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Here's Why Aqua America Fell as Much as 10% Today

By Maxx Chatsko - Oct 23, 2018 at 2:04PM

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The water utility is expanding into natural-gas utility services with a major acquisition.

What happened

Shares of Aqua America (WTRG 0.15%) dropped by double digits today after the company announced it had agreed to acquire natural gas utility Peoples in an all-cash transaction valued at $4.275 billion, including approximately $1.3 billion in debt. The water utility's decision to expand into natural-gas utilities is a bit unusual, but management thinks it can provide a higher-growth opportunity in the long run.

Wall Street is discarding that promise for now and instead focusing on the financial implications. The nearly $4.3 billion price tag will need to be met with a combination of capital raises, including issuing debt offerings as well as new shares of Aqua America. That could imperil the balance sheet, especially if Peoples doesn't deliver healthy returns relative to the acquisition price.

As of 1:40 p.m. EDT, the stock had settled to a 8.2% loss.

A declining chart drawn on a chalkboard

Image source: Getty Images.

So what

Both Aqua America and Peoples are headquartered in Pennsylvania, near Philadelphia and in Pittsburgh, respectively. That creates logistical synergy for the combined company, which would serve approximately 1 million water utility customers and 740,000 gas utility customers across the same 10 states. More important, management expects the natural-gas utility business to achieve annual rate base growth of 8% to 10% through 2021, compared to 7% for the water utility business.

The combined company would have a regulated rate base of $7.2 billion, comprising 70% water and 30% natural gas. In other words, it represents a significant dose of diversification for Aqua America. But details on the financing of the deal are scant. The company simply stated: "The acquisition is supported by a fully committed bridge facility. Permanent financing will include an appropriate mix of equity and debt to target a strong balance sheet and investment-grade credit ratings."

Investors may have to wait for third-quarter 2018 operating results to be announced before learning more, but dilution and increased debt come with obvious risks.

Now what

Interestingly, the idea to combine water and natural gas utility services originated with Peoples. The company approached the beleaguered Pittsburgh Water and Sewer Authority to create a public-private partnership to tackle various infrastructure investments together, including building a new renewable energy-powered water treatment facility outside Pittsburgh for $350 million. The city rebuffed the idea, but perhaps Aqua America coming on board will change the mayor's mind. That could lead to better growth prospects for the company's water utility segment -- thanks to acquiring a natural-gas utility. It makes sense.

Dreaming big aside, the regulated nature of Peoples' natural-gas business should make it a relatively predictable profit generator for the combined company. That said, investors are right to want more details on the financial impact of the proposed acquisition.

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