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.

While everyone is focused on the imminent solar eclipse, a black hole appears to have opened up in the vicinity of Dallas. Fortunately, its formidable gravitational pull only seems to affect utilities.

It centers on Oncor Electric Delivery Co., a utility serving Dallas and northern Texas, which is emerging from the bankruptcy of the TXU Corp. buyout-and-bust. On Monday, Sempra Energy announced a $9.45 billion bid for an effective 60 percent stake in the company, making it the fifth known suitor or potential suitor in the past couple of years.

The Hunt family of Texas wanted to buy Oncor and put its assets into a real-estate investment trust. That didn't fly with regulators. Then NextEra Energy Inc. tried to buy it but wouldn't commit to the ring-fencing of Oncor required by state regulators feeling antsy after TXU's collapse. Then, only last month, Warren Buffett strode onto the stage with a lower bid by Berkshire Hathaway Inc. that was a regulator's dream but less welcome to Elliott Management, the biggest creditor of the entity that controls Oncor. Elliott promptly voiced plans to pull together a rival offer.

What do all these people see in a sleepy utility with a regulator modeled on a Victorian chaplain? Growth.

Growth is hard to come by in utility-land given flat or declining electricity consumption in much of the U.S. Here are Sempra's retail power sales over the past decade or so:

Lacking Power
Sempra Energy's retail electricity volume peaked in 2008
Source: Bloomberg

To counteract this, utilities have been merging or diversifying into other businesses that are growing, be it regulated natural-gas networks or unregulated activities like renewable-power projects or overseas.

Sempra has done this, most notably in South American utilities and with the construction of the Cameron liquefied natural gas export terminal in Louisiana. And therein lie a couple of issues.

First, Cameron's start-up has been delayed, with the second slippage announced earlier this month, knocking the stock down that day despite Sempra also reporting strong second-quarter earnings.

This feeds into the second concern. Sempra's growth targets are very attractive for a utility. In May, it outlined plans for earnings per share to rise by 10 percent to 11 percent a year through 2021.

The catch, however, is that a lot of this growth will be coming from businesses other than the core, regulated power and gas operations in California:

Beyond California
Virtually all of Sempra's profit growth is projected to come from the company's international and unregulated businesses
Source: Barclays
Note: Forecasts for net income before corporate eliminations.

By the time the next decade rolls around, the share of earnings from Sempra's U.S. utilities business looks set to drop from almost three-quarters to around half. While the projected profits are welcome to shareholders, they are higher risk than the boring but reliable activity of building and operating wires -- as the Cameron delays unhelpfully demonstrate. So Sempra runs the risk of growing its way into a credit-rating downgrade and likely multiple downgrade of its stock.

Buying Oncor would solve this by not only bulking up in a regulated business, but one where investment has been lagging over the past several years and in an electricity market, Texas, that has actually shown some growth in demand.

NextEra's rationale was identical, but it also struggled to reconcile its needs for dividends and board control to justify the debt it was taken on with the regulator's demands.

How Sempra does this exactly remains to be seen. It won't be going into detail until later this week, with the haste to get the bid in explained by Monday's scheduled bankruptcy court hearing, which was likely going to tip Oncor into Berkshire's loving arms.

For now, though, Sempra is throwing bones all over the place. For the regulator, it is committing to Oncor's investment plan and having seven independent Texans on the utility's board. The word "synergies" doesn't figure anywhere.

In addition, debt at the holding company that controls Oncor is expected to be just $3 billion -- equivalent to less than 2 times Oncor's trailing Ebitda -- and rated investment-grade. Sempra will issue equity to fund part of the deal, capitalizing on its stock, which is trading at a record high. Elliott, which under this new bid would most likely get covered on its position in Oncor's unsecured bonds maturing next year, appears to be on board.

The big question is whether Berkshire, despite noises to the contrary, decides to sweeten its bid. While Sempra is going all out to win local approval, regulators would still likely prefer the man (and balance sheet) from Omaha. Just as Buffett was counting on his reputation for safe, disciplined hands to enable his lower bid, Sempra is counting on his desire to maintain that reputation to let its own, slightly higher one win the day.

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

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

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net