Three Big Utility Takeover Targets

09/16/2010 12:30 pm EST

Focus: STOCKS

Roger Conrad

Founder and Chief Editor, Capitalist Times

Roger Conrad, editor of Utility Forecaster, says more big utility mergers are on the way, and he identifies three potential targets for hungry acquirers.

With more than 100 electric and gas companies, two dozen major communications companies, and tens of thousands of water systems, there’s a lot more US utility consolidation ahead.

Deal-making is picking up again. And investors are winning both by picking targets in advance and betting on deals in progress. Pinpointing prospective takeover targets is a low-percentage exercise. Well-run businesses, however, generally make you money whether there’s a deal or not.

CH Energy Group (NYSE: CHG) [was one of several] small to mid-sized power and gas companies that paid a price for being too aggressive in the 1990s. But since the 2001-2002 crack up, they’ve systematically refocused on regulated operations, slashing debt and operating risk.

Any would-be acquirer will know exactly what they’re getting: customers of a regulated utility (in New York’s Hudson Valley between New York City and Albany—Editor) that’s continually becoming more efficient and financially healthy.

A buyer of CH Energy would likely face the greatest challenge, owing to erratic Empire State regulation. A new governor next year could change that or make things worse. But CH Energy is doing well dealing with New York officials on its own and is a Buy up to $42. (CHG closed just above that level Wednesday—Editor.)

MarkWest Energy Partners LP (NYSE: MWE) has more than doubled off its lows of scarcely a year ago, as it’s added a fee-based business and the market for natural gas liquids (NGL) has improved. The NGL business especially is attractive for would-be asset aggregators.

The main drawback here is the units have shot up well above my Buy target of $30. Purchases below that level assure a healthy return, with or without a deal. (It closed below $35 Wednesday—Editor.)

Last but not least, Consolidated Communications (Nasdaq: CNSL) has steadily grown its enterprise-focused rural communications business in recent years, most recently inking an Internet-based phone deal with the City of Montgomery, Alabama.

But it’s still an increasingly small player in a rapidly consolidating industry and an easy mouthful for emerging sector giants like CenturyLink (NYSE: CTL). Recent deals in this space haven’t been based so much on the number of phone lines served or even cash flow. Rather, acquirers’ interest appears to be in a territory’s enterprise customers. That’s a quality that should serve Consolidated well if a suitor does appear.

And in the meantime, second-quarter distributable cash flows produced a comfortable payout ratio of 70.6%. Buy Consolidated Communications up to $19. (The stock closed below $18 Wednesday—Editor.).

All [of these] meet my prime directive for takeover plays: Never buy anything you wouldn’t want to own if no deal occurs.

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