IFRS Vs. U.S. GAAP In Utility Analysis And The UIL Merger
Summary Iberdrola USA filed an S-4 with the SEC related to its acquisition of UIL. Previously, IUSA financials were based on IFRS, but the S-4 used US GAAP. This creates a unique opportunity to examine how accounting standards impact utility results. Accounting issues appear to make a noticeable difference when comparing US and international utility companies. IUSA’s income under US GAAP was $20M lower than under IFRS; don’t be surprised if guidance for the combined company is eventually lowered. Iberdrola USA’s ( IUSA ) purchase of UIL Holdings (NYSE: UIL ) was announced back in February. The parties have been progressing through the various requirements to complete the merger, and they are still on track to complete it by the end of the year. IUSA’s financials were previously done under IFRS , because it was a fully-owned subsidiary of Spanish utility Iberdrola S.A. ( OTCPK:IBDSF ). After the completion of the merger, the combined company will be publicly traded on the NYSE, and will be required to provide financials under US GAAP. In the recently filed S-4, IUSA restated its 2014 financials using US GAAP , providing a unique opportunity for investors to see how accounting standards impact utility results. This article provides a side-to-side comparison of the two financial statements under the two standards. This information should be particularly useful when comparing American utilities to those elsewhere in the world. These issues should also be in investors’ minds when comparing utility ETFs like the Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) that are US focused to ones with a bigger international component, like the iShares Global Utilities ETF (NYSEARCA: JXI ). Balance Sheet Assets The first thing that jumps out when reviewing IUSA’s assets on the balance sheet is that the two methods come up with different values for cash. Now, you would think cash is cash, but somehow the accountants have come up with a way to make it different, with US GAAP showing $18M more in cash than IFRS. Another noticeable difference between the two methods is that no deferred tax assets show up in the US GAAP books. These assets have not disappeared, but they have just been netted against the deferred tax liabilities on the other side of the balance sheet. The US GAAP books show almost $900M more in total assets than the IFRS books, but since the deferred tax assets have just been moved to offset the liabilities, the “real” difference between the two methods is closer to $3.3B. The biggest driver of this difference is regulatory assets. IFRS actually does not allow companies to put regulatory assets or liabilities on the balance sheet, but US GAAP does. This is really a big deal for utilities, which have constant dealings with regulatory authorities. While regulators do sometimes change their minds, if a state public service commission says that a utility can collect $100M from customers to cover certain costs, it is very likely the utility can expect to get that money. IUSA has almost $2.5B in current and non-current regulatory assets. These represent promises from regulators that IUSA should expect to receive. These promises will be an asset that helps support the business going forward, and should be recognized on the balance sheet. Balance Sheet Equity and Liabilities (click to enlarge) IUSA’s equity under US GAAP was $1.9B higher than under IFRS. A big reason for higher equity was from regulatory assets and liabilities. There are almost $1.4B of current and non-current regulatory liabilities which partially offset the $2.5B of regulatory assets discussed earlier. Another driver for the increased equity is a decrease in environmental remediation costs and in asset retirement obligations. These items were included in the “other provisions” line under IFRS. Note 18 of the IFRS books shows an $845M liability between these two items while it is only $518M in US GAAP. IFRS requires the use of the midpoint of a range of estimates if no best estimate is available. US GAAP uses the low end of the range. So it seems likely that IUSA is at risk to higher environmental costs than are shown in the latest balance sheet. Deferred income also contributed to the change in equity, with US GAAP showing a $300M smaller liability than IFRS. Another area that is important to understand with IUSA is the special financing it has used for its wind projects. Under IFRS, these are “Capital Instruments with Debt-Like Characteristics” and have a balance of $344M. US GAAP calls them “tax equity financing arrangements”, and has a current balance of $124M, and a non-current balance of $277M. These are very complicated instruments where investors contribute money to IUSA’s wind projects, and are paid back with cash and tax benefits. At first, these investors may receive the majority of a project’s returns, but over time the majority shifts back to IUSA. There is also an interest component to these payments, but how much of the payment should be allocated to interest vs. repayment of principal, or another category, is difficult to determine. This difficulty is likely part of the reason there is a current liability for this category under US GAAP, but there is only a noncurrent liability under IFRS. It is interesting to see that US GAAP seems to think that it is a bigger liability than IFRS, though both methods say they should not be considered “true” debt. However, while it may not be “true” debt under either method, it is still similar and it is significant. When thinking about IUSA’s debt and interest ratios, these values should be considered in the calculation, but most people likely ignore. Statement of Cash Flows (click to enlarge) The statement of cash flows shows the total change in cash during the year to be the same under both methods. However, some of the cash was categorized differently. As many people know, followers of IFRS have the option to run interest expense through the financing instead of operations, but that was not one of the differences in this instance. One of the big items to stand out is capital expenditures. These are $155M lower under US GAAP, which makes up the majority of the difference under investing activities. It is likely that some of this is differences in how major maintenance spending is capitalized. IUSA also has some investments that were proportionally consolidated on a 50% basis under IFRS, while it received equity method treatment under US GAAP. It is possible CAPEX at the proportionally consolidated subsidiary disappeared using the equity method in US GAAP. Under operations, depreciation and amortization was almost $100M higher under IFRS. This would likely be consistent with the CAPEX numbers discussed in the investments section. If more expenses were capitalized, it would make the IFRS PP&E higher (and it was $300M higher on the balance sheet), and therefore depreciation would be higher as well. Regulatory assets and liabilities also played a big role in cash flow from operations. Under financing, the “Changes in borrowings from affiliates” line item disappears under US GAAP. It seems likely that some of this was netted against “repayment of long-term debt and related interest” under US GAAP, but this would seem to be important information that investors would want to know about. Another item of note is that the Aeolus debt and the tax equity financing are basically the same thing, but there is a slight difference in the value recorded. This slight difference is probably reasonable considering the difference discussed earlier on the balance sheet. Income Statement (click to enlarge) IUSA’s net income was $22M lower in 2014 under US GAAP than under IFRS. This seems consistent with what we’ve seen on the other financial statements. Moving spending from capital to expenses would lower income. Including regulatory assets in the financials would lower income as well. Under IFRS, the cash recovery of these regulatory assets would likely go to income while under US GAAP the incoming cash would match up against a decrease in the regulatory asset account. Implications for UIL/IUSA Merger Assuming the merger is completed, this analysis implies that there is a risk that the new company will reduce its combined guidance. According to last month’s S-4 filing, the IUSA forecast used in evaluating the merger was based on the IFRS $446M of net income in 2014. With the biases discussed in this article, it seems like IUSA’s starting point was actually too high, and it makes sense that these biases would have continued in its forecasts. It might be appropriate to reduce the combined 2016 forecast of $700-730M to $680-710M based on these factors. When analyzing the new entity with other metrics, like EBITDA, this accounting review shows that there are a lot of uncertainties created by its tax equity financing arrangements. How much of the payments to these other entities should count as interest and how much as a reduction of the outstanding balance? Should these be considered debt? If the accounting standards cannot agree on how this should be handled, how can investors be consistent when they are comparing different companies on these metrics? While there are no clear answers to these questions, investors cannot forget these issues when analyzing the company. Implications of Analysis of International Utilities This article also shows that the different accounting methods can create significantly different results, with IUSA having a 5% reduction in earnings under US GAAP. Investors should think about this when comparing US utilities to those elsewhere around the world. The different treatment of CAPEX, and especially regulatory assets, would seem to create a bias that would increase international utilities’ earnings vs. the US’s. Obviously each case is different, and there are potential factors that could move results the other direction, but this example should be a wake-up call to US investors considering international utilities. 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. 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.