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.

During M&A booms like the one we're in, acquirers become accustomed to seeing their shares rise as investors cheer the pursuit of growth. For Fortis, however, the reception towards its biggest-ever purchase couldn't have been cooler.

After agreeing to buy Midwestern power-transmission company ITC Holdings for $6.9 billion, the Canadian utility sank as much as 12.8 percent and lost more than $1 billion in market value, its biggest single-day decline since the company was formed in 1987. ITC is expected to add 5 percent to Fortis' earnings per share in the first full year following the deal's completion, and that should hearten investors. But as Bloomberg Gadfly's Liam Denning has pointed out, the market doesn't reward growth at any price.

Switching Off
The utility stock fell by the most in its 29-year history after it said it would buy ITC.
Source: Bloomberg

The deal values ITC at $44.90 a share, easily above the consensus analyst price target on the stock, and also represents a forward price-to-earnings multiple of 20. That's in line with the lofty valuations ascribed to recent deals, and justifies ITC's decision to seek out a buyer at a time when its larger rivals are starved of growth and debt is cheap. But borrowing isn't going to be cheap forever, and the fact that Fortis shareholders are fleeing suggests that they aren't overly enthused about the company lifting its debt burden to more than $15 billion from some $9.1 billion, even though it plans to maintain an investment-grade credit rating.  

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

There's another wrinkle: As part of the deal financing, Fortis needs to find an infrastructure fund (or funds) to write a check of between $1 billion and $1.4 billion in return for a stake in ITC of between 15 percent and 19.9 percent. While underbidders could step up (Borealis Infrastructure Management is said to be one, according to Bloomberg News), it's unclear why Fortis didn't pre-select a partner. If, for whatever reason it is unable to find one, Fortis said it could issue equity (which will dilute existing shareholders) or sell assets (at which time it'll be a forced seller), both seemingly sub-optimal alternatives. 

Sure, ITC's earnings and cash flow will help Fortis meet its targeted annual dividend growth rate of 6 percent through 2020, providing a buffer if the company's planned capital expenditure of some C$9 billion ($6.5 billion) doesn't pay off. 

But paying up for a buffer doesn't sit well with shareholders and should provide a reminder for other potential buyers in the utilities sector and otherwise: Prepare to be punished if the price isn't right. 

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