SRE: We like strategic direction of Oncor acquisition; not sure of financing

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Market Price (8/21/2017): $118.40; ST-Target: $165/share; NIV: $210/share

  • Strategically, we believe this is a good deal for SRE’s investors: The five year $7.5B investment program at Oncor should be accretive to SRE’s earnings and help raise the value of SRE. More than anything else, we believe that SRE paid just the right amount to win the bid, but not be strapped with the infamous “Winner’s Curse,” in our opinion. However, SRE’s choice to finance part of the deal with debt may be something that needs some explanation, in our opinion, based on some basic math.
  • Deal terms: Although details were scant, it seems SRE would buy 100% of Oncor’s ultimate parent, Energy Future Holdings Corp. (EFHC), for $9.45B in cash, resulting in an EV for Oncor of about $18.8B.
  • Third-party investor(s) for risk mitigation:
  • Based on some simple calculations, we believe that SRE paid just about the right amount for the deal:
  • SRE’s ultimate ownership: Sale to a 3rd-party investor(s) would leave SRE with total equity interest in EFHC of some 60% and, therefore, a 48% non-controlling interest in Oncor (EFHC currently indirectly owns an 80.03% equity interest in Oncor).
  • Depending on the tax rate at EFHC, debt financing may or may not be accretive to ROE:
  • Oncor’s CAGR in net income from 2016-to-2018 must be above 7.06% for SRE’s 2018 AEPS to be breakeven or higher:
  • Conclusion: We always believed that this transaction could be good for SRE, but circumstances had not prevailed on management to allow for SRE to submit a winning bid. However, given the price and the way it was structured, we believe that this transaction is good for SRE’s shareholder value, and strongly support management’s decision to make the acquisition.

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