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NextEra’s Next Era

Everyone’s been waiting for it … and NextEra Energy Inc. (NYSE: NEE) finally went ahead and did it: The utility giant was the winning bidder for the Texas-based transmission and distribution company Oncor.

Oncor, itself, has already had a pretty wild year. As the crown jewel of Energy Future Holdings’ (EFH) former empire, the TransCo figured prominently in its bankrupt parent’s restructuring plans.

EFH and its creditors had been hoping to spin off Oncor, which provides power to more than 10 million customers in Texas, at a premium valuation. After all, transmission and distribution (T&D) infrastructure promises to be one of the most valuable pieces of the 21st century utility.

As such, NextEra was hardly Oncor’s only suitor. And the firm had previously been in the running during an earlier round of bidding last year. That time around, a consortium led by oil and gas producer Hunt Consolidated won out with a $17 billion bid.

That deal had the potential to further pioneer a new income security: the Wires REIT. As part of the transaction, Hunt proposed to put Oncor’s T&D assets in a real estate investment trust (REIT).

The investment vehicle held the promise of a supercharged dividend thanks to T&D infrastructure’s high returns on equity coupled with the tax-advantaged status of a pass-through entity.

But regulators and creditors hit an impasse over whether ratepayers should share in the tax savings that would result. And the deal fell apart in May.

In the interim, of course, the utility sector has been going through an aggressive wave of deal-making and consolidation. And we figured that would mean the Oncor assets would fetch an even higher price than what Hunt had agreed to pay last year.

So while we had been hoping that NextEra’s $4.3 billion deal to acquire Hawaiian Electric Industries Inc. (NYSE: HE) would fall apart in time for it to make another run at Oncor, we were also bracing ourselves for the resulting leverage.

In a bit of fortuitous timing, the HEI deal, which had been dragging on for more than 19 months due to the intransigence of local regulators and politicians, finally unraveled earlier this month, freeing NextEra to top Oncor’s other suitors with a truly premium bid: a deal with an implied enterprise value of $18.4 billion.

At the same time, Bloomberg’s listing of comparable deals around the world suggests that with a transaction value to EBITDA ratio of 9.8 times, this deal isn’t nearly as expensive as the price tag suggests, at least on a relative basis.

The transaction is actually for EFH’s 80% indirect interest in Oncor. At the moment, it remains to be seen what NextEra’s plans might be for the 20% portion it doesn’t control.

NextEra won out against suitors that reportedly included Edison International (NYSE: EIX), American Electric Power Co. Inc. (NYSE: AEP), CenterPoint Energy Inc. (NYSE: CNP), and Berkshire Hathaway Inc. (NYSE: BRK/B).

To be sure, this is a sizable deal for the $60 billion utility. However, NextEra has a richly valued stock and access to dirt-cheap financing, which should make it manageable.

Additionally, analysts believe that even with the leverage that results from this transaction, Oncor’s cash flows should be ample enough to fully service it. And management expects to maintain the firm’s credit rating.

As part of the transaction, NextEra will fund $9.5 billion to help EFH retire existing debt. Financing will be a combination of debt, convertible preferreds, and proceeds from asset sales.

While NextEra is primarily known for its regulated Florida-based power utility, the firm already has a footprint in Texas through its competitive renewable power segment.

Management noted that the firm has been operating in the Lone Star State for more than 15 years, with $8 billion in investments during that time. So Oncor’s assets may prove complementary to some of NextEra’s existing Texas-based merchant generation.

Also of note, NextEra is expected to enjoy constructive relations with Texas regulators, just as it does with Florida regulators.

Management believes the deal will allow NextEra to grow its earnings near the top of its targeted range of 6% to 8% annually through 2018, which is well above the industry’s average of 4% to 5%.

Although EFH will be able to consider other bids as NextEra’s deal works through various approvals, the transaction’s more conventional structure than the one Hunt previously proposed should mean that NextEra will secure its prize.

The deal is expected to close by the first quarter of 2017.


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