The Great Gas Grab Goes Midstream
Why build it when you can just buy it?
That’s clearly the conclusion both Dominion Resources Inc. (NYSE: D) and TransCanada Corp. (TSX: TRP, NYSE: TRP) arrived at when deciding to pursue acquisitions of companies with significant natural gas pipeline assets.
And their two deals tell us that despite the energy sector’s woes, midstream pipeline infrastructure is still very attractive to acquirers so long as it’s unencumbered by excessive leverage.
At first glance, most investors probably assumed that Dominion’s $4.4 billion all-cash bid for Utah-based Questar Corp. (NYSE: STR) was all about the firm’s regulated gas utility.
After all, the Great Gas Grab, as we’ve dubbed it, has been a major theme in the electric utility space. Basically, the utility giants are trying to offset weak demand for electricity by buying pure-play gas utilities, which gives them a growing, regulated stream of earnings.
But it turns out that from Dominion’s standpoint the gas utility was just gravy. They were really after Questar’s midstream pipeline segment, whose 2,500-mile network of pipelines moves natural gas from six major producing areas to other major pipeline systems for delivery to key markets in the West and Midwest.
As Dominion CEO Thomas Farrell put it, “I don’t view [the deal] as being a utility-ish combination. We’re perfectly happy with the [gas utility] … but it was the MLP-eligible assets that particularly caught our attention.”
Dominion is trying to grow its master limited partnership (MLP) subsidiary, Dominion Midstream Partners LP (NYSE: DM), so it’s been on the lookout for attractive assets it could pick up at a reasonable price and then drop down to its MLP.
When we added Questar to the Income Portfolio in late November, a key consideration was that it was trading at a valuation that was far cheaper than its peers.
This relative discount was likely due to the fact that Questar isn’t just a pure-play gas distributor—it also has an exploration and production (E&P) segment, in addition, of course, to the aforementioned midstream pipeline business.
So Questar took a hit from its apparent exposure to the energy sector, which allowed Dominion to pick it up at a nice price.
Similarly, last night TransCanada revealed that last week’s rumors were true: The firm has agreed to acquire Income Portfolio holding Columbia Pipeline Group Inc. (NYSE: CPGX) in a $12 billion deal, including the assumption of debt. The all-cash bid translates into $25.50 per share of CPGX and is expected to close by the end of the year.
Chastened by its failure to secure a permit for its Keystone XL pipeline, TransCanada chose to pursue a premier collection of assets that already operate in a top resource play.
CPGX owns and operates a network of 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.
And TransCanada made its move at a time when CPGX was still bloodied by the energy sector’s shakeout. Even with the premium, the deal price is about 17.7% below the price at which CPGX debuted when it was spun off from NiSource (NYSE: NI) last June.
Although the assets are what brought TransCanada to the negotiating table, we suspect the Canadian pipeline giant was also enticed by the fact that CPGX carries significantly less debt than many of its midstream peers.
That attribute is simply an accident of timing. NiSource’s spinoff of the Columbia Pipeline empire happened to occur when the energy sector was already in the midst of a meltdown. So CPGX and its MLP subsidiary Columbia Pipeline Partners LP (NYSE: CPPL) never had a chance to fully lever up.
Both entities’ ratios of net debt to EBITDA (earnings before interest, taxation, depreciation and amortization) were well below the average of 4.5x to 5.0x of many of their peers.
In fact, the debt that energy sector firms piled onto their balance sheets when times were good has been a major impediment to M&A now that things have gone bust. Many potential acquirers would rather wait for debt to be wiped out via bankruptcy, no matter how attractive the assets might be.
But there are other firms like Questar and CPGX that have decent pipeline infrastructure without the taint of excessive leverage. And while many of the utility giants are working on building midstream pipelines of their own, they’re also interested in acquiring readymade pipelines on the cheap.
Of course, at Utility Forecaster we take a long-term perspective toward investing, so we don’t simply recommend a stock just because it might be a takeover target. Instead, we look for companies that we’d be happy to hold through thick and thin, while collecting a rising dividend.
Right now, we’re sifting through the carnage in the midstream space for smaller players with similar qualities to Questar and CPGX. And if we find enough that fit the bill, we’ll tell you more about them in an upcoming issue of Utility Forecaster—possibly even the forthcoming one.
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.