Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. As utility ITC Holdings (ITC) continues to look for a buyer, I'm here with Matt Coffina--he's the editor of Morningstar StockInvestor newsletter--for his take on how investor should think about companies that are putting themselves up for sale.
Matt, thanks for joining me.
Matt Coffina: Thanks for having, Jeremy.
Glaser: Let's start with ITC, specifically. Why are they looking for a buyer right now?
Coffina: I think ITC is just looking around at the market and realizing this is a great time for a small or midsize utility to sell itself. We saw Duke (DUK) make a bid for Piedmont Natural Gas (PNY) at more than 30 times earnings. Southern Company (SO) made a bid for AGL Resources (GAS). In both cases, the premiums over the previous stock prices were about 40%. So, buyers are willing to really pay up for small and midsize utilities, and I think that's, in part, a function of the low-interest-rate environment. People want to take advantage of that while it lasts. Secondly, a lot of utilities are just looking for growth, and those larger electric utilities where you haven't seen a lot of load-demand growth are looking to natural gas infrastructure and electricity transmission--which is ITC's business--because there is a lot more growth in those areas.
Glaser: What do you think the most likely outcome is here? Will they able to find a buyer?
Coffina: I think it's very likely that companies will be interested in acquiring ITC. It could be a larger utility; some international utilities have been rumored. But it could also be a private-equity fund or an infrastructure fund. Berkshire Hathaway (BRK.A)(BRK.B) has shown some interest in transmission assets. So, I think there are a lot of potential bidders out there, and ITC has a great growth outlook relative to other utilities. We're looking for double-digit or close-to-double-digit earnings growth over the next five years. They have a very large backlog of potential capital projects. They have been very well managed historically. They have a very favorable regulatory framework, which really limits their risk and increases their returns on capital.
So, there is some uncertainty about whether they'll get an offer and whether they'll find the offer acceptable, but I think it's likely that they will get an offer. I would like for price somewhere around $45 a share or higher. I would be surprised if management accepts at anything less than that, which would be about a 33% premium to where the stock was trading before these rumors began.
Glaser: So, generally speaking, if you own a company that's put itself up for sale or that gets put into play for whatever reason, what do you think is the best way to approach it? Should you sell after that initial pop? Do you hold on until the offer actually comes? How do you make that decision?
Coffina: I think it really depends on the situation. In this case, our fair value estimate for ITC was $42 a share. The stock was in the low thirties before these rumors began, so we thought that it was a really compelling value on its own. Even if a deal fell through, I would still be happy hold ITC at the current price. I think that's really the key. If an acquisition rumor comes through and the stock starts trading well above what you think it's worth on a standalone basis, then you might just take that as a little bonus and just get out before you actually have information about whether a deal is going to happen or not. But if you are comfortable holding the stock even if the deal falls through, that really gives you the flexibility to wait and see what happens. In this case, again, I think ITC--in an acquisition scenario--is worth at least $45 a share. There is still about 15% upside if that comes to pass. If it doesn't, the stock is still trading right around or slightly below our fair value estimate. So, in this particular circumstance, I'm happy to hold, but other circumstances can certainly be different.
Glaser: So, as with a lot of things, valuation is key.
Glaser: Matt, thanks for your thoughts on this today.
Coffina: Thanks for having me, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
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