Dominion Resources, Inc. (NYSE:D) is getting bigger -- but investors don't seem to think bigger is better.
On Monday, Dominion announced that it has agreed to acquire natural gas distributor Questar Corporation (NYSE:STR) for $25 a share. As soon as the news broke, Questar shares shot up to within a few pennies of Dominion's promised purchase price. Dominion shares, on the other hand, sank 3%.
But were those sellers right?
Valuing the buyout
Dominion is paying $25 per share for Questar. That's $4.4 billion for the target's equity. Dominion will also assume Questar's $1.6 billion debt load, so the total cost of acquiring Questar works out to a nice round $6 billion.
In exchange for this princely sum, Dominion will inherit Questar's $1.1 billion annual revenue stream and $220 million in annual income. Altogether, therefore, Dominion is paying an enterprise value of about 5.4 times sales for Questar, and about 27.3 times earnings.
Evaluating the reaction to the buyout
Since the acquisition was announced, Questar shares are up 22% -- so somebody's feeling pretty happy over there. But what about the Dominion shareholders?
Although Dominion shares are down on the deal news, by and large I think this is a pretty good deal for Dominion shareholders. if you factor debt and cash into the picture, Dominion has a $68.9 billion enterprise value. Divided by $12.1 billion in annual sales, Dominion shares sell for a debt- adjusted price-to-sales ratio of 5.7. (That's bigger than their plain-vanilla 3.4 P/S ratio, which doesn't take account of debt.) So in effect, Dominion is getting Questar's revenues at a discount.
Earnings-wise, Dominion's $68.9 billion enterprise value divided by its $1.8 billion in trailing earnings yields a similarly adjusted P/E ratio of 38.3. So compared to the 27.3 multiple to earnings that it's paying to acquire Questar, it again looks like Dominion is buying Questar on the cheap.
What it means for Dominion (and its shareholders) going forward
With $961 million annually coming from its Questar Gas division -- more than 80% of annual revenues -- Questar is primarily a gas distributor. It also produces, stores, and distributes gas via pipeline. Dominion, on the other hand, is a much bigger operator, with gas distribution operations alone that rake in three times as much revenue ($2.9 billion) annually as Questar does. Electricity distribution contributes a further $1.9 billion to Dominion's business, while power generation dwarfs the company's other business lines with $7.7 billion in annual revenue.
Even after absorbing Questar's business, therefore, Dominion will remain very much a power generator first, and an electricity distributor third -- with natural gas distribution stuck somewhere in the middle. That middle unit will, however, get bigger as Dominion swallows and digests its smaller rival.
Valuation-wise, if we assume that Dominion spends down its cash reserves, and takes on new debt to finance Questar's buyout (this is an all-cash acquisition, after all), then the company's enterprise value will probably rise to roughly $75 billion after this deal closes. Divided by the $2 billion the merged company should earn annually, that works out to a going-forward debt-adjusted P/E of about 37.5 on Dominion stock -- versus Dominion's 38.3 earnings multiple before the deal.
I don't think 37.5 times earnings is a very good price to pay for a 6%-a-year-growing utility company paying a 4% dividend. I don't think Dominion stock is cheap at all. But with Questar in its pocket, the stock should at least look less expensive after the acquisition than it did before.