10 Tempting
Takeovers
by Roger Conrad, editor, Utility Forecaster
The
WorldCom/Sprint merger is toast. But utility merger mania is
alive and well.
With 140 major resource
companies, three dozen communications firms and 50,000 water
systems in the U.S. alone, there are plenty more targets. And
with European utilities on a shopping spree, there's no shortage
of suitors. Already, $200 billion in new unions were announced
in 2000.
There are two ways
to play continuing utility merger mania: Buying likely candidates
and betting on the success of mergers in progress.
All of the companies
profiled below are solid and most are suitable for even conservative
investors.
Likely Targets
Picking
a utility takeover target depends on correctly anticipating what
a would-be suitor wants. A great company can go begging for years,
while a basketcase can fetch a high merger premium if it fits
in with someone else's master plan.
Happily, Allegheny
Energy (AYE $29.31, Yield: 5.9%) is a great company with
an asset everyone wants: 6,000 megawatts of low-cost, unregulated
generating capacity.
Under deals worked
out with regulators in Maryland, Ohio, Pennsylvania and West
Virginia, the utility is free to sell the output from its coal-fired
plants at market prices. Even factoring in clean air costs, these
plants generate some of the cheapest power on the market. That
spells big profits from power sales.
With a four-state electricity
and gas distribution network, a stake in a major nationwide fiber
optic network and selling at barely 10 times expected 2000 profits,
the stock is a steal. Buy Allegheny Energy up to 32.
New York's EnergyEast
(NEG $19.31, Yield: 4.6%) is attractive for a different reason.
After completing a series of mergers with our New England-based
utes and the sale of its power plants later this year, it will
control "wires and pipes" serving 2 million customers
with no competition or fuel cost risk.
Despite these strengths,
the stock remains dirt cheap, trading at just 9 times 2000 estimates
and 1.34 times book value. That makes it doubly attractive to
would-be suitors like Britain's National Grid, which purchased
wires and pipes company New England Electric for a hefty
premium last year. EnergyEast is a buy up to 28.
Florida-based Core
Holding TECO Energy (TE $21.38, Yield: 6.3%) features
a unique combination of low-cost clean coal plants and low sulfur
coal mines to feed them. The company's primary attraction to
acquirers, however, is its statewide gas and electric distribution
system, which would provide instant inroads throughout the sunshine
state's high growth energy market.
A perpetual bridesmaid,
the stock fell last year in the wake of a now-settled environmental
dispute, and many have given up waiting for a marriage to happen.
But trading at just 1.9 times book value and yielding over
6 percent, there's little risk to buying TECO Energy up to 24
and hanging around for the inevitable wedding.
Crippling
rate cuts in their own markets have sent European water utilities
scurrying to buy U.S. utes to make up the lost revenue. Already
bid up Connecticut Water will almost certainly be one
of the next to go. A cheaper, but equally sure pick, is California
Water (CWT $24.75, Yield: 4.4%).
By completing its merger
with Dominguez Water, Cal Water has basically published
a blueprint for its own profitable buyout. Bids could come from
overseas or from U.S.-based American Water Works, which
will own a sizable chunk of the company as the result of its
pending merger with SJW Water. Cal Water is a value
up to 32, its most recent high.
Like a first-time fisherman,
Deutsche Telekom's crashing around to catch a U.S. telecom
prize has muddied the waters for other mergers. One exception
is Global Crossing (GBLX $32.19), which has stayed in
clear waters so far, despite attracting considerable attention
as a target last year.
From its roots as a
builder of undersea cable routes, the company now boasts a full
range of advanced network services, dramatically enhanced by
last year's buyout of Frontier Corp.
The planned sale of
its 1.1 million consumer local phone lines to Citizens Utilities
for $3.65 billion later this year will further focus the company
on the profitable business market, making it more attractive
to a host of acquirers. And given its relatively small size,
it's one of a shrinking handful of telecoms that can count on
painless regulatory approval for a merger.
The company is still
running up a fair amount of red ink, largely due to expansion
costs. But aggressive investors will find few better takeover
bets than Global Crossing up to 40.
High-Percentage Plays
With
21 of 22 deals winning regulatory approval this year, banking
on the success of utility mergers is still one of the highest
percentage plays on the market. The five below will prove no
different.
Added to the Income
Portfolio last month, Columbia Energy's (CG $68.31, Yield:
1.3%) planned merger with NiSource has won all nine needed state
regulatory approvals, securing the go-ahead in Pennsylvania and
Virginia last month. With a fall completion likely for the merger,
the stock has rallied closer to the deal's locked-in takeover
value of between $72.60 and $74 per share. Buy Columbia
on dips to 66.
Maine-based Bangor
Hydro (BGR $23.56, Yield: 3.5%), which is being bought by
Canada's Emera, is cheaper relative to its takeover value.
So is Indian-based Ipalco Enterprises (IPL $21.50, Yield:
3.0%), which is merging with Core Holding AES Corp. Both
mergers require regulatory review in only one state and will
likely sail through federal approvals as well, given the acquired
companies' small sizes. I expect both mergers to be completed
by early next year.
Both Emera's all-cash
$26.50 per share offer for Bangor and AES' all-stock $25 offer
for Ipalco are fixed. Whether the Dow goes to 5,000 or 15,000,
investors are guaranteed total returns of around 15 percent,
including dividends, as long as the mergers are completed.
A safe enough
play for even the most conservative investors, Bangor is a buy
below 24. Ipalco, which could attract an even higher counterbid,
is a bargain to 22-1/2.
Takeover values of
my other two picks MCN Energy (MCN $21.61, Yield: 4.7%)
and Empire District (EDE $23.94, Yield: 5.3%) depend on
the share price performance of their acquirers, DTE Energy
and UtiliCorp respectively. Adverse market conditions
could limit gains, even if the deals win regulatory approval.
Alternatively, profits will soar if the acquirers' stocks do
well. And given the strengths of both DTE and UtiliCorp, that's
likely.
A move by UtiliCorp
to $22 per share would increase Empire's takeover value to $29.50
a share, 23 percent above its current level. DTE's target bid
of $28.50 for MCN contains a fixed cash component that protects
the overall takeover price from fluctuation. But a return to
the upper 30s for DTE stock would push the value of the deal
toward $30.
Both mergers face some
regulatory scrutiny. However, odds are high both deals will be
approved and at higher prices. Both Empire and MCN are
superb choices for more aggressive investors up to 24.
Editor's Note: Roger
Conrad is editor of the Utility Forecaster, 1750 Old Meadow
Road, Suite 301, McLean, VA 22102. 1 year, 12 issues, $129. Utility
Forecaster offers the nation's most in-depth coverage of energy,
communications, water, and foreign-based utilities. Utility Forecaster
was named America's best financial advisory by the Newsletter
Publishers Association in 1996 and 1998.
