Transcript Valuing a Utility - American Public Power Association

Valuing a Utility
APPA Conference
April 21, 2005
Agenda
1.
Overview/Relevance of Valuation Issues to Public Utilities
2.
Valuation Perspectives in Utilities/Power
3.
Overview of Valuation Methodologies
4.
Illustrative Valuation Analysis
1
1. Overview/Relevance of
Valuation Issues to Public
Utilities
Why Understand Valuation?

Acquisition or Assumption of Service Territory

Divestiture of Generation Assets

Contribution of Assets to Pooling Arrangements

Responding to Questions Related to Residual Equity- “Elected
Officials Have Considered Selling Us.”
2
Capitalization Issues Make Public
Utilities Different
Public Utility
Investor Owned Utility
100%
100%
Debt
Debt
80%
75%
50%
80%
60%
60%
40%
40%
Publicly
Traded
20%
Contributed
Equity
20%
50%
Equity
0%
25%
0%

All equity is rate payor contributed

Equity is investor owned and traded

Most debt is secured by revenues

Debt is secured by assets or unsecured

Average life of debt is long (typically over 15 years)

Tax law impacts use of divestiture proceeds and
acquisition debt types

Many public agencies may not own shares
3
Valuation in the Public Arena is
Influenced by Buyer Type
Public Sector Transactions
Public/Investor Owned Transactions
Acquisition
Cash or
Assets
Public
Agency
Cash
Public
Agency
Cash or
Assets

Acquisition rules for tax exempt funding

Investor
Owned Utility
Assets

Potential taxable funding

Governmental ownership tax free

Assets often are drivers of pilot payments or dividends
Two agencies unrelated

Flexible rules related to disposition of tax exempt debt

Debt structure of two agencies unrelated

Debt restructuring flexibility is often a source of value

Taxes are not a valuation influence
4
Public
Agency
Divestiture
Assets
Public
Agency
Investor
Owned Utility
Cash

Limited ability to accept only cash

Mitigation of tax exempt debt may be costly
2. Valuation Perspectives in
Utilities/Power
Market Themes

Significant outperformance by utility stocks in 2004
 Continued low interest rate environment
 Rising commodity prices benefiting integrated utilities
 Large dividend increases

Interest rate movements likely to be key driver of valuations going
forward

Merchant generators trading at significantly higher multiple than
regulated utilities, but with substantially higher earnings volatility

Utilities with unregulated generation less penalized than in recent past
Understanding the broader public market
is critical when valuing any asset
5
Evaluating the Market:
Illustrative Sector Groupings
“Defensive” Utilities


Offer significant current income
and lower risk profile
Highly correlated to interest
rates
'05E Dividend Yield
'05E P/E
'05E Regulated EPS / Total
'04-'06E EPS Growth
'04-'06E Dividend Growth
6
Source: Equity research.
4.8%
14.4x
83%
5.4%
4.3%
“Integrated” Utilities


Lower current income but
higher potential earnings
growth
“Transitional” Utilities

Diverse risk / reward profile

Expected to migrate into the
other categories over time
Less correlated to interest
rates; more correlated to
commodity prices
'05E Dividend Yield
'05E P/E
'05E Regulated EPS / Total
'04-'06E EPS Growth
'04-'06E Dividend Growth
3.1%
14.4x
55%
13.6%
14.1%
'05E Dividend Yield
'05E P/E
'05E Regulated EPS / Total
'04-'06E EPS Growth
'04-'06E Dividend Growth
4.1%
16.0x
92%
11.9%
3.2%
Utilities: Outperforming the Market
DAILY DATA: DECEMBER 31, 2003 THROUGH APRIL 15, 2005
D o lla r V a lu e
( $ )
1.5
1.4
Integrated
Transitional
Defensive
S&P 500
1.3
‘03-’04
27.6%
19.2%
11.8%
9.7%
’05 YTD
13.8%
5.4%
(3.7)%
(6.3)%
1.2
1.1
1.0
Feb
7
Mar
Apr
May
Jun
Jul
Aug
Sep
Oc t
Nov
Dec
"Defensive" Index: AEE, CIN, NST, PNW, PGN, SO, WR, XEL
"Integrated" Index: CEG, D, EIX, ETR, EXC, FPL, SRE, TXU
"Trans itional" Index: AEP, CMS, DUK, FE, PCG, PEG, SRP, TE
S&P 500
Source: Equity research.
Jan
2005
Feb
Mar
Apr
Current Valuations Appear Full
1-Yr Fwd P/E
14.8x
1-Yr Fwd P/E Relative to S&P 500
15.7x 15.9x
0.83x 0.86x
13.7x
13.0x
0.88x
0.92x
0.87x
0.93x
13.8x
7.5x 7.3x
0.32x 0.30x
0.29x
5.8x
Historical Low
Historical High
Defensive
8
Integrated
Current
Transitional
Source: Equity research.
Note: Historical high / low reflects January 1989 through April 2005 statistics.
Historical Low
Historical High
Defensive
Integrated
Current
Transitional
Interest Rates vs. Dividend Yield:
Implication for Sector Valuations
Dividend Yield & Treasury Rates
Sustainability of Elevated P/Es

6.5%
1994
6.0%
1995
1996
5.5%
UTY Dividend Yield
With a large portion of regulated cash
flows and high payout ratio, large cap
utility market values trend to be highly
correlated with treasury yields
• Spread to Treasury is a large
1997
component of sector valuation
5.0%
2000
4.5%

Correlation implies that elevated P/Es
may not be sustainable in a rising
interest rate environment

Sector valuation may come under
pressure if interest rates rise as
expected
1999
2002
1998
4.0%
2003
2004
2001
3.5%
3.0%
3.0%
3.5%
4.0%
4.5%
5.0%
5.5%
10-yr Treasury
9
6.0%
6.5%
7.0%
7.5%
ROE Trends – Electric Utilities

ROEs have declined, but not as much as interest rates

Fewer equity return determinations in recent years relative to the 1980’s and early 1990’s, but more
data points in early 2005
ROE Trend vs Interest Rates
8%
Trend in # of Determinations
13%
45
12%
11%
11%
5%
10%
4%
10%
9%
3%
9%
2%
8%
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Average 10-Year Treasury
10
Average ROE's
Source: Regulatory Research Associates.
Note: Dotted line reflects 1Q 2005 annualized.
1Q
2005
40
No. of Determinations
6%
Average ROE's
Average 10-Year Treasury
12%
7%
35
30
25
20
15
10
5
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
1Q
2005
Current Market Valuations by
Strategy
Fwd P/E (2006E)
LTM EBITDA
17.3x
13.8x
13.7x
13.9x
9.0x
11
Regulated
Utilities
Utilities with
Material Unreg
Generation
9.1x
14.8x
7.6x
Distribution
Utilities
8.9x
Gas
Distribution
Generation
Merchants
Note: Data as of April 15, 2005. EPS estimates reflect IBES consensus.
Distribution
Utilities
7.7x
Regulated
Utilities
Utilities with
Material Unreg
Generation
Gas
Distribution
Generation
Merchants
U.S. Utility M&A Activity
$70,000
$60,000
$13,039.8
$50,000
$16,451.9
$13,643
$ in million
$40,000
$22,773.9
$8,506.7
$12,868.1
$30,000
$9,265.2
$2,018.0
$3,915.0
$20,000
$27,356.6
$18,033.0
$11,346.6
$22,551.0
$7,643.2
$10,000
$293.5
$7,227.8
$17,387.8
$21,413.4
$919.9
$194.3
$1,107.1
1995
$1,541.0
$1,237.5
1996
1997
1998
Electric T&D
12
Note: Excludes terminated deals.
$7,780.1
$7,655.1
$4,745.5
$0.0
$8,626.1
$2,881.0
$6,255.4
1999
Gas LDC
2000
Integrated
2001
Generation
$4,044.6
$852.2
$2,350.0
2002
2003
$3,379.1
2004
2005 M&A Predictions
Corporate Utilities
 Exelon / PSEG transformation to provide stimulus to other merger discussions
 “Back-to-basics” strategies to be overtaken by renewed focus on growth
 Regulators continue to make industrially logical mergers more difficult than they should be
 Political pressure to keep end-user energy prices contained in continued high commodity
price environment will facilitate some cost-reducing consolidation activity
 Foreign interest revived by Dollar weakness
 Return to levels of M&A activity experienced in late 1990s
Contracted Generation
 High yield markets to provide competitive alternative to outright sales
Merchant Generation
 Emergence of multi-fuel, multi-regional generators with significant scale
 Continued divergence of valuations between CCGT and coal/nuclear operators
 Further migration of trading and marketing to Wall Street
13
3. Overview of Valuation
Methodologies
Valuation Overview

Valuation is 25% quantitative analysis and 75% qualitative
considerations
 Sophisticated M&A practitioners look beyond financial models
 The math is relatively straight-forward; the interpretation and the
inputs are not

Judgment always needs to be applied to ensure the inputs are
appropriate and the results meaningful

Multiple methodologies are typically used to “triangulate” to a
valuation conclusion
14
Overview of Primary Valuation
Methodologies
Public Mkt Multiples
Private Mkt Multiples
Discounted Cash Flow

Based on multiples at which
comparable companies
currently trade

Based on multiples paid for
comparable targets in
previous M&A transactions

Based on the companyspecific projections and
outlook for the future

Valuable benchmark for M&A
valuation

Critical benchmark for M&A
valuation

Theoretically most closely
approximates intrinsic value

Reflects collective wisdom of
market given current
conditions

Reflects value of “control”

Relies on analogy



May ignore relevant
company-specific factors
Affected by market
conditions at the time
Highly dependent on
accuracy of projections

Affected by transaction
structure and synergies

Terminal value often
comprises large %age of
present value
15
Key Considerations:
Multiples-Based Valuation Analyses

For public market valuation analysis, the key factor is selecting “comparable”
companies, and applying the data

In a private market valuation analysis, same considerations plus transaction
structure and timing considerations

Key considerations for selecting comparable companies include:
Qualitative
Quantitative

Business mix (e.g. % regulated)

Growth prospects

Composition of customer base

Profitability

Geographic mix

Size / scale

Allowed rate of return / rate
stability

Capital structure

Liquidity

Regulatory environment

Quality of management
16
Key Operating Metrics for
Multiples-Based Valuation Analyses
Regulated T&D
Integrated Utility
Generation

Forward earnings

Forward earnings

EBITDA

Tangible book value

EBITDA

Forward earnings

Rate base

Tangible book value

Capacity ($ / kw)

Customers

Rate base
17
Key Considerations:
DCF Valuation Analysis

Three drivers of discounted cash flow valuation analysis:
 Forecasted unlevered free cash flows
– Underlying assumptions
– Timeframe: specified number of years up to the life of asset
 Terminal value assumption if forecast cash flows < life of asset
– Apply a public market multiple
– Apply a perpetuity growth rate
 Discount rate assumption
– Reflects a long-term target capital structure
– Reflects the long-term cost of the related debt and equity,
raised in today’s environment
18
Other Key Considerations

Cost of capital advantage of tax-exempt entities relative to IOUs

Perceived competition for the asset

Competitors ability to pay

“Premium” paid

Potential synergies

Other items of potential value
 Basis step-up in an asset deal
 Net operating losses that go with the stock
19
4. Illustrative Valuation
Analysis
Summary Valuation Analysis:
Regulated Electric T&D Asset
Private Market
$1,940
$2,295
$2,165
DCF
$1,000
$2,160
$1,925
Public Market
$1,300
$1,600
$1,900
Equity Value
20
Note: Green bar reflects estimated incremental value associated with a 2007 rate case.
$2,375
$2,200
$2,475
$2,500
$2,800
Multiples-Based Valuation
Public Market Valuation
Operating
(Dollars in m illions, except per share d ata)
Data
Equ ity Valu e/
2005E Earnings
2006E Earnings
LTM Tangible Book Valu e
$140
150
1,000
Private Market Valuation
(Dollars in millions, except per share d ata)
Multiple Range
Low
14.0x
13.5
1.8
----
15.0x
14.5
2.2
Low
$3,600
3,675
3,700
High
$2,100
2,175
2,200
Med ian
Mean
$1,960
1,928
---
$2,175
2,158
Selected Reference Range
$1,925
--
$2,160
Multiple Range
----
Implied Equity Value
Low
----
Low
$3,460
3,525
3,300
High
$1,960
2,025
1,800
Operating
Data
Implied Firm Value
High
Implied Firm Value
High
Low
High
Implied Equity Value
Low
High
Firm Value/
N et Rate Base
Customers ('000)
$2,000
1,000
1.8x
3.5
---
2.2x
4.0
$3,600
3,500
---
$4,400
4,000
$2,100
2,000
---
$2,900
2,500
Equity Value/
LTM Tangible Book Value
$1,000
2.0x
--
2.5x
$3,500
--
$4,000
$2,000
--
$2,500
Med ian
Mean
$2,000
1,942
---
$2,200
2,292
Selected Reference Range
$1,940
--
$2,295
21
Public Market Comparables
Valuation Multiples
(US Dollars in Millions, Except Stock Price)
Equity
Stock
% of 52 Week
Company
Price (a)
High
Low
Value
Consolidated Edison (ED)
Pepco Holdings, Inc. (POM)
Energy East (EAS)
NSTAR (NST)
Great Plains Energy (GXP)
Puget Energy (PSD)
$41.84
21.03
26.12
54.74
30.31
22.03
(8.2)
(9.5)
(3.5)
(7.8)
(11.3)
(11.2)
12.4
24.1
19.5
20.8
8.8
7.4
Consolidated Edison (ED)
Market
Price /
Firm
Net Income (c)
LTM
EBIT
LTM
2005E
2006E
Book
$10,176
3,952
3,837
2,913
2,253
2,196
$17,364
9,968
7,582
5,278
3,451
4,802
18.7
16.1
9.0
15.7
15.7
19.3
14.7x
14.1
14.5
14.8
14.6
16.0
14.1x
13.4
14.0
14.2
15.1
14.9
1.5x
2.0
3.4
2.9
2.1
1.5
9.8x
8.6
6.5
7.4
7.4
7.8
14.2x
13.7
10.1
11.4
11.8
12.9
LTM
High:
(3.5%)
24.1%
--
--
19.3x
16.0x
15.1x
3.4x
9.8x
14.2x
Median:
(8.9)
16.0
--
--
15.9
14.6
14.2
2.1
7.6
12.3
Mean:
(8.6)
15.5
--
--
15.8
14.8
14.3
2.2
7.9
12.3
Low:
(11.3)
7.4
--
--
9.0
14.1
13.4
1.5
6.5
10.1
(8.2)
12.4
$10,149
$17,236
14.7x
14.1x
1.5x
9.7x
14.1x
$41.84
18.5x
LTM: Latest Twelve Months as of 09/30/04.
(a) Stock price as of April 1, 2005.
(b) Firm Value equals equity value plus straight debt, minority interest, straight preferred stock, all out-of-money convertibles, less cash.
22
Tangible EBITDA
Value (b)
Note: EBITDA, EBIT, Net Income to Common, and EPS adjusted for unusual and nonrecurring items.
(c) I/B/E/S EPS estimates as of April 1, 2005.
Firm Value /
Private Market Comparables
(Dollars in Millions)
Date
Announced/
(Completed)
Target (Parent)
Acquiror
Target Equity
Value
Aggregate
Value
Equity Value /
Net Income
Tangible
LTM
Book Value
Aggregate Value / LTM
Total
"Net Rate
EBITDA
Customers
Base" (a)
25-Jul-04
(Pending)
3-Feb-04
(10-Jan-04)
3-Nov-03
(Terminated)
TNP Enterprises, Inc
PNM Resources
$189
$1,024
NM
NM
9.1x
$4,063
2.3x
Illinois Power (DYN)
Ameren
$500
$2,355
4.2x
0.3x
7.9x
$3,623
2.2x
Illinois Power (DYN)
ComEd
$425
$2,335
4.3x
0.3x
7.5x
$3,592
20-Feb-01
(28-Jun-02)
RGS Energy
Energy East
$1,385
$2,399
#DIV/0!
15.1x
NM
1.9x
#DIV/0!
7.4x
12-Feb-01
(1-Aug-02)
Conectiv
Potomac Electric Power
$2,200
$5,381
13.6x
2.7x
7.2x
$5,067
2.2x
2-Oct-00
(15-Feb-02)
MTP Utility Operations
NorthWestern Corp.
$602
$1,306
3.8x
0.7x
4.4x
$2,974
1.0x
5-Sep-00
(31-Jan-02)
Niagara Mohawk
National Grid
$3,048
$8,936
NM
1.1x
11.6x
$4,176
2.1x
8-Aug-00
(6-Nov-01)
GPU, Inc.
FirstEnergy
$4,441
$10,788
12.1x
4.2x
8.0x
$5,394
1.9x
30-Jun-00
(10-Oct-01)
Bangor Hydro Electric
NS Power Holdings
$206
$383
12.2x
1.5x
7.5x
$3,581
1.7x
Northeast Utilities
Consolidated Edison
$3,311
$7,940
7.8x
$4,671
15-Jun-99
(5-Sep-00)
CMP Group
Energy East
$964
$1,541
7.3x
$2,908
1-Feb-99
(24-Apr-00)
Eastern Utilities Associates
New England Electric System
$634
$1,121
8.4x
$3,712
14-Dec-98
(23-Mar-00)
New England Electric System
National Grid Group
$3,217
$4,755
6.7x
$3,657
7-Dec-98
(25-Aug-99)
Commonwealth Energy System
Boston Edison
$950
$1,575
8.8x
$2,608
11-May-98
(8-Jul-99)
Orange & Rockland
Consolidated Edison
$791
$1,325
9.7x
$3,459
New York State Electric & Gas
CalEnergy
$1,884
$3,645
5.9x
$3,485
13-Oct-99
(Terminated)
15-Jul-97
(Terminated)
Note: Shaded areas represent transactions of greater than $1 billion targetequity value.
(a) Net Rate Base equals net utility PPE minus deferred taxes plus working capital.
23
2.1x
#DIV/0!
$3,651
2.5x
#DIV/0!
1.8x
1.6x
Discounted Cash Flow Analysis
Projected Fiscal Year Ending December 31,
2005
2006
2008
2009
Net Income
Net Interest Expense / (Income)
Marginal Tax Rate
Financing Tax Shield
Earnings Before Interest
$99.7
50.0
39.0%
(19.5)
$130.2
$150.0
70.0
39.0%
(27.3)
$192.7
$162.2
75.0
39.0%
(29.3)
$208.0
$168.7
75.0
39.0%
(29.3)
$214.5
Depreciation
Amortization
Increase in Deferred Taxes
Other
Change in Net Working Capital
Capital Expenditures
Unlevered Free Cash Flow
53.4
25.0
0.0
0.0
1.0
(100.0)
$109.7
100.0
50.0
0.0
0.0
(5.0)
(150.0)
$187.7
100.0
100.0
0.0
0.0
(5.0)
(150.0)
$253.0
100.0
100.0
0.0
0.0
(2.0)
(125.0)
$287.5
(Dollars in Millions)
Terminal Net Income
$168.7
Terminal P/E Multiple Range
14.5x
14.8x
15.0x
15.3x
Terminal P/E Multiple Range
15.5x
14.5x
14.8x
15.0x
15.3x
15.5x
Terminal Firm Value
$3,697
$3,739
$3,823
$3,865
$3,855
3,780
3,706
3,635
3,565
Firm Value as of 4/15/05
$3,889
$3,922
$3,955
3,812
3,845
3,877
3,738
3,770
3,801
3,666
3,697
3,728
3,595
3,626
3,656
$3,988
3,910
3,833
3,759
3,686
WACC
5.3%
5.8%
6.3%
6.8%
7.3%
WACC
5.3%
5.8%
6.3%
6.8%
7.3%
24
2.4x
2.3
2.2
2.1
2.1
$3,781
Implied Price / Tangible Book
2.4x
2.4x
2.5x
2.3
2.3
2.4
2.2
2.3
2.3
2.2
2.2
2.2
2.1
2.1
2.2
WACC
5.3%
5.8%
6.3%
6.8%
7.3%
$2,355
2,280
2,206
2,135
2,065
WACC
2.5x
2.4
2.3
2.3
2.2
(a) Equity Value equals Firm Value less total straight debt and preferred stock, plus cash.
5.3%
5.8%
6.3%
6.8%
7.3%
16.8x
16.3
15.8
15.2
14.7
Equity Value as of 4/15/05 (a)
$2,389
$2,422
$2,455
2,312
2,345
2,377
2,238
2,270
2,301
2,166
2,197
2,228
2,095
2,126
2,156
Implied P/E (2005E)
17.1x
17.3x
16.5
16.7
16.0
16.2
15.5
15.7
15.0
15.2
17.5x
17.0
16.4
15.9
15.4
$2,488
2,410
2,333
2,259
2,186
17.8x
17.2
16.7
16.1
15.6
WACC Analysis
Low
High
Cost of Equity
U.S. Risk Free Rate (30 Year U.S. Treasury)
Betas
4.73%
4.73%
0.82
eas
0.59
Equity Market Risk Premium
5.50%
7.50%
ed
0.50
Equity Beta
0.66
0.66
nst
0.65
Adjusted Equity Market Risk Premium
3.63%
4.95%
psd
0.72
gxp
0.67
Average
0.66
Cost of Equity
8.36%
9.68%
4.45%
4.45%
0.70%
0.70%
5.15%
5.15%
Effective Marginal Tax Rate (b)
Cost of Debt (Aftertax)
39.00%
39.00%
3.14%
3.14%
Debt/Capitalization (Market)
50.00%
50.00%
5.75%
6.41%
Cost of Debt
U.S. Risk Free Rate (10 Year U.S. Treasury)
(a)
Credit Spread
Cost of Debt (Pretax)
WACC
(a) Provided by Citigroup Fixed Income Capital Markets.
(b) Assumed tax rate.
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pom
6.1%
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