When Hydro One announced a $4.4-billion bid for Washington-based Avista this month, chief executive Mayo Schmidt said that in scouting for a deal, the Toronto-based company found there are roughly 40 U.S. utilities that qualify as takeover targets in the consolidating sector.
There may soon be one less name on that list.
Shares in Indiana-based electric and natural gas utility Vectren Corp. soared 8 per cent Tuesday on reports that larger rivals, including leading Canadian players, are stalking the company. With a $5.5-billion (U.S.) market capitalization and a portfolio of wires, power plants and pipelines that serve a million customers in the U.S. Midwest, Vectren qualifies as a tasty meal for North America's major utilities, all of whom have become obsessed with bulking up.
"There are a number of mid/large cap utilities that could be considered strategic buyers [for Vectren], a number of which are in the surrounding area, along with likely interest from the Canadians," said a report published Wednesday by Wells Fargo senior analyst Sarah Akers. A spokesperson for Vectren declined to comment on takeover speculation, which was kicked off by a Bloomberg report that the company hired financial advisers after receiving an unsolicited offer.
A long and growing list of domestic heavyweights – including TransCanada, Enbridge, Emera, Fortis and AltaGas – recently made significant U.S. acquisitions. PricewaterhouseCoopers LLP counted $170-billion (Canadian) of utility and power company deals with Canadian content in the past 18 months.
While some domestic companies, such as Hydro One, need time to digest what they've acquired before stepping up for another takeover, others remain hungry. PwC Canada power and utilities deals leader Ken Goodwin said: "Following multiple blockbuster deals in 2016, Canadian players continue to look for cross-border growth."
The attraction of mid-sized U.S. utilities such as Vectren starts with what Ms. Ackers called a "constructive regulatory environment." That's how analysts flag the fact that a utility can consistently push through rate hikes without drawing the wrath of regulators. As a general rule, U.S. utilities are finding it easier than Canadian rivals to earn strong returns on their capital by both building out their operations and jacking up rates.
Vectren, a company with 5,600 employees that was created from a series of regional mergers, is expanding its electrical grid and pipeline networks, which cover Indiana and Ohio. Profit in the first six months of 2017 was up 15 per cent from the same period in the previous year.
The other advantage Canadian companies are exploiting when shopping south of the border is a supportive credit market. Again, as a general rule, large domestic utilities can strap on more debt, at relatively low interest rates, than similar-sized U.S. rivals, while maintaining investment-grade credit ratings.
When takeovers become commonplace in a consolidating sector, history has shown that buyers start overpaying for businesses, and come to regret top-of-the-market deals. There are certainly signs that valuations are getting frothy in the normally staid world of utilities.
Earlier this week we saw Warren Buffett's Berkshire Hathaway, a company known for its discipline on deals, drop a $9-billion (U.S.) bid for Texas utility Oncor after being topped by a $9.45-billion offer from California-based Sempra Energy. PwC's data show that in 2014, electrical utilities were acquired at a multiple of 10 times their earnings before interest, taxes, depreciation and amortization (EBITDA), while recent deals played out at 11.4 times EBITDA. The multiple on takeovers of gas utilities rose from 12 times EBITDA three years ago to 13.2 times in deals announced this year.
However, we only tend to recognize the booms after things go bust. Right now, the path to success in the utility space is to build scale through acquisitions, and Canadian companies are leading proponents of this strategy. Vectren is the latest target, and unlikely to be the last.