While identifying potential takeover targets isn’t at the core of what we do at as an income-oriented service, we do perform such an analysis as part of our approach to stock selection, notes Ari Charney, editor of Utility Forecaster.
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One of those themes was underscored by last month’s announcement that the Canadian utility Hydro One Ltd. (Toronto: H) has agreed to acquire the U.S. utility Avista Corp. (AVA). If you’re keeping score, that’s the fourth major cross-border acquisition by a Canadian utility over the past two years.
What’s driving this action? For one, a lack of opportunity up north. There are really only a handful of Canadian utilities, so companies looking for new growth have to head south.
In addition to being the land of opportunity for Canadian acquirers, the U.S. is also home to utilities with stronger regulated earnings growth.
Following this latest deal, there’s now just one Canadian utility giant that has yet to make a play for a U.S. utility: Canadian Utilities Ltd. (Toronto: CU) (OTC: CDUAF).
Of course, that doesn’t mean the company has to make such a move. But the family-controlled utility empire — is no stranger to buying assets far afield from its home turf in the province of Alberta.
In 2011, Canadian Utilities acquired an Australian gas distributor for $1.1 billion. So it stands to reason that the company has probably also surveyed the landscape closer to home.
While Canadian Utilities currently shoulders a fair amount of debt, it does appear to have just enough balance-sheet capacity to undertake a transformative merger.
With founder Ronald Southern’s death last year, the second generation of the family is now running the whole show. CEO Nancy Southern has been at the helm since 2003, but her father remained on the company’s board until he died.
The younger Southern, who’s now 60, is no stranger to boom-and-bust cycles, as well as what it feels like to enter a downturn saddled with excessive debt. So she may be leery of pursuing another acquisition in this environment.
But let’s suppose Southern is looking to extend her company’s footprint to the U.S. anyway. Where might she look? When identifying potential utility pairings, it always makes sense to start with companies that operate in nearby or adjacent service territories.
That’s because utilities can realize greater economies of scale when their existing networks are complementary. So our search began with utilities domiciled in states near Alberta.
In addition to location, we also look for companies that are the right size for a potential acquirer to swallow. In this case, that narrowed our search to stocks with market caps below $5 billion.
And, of course, a potential target must offer the prospect of strong earnings growth while trading at a reasonable value and having manageable debt.
With these details in mind, the three companies that could attract Canadian Utilities’ attention are as follows: Allete Inc. (ALE), Black Hills Corp. (BKH), or NorthWestern Corp. (NWE).
Of course, we would never recommend buying a stock for its takeover potential alone. Instead, we only recommend stocks that we’d be comfortable holding through thick and thin, even if a takeover never materializes. Among these three, Allete is the company that best satisfies this crucial criterion.
