Credit analysts slam Southern Co.’s planned purchase of AGL Resources

By David Pendered

Southern Co. plans to take on so much debt to buy AGL Resources that its faces the biggest potential financial nightmare of any of the three utility holding companies that are buying gas companies, according to a new report from Moody’s Investors Service.

AGL Resources, Southern Co.

Southern Co. is to acquire AGL Resources in a deal expected to close in the second half of 2016. Credit: sec.gov

The March 21 report looks at three utility holding companies that have announced acquisition plans – Southern Co., Duke Energy Corp., and Dominion Resources, Inc.

This is how analysts characterize Southern’s plan:

  • “Of the three transactions announced in the past eight months, Southern is most exposed to an immediate decline in financial metrics, given its $12 billion proposed acquisition of AGL Resources … – roughly 10.4x AGL’s 2015 reported EBITDA [earnings before interest, tax, depreciation and amortization] – and the $8 billion of debt initially used to finance the deal.
  • “We estimate that Southern’s holding company debt will rise to about 25 percent of consolidated debt, from around 10 percent before the acquisition. Moreover, of the three holding companies, Southern’s ratio of cash flow to debt will decline the most.”

The biggest issues analysts cite in this wave of acquisitions is the means by which the holding companies are expanding – through significant levels of debt. Their thoughts on this scale of borrowing to finance acquisitions is right there in the first paragraph of the in-depth report on regulated utilities:

  • AGL Southern transaction overview

    AGL Resources is to be the third-largest revenue stream for Southern Co., trailing only No. 1 Georgia Power and Alabama Power. Credit: sec.gov

    “Large US electric utility holding companies are acquiring natural-gas infrastructure assets, in deals designed to diversify revenue and provide growth opportunities not found in the power sector. But added debt and financial risk will offset these benefits for bondholders.”

In addition, the acquisitions by all three holding companies don’t offer much opportunity to reduce operating costs, the report contends. AGL stated as much in a filing with the Securities and Exchange Commission – AGL will retain its board of directors and leadership team, and maintain its corporate office in Atlanta.

Analysts at Moody’s reviewed the potential for cost cutting by Southern and the other two companies and observed:

  • “Utility companies have often touted significant synergies as part of the strategic rationale for [merger and acquisition]; however, we see little synergistic benefit in this wave of electric and gas transactions. While Southern’s, Duke’s and Dominion’s pro-forma financials will benefit from consolidating some corporate functions (IT or accounting, for example), these business combinations have most different operations and geographic locations, which will make cost-sharing difficult. Further, many acquirers have said they plan to maintain operations at the target company’s corporate headquarters, which are typically some of the most easily obtained sources of M&A cost synergies.”
AGL Resources

AGL Resources has 80,000 miles of natural gas pipeline, according to an SEC filing. Credit: sec.gov

The report is not all doom and gloom for Southern. Analysts observe that Southern will benefit from diversifying its core business.

Today, 100 percent of Southern’s revenues come from selling electricity. Once the AGL deal closes, Southern will collect 77 percent of its revenues from electricity and 23 percent from natural gas, according to the Moody’s report.

In this scenario, gas will be Southern’s third-largest revenue source, behind Georgia Power Co. in the No. 1 spot and Alabama Power Co.

The deal also will provide Southern with entirely new gas distribution, transportation, and storage revenue streams, according to the Moody’s report.

Southern’s geographic footprint will expand from four states to seven states, given that AGL delivers gas in states where Southern doesn’t sell electricity.

Finally, the acquisition of AGL will enable Southern to grow in strategic ways, the report states. AGL is expected to add nearly $2.4 billion in distribution and pipeline investment through 2017.

David Pendered, Managing Editor, is an Atlanta journalist with more than 30 years experience reporting on the region’s urban affairs, from Atlanta City Hall to the state Capitol. Since 2008, he has written for print and digital publications, and advised on media and governmental affairs. Previously, he spent more than 26 years with The Atlanta Journal-Constitution and won awards for his coverage of schools and urban development. David graduated from North Carolina State University and was a Western Knight Center Fellow. David was born in Pennsylvania, grew up in North Carolina and is married to a fifth-generation Atlantan.

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