestone when Connecticut’s Public Utility Regulatory Authority (PURA) issued a draft decision approving the merger on November 24. This was a big change in tune compared to its previous draft decision rejecting the merger back in July. (An article discussing the rejection can be found here ). At that time, PURA was not convinced the deal was in the public interest, as clearly shown from this excerpt from the original draft decision: The Applicants have not provided any measurable or quantifiable commitments that unequivocally assure the Authority that the public interest of the ratepayers will not be harmed. A new merger application was filed on July 31, and UIL addressed many of PURA’s issues with the original application. (Article discussing the updated application is here ). In September, the merging parties were able to reach a settlement agreement with the Office of Consumer Counsel. The settlement addressed items like ring fencing, rate freezes, and goals for customer service improvements. Another part of the settlement involved UIL’s former English Station power plant. This plant had been retired and sold years ago, and there was a dispute over environmental cleanup costs. UIL agreed to pay up to $30M to clean up the site. All briefs filed by intervenors since the settlement have basically supported the merger, so it is unlikely that the draft decision will face opposition. PURA plans to issue a final decision on December 9. The merger also requires approval from the Massachusetts Department of Public Utilities. Massachusetts doesn’t have the same statutory timeline requirements as Connecticut, so there is not a definitive date to expect a decision. A settlement agreement has already been reached with the Massachusetts Attorney General and the Department of Energy Resources, so UIL has requested for the DPU to issue a decision by December 18. UIL feels it is almost done with receiving approval from the SEC. It filed its second amendment to its S-4 filing in October. The company has not received comments from the SEC on the second amendment, but it said the SEC comments about the first amendment were relatively minor, so it is unlikely there would be any SEC concerns that would cause a roadblock to the merger. With the regulatory approvals essentially completed, the final requirement to get the merger done is to receive shareholder approval. A vote has been scheduled for December 11. Assuming the merger passes these final hurdles, the merger will be completed, creating a new company by the name of Avangrid, ticker AGR. Now that it looks like the merger will happen, UIL’s shareholders need to seriously think about how to value the company’s shares. A couple of important items come to mind. First off, each UIL share will receive $10.50 in cash. In some ways, shareholders would probably prefer a slight delay in completion of the merger until January so that they don’t have to pay the taxes on this payment until they file their taxes for 2016. When the merger was announced in February, the companies estimated 2016 earnings at $700-730M and 2017 earnings at $800-850M. One thing to remember is that IUSA was using IFRS accounting before the merger. UIL and the new AGR will be using the US GAAP going forward. These accounting choices impact the results in the financial statements (see more on the accounting impact here ), and the February estimates were made before the differences were quantified. It turns out that IUSA’s 2014 income was $20M lower under US GAAP than under IFRS. This means there is a risk the 2016 estimate is too high. Also, UIL has made more spending commitments as it has negotiated with the regulators, which could also be a drag on future earnings. Of course, after the companies combine, they could discover more cost savings opportunities, which would lift future earnings higher. Another point to keep in mind is that utility valuations have fallen since February. In the original merger presentation the P/E of the combined company’s utility peers was 17.5x in 2016. Today, the average of this group is 16.5x. Table 1 (click to enlarge) Source: FactSet, UIL February merger presentation , and Garnet Research, LLC In February, based on the midpoint of the earnings guidance provided, UIL’s shareholders would be receiving compensation of almost $51/share based on 2016 multiples or $54.50/share based on 2017 multiples. The value based on current 2016 multiples drops about $2.40/share compared to February, and current 2017 multiples give a value about $2.80 below February. UIL’s stock price has been in the low-$50s/high-$40s range for a few months, and it is very possible people are zeroing in on the old numbers from the February presentation that are starting to get stale. Conclusion The current regulatory situation suggests that the UIL/IUSA merger creating Avangrid will be completed in the next few weeks with little controversy. Investors now have to focus on the outlook for the combined company, but it is likely many have been depending on information from the February merger presentation. This information is getting a little stale, with a number of new data points suggesting that investors should be using lower values. 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.