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Another Day, More M&A

The ink has barely dried on our mergers-and-acquisitions themed March issue of Utility Forecaster, and one of the nine companies we identified as potential takeover targets has already put itself in play.

Kansas-based Westar Energy Inc. (NYSE: WR) saw its share price jump 6.4% yesterday on speculation that the company is considering strategic alternatives, including a possible sale.

According to Bloomberg, insiders revealed that Westar has reached out to potential buyers to gauge interest, though the company has yet to formally hire an adviser.

The $6.6 billion electric utility has many of the attributes deep-pocketed suitors are seeking: a mostly regulated utility with above-average earnings growth that operates in a single state with a constructive regulatory environment.

In addition to 7,200 megawatts of generation, Westar also owns nearly 29,000 miles of distribution lines and 6,400 miles of transmission lines.

With the growth of renewables, the wires will likely be one of the most valuable pieces of the nation’s 21st century energy utility infrastructure. That’s because the Federal Energy Regulatory Commission authorizes higher returns on equity for transmission in order to incentivize a buildout.

Consequently, transmission is a big part of Westar’s long-term growth plan, with management forecasting rate-base growth in this area of 11% annually versus 5% annually for generation.

Westar has a diversified fuel mix, which still tilts toward coal. With regulatory momentum toward renewables, Westar stands to get a growth kicker by retiring aging coal plants and building new gas-fired generation and additional renewables, particular wind power. Westar already has more than 1,000 megawatts of wind generation, or about 15% of the company’s total generation.

One of the key attractions of a utility that operates with a single-state service territory is that there are fewer regulatory hurdles to clear on the way to consummating a deal.

As we’ve seen with other utility sector tie-ups, such as Exelon Corp.’s (NYSE: EXC) pursuit of Pepco Holdings Inc. (NYSE: POM), the more approvals a deal requires the more likely it is to be hamstrung as each state’s regulators attempt to extract concessions from the acquirer.

Westar’s management had previously tipped investors that it might be contemplating a sale. During the company’s analyst call to discuss third-quarter earnings last November, CEO Mark Ruelle observed that given Westar’s small size the company would more likely be a seller than a buyer.

Unfortunately for value-conscious investors, Westar has been priced at a premium for some time, trading above our buy target since late September. Over the past six months, its price-to-earnings ratio (P/E) has averaged 19.3, well above 16.2 for the average utility.

Although we’ve advised investors to maintain their discipline by waiting to pick up potential takeover targets at a more reasonable price (many trade at similar premiums), the market may not always cooperate.

First the Wires, Then the Pipes

Westar isn’t the only company rumored to be in play. We almost did a spit-take yesterday (we’ve been doing a lot of those lately) when news crossed the wires that TransCanada Corp. (TSX: TRP, NYSE: TRP) is considering a bid for Columbia Pipeline Group (NYSE: CPGX).

Interestingly, CPGX is the former subsidiary of NiSource (NYSE: NI).

CPGX was the second of two spinoffs NiSource completed last year, separating its midstream pipeline business from its regulated utility. The first was CPGX’s master limited partnership (MLP) subsidiary Columbia Pipeline Partners LP (NYSE: CPPL).

The NiSource C-suite left to run CPGX, indicating that the spinoffs were where the lion’s share of the former consolidated entity’s future growth would be. Indeed, upon its listing, CPGX management announced they expected to grow the dividend 15% annually through 2020, and they recently reaffirmed that target with their latest earnings release.

Underpinning this growth is a collection of premier assets–more than 15,000 miles of natural gas pipelines across 16 states–positioned to transport cheap natural gas from the prolific Marcellus and Utica shale plays to utility and industrial customers in fast-growing end markets along the East Coast and Gulf Coast.

Unfortunately, superior assets and strong dividend growth weren’t enough to save the company’s share price from the energy sector crash. But a nice premium could more than make early investors whole again.

For its part, TransCanada would have an opportunity to buy assets with exposure to one of North America’s top resource plays, rather than going through the trouble of building and securing approvals (cough … Keystone … cough) for infrastructure of its own.

And the acquisition would give TransCanada an expanded U.S. footprint in a prolific formation, helping support its targeted long-term dividend growth rate of 8% to 10% annually.

Talks between the two companies have reportedly hit a standstill according to Bloomberg, so it’s possible that TransCanada’s overtures won’t result in a deal.

Regardless of what happens, TransCanada’s interest shows that there was at least one fortuitous aspect to the timing of NiSource’s spinoff of the Columbia Pipeline complex: The two listings occurred during a sector downturn that’s kept each entity from levering up like so many of their midstream peers. No doubt that was an additional attraction for TransCanada.

Our Super-Secret Stock Pick

In May, we’re holding our annual Wealth Summit–this year in Las Vegas. It’s a great way for us to meet you, our subscribers, one-on-one, and there are still spaces open if you’re interested.

Also this year, we’ll be making a special recommendation to those who attend the Summit, and to those who are part of our Wealth Society, whose members receive all the Investing Daily newsletters and other premium services.

It’s a fun exercise for us because there are no rules. We don’t have to pick a utility stock. In fact, our pick doesn’t even need to be a stock: It could be an alternative investment that isn’t traded on a public market.

Our publisher says we can’t reveal the pick in Utility Forecaster, or even to him before the Summit. But in the weeks ahead, we’ll let you in on some of the research we’re doing to identify this exclusive pick.

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