Integrys Energy Group Finds Its Sugar Daddy

A nuclear power plant in Illinois. Photo by Michael Kappel. 

Yesterday Wisconsin Energy (NYSE: WEC  ) announced that it would buy Midwest-based gas and electricity utility Integrys (NYSE: TEG  ) . Wisconsin Energy will pay $5.8 billion for Integrys shares and will also assume all of Integrys' $3.3 billion in debt. The transaction will be paid to Integrys shareholders in 26% cash and 74% equity.

All in all, Wisconsin Energy paid a 17% premium for Integrys. Perhaps most telling, shares of Integrys were up 12% yesterday, while shares of Wisconsin Energy were down 3.5%. The market believes that Integrys got the better deal than Wisconsin Energy did. Of course, both companies are saying that the deal was great for both parties, but is that really the case?

Deal rationale

Source: Wisconsin Energy investor relations

Wisconsin Energy bought Integrys for one big reason: Growth. While both companies are growing earnings by between 4% and 6% at the moment, the pro forma company, WEC holdings, expects to grow earnings by between 5% and 7% per year. Not bad for a utility. But how could growth be accelerated by combining two slower-growing companies? Typically, the answer to that question would be cost synergies. But in fact, management claimed that cost synergies were not part of the rationale of this deal. 

So here's why the deal accelerates growth and thereby makes sense: Integrys needs to upgrade and replace much of its aging distribution and transmission infrastructure, and Integrys will get rate growth approvals in exchange for its efforts. Integrys' problem was that the required work was so costly that capital expenditure exceeded operational cash flow in 2013, and the company is on course to do so again this year. 

That's where Wisconsin Energy comes in. Wisconsin Energy is a cash-flow healthy company, and it pays only 60% of its earnings in the form of a dividend. Basically, Wisconsin Energy will use its cash flow to plug the gap for Integrys' upgrades, and the former will pay a 17% premium for the priveledge. It's no wonder Integrys' stock soared while Wisconsin Energy's stock dipped. 

What Wisconsin Energy gets
Really, this deal isn't as bad as it looks for Wisconsin Energy. In exchange for its investment, the pro forma company will reap the benefits which will come after Integrys' upgrades and replacements are complete, hence the accelerated growth. And it's more than that, really. In buying Integrys, Wisconsin Energy is getting some great upper Midwestern assets: Integrys is mostly involved in electricity transmission, natural gas distribution and natural gas power generation. Right now natural gas is replacing propane due to the latter's low price. Both Wisconsin Energy and Integrys are benefiting from the conversion from propane to natural gas in the Midwest, and the pro forma company will have broad exposure to this terrific trend. 

Bottom line
Once this transaction is complete, Wisconsin Energy will become WEC holdings, and a well-run, one-state utility will become a regional holding company for several utility brands. At the end of the day, I'm not too excited by that prospect, and I will miss the old Wisconsin Energy. 

Still, there's no doubt that management's rationale makes sense here. If growth does indeed accelerate as a result of this transaction, then this acquisition will be a success. 

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