Sempra Energy (NYSE:SRE) – market cap as of 16/09/2017: $29.39bn
On August 20, 2017, Sempra Energy announced an agreement to acquire the 80% stake that Energy Future Holdings Corporation holds in Oncor Electric Delivery Company. The deal agreement ends a series of bids from relevant players, with Sempra being the fourth public suitor for Oncor and beating the competition of Warren Buffet’s Berkshire Hathaway.
The transaction, which values Oncor at $18.8bn, is expected to generate relevant synergies, with both companies benefiting from the acquisition. Oncor will contribute to the expansion of Sempra by providing new opportunities in the US energy market, whose power demand is largely flat. The takeover will allow Sempra to exploit cross-selling opportunities in the Texas energy market and to establish it as a platform for expansion into the U.S Gulf Coast Region. On the other hand, Oncor will take advantage of a strengthened capital structure and credit rating. Moreover, Sempra will financially support Oncor’s plan to invest $7.5bn over a 5-year period to reinforce its transmission and distribution network.
About Sempra Energy
Sempra Energy is an energy services holding corporation headquartered in San Diego, California. With more than 16,000 employees and 32m consumers worldwide, Sempra Energy owns several companies involved in developing energy infrastructures, operating utilities and providing related products and services. The company was formed in 1998 as a merge between Pacific Enterprises and Enova Corporation, two established energy companies.
Steered by its Chairman and CEO Debra Reed, Sempra Energy operates two main business segments with a total of six subsidiaries. On one side, Sempra Utilities owns and operates electric gas utilities in the US and South America. On the other, Sempra Infrastructure invests in and develops long-term contracted energy infrastructures in the US and Mexico. Recently, Sempra Energy has disclosed a plan to grow EPS by 10% YoY over the period 2017-2021, thus potentially outperforming the utility sector’s measure which is expected to rise by approximately 6% on a yearly basis. Additionally, the US-based conglomerate has announced it will invest $14.2bn to sustain the growth of its regulated-businesses portfolio as well as to support its expansion in offering innovative services and seizing international opportunities.
In the past 5 years, Sempra Energy doubled its market capitalization, exceeding the $25bn threshold, and delivered substantial value to its shareholders, with a 5-year total shareholder return of 112% compared to 64% of the S&P’s 500 Utilities Index. In February 2017, the BoD approved raising the dividend by 9% to an annualized value of $3.29.
About Oncor Electric Delivery
Headquartered in Dallas, Oncor is a regulated electric distribution and transmission business. It operates the largest distribution and transmission system in Texas, serving more than 10m customers in the region.
Oncor is a financially sound company, with FY2016 profit of $341m and a latest reported ROE of 9.8%. Additionally, as utilities are now wary of their exposure to volatile energy prices, they tend to look for alternatives such as electricity distribution assets which are supported by a growing demographic base and stable cash flows. Therefore, the business model adopted by the company is poised to capitalize on the growing trend in the industry.
Oncor is owned by a limited number of investors (including Energy Future Holdings, with its 80% stake), but effectively managed by its majority independent BoD. Indeed, EFH does not take part in the management of Oncor and, in line with commitments made to the Public Utility Commission of Texas, certain “ring-fencing” mechanisms have been put in place in order to further separate Oncor from its majority shareholder.
About Energy Future Holdings
Energy Future Holdings, Oncor’s leading shareholder, is an electric utility company headquartered in Dallas, Texas. Formerly known as TXU Corporation, in October 2007, the company was acquired by KKR, TPG Capital and the buyout arm of Goldman Sachs. It was the biggest LBO deal ever observed to that date ($45bn).
However, the excessive leverage and the decline natural gas prices led it to bankruptcy (it filed for Ch.11 bankruptcy protection in April 2014). After that, the company has been continuously capturing the attention of several bidders, mainly interested in the strategic location and growing business of Oncor in spite of the parent company’s financial distress.
A main role is now played by Elliot Management (creditor of Energy Future Holdings) steered by famous investor Paul Singer and having a great influence on the decisions of the financially distressed company.
According to the terms of the transaction, Sempra Energy will pay $9.45bn in cash for Oncor, topping the previous $9bn offer by Warren Buffett’s Berkshire Hathaway. Sempra will finance its bid with a combination of debt, newly issued shares, and outside investment.
The implied EV of $18.8bn is c. 9.9x Oncor’s 2018 expected EBITDA and c. 23x the company’s 2018 expected Net Income. Although Sempra is acquiring the whole 80% stake held by Energy Future in Oncor, Sempra also plans to sell some of that equity to other external investors and, in the end, to hold c. 60% of the reorganized entity.
The transaction also stipulates that Oncor’s management and employees will be preserved and that the BoD will increase by one member to 13. Of those, 7 will be independent and all the other “ring-fencing” protections will also remain in place. The transaction, which is expected to be accretive to EPS starting from 2018, still needs governmental approvals and will likely close in H1 2018.
Oncor Electric Delivery has consumed the attention of many companies since its biggest owner filed for bankruptcy in 2014. Finally, after having seen two deals blow up due to regulatory concerns from the Texan authorities and the Buffett proposal battled by EFH’s biggest creditor (the Elliot Management hedge fund), the costly bankruptcy of Energy Future Holdings is nearing its end.
What has pushed Sempra Energy, backed by Elliot Management, into the heart of this complicated and long bankruptcy filing is primarily the possibility to expand its regulated customer base by 10m new customers (Oncor current customers) and, consequently, to boost its profit starting from 2018. Moreover, the deal will allow Sempra to exploit cross-selling opportunities in the Texas energy market and fuel growth into the US Gulf Coast Region.
By looking at the great interest which Oncor has generated in the market a further question comes natural: why is getting into the utility industry so convenient? The short story is that it provides stable cash flows due to its market structure, without the requiring a lot of investments. As a result, is it very likely to achieve reasonable rates of return. In this specific case, what makes it even more appealing is that Oncor is owned by a company which is in financial distress. Hence, the holding company will find itself obliged to sell its crown jewels to pay back creditors, thus allowing bidders to buy at reasonable prices.
Oncor itself will also benefit from the transaction. Not only will its credit rating profile improve, but it will be able to count on Sempra’s financial support in new projects. In fact, Sempra Energy has already announced that it will invest up to $7.5bn in the next five years to further strengthen its distribution and transmission network.
On August 21, 2017, the stock price of Sempra Energy increased by 1.80%, while it is impossible to record any movement in stock price for both Oncor and Energy Future Holdings because they are not listed. In addition, the value of Berkshire Hathaway registered a slight upturn, possibly due to the $270m owed in break-up fees.
Sempra Energy has been advised by Morgan Stanley and Lazard, which has also involved in this transaction its restructuring team. Energy Future Holdings chose Barclays, Evercore Partners and Moelis & Co. to lead the deal.