Investment needs, commodities-sensitive customers drove $6.2B Allete takeover

The Canada Pension Plan Investment Board and Global Infrastructure Partners' planned $6.2 billion take-private deal for Allete Inc. should help the Minnesota company better manage volatility within its renewables business and from industrial utility customers, industry analysts said, also suggesting the transaction does not portend a broader pickup of M&A activity in the sector.

The acquisition amount represents a premium of approximately 19.1% to Allete's closing share price Dec. 4, 2023, before reports emerged it was exploring a sale. Allete's stock price had gained nearly 16% since the report, settling at $64.27 on May 2. Shares closed May 6 about 2% lower at $63.01 in more than 12 times average trading volume.

"[Allete] historically traded at a discount to regulated peers, likely reflecting a high concentration of taconite customers along with various challenges at [Allete Clean Energy Inc.]," analysts at Wells Fargo wrote in a report following announcement of the deal.

Guggenheim analysts agreed that "the unique business mix and macroeconomic sensitivities," particularly utility subsidiary Minnesota Power Inc.'s exposure to producers of taconite, a type of iron ore, has negatively impacted Allete's equity value "despite a step-function improvement in rate base growth in recent quarters," they wrote.

Almost 70% of Minnesota Power's retail sales are to taconite mining, paper/pulp and pipeline customers.

In a November 2023 electric rate case application to the Minnesota Public Utilities Commission, Minnesota Power proposed a rate stabilization mechanism to smooth the cyclical volatility experienced by its taconite and paper manufacturing customers and to reduce the impact of setting test-year industrial production levels either too high or too low. On May 3, a settlement was proposed.

Allete Clean Energy's 2023 earnings, meanwhile, "were affected by congestion and market volatility" at the 303-MW Caddo Wind Farm and 303-MW Diamond Spring Wind Farm in Oklahoma, "as well as a third-party substation's forced network outage," Allete Senior Vice President and CFO Steven Morris told investors Feb. 20 during a fourth-quarter 2023 earnings conference call. A first-quarter call scheduled for May 9 was canceled.

Morris also disclosed that Allete was evaluating "liquidity options," including "opportunistic sales of assets," to help fund its $4.3 billion, five-year capital expenditure program.

"The company's above-average capex and coal exposure are the main drivers of the deal, and we note all utility M&A targets of the last five years have been coal heavy names as those coal plants are fully depreciated for rate-making purposes and they can be retired and replaced with new wind/solar/batteries/gas, which then resets rate-base and earnings higher," analysts at CreditSights wrote May 6.

Minnesota Power's largest power plant is the 937-MW coal-fired Clay Boswell plant in Itasca County, Minn. It owns an about 87.5% interest, with Wisconsin utility WPPI Energy owning the remainder. The two operating units have been running since 1973 and 1980.

Allete's 2,242 MW of renewables generation "could add some significant local permitting and corporate relationships for growth or [Global Infrastructure Partners] could seek to move the best development projects into Clearway Energy Inc.," CreditSights added. Global Infrastructure Partners owns a 50% interest in Clearway.

The deal itself is a "modest premium" compared to South Jersey Industries Inc.'s $8 billion acquisition by Infrastructure Investments Fund, an equity fund managed by J.P. Morgan Investment Management Inc.'s Infrastructure Investment Group, in 2023, according to Guggenheim.

Canada Pension Plan and GIP's $67 per share cash offer, which includes debt, is expected to close in mid-2025. The parties can opt to extend the timeline by up to six months if the deal does not close by Aug. 5, 2025, and only regulatory approvals remain outstanding. The buyers would pay either $164 million or $212 million if they terminate the deal, while Allete would pay $116 million.

Both Guggenheim and CreditSights said they foresee little in the way of additional corporate-level utility M&A for North American utilities in 2024, describing the Allete transaction as unique.

"These are two very established and sensible buyers — we just don't believe this is a proxy for the industry at this point," the Guggenheim analysts said.

Canada Pension Plan, known as CPP Investments, owns renewables developer Pattern Energy Group LLC and a stake in independent power producer Calpine Corp.