Each year around this time we take the opportunity to review the transactions and other significant industry developments over the past year and offer our views on what they may mean for the coming year.
Mergers and acquisitions activity in the energy industry during 2015 was, to say the least, robust. The low interest rate environment and favorable economic conditions that contributed to record deal volume in 2014 persisted into 2015. With the tailwind of economic conditions and interest rates, total transaction volume exceeded the all-time high watermark of $184 billion established in 2014 by almost $20 billion. By the end of 2015, approximately $202 billion of transactions had been announced. 2016 also is off to a fast start with roughly $20 billion of transactions announced in the first 6 weeks of the year.
More than half the 2015 activity involved pipelines, midstream companies and MLPs. In that sector, deal volume maintained its robust activity, increasing slightly in 2015 to $133.3 billion as compared to 130.8 billion for 2014. Transactions among regulated electric utilities notched a similarly modest increase, from roughly $30 billion in 2014 to almost $34 billion in 2015. Among LDCs, volume shot up from $3.4 billion to over $18 billion, driven by transactions involving AGL Resources and Piedmont Natural Gas Company. The value of transactions involving electric generation assets decreased, from $12.3 billion to $8.1 billion, while the value of transactions involving renewable generation assets increased to $8.5 billion in 2015 as compared to $7.5 billion in 2014. We offer additional commentary about key transactions and the general trends that we see in each of these subsectors below.
Among regulated companies, the headline for 2015 was the premiums achieved by sellers. As the chart attached as Exhibit A shows, since 2013 premiums in regulated transactions have been rising, reaching unprecedented levels in 2015. During 2013 and 2014, premiums to market price prior to announcement tended to be in the range of the 15% to 21% (the UNS/Fortis transaction being the one exception). Valuations as a multiple of next twelve months earnings ranged from 15.9x to 22.4x. All of the transactions announced in 2015 exceeded these levels by almost every measure. The UIL transaction was at the low end of the range with a premium to market (as estimated by the companies) of 24.6% and a forward multiple of 21.6 times the next year’s earnings. AGL, TECO and Piedmont all achieved higher valuations, with Piedmont in particular establishing a 40% premium to market and a forward multiple of 30.9x. As Exhibit A shows, over the past three years, transactions have been about evenly split between competitive bidding and bilateral negotiations. Some might ask whether the nature of the process, competitive bidding versus bilateral negotiations, has an impact on acquisition price. On average, it does appear that higher valuations have been achieved in competitive processes, although substantial premiums have been achieved in bilateral negotiations too. The two transactions that achieved the highest multiples – Piedmont/Duke and TECO/Emera were both competitive processes, but the highest premium to market on the chart was the AGL/Southern transaction at 48%, which was a bilateral negotiation.
Another trend worth commenting on is the appearance of reverse break-up fees in transactions involving regulated companies. These provisions require the buyer to pay a fee to the seller in the event the transaction does not close for specified reasons, typically either a financing failure or a failure to obtain required regulatory approvals. Reverse break-up fees have been common for some time in transactions in other industries. Initially, these provisions were used to provide private equity buyers with a way to get out of a transaction if for some reason their financing was not available when it came time to close. The mechanism spread to transactions involving strategic buyers, where a buyer would be required to pay the fee if it did not obtain the necessary anti-trust clearance for the transaction. Since these fees are generally at least 3%, and often more than 5%, of the equity value, a reverse break-up fee creates a strong incentive for a buyer to work hard to obtain antitrust and other regulatory clearances for the transaction.
Until recently, reverse break-up fees were seen in energy and utility transactions only in competitive bidding situations where a buyer intended to obtain financing for the transaction. The reverse break-up fee typically would be triggered only in the event of a financing failure. Over the past two years, reverse break-up fees have become common in transactions involving regulated companies, beginning with the Pepco/Exelon transaction. In that instance, the reverse break-up fee was structured as a mandatory purchase by Exelon of a block of preferred stock that is redeemable by Pepco at its original purchase price in the event regulatory approval is obtained, and for no consideration if all regulatory approvals are not obtained. Since then, the WEC/Intergrys, Cleco/Macquarie/BCIMC, HEI/NextEra, TECO/Emera and Piedmont/Duke transactions have all included some form of reverse break-up fee. Fees have ranged in size from a low of 2.60% of equity value in the Pepco/Exelon deal to a high of 5.35% in the TECO/Emera transaction. Exhibit A provides more detail regarding the size of these fees and how they compare to the primary break-up fee for the target company.
There are many factors that favor continued consolidation among electric, gas and power companies in the United States, just as there have been for many years. Scale and diversity are as important as ever. The US energy industry is going through a period of significant change, with many companies facing unprecedented capital expenditures. Much of our national energy infrastructure is in the process of being rebuilt. Energy policy and consumer preference are driving a massive shift away from fossil fuels toward renewable resources. In many instances new renewable generation requires substantial investments in new high-voltage transmission lines to get the power to load centers. At the distribution level for regulated utilities, both electric and gas companies are in the process of replacing and upgrading much of their local infrastructure to improve both safety and reliability. Finally, the precipitous drop in oil and gas prices over the past two years is disrupting all aspects of energy supply, in the U.S. and around the world. Larger companies are generally better positioned to withstand the panoply of risks they face, whether they be from weather, commodity cost volatility, regulatory factors or local economic cycles. A favorable economic environment and the continuation of historically low interest rates provided a tail wind for transactions during the past two years. Finally, the higher growth rates, lower levels of volatility in earnings of LDCs compared to regulated electric operations and the increased scarcity of pure play regulated gas companies has driven an unprecedented level of interest in LDCs.
Looking forward, we expect consolidation to continue, most likely episodically and with levels of activity that vary dramatically among industry sectors. Among regulated companies, it is difficult to see how the level of activity over the past couple of years can continue. There are indications that increasing interest rates and higher levels of regulatory scrutiny may create at least modest headwinds for additional deals. We expect the strong demand for gas distribution companies to continue, but there are only a limited number of such companies, and an even smaller number that are interested in pursuing a transaction. Consequently, we see the level of activity among regulated companies in 2016 as likely to decrease from 2015 levels. Renewable assets continue to generate strong interest among YieldCos, strategic buyers and private equity, as a result of which we expect 2016 to continue the relatively high level of activity in renewables M&A. Indications are that activity will continue in the generation sector at levels similar to previous years, particularly as regards gas-fired generation. There are several sale processes underway or being considered and the demand for good quality assets appears strong. In the oil and gas sector, M&A activity in 2016 will likely be driven by the intense financial stress that many oil and gas companies are under. There have been expectations for some time of a distress driven wave of M&A in the sector. Perhaps 2016 will be the year it comes about.
The discussion below covers the following areas:
- Regulated Utilities
- Power Companies and Generation Assets
- Master Limited Partnerships
- LNG Developments
- Project Finance
- Bankruptcy Developments in the Energy Sector
- Environmental Regulation
- Mexico Implementation of New Wholesale Power Markets
- Distributed Generation
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