When energy firms zig, Duke Energy Corp. usually zags.
Power shopper
by:Claire Poole/The Deal.Com
Last year, when wattage-hungry electricity generators like Mirant Corp. of Atlanta, Calpine Corp. of San Jose, Calif., and NRG Energy Inc. of Minneapolis were buying up power plants at ever-inflated prices, the Charlotte, N.C., energy company was selling, including plants under construction in Oklahoma and Missouri.
And now, while Enron Corp.'s implosion is forcing many power producers to sell assets to shore up their balance sheets, Duke is in the position to buy. It's expected to pick up assets from a variety of power producers — or even pick up one of the power players themselves.
“If they're going to do something significant on the M&A front, this would be the time, given the multiple disparity between their stock and that of their competitors,” says Tim O'Brien, portfolio manager of the Gabelli Utilities Fund in Rye, N.Y. “They can afford to be opportunistic.”
The company's top dealmaker, Buck Gatewood, wasn't available for an interview, but according to analysts and other observers, Duke is in a prime position to clean up in an industry that's fallen on hard times. “Asset prices are low — and it looks like they'll stay low for a while — but not a lot of companies have capital right now,” says Andre Meade, who follows the company for Commerzbank in New York. “So Duke is in good position to buy, either projects here and there or entire companies.”
Still, Duke, which stuck to its asset-heavy strategy when asset-light was cool -- remember Enron? -- is expected to keep its head while examining today's bargains. “We wouldn't be surprised to see Duke taking advantage of its strong balance sheet to pick up some of the multitude of energy assets being sold by its weaker industry peers,” wrote Carol Levenson, the normally critical analyst at bond rating newsletter Gimmecredit.com, in “The Best of a Bad Lot,” a recent report. “[But] we expect as usual it will endeavor to finance such sales in a conservative manner.”
Duke hasn't exactly been a big acquirer over the last few years. It's picked up a few strategic assets, including natural gas storage facilities from NiSource Inc. of Merrillville, Ind., in August 2000 for $250 million plus $150 million in debt. It also bought Gas Supply Resources Inc., a propane wholesaler in New England, in May for an undisclosed amount, and swapped some natural gas assets over the last year with CMS Energy Corp. of Dearborn, Mich., and Williams Cos. of Tulsa, Okla.
The company's reticence to buy changed Sept. 20, when Duke announced it would acquire Canadian natural gas outfit Westcoast Energy Corp. in an $8.5 billion deal. The transaction — $3.5 billion in cash and stock and $5 billion in debt — was big for Duke. Westcoast, based in Vancouver, British Columbia, owns $15 billion worth of assets, including natural gas gathering, processing, transmission, storage and distribution facilities as well as power generation. The purchase dovetailed nicely with Duke CEO Richard Priory's strategy to converge the gas and electricity markets.
Yet the transaction, which Merrill Lynch & Co., Vinson & Elkins llp and Stikeman Elliot advised on, was not investors' favorite deal. The markets hammered Duke's shares the day after the transaction was announced, worried that the acquisition of Westcoast's regulated, slow-growing business would prevent the company from meeting its aggressive growth targets. “Duke has been holding itself out to investors as a new model utility, with 10% to 15% earnings growth,” Gabelli's O'Brien said at the time. “Then they make a $8.5 billion acquisition of high-quality, but slow growth and tightly regulated assets. It will be accretive to earnings, but will have to reduce the company's earnings potential. We expected Duke to do a different kind of acquisition.”
Duke rushed out a statement, saying the deal would achieve cost synergies of $125 million by the fifth year and boost its earnings per share by 4.5 cents in 2002 and 10.4 cents by 2004. The company's executives also argued that its regulated and unregulated businesses would balance each other out. Westcoast shareholders bought it, overwhelmingly approving the acquisition Dec. 13. The Supreme Court of British Columbia cleared it Jan. 10, and the deal is expected to close in the first quarter.
Once the Westcoast deal is complete, Duke is expected to go on the prowl for assets or companies to buy. “They don't need to do another, but they want to do another,” says Gabelli's O'Brien. Targets could include Mirant, which has endured bond rating downgrades and stock selloffs since Enron filed for bankruptcy Dec. 2. It's currently trying to sell $600 million worth of assets to improve its liquidity position, including its two power plants in Massachusetts and its trading and marketing operation in Europe.”An acquisition of Mirant would be very substantially accretive,” O'Brien says. “Cost savings would not be enormous, but there would be synergies which could approach $1 per share,” he notes.
Both companies are also based in the Southeast, which would eliminate some of the cultural differences that have plagued other energy mergers. “There are former Duke people at Mirant and former Mirant people at Duke, so they know each other,” O'Brien says.
Cogentrix Energy Inc. is another possibility. The power producer, owned by North Carolina entrepreneur George Lewis and his family, would make a nice fit with Duke. Besides being based in Duke's hometown of Charlotte, Cogentrix owns 23 plants with 1,753-megawatts of generation capacity, mainly within the U.S., involving an equal mix of coal-fired and gas-fired facilities. It is also constructing six more power plants, which will add 3,800 megawatts of capacity. Five of these are in the U.S. (one each in Oklahoma, Idaho, Louisiana and two in Mississippi) besides one 300-megawatt facility in the Dominican Republic.
There's a broader question of whether Cogentrix is for sale: The company has refused to comment on reports in late October that it had put itself on the block after scrapping plans for an initial public offering, hiring Goldman, Sachs & Co. to advise it. But sources close to the situation say Cogentrix is currently gathering bids with the hope of fetching $2 billion.
Yet another prospect is Oneok Inc., a Tulsa, Okla., explorer, gatherer, processor, transporter, storer, distributor, marketer and trader of natural gas. Its recent stock price was $17.50, giving it a market capitalization of just over $1 billion. A deal that size would add another substantial piece to Duke's power-gas puzzle.
Whatever Duke acquires, it will probably be with a combination of cash and stock. While the company is fairly conservatively leveraged (its debt-to-capital ratio is around 50%), its stock — at $34.50 per share, or 12 times forward earnings — is almost better than cash.
“They've got a premium currency — their stock,” says Gabelli's O'Brien. “To do it with cash would stretch it. They wouldn't want to do anything that would jeopardize their credit rating.”
Expect Duke to scrutinize whatever it considers, and walk away if the price is too steep or the deal too risky. The company has not been afraid to do so in the past. “They've been pretty selective buyers,” Commerzbank's Meade says.
Two examples: In April 1999, the company took itself out of the running for power company Endesa Chile when the bidding became too frenzied. It was ultimately acquired by Chile-based electric conglomerate Enersis, which, in turn, is controlled by Spanish power giant Endesa SA. And in May, Duke also walked away from the auction of Brazilian state-owned electric utility Cesp, which provides power for São Paulo, the country's richest and most populous state.
Duke is still shedding assets. In January, it agreed to sell its Engineering & Services unit to Framatome ANP Inc., a Paris-based nuclear power supplier owned by the Areva Group and Siemens , for an undisclosed amount. (CIBC World Markets Inc. advised Duke.) The deal, which requires Hart-Scott-Rodino clearance, is expected to close next quarter. But soon, Duke will probably become better known for buying than selling. “If you're going to be a vulture investor, this is a good time, because there's a lot of road kill,” O'Brien says. “And being a buyer in a buyer's market is not a bad position to be in.” |
