Deals

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.

TransCanada just bought the enemy. When rumors first surfaced last week that the Canadian firm might buy Columbia Pipeline Group, I explained here how a deal would help TransCanada defend against U.S. shale gas muscling into its home market. It turns out the deal is even more defensive than that.

TransCanada is valued chiefly for being -- how to put this politely? -- boring. And boredom is really in fashion when it comes to the energy business; those wild-and-crazy types who gorged on debt and risky assets in the pipeline and oil and gas sectors just aren't very welcome right now. Meanwhile, utilities are the second-best performing group in the S&P 500 so far this year.

Even with a $13 billion all-cash deal, TransCanada seeks to retain that humdrum crown. How? It's all about the financing.

Columbia Pipeline comes at a premium, but TransCanada did at least wait until expectations had come down quite a bit (you'll notice its own multiple has remained reassuringly flat through the last nine months of turmoil).

Choosing the Moment
By mid-February, Columbia's premium to TransCanada had shrunk from 7 times Ebitda to less than 1.
Source: Bloomberg

It is clear that TransCanada is being opportunistic because of the way it is financing the deal. Part of the check is to be funded by selling the company's fleet of merchant power plants in the northeastern U.S. And, as my colleagues at Bloomberg News pointed out, only six weeks ago the company closed on the $657 million acquisition of one of those plants, the Ironwood facility in Pennsylvania.

This volte face is interesting because merchant generation is one of the few bits of TransCanada that isn't boring. This business is all about trading in the wholesale electricity market rather than signing long-term contracts charging fees to use pipelines. Explaining the move during Thursday evening's presentation, TransCanada's chief financial officer said ditching the plants would further "de-risk" the business.

Recent deals, such as Dynegy's tryst with Energy Capital Partners to buy a fleet of power plants, also suggest TransCanada should get a reasonable price. The plants made about $500 million of Ebitda last year, which at a multiple of 8 times would bring in enough cash to fund a third of the cost of buying Columbia Pipeline. Meanwhile, TransCanada also sold new shares, which should bring in another C$4.4 billion, enough to fund 28 percent of the cost. Its plan to sell part of its Mexican pipeline assets could raise perhaps another C$2 billion or so.

Altogether, these would cover about 75 percent of the cost of buying Columbia Pipeline. Obviously, some profit streams would go with the assets being sold. Still, assume TransCanada gives up roughly C$900 million of Ebitda, throw in its synergy target and assume a cost of debt of 4.5 percent, and even with the new shares factored in, consensus forecasts imply the deal would break even or perhaps modestly add to earnings in 2017. What's more, TransCanada's pro-forma net debt would rise to just 5.4 times Ebitda from its current 5.1 times.

So TransCanada is playing to its stodgy strengths. Co-opting one of the biggest competitive threats to its main pipelines business will be valued far more by its shareholders than continuing to build a more volatile side business in power trading. It is notable that the stock, while lower on Friday, is still comfortably above the C$45.75 level at which the new shares were sold.

What's more, that same pipeline business, by helping to connect the giant Marcellus shale basin with customers, puts even more downward pressure on already-battered natural gas prices -- which, by extension, may also weigh on power prices. It is far better right now to be in the business of shipping gas around rather than actually trading the stuff.

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