John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
Okay, so maybe my timing wasn't the greatest.
Two days after I wrote a favourable column about Emera Inc., the parent of Nova Scotia Power Inc. surprised everyone by announcing a blockbuster $10.4-billion (U.S.) deal (including $3.9-billion of debt) for Tampa-based electric and gas utility Teco Energy Inc.
The transaction was announced late on the Friday before the Labour Day weekend, and judging by the 4.6-per-cent drop in Emera's stock price when markets opened the following Tuesday, investors weren't thrilled with the deal.
It's not unusual for an acquiring company's stock to drop following a takeover announcement, and in Emera's case the anxiety was understandable: Buying Teco will double Emera's size and transform it from a company that generates more than half of its EBITDA (earnings before interest, taxes, depreciation and amortization) from Canadian-based operations currently into one that derives more than two-thirds of its EBITDA from the United States.
The deal, which is expected to close in mid-2016, also represents a major departure from Emera's geographic focus on Atlantic Canada and the U.S. northeast. As chief executive officer Chris Huskilson said on the conference call: "This is a transformational announcement for Emera."
Any transaction of this size comes with risks, of course, including obtaining the necessary financing and regulatory approvals and integrating the assets once the deal closes. But as an Emera shareholder and dividend growth investor, I welcome the Teco acquisition.
Here's why:
It improves Emera's diversification
Teco's largest business is Tampa Electric, a regulated utility that owns and operates four power plants and distributes electricity to more than 700,000 customers in West Central Florida. Teco also owns Peoples Gas and New Mexico Gas Co., the largest gas utilities in Florida and New Mexico, respectively.
With Emera's near-term growth focused on its generating plants in New England and transmission projects tied to the Lower Churchill hydro development in Labrador, acquiring Teco provides a new platform for growth – for example, as Teco shifts its generating portfolio toward lower emission alternatives. As the parent of Nova Scotia Power, Emera has plenty of experience operating a large electric utility. That knowledge will serve Emera well as it takes control of Tampa Electric.
It supports future dividend growth
In August, Emera announced an unusually large dividend increase of 19 per cent – its third hike in less than a year. In a related move, the company raised its annual dividend growth target to 8 per cent through 2019, up from 6 per cent previously. With the Teco acquisition, the outlook for dividend investors is even brighter: Emera expects that its earnings per share will get a boost in the first full year after the deal's closing, with EPS gains reaching more than 10 per cent by the third year following the acquisition. This will provide "tremendous support to our dividend as we go forward" and allow Emera to extend its 8-per-cent dividend growth target beyond 2019, Mr. Huskilson said.
It adds to Emera's stability
Because utilities are regulated, their earnings are relatively stable and predictable. In recent years, however, the strong performance of Emera's non-regulated businesses – specifically Emera Energy and New England Gas – pushed the company's regulated earnings below its target of 75 per cent to 85 per cent of the total. That will change immediately with the acquisition of Teco, a pure-play regulated utility. "The benefit of this transaction is it brings our regulated … earnings pretty close to 85 per cent," said Scott Balfour, Emera's chief financial officer.
The price is reasonable
One reason for the market's cool reception is that Emera is paying a 31-per-cent premium to Teco's share price before the deal was announced. That equates to an enterprise value/EBITDA multiple of 11.6. "While the transaction multiple appears steep, Teco's tax attributes can be used to offset Emera's taxable income in New England, and its organic growth profile delivers longer-term value and accretion," CIBC World Markets analyst Paul Lechem said in a note. Including Teco's $1.7-billion of net operating tax losses and alternative minimum tax credits, the EV/EBITDA multiple drops to a more reasonable 10.8, Mr. Lechem said.
Closing thoughts
Because I'm focused on the long-term, I'm not troubled by the recent softness in Emera's share price. If anything, I'll consider adding to my position if the price falls further. The takeover of Teco, assuming it receives all the required approvals, will give Emera's earnings a lift and support the company's objective to raise its dividend at a high single-digit rate through the end of this decade, and perhaps longer. As a dividend investor, I look for companies that will pay me a growing amount of cash, and Emera meets that test. Remember to do your own due diligence before investing in any company.