CEOs at Canada's largest utilities would be reluctant to admit it publicly, but for the past year, they've taken advantage of what they privately like to call "lazy" balance sheets at their U.S. rivals to stage a series of bold takeovers.
Led by massive acquisitions from pipeline companies Enbridge and TransCanada, six domestic businesses spent approximately $87-billion in the past 12 months snapping up U.S. firms. These are transformative deals, as each buyer vaulted to the leading ranks of North American utilities. For Canadians, the takeovers are a refreshing reverse of the trend that saw local champions in sectors such as mining and manufacturing picked off by foreign buyers.
Why are the Canadians suddenly stepping up? And can domestic CEOs in other sectors, all of whom aspire to grow internationally, steal a page from the utilities?
On the first question, the starting point for takeovers is this concept of lazy balance sheets south of the border. Executives at capital-hungry companies such as utilities are always conscious of their credit ratings. This is especially true of CEOs and boards at U.S. pipelines: Enron's meltdown and the near-death experience of the global financial crisis made top-notch ratings a priority. As a result, many U.S. utilities carry relatively little debt. That's "lazy" in the sense that the company could easily borrow more money, while continuing to be judged as investment grade by the likes of S&P and Moody's.
While utility executives might care about ratings, the credit market stopped paying much attention last year. In the spring of 2016, borrowing costs began to fall for any investment grade-rated company. At the same time, the spread or gap narrowed between the interest rates paid by a blue-chip double-A-rated borrower and a still-respectable but more leveraged triple B-rated business. And credit markets opened up – massive loans and bond sales were possible.
Clever CEOs realized Canadian companies could snap up a conservatively financed U.S. utility, confident that they could pay for the takeover by adding more debt, while maintaining an investment-grade rating. Analyst Jean-François Godin at Desjardins Securities said: "These utilities are large, sought-after issuers; their deals are generally sold in the blink of an eye."
In addition to raising debt, the Canadians knew they could finance acquisitions by selling stock, in the form of large bought deal-style financings that see banks guarantee the equity offering will be successful. Large bond and stock sales were common to all the companies that did takeovers. In addition to Enbridge and TransCanada, the companies expanding in the United States are Emera, Algonquin Power & Utilities, Fortis and AltaGas.
The most recent and most revealing of these takeovers came from AltaGas, which is buying WGL Holdings in a takeover that has an enterprise value – debt plus equity – of $8.4-billion. To pay for the acquisition, AltaGas rolled out an equity offering that was larger than the company's market capitalization at the time. AltaGas sold $2.1-billion in stock to a team of banks led by TD Securities, RBC Capital Markets and JPMorgan, and an additional $400-million of equity to the OMERS pension plan. In addition, AltaGas took out a $4.95-billion (U.S.) bridge loan from JPMorgan, TD and RBC.
The fact that AltaGas came calling with an all-cash takeover that included a seal of approval from OMERS impressed the WGL board, according to sources familiar with both companies, and set the stage for a friendly deal, rather than an auction of WGL that might have led to a slightly better price, but would certainly have created enormous uncertainty and stress. WGL looked to Goldman Sachs and Lazard for advice.
Can we expect more Canadian takeovers along these lines? Within the utility space, where credit ratings matter and there are more lazy balance sheets at U.S. companies, the answer is yes – further consolidation is expected.
However, credit ratings don't count for much at other businesses. And the majority of U.S. companies have balance sheets that look much like those of their Canadian peers, which eliminates the opportunity to pay for takeovers by loading up on debt. Full marks to CEOs at Canadian utilities for taking advantage of an opportunity provided by wide-open capital markets. But this proven growth strategy doesn't easily translate to other sectors.
Andrew Willis