Utilities are in great shape, and there's a flurry of merger activity going on…but not all mergers are the same, warns Roger Conrad of Utility Forecaster.



America’s essential-service infrastructure will need trillions of dollars in new investment over the next decade.



Companies that earn a fair return will reliably build wealth for investors. Those that can’t will be graveyards of capital.



Since the historic post-deregulation crackup of 2001 and 2002, regulators have generally been willing to allow a fair return on utility capital spending. The happy result of this era of good feelings: Utilities are at their healthiest since 1989.



Relations still look solid in most states. But with unemployment high, utility bashing is becoming all too tempting for many politicians. Pressures will only rise as capital spending increases.



Mergers are a great way out for companies and shareholders. In a century-plus, not one combination of utilities has failed to eventually produce a stronger company.



No merger between essential-service companies is ever a sure thing. Companies must secure shareholders’ approval and jump through local, state and, federal regulatory hoops. But the time needed often creates opportunities to bet on the success of deals in progress.



When the offer is all cash, the return is the difference between entry price and the bid price—the premium—plus the yield. In a deal involving stock, it’s that premium and yield, plus or minus whatever happens to the share price of the acquirer.



Returns on the first variety are basically fixed but safe, so long as the deal is consummated. Returns on the second are variable, but can ultimately be far more lucrative—particularly in the longer term.



Three deals in particular offer strong, high-percentage bets…



Buying AT&T (T) is the best bet on the success of its proposed purchase of T-Mobile USA from owner Deutsche Telekom (DTEGY), which I rate a sell.



The Federal Communications Commission (FCC) and DoJ won’t rule on the deal until spring 2012, and conditions on a still-likely approval are unknown. But the company is a winner in rapidly growing US communications no matter what happens.



  • Buy AT&T up to $33.
Constellation Energy Group (CEG) trades at a 5% discount to the current value of Exelon Corp’s (EXC) takeover offer. And shareholders’ dividends will more than double when the deal closes, which the companies expect in the first quarter of 2012.



  • That’s enough to rate Constellation a buy up to $37.
Even better, Exelon isn’t at risk to deal failure, should Maryland or any other regulator kill it. The stock also trades at a discount, due to a forecast drop in earnings that would occur in 2012 and/or 2013 without a deal.



Adding Constellation’s assets and expertise in unregulated retail energy markets will alleviate the near-term crunch with new growth and cost-cutting opportunities. Meanwhile, added nuclear capacity provides strong leverage to an eventual power price recovery.



  • Still yielding over 5%, Exelon Corp is a buy up to $50.
The value of the deal between Progress Energy (PGN) and its would-be acquirer Duke Energy (DUK) rose again last month.



Duke boosted its dividend to a quarterly rate of 25 cents, and the US Supreme Court dismissed a long-standing case against it and other big utilities. In addition, regulatory approval in North Carolina advanced, as a leading co-op and the state’s two municipal power agencies agreed not to oppose.



Every $1 move in Duke’s price increases Progress’ takeover value by about $2.61 per share. The same leverage applies to the recent dividend increase.



  • Buy Duke up to $19 and Progress below $47.
Subscribe to Utility Forecaster here…



Related Reading:






Filed Under: ,
Tickers in this Article: CEG, DTEGY, DUK, ETP, EXC, PGN, SUG

comments powered by Disqus

Trading Center