Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Southern Co. is paying some big insurance premiums these days. But it can probably afford it.

At $431 million, Southern's check to acquire PowerSecure International isn't especially large. But the 90 percent premium, all in cash, certainly catches the eye. PowerSecure's stock hasn't traded at $18.75 in almost two years, and even the perennial optimists writing sell-side research on it had an average price target of only $18.14, according to Bloomberg figures.

What is more, this is only the latest in what has been a shopping spree by the traditionally staid Atlanta-based utility.

Southern has now announced at least eight acquisitions since the start of 2015, according to data compiled by Bloomberg, including its $11.9 billion offer for AGL Resources. That deal, with Southern offering 21 times 2016 earnings (again, in cash) for a regulated gas network, raised eyebrows and sank Southern's stock last August.

The multiple on the PowerSecure deal is 30 times. Granted, it is not a utility, but rather counts utilities among its clients; it provides services such as boosting energy efficiency, building backup grids or installing and managing solar projects. So it is a relatively high-growth business, albeit not without its ups and downs:

Powering Up
PowerSecure's annual revenue
Source: Bloomberg
Note: Revenue for 2015 and 2016 are consensus estimates.

Southern's willingness to splurge is simultaneously a defensive move and a display of power.

The defensiveness centers on Southern's struggle to meet its earnings-per-share growth targets. It effectively reset these from a lower base when it announced its 2015 results earlier this month. The big culprit for this was the hit dealt to Southern's regulated asset base by Washington's extension of bonus depreciation at the end of the year, reducing the basis for the allowed return on equity from its utility assets, which comprise the bulk of its earnings.

However, the advent of distributed, non-grid power sources such as rooftop solar panels and increasing energy efficiency present a structural threat to growth in Southern's main business. Part of the problem with fourth-quarter results was a sharp drop in sales to industrial customers. With major capital projects due to roll off soon, too, it will get harder to maintain the credibility of earnings targets.

Acquisitions help offset this. AGL, with its exposure to gas consumption, represents diversification into a business that is still regulated but faster-growing.

PowerSecure, meanwhile -- along with the solar power projects Southern has been scooping up -- lets the utility hedge against the growing threats to its core business of pushing volts. Having an in-house renewables and efficiency services business also gives Southern more capability to both fend off interlopers into its southeastern U.S. service territory and be an interloper itself elsewhere.

And Southern can do all this because it is a major utility with a low cost of equity capital in a world of low interest rates. Indeed, the bonus depreciation extension, while it weighs on earnings, also boosts cash flow due to the tax savings it brings. This is why Southern is able to offer such big premiums.

Whether it should is, of course, another matter and why investors reacted so unfavorably to the big AGL deal in particular. Rival Duke Energy was similarly punished for its high-priced move on Piedmont Natural Gas, a deal struck with a similar rationale to AGL.

PowerSecure looks like a sensible strategic move and, based on the consensus estimate for 2016 net income and assuming no synergies, should be accretive to Southern's earnings this year.

Still, this flurry of deals, along with those eye-popping premiums, carry an implicit warning about the growing challenge to Southern and other electric utilities.

Update: An earlier version of this story incorrectly referred to PowerSecure in two instances as PowerSource.

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

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net