CenterPoint-Vectren Deal Shows The Allure of Natural Gas

(Bloomberg Gadfly) -- Natural gas is so hot right now.

CenterPoint Energy Inc. announced Monday it will pay about $8.5 billion in cash and assumed debt for Vectren Corp., an electricity and gas utility operating in Indiana and Ohio. If that sounds like a pretty humdrum business, the valuation is anything but: 25 times 2018 earnings. That’s a premium of about 50 percent to the wider market and CenterPoint itself – for a company forecast to post earnings growth this year of all of 0.2 percent.

Vectren makes more than half its earnings from piping gas to homes and businesses. Your eyes may glaze over at the thought of that, but utilities struggling with flat or declining demand for electricity across much of the U.S. love the gas business. Demand there is still growing; lots of old pipes need replacing; and, unlike in the power business, renewable energy and distributed generation such as solar panels aren’t a threat.

That’s why when I say gas is so hot right now, it’s actually been that way for a few years. Giant utilities Duke Energy Corp. and Southern Co. both turned heads – and raised some eyebrows – in 2015 when they announced multi-billion-dollar gas network deals at social-media-like multiples. And when I put together a list of potential acquisition targets in the utility sector in summer 2016, I highlighted the gas-weighted companies as especially attractive. Here’s the chart from back then:

Looking at those darker green, gassy blobs, what’s striking is that most of them are now involved in deals:

  • CenterPoint and Vectren, obviously;
  • Questar Corp. was  bought by Dominion Energy Inc. in September 2016;
  • WGL Holdings Inc. and Avista Corp. are both currently in the process of being acquired.

Chesapeake Utilities Corp. is still unattached, though it’s a pricier proposition these days, with a multiple of 22 earnings. Indeed, looking at the top 10 utilities by forward price/earnings multiple, there’s a preponderance of relatively small-cap companies with significant gas business:

The sight of Vectren getting taken out at 25 times earnings will only serve to entrench those premiums.

As for CenterPoint, while I originally saw it as a potential target, its scale marked it out on my hit-list and it clearly sees itself as predator rather than prey.

Clearly, it’s stretching for this deal given the multiple and the planned $2.5 billion equity raise to help finance the bid. As is often the case with utility deals, the announcement was heavy on promises of strengthening the target’s local presence rather than cost-cutting. CenterPoint’s combined gas business is to be headquartered in Evansville, Indiana, and the conference call providing details is delayed until Tuesday, in part so CenterPoint’s Houston-based CEO can fly up to deliver it from Vectren’s hometown.

Besides the allure of Vectren’s gas-distribution business, buying it should cut the proportion of CenterPoint’s earnings coming from its stake in Enable Midstream Partners LP from about 30 percent to 22 percent, pro forma. CenterPoint has tried, unsuccessfully, to sell its stake in this master limited partnership, and reducing its weighting is one way of addressing the issue.

There’s another gas angle CenterPoint may value. Vectren, like many a Midwestern utility, has long relied on coal-fired power. It’s in the process of closing some of those plants and building gas-fired capacity to take its place. And that means some big spending going into the regulated rate-base of its power business:

With utilities searching for ways to support growth in a flat power market, keeping the investment pipeline full is paramount. Expect their love of gas to keep burning strong.

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

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