Buy Small, Win Big


Smaller Utilities for Next Deal

PUF 2.0 - June 15, 2017

You don't need me to make the case for investing in U.S. utilities. The goodness of utilities is well known: good infrastructure business, good regulatory support, good opportunities to expand rate base, and good upside - especially with gas. This is why investors have been snapping up utilities at every opportunity for more than a decade.

Billion-dollar utility deals grab the headlines, such as the AltaGas' purchase of WGL Holdings earlier in 2017 for 8.4 billion dollars. While the case for buying big is relatively easy to make, I believe that investors should continue to look to smaller utilities for their next deal. In my view, these smaller utilities represent great long-term investments and have fewer management challenges for the buyer.

Moreover, there is substantial value to capture. Oliver Wyman estimates that the small utility opportunity is worth about fifteen billion dollars. And it can deliver annual earnings exceeding seven hundred million dollars.

But those that are looking for a deal should consider moving fast. The smaller utility market is shrinking. Various strategic as well as financial investors have gobbled up several small utilities in recent years, such as Delta Natural Gas, Mobile Gas, Gas Natural, and Arkansas Oklahoma Gas.

That said, there are still plenty of opportunities out there for any smart buyer who wants to invest for the long term. And if you need further convincing, here are four reasons why I believe there is still a lot of benefit to thinking small.

More small opportunities: There are still more than a hundred potentially lucrative small utility acquisition opportunities out there. Some are whole companies. Others are unloved or orphaned among larger corporate parents. While still others represent carve outs and unique situations. By comparison, realistically, there are fifteen to twenty-five future mega-deals to be done.

More upside: The bigger and more complex it gets, the harder it is to improve. Our analysis of completed acquisitions over time suggests that smaller takeovers are more likely to yield faster rate base growth and greater improvement in earned return on equity than bigs.

Easier to get approval: The recent approval issues with the NextEra/Oncor and Great Plains/Westar mega-deals continue to highlight challenges. Smaller deals often get through the regulatory approval process quicker with fewer permanent scars.

Fewer negotiation, social, and management team issues: Dating and marriage are easier with smaller utilities.

To be clear, I'm not saying that buying small is the perfect solution. All else being equal, I would prefer EBITDA of a billion, not ten million dollars. Utility buyers outnumber sellers by a wide margin, even for small deals. Small utilities are not cheaper than large. Both now require similar premiums and multiples.

The number of smaller opportunities will continue to fall. Further consolidation is inevitable. However, the juice is still worth the squeeze with small acquisitions.