Fitch Places Duke Energy Ratings on Rating Watch Negative Following Acquisition Announcement
The cash offer will be financed with a combination of DUK corporate debt and equity and cash. Management indicated the equity portion of the funding will range between $500 million and $750 million. Potential sources of cash include $300 million from its international businesses and approximately $650 million in the form of dividends from subsidiary Duke Energy Florida, Inc. following a planned securitization of the Crystal River 3 (CR3) regulatory asset. The purchase price equates to a 40% premium over Piedmont's Oct. 23, 2015 closing stock price and approximately 12.2x EBITDA for the 12 months ended July 31, 2015.
The ratings of DUK's subsidiaries are unaffected by this transaction. Post-closing, Piedmont will become a direct subsidiary of DUK.
KEY RATING DRIVERS
Financing plan: The preliminary financing plan includes a large debt component that increases consolidated debt leverage compared to Fitch's previous base case, which assumed debt/EBITDAR would fall below 4.5x and accounts for the Negative Watch. It also increases parent level debt from approximately 30% of adjusted consolidated debt to about 35% post-acquisition. The rise in leverage is driven by the combination of the acquisition debt to be issued by DUK and the assumption of existing Piedmont consolidated debt.
Business risk: Fitch did not consider the acquisition of Piedmont to meaningfully alter DUK's business risk. The pro forma earnings contribution from regulated businesses increases to approximately 90% from 85%. However, the acquisition does increase the diversity of DUK's revenue and provides a platform for potential growth. Management did not identify merger synergies. Piedmont will retain its current headquarters in Charlotte, NC and operate as a separate business unit and subsidiary of DUK. Workforce reductions typically associated with an acquisition are likely to be limited given the differences in electric and natural gas operations.
Regulatory Approvals: Regulatory approval is required by the North Carolina Utilities Commission (NCUC), but no other state public utility commission. In addition, Piedmont shareholder approval is required as well as the expiration or termination of any applicable waiting period under the Hart-Scott-Rodino Antitrust Act. DUK expects to close this deal in the fourth quarter of 2016.
In approving utility mergers the NCUC must determine whether a proposed merger is justified by 'the public convenience and necessity.' The NCUC has interpreted the statute to require a determination that rates and service will not be adversely affected by the transaction. In addition, the NCUC has concluded that for the public convenience and necessity standard to be met, expected benefits must be at least equal to known and expected costs so that customers are not negatively affected. Other factors to be considered by the NCUC include, but are not limited to, maintenance of, or improvement in, service quality, the extent to which costs can be lowered and rates can be maintained or reduced, and the continuation of effective state regulation. In approving DUK's acquisition of Progress Energy, Inc. the NCUC required $687 million of fuel savings over five years. Fitch anticipates that some form of customer benefits that either maintain or lower customer rates will be required, but these are not expected to affect our ratings.
--Acquisition financing to include up to $4.3 billion of DUK parent debt
--Cash component of financing plan may include approximately $950 million of cash, exclusive of equity issuances
--No change in existing capex or financing plan
--Acquisition closes in late 2016
--Limited customer credits or other regulatory concessions
[Positive: Positive rating action is not likely given the expected rise in leverage. However, current ratings can be maintained if debt/EBITDAR is maintained below 4.75x.
Negative: Ratings could be downgraded if adjusted debt/EBITDAR exceeds 4.75x on a sustained basis. Downgrades of one or more of its utility subsidiaries could also lead to lower ratings.]
DUK has ample liquidity primarily through a $7.5 billion committed revolving credit facility that supports its commercial paper (CP) program and has borrowing sub-limits for each of its six utility subsidiaries. The credit facility extends to January 2020. The CP program allows for issuances of up to $4 billion, but issuances are limited to the amount of available credit facility borrowings (including subsidiaries). As of June 30, 2015, borrowing capacity under the master credit facility was $5.2 billion net of $1.6 billion of outstanding CP, letters of credit and other uses, and cash and short-term investments $960 million.
Fitch has placed the following ratings on Negative Watch:
Duke Energy Corp.
--Long-term IDR at 'BBB+';
--Senior unsecured debt at 'BBB+';
--Junior subordinated notes at 'BBB-';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.