Year-End Power Utilities M&A Insights and Outlook Report

PUF looks forward to regular conversations with PwC powerhouse Jeremy Fago, for insights on where utilities have been and where they are going. This time, the PwC US Power and Utilities Deals Leader wraps up the year, and discusses 2021's hot topics, including of course, the pandemic, ESG, and the latest from Washington, D.C.

It's all tied together, leading to where the energy and utilities industry is putting its money and eyeing deals. An industry that is undergoing profound change invests lots of capital, and that makes Jeremy Fago more needed, to help understand the intricacies of investment and where 2022 will take that money. Listen in.
 

PUF's Steve Mitnick: Where are we now? What are the headlines? How has the pandemic influenced deals?

Jeremy Fago: 2021 was up from where we were in 2020. That's not a huge surprise. Volumes have been roughly consistent with prior years, but the deal types have changed.

I don't know how much of it is pandemic related versus the types of deals that were being done four or five years ago. When you look at those mega deals that were being done where maybe an electric is buying a gas platform, for example, you saw some high premium deals.

The rationale for those deals was to be able to focus organically for the next ten to twenty years, particularly on those gas platforms where tremendous build out needs existed. It's not surprising that we see some dearth in mega deals as a result right now. 

Then, when you think about the fact that we've got forty-something publicly traded utilities plus or minus, it's not like you're going to have serial mega-deals coming to bear every year. There was just so much activity over that five-year period. I think the volume story is holding steady, and we hit on this in prior periods, but we didn't feel that the deal values were going to be like what we saw in '16, '17, '18, just because of those facts I mentioned.

But I do think we're going to see some of what we saw in '21 continue into '22. There's been a bit of a pause in the last few months, but I think '21 and '22 are going to be defined by more portfolio and asset level deals �" divestitures and reshuffling of portfolios in some cases.

Also, we've seen companies shuffle their portfolios before in a move to focus on core business platforms, which drove deals, and we believe ESG and specifically net-zero goals, will take us there again to some extent.

In the last few months there's been a bit of a wait and see on what happens in Washington on the Build Back Better plan and what's potentially coming down from a tax incentive perspective, and folks in this industry are looking at various scenarios related to that, and we do expect it will drive some deal activity.

PUF: The tax side could affect deals, whether they're portfolio, like buying into renewable assets or divesting generating assets. You're saying the tax aspects are important.

Jeremy Fago: Yes. There are two pieces. One is, the tax credits, for example, related to traditional renewable, and it looks like that's going to get more technology agnostic from a zero-carbon perspective and perhaps not as narrow as it has been before.

You also have potential broader tax reform hanging out there too. Feels like we just went through that before where rates came down and for regulated utilities and some others it wasn't necessarily an obvious win, given they weren't cash taxpayers for the most part due to their NOL positions. You had an industry heavily focused on how that would impact their business and financial position, which slowed deal activity at the time.

PUF: There are few large gas and electric deals.

Jeremy Fago: There are probably a couple out there, but it's not going to be like it was. The other part of that is there will probably be opportunities on some of the more traditional generation types and things like that.

It's going to somewhat depend on your stakeholders and their view as well. If you're a large, publicly traded company and depending on what your asset profile looks like, you may start to look at divestiture for certain things that maybe aren't aligned with your carbon reduction goals and try to reshuffle that capital into something that may have more of a green footprint.

But that's also going to depend on the opportunity you have. What opportunities are out there for you to take capital that you may raise through divesting a portfolio or asset to put it to work quickly into those types of businesses.

There's going to be a lot at play. These last six months we saw the financial players show up in a big way, where over the last several quarters it's been heavily strategic players. 

You're going to start to see more of that I think, where the financials can put money to work into areas of opportunity that may have fallen out of favor with certain investor types but are still very much needed to get us where we intend to go as an industry on the decarbonization front while sustaining reliability in that path forward. We'll see how that unfolds.

PUF: There's investment in emerging. There are the new, small nukes in Wyoming and Utah, there are emerging tech investors and other funds focused on net zero and ESG. Is that a factor on where the attention is?

Jeremy Fago: It's definitely drawing attention. Just to take that a step further, I talked about, for example, gas infrastructure, where we saw those big deals in '16, '17, '18, and recently we're seeing some pressure on gas from an environmental perspective. But I wouldn't sit here and tell you that the rationale for those deals that were done and the high premiums that were paid, were all for naught, because we are going to need gas in this transition, and I believe it will be around for a while.

But also, if you start to think about opportunities on the hydrogen and RNG side, you can potentially leverage those platforms to innovate and put capital to work in some of that emerging technology. I don't think necessarily the value proposition for those deals that were done five, six years ago is diminished in any way.

PUF: There's also a push for offshore, and that involves partnerships. There's attention being drawn to those kind of deals, joint ventures.

Jeremy Fago: We've been talking about offshore in the U.S. for a few years, but it's starting to ramp now. This again is where we are watching closely as to what comes down from Washington and specifically the tax credits and how those are structured �" direct pay �" versus traditional credits where you need tax capacity to use them. This will obviously have an impact as far as the value proposition for that investment.

With offshore, like other generation, you'll need the infrastructure behind it, i.e., transmission. That too will be one area to keep a close eye on.

And although offshore will generate at a higher capacity factor than a lot of the onshore, you still need to backstop that. You're still adding intermittency to the grid and until other technologies catch up in scale, there's going to be some need for quick start capacity to support that. You may see some more transmission, some more quick start generation, to support and backstop some of that big intermittent renewable.

PUF: We still have the case where there's a huge amount of capital, that's looking for a place to go.

Jeremy Fago: That's right. You're seeing some of that play out where you see some minority interest sales happen, for example.

It's an attractive industry, as you know, and there's significant value opportunity given the amount of change and requisite investment needed.

There's the ability to raise that capital for the utility folks at a decent premium, particularly in the low interest rate environment where that yield is attractive. But there's also the opportunity for capital to find a place like that to invest in without having owner/operator responsibilities. From an owner/operator perspective, it's a great source of capital to make those needed investments, so I think we will see some more of those in '22.

PUF: Much of the industry over the last year has been ESG driven. How can that influence the way you are looking at issues like M&A?

Jeremy Fago: It would be hard to imagine that in the near term, and probably in the longer term, inorganic activity is not going to have to have some ESG consideration.

When you think about a regulated industry like this one and the regulatory overlays related to that, ESG considerations will no doubt play some role. Clear strategy and articulation of how a potential deal fits within one's stated net-zero or carbon reduction goals, for example, will be critical. I think the bar continues to raise on the net-benefit, no net-harm, side of things with the ESG overlay.

I also think that's a reason we'll see a slow-down in some of the mega deals as compared to what we saw five, six years ago. You're going to see that rationale play out, but I can see some pressure to the extent that you do a deal that maybe doesn't necessarily fit neatly within what your decarbonization goals are.

PUF: M&A is not going away. We're still going to have activity. Why is that? Why aren't the companies fine as they are?

Jeremy Fago: The reason M&A is here for a long time to come is because of how quickly this industry is changing. There are a lot of industries that change quickly, but the capital intensiveness of this industry is hard to touch. When you think about putting capital to work, and about change at a fast pace, a lot of times inorganic activity is the way to get it done.

That's versus building or changing organically or, specifically, from scratch. From a macro industry perspective, it would be tougher to accelerate change without deals in a lot of cases.

Matching platforms with opportunity with capital, is a significant accelerant to affecting and supporting that change. That's why you're going to continue to see deals in the space.