What a Key Analyst Has to Say About Southern Company’s Acquisition

Southern Company is using the power of leverage to buy AGL Resources Inc. (NYSE: GAS), which has sound strategic motivations with the financials working because the equity outlay is low and utility debt is cheap.

According to Credit Suisse, Southern Company still needs to work through all the numbers, but taking its commentary on the growth rate increasing from 3% to 4% to a range of 4% to 5% before synergies or additional gas pipeline capex, plus providing diversification away from the bigger concerns of Kemper and Vogtle construction projects, the firm appreciates the longer-term motivations behind the deal.

Credit Suisse’s struggles with Southern Company remain rooted in the uncertainty of the big construction projects and now what will be about a year of regulatory back and forth on the AGL deal. On August 24, Southern Company announced a definitive agreement to acquire AGL Resources for $66 per share in cash, or a premium of 36%, with a total enterprise value of $12 billion and implied price-to-earnings ratio of 20.5 times on 2017, versus Southern Company’s currently P/E at 14.4. The transaction is anticipated to close in the second half of 2016 and will require approvals from AGL shareholders and state regulators.

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According to Credit Suisse:

Financing will be with $3 billion of equity through a convert and then annual equity issuances under DRIP and DRIBBLE programs through 2019; the other $9 billion will be permanently funded by debt. Southern Company was tight lipped around target credit metrics that they think will be needed to support the current credit ratings but should expect the coverage ratios to be lower (with our quick back of the envelope putting funds for operations (FFO) / Debt below 15% out in 2019) with diversification of mix expected to allow more leverage. We expect the financing plans for AGL to be an ongoing point of discussion / debate amongst investors.

As a result, Credit Suisse maintained an Underperform rating with a $51 price target.

Shares of Southern Company were up 1.2% Tuesday morning, at $44.12 in its 52-week trading range of $41.40 to $53.16. The stock has a consensus analyst price target of $45.64.