Enbridge Inc.'s announced $14 billion deal to purchase three Dominion Energy Inc. gas utilities may have marked the end of a period of pricey valuations in the sector.
The price of the proposed acquisition represented 1.5x the combined utility companies' 2022 rate base, falling short of many analysts' expectations. It was also well below several gas utility asset sales to infrastructure investment funds between mid-2021 and mid-2022, which fetched valuations of 2x or more the rate base as views on the sector improved.
These deals tapered off in the second half of 2022, as several companies that explored sales of their gas utility businesses decided against the transactions. Dominion's long-anticipated sale of its Ohio, North Carolina and Western US gas utilities provided the first major data point in the gas utility mergers and acquisitions market since 2022.
In comments after the Sept. 5 announcement, Enbridge executives highlighted the valuation, which they placed at 1.3x the three utility companies' estimated 2024 rate base.
"This type of opportunity isn't something I would have envisioned being possible just eight months ago when I began serving as Enbridge's CEO," Enbridge President and CEO Greg Ebel said during a Sept. 5 conference call. "Today, however, we have a transaction that represents a rare and unprecedented opportunity to acquire high-quality growing natural gas utilities at scale and at a historically attractive valuation."
Tough environment for asset sales
The view of the deal on Wall Street was largely homogenous, though several analysts cautioned that market watchers must take into account rising interest rates, which make transactions more expensive.
The deal value was "somewhat softer" than investor expectations and transactions in recent years, illustrating the limitations that gas utility operators face if they sell at a time when interest rates are much changed from a year or two ago, JP Morgan analysts said in a Sept. 5 research note.
Wolfe Research analyst Steve Fleishman also highlighted the difficulty of finding buyers for large gas utility assets, particularly in the current rate environment. In a Sept. 5 note to clients, he additionally noted utility stock underperformance amid Dominion's ongoing strategic review aimed at bolstering its stock price performance.
"Utility stock valuations have been under pressure, and [Dominion] needed to sell a lot of assets," Fleishman said. "[Enbridge] took advantage of that."
Guggenheim Partners also acknowledged the "slight decline" from recent gas utility valuations, but the global investment and financial services firm said the deal value fell within the range of investor expectations.
"The transaction multiples landed towards the lower end of our expectations earlier in the process for gas assets; however, we note that they are not as draconian as some had recently pitched us and come against a backdrop of consistent rate headwinds," Guggenheim analysts said in a Sept. 6 research note. "In our view, the wholesale packaging of the portfolio to a strategic like Enbridge is a positive from a sale process and for the ongoing review (e.g., not piecemeal), with the transactions themselves separate, removing a degree of regulatory overhang."
Shares of Enbridge were down close to 6% in trading on Sept. 6, on more than eight times average volume. Dominion's stock price was down about 1.8% on more than double average volume.
Parsing the assets
Dominion is selling each of the gas utilities in a separate transaction to Enbridge. Looking at each, BofA Securities analysts said Public Service Co. of North Carolina Inc. commanded a premium valuation, at 1.7x the 2022 rate base. Meanwhile, East Ohio Gas Co., which operates as Dominion East Ohio, and Questar Gas Co. which distributes gas in Idaho, Utah and Wyoming, attracted weak valuations at 1.5x, the BofA analysts said in a Sept. 6 note.
BofA had valued the utilities at $12 billion, compared to after-tax proceeds of $8.7 billion that Dominion expected to reap from the sales. The biggest disparity was at Questar: BofA Securities valued the company at $4.75 billion, while Dominion expected to realize $2.7 billion in after-tax proceeds. The analysts also noted that Dominion purchased the Questar assets in 2016 at higher valuations, suggesting there has been "limited equity value creation" since the transaction.
Guggenheim saw the gas reserves development business linked to Questar, Wexpro Co., dragging on the deal's price-to-earnings ratio, which Dominion placed at 16.7x estimated 2024 operating earnings. Without Wexpro, the multiple would have been closer to 19.2x, according to the analysts.
Price-to-earnings premium
On that front, several analysts noted that the aggregate purchase price of $9.4 billion, not including debt, translated to a price-to-earnings ratio that represented a premium over electric and gas utility peers.
Still, KeyBanc Capital Markets analyst Sophie Karp said the price-to-earnings multiple fell short of recent transactions as well as the investment bank's expectations. However, in a Sept. 5 research note, Karp acknowledged that "the M&A environment has evolved since the start of the year." She said her research team was "nonetheless enthused by the announcement of a comprehensive transaction under difficult macro circumstances that should bring [Dominion] very close to the end of its restructuring initiatives."
In a pair of Sept. 6 notes, Morningstar analysts Andrew Bischof and Stephen Ellis said the deal was roughly in line with gas utility valuations and represented a fair outcome for both parties.
"Enbridge was likely able to pay a fair price for the assets because of the lack of other natural buyers," Ellis said. "We viewed Dominion as having few options as it was late in recognizing the need for external financing amid a deteriorating regulatory environment in Virginia." The largest of Dominion's regulated electric utilities is in Virginia.
Bischof added that "with Dominion trading at just 13.2 times our 2023 earnings estimate as of Sept. 5, the asset sale was more attractive than issuing market equity since the stock has been depressed during the strategic review."
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