The failed sale of American Electric Power Co. Inc.'s Kentucky operations to Algonquin Power & Utilities Corp. subsidiary Liberty Utilities Co. indicates that momentum for US utility M&A has started slowing down, industry experts said.

If asset sales like American Electric Power's (AEP's) divestment of regulated utility Kentucky Power Co. and AEP Kentucky Transmission Co Inc. become untenable, analysts at Guggenheim Securities and Neil Kalton, managing director of utility equity research at Wells Fargo Securities, said some utility holding companies may need to consider issuing equity.

"With delays vs. several deals' original expected closing dates, we have been hearing more concerns and 'what-ifs' being floated by investors about whether equity remains off the table if certain deals do not close," Guggenheim wrote April 20.

A proposed sale of regulated assets also has the added risk of potential opposition from federal and state regulators at a time when those agencies may be less inclined to allow recovery of certain costs.

"Now is not a good time to be in front of your regulators just because of high commodity prices last year and inflation," Kalton said in an interview. "The regulators typically want to extract their pound of flesh and right now, given rising bills, it becomes more problematic to get things approved on reasonable terms."

Deal pace decelerates

AEP and Algonquin announced the deal in October 2021 at an enterprise value of $2.85 billion, but the following year, AEP reduced the sale price to $2.65 billion and delayed closing of the transaction from October 2022 to January 2023. At the end of 2022, the Federal Energy Regulatory Commission denied the deal's approval "without prejudice" because the parties "failed to show that the proposed transaction will not have an adverse effect on rates." (FERC docket EC22-26)

FERC stepping in to deny the sale was unusual, Kalton said, since opposition to regulated M&A usually comes from the states, demonstrating just how much "inflation and high bills have a chilling effect" on dealmaking.

In February, AEP and Algonquin reapplied for FERC authorization and added financial details to assuage the agency's concerns, but the revised filing still drew protests from the Kentucky Public Service Commission and Kentucky Attorney General's Office. (FERC docket EC23-56)

Wells Fargo, Scotiabank, Mizuho and Guggenheim all expect the pace of dealmaking to slow considerably given the continuing high interest rate, high customer bill environment and a dwindling list of targets.

So far in 2023, only AEP and FirstEnergy Corp. have inked asset sale agreements, with a Brookfield Asset Management Ltd. fund buying a 30% stake in FirstEnergy Transmission LLC and a partnership owned by Invenergy LLC, the Caisse de dépôt et placement du Québec and Blackstone Infrastructure Partners LP purchasing AEP's contracted renewables portfolio.

Eversource Energy is marketing its partial ownership of a US offshore wind joint venture, and Duke Energy Corp. is offering a portfolio of more than 5,000 MW of unregulated renewables, though both deal timelines have been extended.

Mizuho Managing Director Anthony Crowdell said in an interview that he expects Duke's contracted assets will attract "a financial interest or a foreign energy or utility company," while Eversource likely needs to find an international energy company willing to take on the offshore wind industry's ballooning costs. Eversource is currently partnered with Denmark's Ørsted A/S.

On the regulated side, NiSource Inc. is looking to unload a stake in Northern Indiana Public Service Co. LLC, which serves 1.2 million natural gas and electric customers, but Crowdell said buyers' interest in paying premiums for gas utilities likely peaked when CenterPoint Energy Inc. agreed to sell its Oklahoma and Arkansas local distribution companies in 2021 for $2.15 billion, given that interest rates are higher now.

Any potential buyers of regulated gas assets need to see attractive returns and, given higher financing costs, they expect to pay less for such assets, according to Crowdell, who added that gas utility holding companies have sent mixed signals regarding the potential for future deals.

"On fourth-quarter [2022] earnings calls we had Black Hills Corp. and Southwest Gas Holdings Inc. say that they have not seen attractive valuations for their LDC sales," Crowdell said. "On the opposite side, we had CenterPoint say that a certain size and scale of LDC is attracting a good price."

Raising equity

FirstEnergy saw shares dip April 28 after suggesting in a 10-Q filing that it would consider issuing hybrid securities, in an example of investor concern regarding any hint of equity issuance by utilities.

AEP said in February that it did not expect to issue equity if the Algonquin fell apart, but S&P Global Ratings downgraded Kentucky Power's issue-level credit rating from BBB+ to BBB in April after the transaction collapsed to reflect "stand-alone weakening financial measures" that CreditSights called "some of the weakest ... across AEP's opcos."

Analysts at Mizuho wrote April 17 that there are likely no other interested buyers for Kentucky Power, while Scotiabank and Morningstar noted they anticipate AEP will have to sell off other assets instead.

With asset sales slowing considerably, utility holding companies might start to consider corporate mergers to avoid issuing equity, according to Wells Fargo's Kalton.

"Given customer bill pressures and rising interest rates and given a desire to stay out of rate cases, maybe this merger of equals will come back into the fold" during the next five years or so, he said.

Kalton added he does expect Avangrid Inc.'s delayed $8.3 billion enterprise value merger with PNM Resources Inc. to close.

The companies agreed in April to exercise a three-month extension through July 20 after filing a motion to dismiss their merger appeal, which is pending at the New Mexico Supreme Court, and remand the case to state regulators for rehearing.

Avangrid and PNM announced the deal in October 2020, but New Mexico regulators rejected it in December 2021. There is no statutory deadline for the New Mexico Supreme Court decision nor the potential remanded case at the commission, the companies said April 12.

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