Deals

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

When you're operating in an industry that's consolidating rapidly, it's hard to just stand by.

ITC Holdings, an independent power-transmission company operating in the U.S. Midwest, confirmed late Monday that its board has begun reviewing strategic alternatives which "may result in the company’s possible sale or pursuit of other initiatives to maximize value for shareholders."

The news followed a Bloomberg News report that the $5.8 billion company was exploring sale options, with companies including the UK's National Grid and Spain's Iberdrola considering bids. Warren Buffett's Berkshire Hathaway is another company exploring an offer for the utility, the Financial Times reported on Tuesday. 

The review puts ITC on track for a possible sale that would add to the almost $200 billion worth of utilities transactions across North America over the past two years. (In just one of those deals, Berkshire's energy unit stunned the competition last year when it emerged as the winner of an auction for SNC-Lavalin Group’s AltaLink, an electricity-transmission business in western Canada.) For a middle-of-the-pack company such as ITC, that kind of activity may have been a catalyst for considering whether to enter the fray. 

So what are its prospects as a seller? After climbing 12 percent on this week's news, ITC's forward price-to-earnings multiple has crept up to 17.5, but there's still room for the company to command a premium as high as 40 percent to its 90-day volume-weighted average price of $33.12, based on where recent utility deals have cleared.

Fully Charged
Recent utility deals have commanded relatively high valuations.
Source: Bloomberg

Also boosting the likelihood of a windfall for shareholders is the fact that the sector's average deal premium this year is 53.1 percent, according to data compiled by Bloomberg. Among larger transactions, Southern Co.'s deal for AGL Resources and Duke Energy's purchase of Piedmont Natural Gas were at premiums in the neighborhood of 40 percent.

Regulated utilities such as ITC, which boasts sector-leading Ebitda margins in excess of 70 percent and posted annual sales growth of 8.7 percent last year, are in high demand as larger diversified rivals in the U.S. and abroad hunt for ways to grow. In the U.S., electricity demand is expected to grow by an average of 0.7 percent a year through 2040, according to the Energy Information Administration.

Best in Class
ITC has the highest adjusted return on equity of any U.S. electric network utility.
Source: Bloomberg Intelligence

It's a good time for the company to sell: Rebounding to the record high of $44 it reached in January looks like a tough task given that the Federal Energy Regulatory Commission is expected to deliver a ruling soon that will reduce ITC's industry-leading return on equity, a profitability measure. Based on this headwind, analysts on average predict the stock will be trading at $36.13 this time next year, lower than what it could fetch in a potential deal.

Also, ITC carries a fairly hefty debt load of $4.1 billion, roughly five times its estimated 2015 Ebitda. When interest rates are eventually lifted -- be it this month or next year -- that debt will become slightly more expensive to service. 

ITC is an example of a private-equity backed company that has thrived: it was acquired from DTE Energy in 2002 by KKR & Co. and Trimaran Capital Partners LLC for roughly $610 million, then taken public in 2005. That deal made KKR five times its initial investment, according to the Washington Post, which added that the New York firm required ITC CEO Joe Welch to put his own money into the company. That's a demand he's sure to be grateful for if the company is sold, given his current stake is worth some $85 million. 

Early shareholders are set to earn themselves some private-equity style gains: based on the stock's performance, those that bought it around its July 2005 IPO have nearly tripled their money, or made an annual return of 21.4 percent even without accounting for dividends. 

With the stars seeming to have aligned for a takeover of ITC, the electricity-transmission company could do worse than go with the flow. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net