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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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Why Southern Company Just Sold Billions In Prime Assets

On May 21, Southern Company, the utility holding company based in Atlanta, with core electric utility franchise areas in Georgia and Alabama, announced a multi-billion dollar asset sale with proceeds designated to pay down debt. The buyer is NextEra Energy, located in neighboring Florida. In the deal, Southern will sell its Florida utility subsidiary, Gulf Power, plus gas utility and power plant assets also located in Florida.

With almost $100 billion in assets, NextEra Energy, bills itself as the world’s largest utility company. (Large Chinese power companies might quibble about this claim.) NextEra's investments include the electric utility Florida Power & Light (FPL), solar and wind power generating facilities across the country and a fleet of nuclear generating stations.

NextEra has been on a relentless search for additional non-fossil power generation assets and regulated distribution utilities to add to its already considerable holdings. Southern’s Gulf Power service area is literally in its back yard so to speak. From a regulatory perspective we would expect little difficulty in receiving the requisite state and federal approvals. But unlike much of NextEra's holdings, this newly acquired entity is not fossil-fuel free and carries a conventional utility fuel mix.

The question inquiring minds will ask is, "Why on earth would a smart management like Southern Company's sell an asset like Gulf Power when other large utilities in the US are doing just the opposite and aggressively acquiring? Simply put, two technology bets gone wrong and the significant adverse financial consequences thereof. Related: Is $70 Oil Enough For Shale Drillers?

In 2010 Southern's Mississippi Power subsidiary commenced construction of the Kemper Integrated Gas Combined Cycle power station. The Kemper plant was to be the first of its kind to employ IGCC technology for coal gasification and carbon capture. The bill for the $2.5 billion facility tripled to $7.5 billion after extensive cost over runs and sub par operating performance. The facility limped into service in Mississippi without its gasification unit in efforts to save money. State regulators in Mississippi have not permitted the company to fully earn on this troubled investment.

The Plant Vogtle 3 & 4 nuclear construction project currently under construction in Georgia is likely to come in about 100 percent over budget at a cost approximating $25 billion for the two unit station. That the cost is wildly uncompetitive in today’s power markets is fortunately for SO not at issue. Southern's Georgia Power subsidiary is a monopoly. But regulators even in traditionally supportive Georgia have indicated that excessive nuclear construction costs will not be borne solely by utility customers.

Despite its size, these two regulatory efforts to share the pain of over budget nuclear and clean coal construction have put Southern Company under financial pressure. A substantial amount of debt has been incurred to finance these ill-fated projects not all of which will be supported by future returns on these assets.

Turning these other properties into cash will reduce Southern's considerable debt burden without impairing the company’s core assets or strategy. Perhaps Southern could sell more assets, too. Southern's Nicor gas utility in Illinois, for instance, seems less than critical to Southern’s future. And despite some adverse price pressure in the utility group due in part to interest rate moves, asset prices remain robust for sellers.

NextEra has agreed to pay Southern Company $5.1 billion in cash and to assume $1.4 billion of debt. That price equates to a high 13x earnings before interest, taxes, depreciation and amortization. NextEra’s payment breaks down this way: $4.3 billion in cash for Gulf Power’s equity, $1.4 billion to take on of Gulf Power debt, and another $0.8 billion cash for the natural gas and generation assets. Although Southern has not released an estimate of profit on the sale, we believe that the profit on the Gulf Power portion could go as high as $2.8 billion, pretax. Related: Oil Majors Double Down On Refining

For NextEra, this acquisition continues its efforts to add regulated assets. But also concentrates the company's regulatory risk even more heavily in the state of Florida. While this is not an immediate concern, even the most constructive political and regulatory environments can shift. But this deal is accretive to earnings per share by perhaps 20 cents (2-3%)—which in an industry with no sales growth is a big deal.

But Southern has been no slouch in the M&A department, either, in recent years, it bought half of a gas pipeline run by Kinder Morgan, and acquired AGL Resources (the old Atlanta Gas Light Co.) in an effort to diversify. And at the same time, regrettably (in a financial sense), it invested mightily in both clean coal and new nuclear.

Southern’s consolidated balance sheet shows about $53 billion of debt) and $26 billion of equity. That equates to a rather anemic 33% equity ratio. Which deteriorates even further when subtracting an assumed to be dodgy $7 billion of intangibles and goodwill. In their press release, Southern company's executives made quite clear that they intended to use deal proceeds for holding company debt reduction and that maintenance of credit quality would be their primary focus.

Southern’s recent travails come after much heralded but thus far unproductive bets on an uneconomic "clean" coal and "new" nuclear power generation. As a company Southern will no doubt survive. But it may need to shrink and retrench, as a result of its bets made to expand and improve central station, regulated technology, the business that it knew best.

By Leonard Hyman and William Tilles for Oilprice.com

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