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Southern Company Inks $6.5B Divestment Deal to Reduce Debt

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Southern Company (SO - Free Report) recently inked a deal to divest stakes in several of its Florida assets to the U.S.-based wholesale electricity supplier, NextEra Energy, Inc. (NEE - Free Report) , in a bid to strengthen its financials. Atlanta-based electric utility, Southern Company will sell its Gulf Power Company, Florida City Gas, along with interests in the Oleander and Stanton natural gas plants in a deal valued $6.5 billion.  

Post the announcement of the deal, shares of Southern Company have moved up 1.66% to close at $43.44 on May 21. Meanwhile, shares of NextEra have edged up 2.41% to eventually close at $160.22. The deal seems to be a win-win for both the companies. While the move will help NextEra to expand and diversify its operations, it will address Southern Company’s leverage issues at the same time.

Deal Details

The total transaction value is estimated at around $6.5 billion. This includes $5.1 billion in cash, which is expected to be financed by the issuance of new debt. Moreover, NextEra will also assume the $1.4 billion debt burden of Gulf Power, raising the total consideration to $6.5 billion.

NextEra will be acquiring the Florida-based utility, Gulf Power, which serves around 450,000 customers in eight counties in Northwest Florida. Further, it will also purchase Florida City Gas, which supplies natural gas to approximately 111,000 residential and commercial consumers in four counties along the state’s East Coast.

Apart from these holdings, NextEra will buy Southern Company’s entire stake in Oleander Plant — a 791-MW gas-fired simple-cycle combustion turbine power plant — which the latter purchased from Constellation Energy Group in 2005. The cash-starved Southern Company will also jettison its 65% stake in the Stanton Energy Centre — a gas-fired combined cycle plant — to NextEra. Both Oleander and Stanton Plants have dual fuel power, with distillate as the backup fuel.

Subject to approvals from Federal Energy Regulatory Commission (FERC) and Federal Trade Commission, the acquisition of Gulf Power and Stanton/Oleander facilities is set for closure in the first half of 2019. On the other hand, subject to Federal Trade Commission’s approval, the Florida City Gas buyout is likely to close by the third quarter of 2018.

Deal Rationale for Southern Company

The deal is likely to be a prudent strategy for Southern Company, which is grappling with elevated leverage along with cost overruns in two of its large construction projects, Vogtle and Kemper. Notably, the company, which spent around $12 billion for the AGL Resources buyout in 2016 to expand and diversify its offerings, is heading toward the retrenchment road, weighed by its financial struggles. As of Mar 31, the company’s long-term debt stood at $44.4 billion, representing a debt-to-capital ratio of more than 63%.

The company suffered a massive loss last year when Mississippi Public Service Commission ordered Southern Company’s subsidiary, Mississippi Power Company, to suspend all coal gasification operations in the Kemper project, thus converting it to a natural gas project. Originally estimated at around $3 billion, the project’s cost ballooned to $7.3 billion, affecting its commercial viability and balance sheet. The Vogtle project is also being bankrolled with more than $8 billion in federal loans and loan guarantees. The project’s cost is soaring to $25 million, thereby increasing its credit risk. 

With Southern Company winning Georgia PSC's nod for the construction of the Vogtle plant in December 2017, the divestiture deal will enable the company to sharpen its focus on the first U.S. nuclear project in decades.

With the divestiture deal, Southern Company will also be able to streamline its portfolio, boost utility returns, along with raise cash to repay debts and pay for the new reactors. The sale eliminates the overhang of its equity needs by helping the company reduce $3 billion from the amount it is required to raise in the next three years. In fact, the company is planning to offload its interests in its solar projects as well as raise another $1 billion. It is also seeking $1 billion in third-party tax equity financing for its wind projects.

Thus, apart from bolstering its financial strength, the deal will streamline Southern Company’s portfolio and enable the company to forge ahead with its Vogtle Project more effectively. With limited cash flow and large amounts of investment to make, the deal would provide some relief to the company.

Deal Benefits to NextEra

The deal has enabled Next Era, America’s most valuable power company, to significantly progress with its strategic expansion. The deal will further enhance its long-term growth prospects in a space, in which it already has a command.

The acquired assets, including the regulated electric and natural gas franchises, serve as a complementary fit to NextEra’s existing portfolio in Florida. The assets, which are a perfect geographic and strategic fit, will lead to several commercial, financial and operational synergies.

Upon closure, the deal is likely to be immediately accretive to NextEra’s earnings. As a result, the company raised its adjusted EPS guidance for 2020 and 2021 by 15 cents and 20 cents, respectively.

The company, which has a long-term track record of delivering value to its shareholders, is likely to continue its momentum, going forward. NextEra expects to maintain $5-$7 billion of excess balance sheet capacity, post the completion of the deal and is likely to witness an upgrade in its credit ratings.

Zacks Rank and Key Picks

Currently, Southern Company carries a Zacks Rank #3 (Hold).

Some better-ranked players in the same industry include NRG Energy, Inc. (NRG - Free Report) and TerraForm Power, Inc.(TERP - Free Report) , each sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

NRG Energy’s 2018 earnings are expected to grow 201.83% year over year.

TerraForm’s 2018 earnings are expected to grow 117.36% from the prior-year quarter.

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