DPL Deal Stops at Lowest Premium for Widest Margins: Real M&A

DPL Deal Stops at Lowest Premium for Widest Margins
A Dayton Power and Light Co. facility stands in Moraine, Ohio. Photographer: Jay LaPrete/Bloomberg

DPL Inc. shareholders may be pining for the days when utilities were dull and predictable after the partial deregulation of the Ohio market consigned them to the industry’s lowest takeover premium.

AES Corp., a power utility with operations in 28 countries, agreed to buy Dayton, Ohio-based DPL for $30 a share -- a 9.5 percent premium, the cheapest ever for an all-cash takeover of a U.S. electric utility, according to data compiled by Bloomberg. The $4.6 billion deal including net debt values DPL at 7.2 times earnings before interest, taxes, depreciation and amortization in the last 12 months, lower than the industry median of 7.5.

While the shares surpassed the acquisition price, investors may not be able to count on a sweetened offer or rival bid for the company with the highest profit margin among similar-sized utilities. Earnings at DPL, a regulated power supplier with more than 500,000 Ohio customers, are projected to fall 4.4 percent this year after rivals were allowed to enter the market and companies like FirstEnergy Corp. pressured pricing.

“They looked and saw very limited growth and they took this premium,” said William Costello, a Dallas-based utility analyst and fund manager at Westwood Holdings Group Inc., which oversees $10 billion including 2.7 million DPL shares. “I would like to see them raise it, but I don’t think they’re going to have to. I don’t envision another company coming in to bid for it. There’s not that many people that would find Ohio attractive.”

Yesterday’s Trading

Lucas Bushman, a spokesman for AES, didn’t respond to a request for comment. A representative for DPL didn’t respond to e-mails requesting comment.

AES of Arlington, Virginia, announced yesterday that it would pay $3.5 billion for DPL’s equity and assume more than $1.1 billion in debt, data compiled by Bloomberg show. The deal, which is expected to close in the next six months to nine months, was unanimously approved by both boards and still requires signoff from shareholders and regulators.

DPL climbed 9.4 percent to $30.17 yesterday, or 17 cents above the offer price, indicating some investors may expect a marginally higher bid. AES gained 3.3 percent to $12.88 after the announcement, the biggest increase in a month.

AES’s $30-a-share bid is 9.5 percent higher than DPL’s 20-day trading average prior to the announcement. That’s one-third of the average 29 percent offered in all-cash takeovers of U.S. electric utilities focused on integration and distribution since at least 1998, data compiled by Bloomberg show.

No Bidding War

“I don’t foresee a bidding war over an Ohio regulated utility,” said Walter Todd, who helps manage $950 million at Greenwood Capital Associates in Greenwood, South Carolina. “AES is much more globally diversified. They can utilize the stable cash flow from a business like DPL and use that to fund more growth-oriented acquisitions elsewhere.”

AES is getting a company that is generating about 15 cents of net income for every dollar of sales, the highest profit margin among comparable U.S. electric utilities with market values between $1 billion and $10 billion, according to data compiled by Bloomberg. DPL’s operating margins are also the highest, at almost 27 percent, the data show.

The company’s earnings climbed 24 percent to $2.50 a share last year as a strengthening economic recovery and warmer-than-normal weather drove demand, Chief Executive Officer Paul Barbas said on a Feb. 18 conference call.

‘The Story’

“DPL seems to execute well,” said Bill Bunn, a Cincinnati-based portfolio manager and utility analyst at Fort Washington Investment Advisors Inc., whose parent Western & Southern Financial Group manages about $30 billion. “That seems to be the story over time.”

Still, “if I was a small utility in the Midwest, I’d be a little bit nervous about the future, especially in Ohio. They’re facing an uphill battle in holding their margins,” he said.

Ohio was one of the U.S. states that moved toward electric-utility deregulation in the 1990s, betting that competitive markets would improve efficiency and lower prices after a round of rate cuts. Ohio hasn’t completed the transition and is left with a hybrid model that has a mix of regulated and deregulated market segments, Bunn said.

“Ohio has allowed other companies to come in and undercut their prices and open it up to competition,” Westwood’s Costello said. “It’s kind of a really messed up utility situation in there.”

In a regulated market, utility providers can pass costs incurred along to customers by raising rates while the state monitors the prices so that the providers aren’t earning excessive returns.

Duke Energy

The deregulated portion of the Ohio power market has drawn companies such as Charlotte, North Carolina-based Duke Energy Corp. into the mix. Duke CEO James E. Rogers said in an interview on Sept. 21 that the company was considering selling $3.84 billion of power plants in Ohio after profit margins narrowed and customers switched suppliers.

FirstEnergy in Akron, Ohio, and American Electric Power Co. of Columbus, Ohio, are also providers in the region.

“The issue with DPL has been, what do they make when the next rate agreement comes up in 2013 and 2014,” David Parker, a Tampa, Florida-based analyst for Robert W. Baird & Co. said. “No one knows. AES was able to take that risk.”

DPL’s earnings are projected to drop 4.4 percent to $2.39 a share this year, according to the average of four analysts’ estimates compiled by Bloomberg.

AES may be pursuing DPL in part for its proximity to one of AES’s Midwest assets, Fort Washington’s Bunn said. AES owns Indianapolis Power & Light, about a two-hour drive from Dayton.

Turkey, Latin America

It may also be a way to offset AES’s international investment risks in countries such as Turkey, according to Bunn. AES said on Dec. 1 it will buy almost half of Turkish utility Entek Elektrik Uretimi AS for $136.5 million to form an energy partnership with Koc Holding AS in Istanbul.

AES generated 69 percent of its $16.65 billion in revenue last year in Latin America and 19 percent in North America, according to data compiled by Bloomberg. The deal would boost its North American sales by 60 percent.

DPL agreed to pay $53 million if it rejects the AES merger in favor of a higher offer within 45 days, and a fee of $106 million if it takes a higher offer after that.

UBS AG of Zurich and New York-based Cadwalader Wickersham & Taft LLP are advising DPL on the transaction. Charlotte, North Carolina-based Bank of America Corp. and Skadden Arps Slate Meagher & Flom LLP of New York are counseling AES.

Overall, there have been 7,526 deals announced globally this year, totaling $729.3 billion, a 31 percent increase from the $556.9 billion in the same period in 2010, according to data compiled by Bloomberg.

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