The following post was written by Regulatory Research Associates, a group within S&P Global Market Intelligence. For further information on the full reports, please request a call.
Since the 2014 bankruptcy filing of parent Energy Future Holdings, several suitors have thrown their hats into the ring to acquire the troubled energy holding company in order to gain ownership of the crown jewel, Oncor Electric Delivery.
The latest suitor, Warren Buffet's Berkshire Hathaway Energy, or BHE, has acted quickly to remove potential regulatory hurdles, but faces challenges from would-be competitors for Oncor's hand.
On July 7, BHE struck a deal to acquire a reorganized Energy Future Holdings Corp., including its crown jewel, Oncor Electric Delivery Co. LLC, for an all-cash consideration of $9 billion, in a deal that values EFH's 80% stake in Oncor at $18.1 billion.
Berkshire is also expected to purchase the remaining 19.75% interest owned by Texas Transmission Investment LLC and 0.22% interest owned by Oncor management.
The Berkshire deal is subject to approval from the Federal Energy Regulatory Commission, the Public Utility Commission of Texas, or PUCT, and the U.S. Bankruptcy Court for the District of Delaware.
EFH's largest creditor, Elliott Management Corp., quickly countered with a plan calling for a debt-to-equity swap that would value Oncor as much as $500 million more than the Berkshire deal. However, Berkshire's offer appears to have the upper hand at present, due to its financial strength and history of allowing utilities to operate autonomously.
Oncor Electric Delivery: Everybody seems to want some
In Oncor, suitors see a financially stable regulated transmission and distribution utility — the largest in Texas, serving 10 million customers — with a growing capital expenditure program and rate base. Oncor's expansion strategy is to invest in technology upgrades and construct transmission and distribution facilities to meet needs of the growing Texas market and support energy production. Oncor benefits from regulatory capital recovery mechanisms known as "capital trackers" to provide timely recovery of transmission, distribution and advanced metering investments through regulated rates.
The utility has grown operating revenue at a compound annual rate of 4.2% from 2012-2016. Revenue grew to $3.92 billion in 2016 from $3.89 billion in 2015. Net income in 2016 was roughly flat at $431 million, but is up from $349 million in 2012. Slightly weaker income in 2016 was attributable to lower electricity consumption due to milder winter, spring and summer weather, as well as increased operation and maintenance expenses.
The company's senior secured debt is rated A and A3 by S&P Global and Moody's, respectively.Oncor capital spending is expected to increase to $1.5 billion in 2017 from $1.35 billion in 2016. The board expects to approve capital spending of $1.6 billion in each of the years from 2018-2021, primarily to invest in transmission and distribution infrastructure.
Oncor's T&D assets are principally in the north-central, eastern and western parts of Texas. This territory has an estimated population in excess of 10 million, about 40% of the population of Texas, and includes the fast-growing Dallas-Fort Worth area. Over the past five years, the number of distribution system points of delivery Oncor serves, excluding lighting sites, grew an average of 1.52% per year.
The fastest growing portion of Oncor's transmission base revenues is recovered through a TCRF rate to cover fees paid to other transmission service providers and the retail portion of its own transmission spending. PUCT rules allow the update in the rates twice each year. Oncor transmission facilities as of year-end 2016 included 6,442 circuit miles of 345kV transmission lines and 9,825 circuit miles of 138-kV and 69-kV transmission lines.
Another suitor for Oncor: Is the 3rd time the charm?
The Berkshire proposal is the third attempt at a merger involving EFH as part of the bankruptcy reorganization proceeding, following failed attempts by NextEra Energy Inc. ($18.7 billion) and an investor group led by Hunt Consolidated Inc., which had sought to roll the assets into a real estate investor trust, or REIT. Other interested parties cited in media reports since the bankruptcy filing by EFH in April 2014 have included Exelon Corp., American Electric Power Co. Inc., Edison International and CenterPoint Energy Inc.
While both NextEra and Hunt were able to secure approval from the bankruptcy court, the PUCT ultimately scuttled both deals.
The commission outright rejected proposed acquisition of Oncor by NextEra Energy Inc., based on the PUCT's understanding that NextEra management would not agree to maintain the existing Oncor ring-fence and the commission's conclusion that the transaction provided insufficient benefits for ratepayers.
Hunt Consolidated withdrew its proposed deal after the PUCT approved the transaction subject to conditions the potential investors found unattractive, including the treatment to be accorded tax savings associated with the proposed real estate investment trust structure, the make-up of the Oncor board of directors and limitations on dividends.
With these past transactions in mind, Berkshire has reportedly offered a series of commitments that are designed to address the PUC's concerns regarding the prior transactions. The proposed commitments are apparently supported by the PUC staff and the Texas Office of Public Counsel, the Texas Industrial Energy Consumers and the Steering Committee of Cities Served by Oncor, signaling the buy-in of several key consumer stakeholder groups.
Regulatory Research Associates, an offering of S&P Global Market Intelligence, expects that a PUC filing would not be tendered until after approval is received from creditors and the bankruptcy court.
Once filed, the PUC would have 180 days to rule on the application, which would put a likely decision date some time in the first quarter of 2018, depending on how soon the filing is tendered.
Assuming the Berkshire plan is ultimately approved by the bankruptcy court, in RRA's view, the company has taken an important first step that may have been overlooked by previous suitors, namely achieving buy-in from major stakeholders prior to the announcing the deal publicly and before seeking formal PUC approval. While there are never any guarantees as to how a commission will view a given transaction, this type of up-front communication and cooperation appear to bode well.Other factors in Berkshire's favor are that it is apparently willing to accept the existing ring-fence and independent board that the PUC considers so crucial to protecting ratepayer interests, the ability to remove/reduce the debt above Oncor and Berkshire's track record for purchasing well-run utilities, retaining entrenched management and retaining/growing those assets over the long-term.
This attributes contrast against the Hunt proposal, where the main "benefit" resulted from an unorthodox, though not unheard of REIT structure, and also the NextEra transaction, where the PUC was concerned that cash flows from Oncor would be used to finance that company's aggressive merchant generation plan, as well as the impact of the related debt load on NextEra and Oncor.
While RRA does not view it as a major concern at this juncture, it is worth noting that there could be some changes to the make up of the PUC as the merger review proceeding gets underway. There is currently a vacancy on the commission for a term that extends to August 2021. The vacancy was created by the May departure of then-Chairman Donna Nelson, who had been serving beyond the end of an expired term. She was part of the unanimous vote that rejected the NextEra deal.
While the remaining commissioners upheld the PUC decision through two requests for reconsideration, Commissioner Ken Anderson's term expires in August, and while not likely, Gov. Greg Abott, could decide to replace Anderson at that time. If he is reappointed or if no action is taken, he may continue to serve pending reappointment/replacement/confirmation until the end of the next regular legislative session in May 2019. The legislature does not meet in regular session in even-numbered years.
Similarly, since the 2017 regular session has adjourned, an individual appointed to fill the existing vacancy would be permitted to begin serving immediately and could continue to serve pending confirmation until the end of the 2019 regular session.
With respect to FERC, the commission's review primarily focus on market power issues and the impact on rates. RRA's initial assessment is that FERC review of this proposed transaction should not prove to be particularly contentious.
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