PPL's U.K. Asset Purchase: Price Matters (PPL)

PPL Corporation (NYSE: PPL) almost seems odd that its shares are trading higher after making such a premium acquisition.  The electric utility is paying more than $5.5 billion to acquire the second largest U.K. electricity distribution operation from Germany’s E.On, and shares are about 2.6% higher at $25.56.  This may be one of those situations where there is more than meets the eye.

The rise in the shares seems to be based on the claim that the deal would be accretive to earnings and because the company will have other cost savings due to its ongoing U.K. operations.

After looking around, the premium paid seems a high price to pay on the surface.  It may just be that there are caveats to the valuation.  Hong Kong’s Cheung Kong Infrastructure was a rival bidder and the terms seem to be at a premium  north of 30% over the asset’s regulatory asset value.  The deal is also higher than other asset premiums, but that might just be part of the better economic environment.  As the economy and the market improves (save the latest pullbacks), the price of poker keeps going up in M&A Land.

Our concern is that PPL may be acquiring this at a time where it seems that long-term rates are more likely to rise rather than fall.  Rising rates generally translate to higher borrowing costs for big capital-intensive utilities which are reliant upon being able to issue debt.  PPL does actually make more sense as an acquirer than say a private equity firm in this case.  After all, it is an operator rather than just a temporary asset owner.

There is a simple question to consider here.  Is outbidding the Chinese smart?  Chinese outfits have been grabbing physical assets whenever they can.  At some point, even the Chinese will allow another bidder to win.

PPL  is going to issue about $2.95 to $3.25 billion in long-term debt to finance the purchase.  Its post-acquisition guidance was also put at $2.50 to $2.75 EPS for 2011, and PPL sees north of $100 million in annual cost savings by 2013.  We may have some concerns over the premium, but value investors seem to be focusing on the notion that shares are still only trading for nine-times to ten-times forward earnings.  It seems that our problem over valuations is probably an issue of considering time horizons.  PPL is probably thinking out for more than a decade.  That is longer than what a private equity outfit would consider.  It is probably longer than yours truly would admittedly consider on the surface.  This is where value investors tend to rise to the occasion.

PPL Corp. was actually raised to “Buy” at S&P Equity Research today, and Thomson Reuters still has  $27.18 for a consensus analyst target.  After a 2.6% gain to $25.56, the 52-week trading range is $23.75 to $29.30.

JON C. OGG