One of the most interesting by-products of the recovery since Financial Crisis has been the rapid inflation of a variety of different types of assets. As the Fed has kept interest rates extremely low, many investors that otherwise would have been investing in a variety of interest rate linked products from bonds to Certificates of Deposit (CDs), instead have been on the hunt for yield. That phenomenon has helped buoy stocks for the last few years, and it’s also now starting to be reflected in M&A deals; case in point – Canadian acquisitions of U.S. utility assets.
Canadian utilities have traditionally been highly regulated to an even greater degree than in the U.S. This more stringent regulation has made it harder for Canadian utilities like TransCanada and Brookfield Renewable (technically based in Bermuda but with a strong Canadian presence) to expand profits compared to U.S. peers. Further, despite its size, Canada’s considerably smaller population has left less opportunity for expansion among Canadian utilities. Put all these factors together and you have a recipe for a stable set of companies that throw off lots of free cash flow from a regulated business at home and who have low interest rates on their substantial debt burdens. Yet the firms have few investment options and are forced to look abroad for opportunity. Related: Cheap Gas Claims Another Nuclear Victim
That reality is made all the more stark by the evaporating opportunities in Canadian oil sands. If U.S. fracking is in trouble at current oil prices, Canadian oil sands are truly circling the drain as a business. Oil sands operators are facing production costs that are considerably higher than sale prices, which, understandably, is making new investors more than a little apprehensive about putting money to work in the area. Several producers are continuing to produce oil despite the losses they are taking, but it’s unlikely that there will be major new investments in the field until prices rebound and show improved stability.
Against this backdrop and with cash piling up on the balance sheet, many utilities across the Great White North are looking to the U.S. for new opportunities. The latest deal was the purchase of three Pennsylvania plants from Talen Energy Corp for $1.51 billion by a pair of Canadian firms. TransCanada bought a natural gas fired plant from Talen for $654 million and Brookfield bought a pair of hydro-electric plants for $860 million. The asset sales were required by regulators as part of Talen’s formation in a merger, but the prices for the assets themselves were excellent nonetheless. Related: The End Of The Oil Major?
Canadian firms facing a dearth of attractive investment opportunities are finding it more lucrative to pay top dollar for U.S. assets that have stronger growth potential rather than returning cash to shareholders or paying down their own debt. And that makes sense economically – after all if a firm can earn a 10 percent return on invested capital by buying a U.S. asset and the cost of capital is 5 percent then the acquisition is consistent with maximizing profits and shareholder value.
This acquisition spree is likely to continue as long as interest rates in Canada stay low. Canadian utilities are not going to suddenly start finding better opportunities to invest at home, nor are enormous growth opportunities about to return to the country.
As a result, U.S. assets will continue to be attractive. Investors can play on this trend either by looking for small U.S. firms that could sell out to the Canadians (there are a lot of possibilities here), or by looking to invest in Canadian firms that can make transformational acquisitions and improve their own growth profiles. There are a number of Canadian utilities that trade in the U.S. for those investors looking to capitalize on international growth by Canadian firms.
By Michael McDonald of Oilprice.com
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