Utilities: Giving the IPO Market a Spark


These days, you can't beat utilities for sizzle. No less an investment legend than Warren Buffett recently said he'll pour billions into U.S. power utilities if the federal government further deregulates the industry.

With power prices soaring and demand outstripping supply, it's not hard to understand the industry's fundamental attractiveness. The only caveat: Padding your portfolio with shares of fast-growing energy companies investments won't come cheap. Among the current Wall Street stars, Houston-based energy wholesalers such as Enron (ENE) and Dynegy (DYN) are trading at sky-high price-earnings multiples of 49 and 33, respectively.

"ANOTHER EXPLOSION." What's a value-minded energy investor to do? One possibility: Buying into initial public offerings by utilities that are spinning off their high-growth operations. With dot-com IPOs all but dead, utilities are taking up some of the market slack by selling shares in their booming deregulated businesses.

A spin-off from a unit that generates power or sells it on the wholesale market gives investors a clear shot at a high-margin, fast-growth business. A spin-off also allows the parent utility to raise millions to pay off debt or make acquisitions using shares rather than cash as currency, points out Gordon Howald, an analyst with Credit Lyonnais Securities.

Frederick Schultz, a utilities analyst at Raymond James & Associates, predicts a raft of utility IPOs involving everything from fiber-optic subsidiaries to fuel cells and high-tech meter-reading units. "It will be another [IPO] explosion like we saw in telecommunications," Schultz predicts.

A mini-boom is already under way. "Energy IPOs are the main theme of 2001 because so many people are scarred from technology [investments]," says Jeff Hirschkorn, who follows the public markets for IPOSyndicate.com. Unlike many of their tech counterparts, power companies boast diverse businesses -- and actual earnings. With demand for power expected to continue to exceed supply, market conditions for utility IPOs could hardly be better.

RISING PRICES. Analysts particularly like offerings from businesses that feed off the shortage of electrical generating capacity. A couple of new deals that could fit the bill nicely are Aquila Energy from UtiliCorp United (UCU), and Reliant Resources, a spin-off from Reliant Energy (REI). Pricing for Aquila, UtiliCorp's wholesale energy-merchant unit, gives a good indication of how hot the market is. When UtiliCorp and underwriter Lehman Brothers Holdings set the stock sale's terms on Apr. 24, they raised the share price to $24, from an intially announced range of $21 to $23. They also raised the size of the issue to 17.5 million class-A common shares, from a previously announced 16.5 million.

In its first day of trading, shares of Aquila, trading on the New York Stock Exchange under the symbol ILA

, closed at $27 and change -- some 16% above the IPO price. The offering raised about $420 million. Based in Kansas City, Mo., UtiliCorp is a global, diversified energy company that distributes power and natural gas to retail customers, offering contract services and broadband communications.

But its leading growth driver by far is the Aquila merchant-energy business, which markets and trades electricity and natural gas to wholesale clients in the U.S. and Europe. Since 1998, Aquila's earnings before interest and taxes have grown 75%, according to Daniel Tulis, an analyst at Banc of America Securities. In 2000, Aquila reported $98 million in net income on revenues of $26.5 billion, accounting for nearly all of Utilicorp's $28.9 billion in overall revenues.

DISCOUNT OFFERING. The Street is probably underestimating the boost UtiliCorp will get from the rapidly accelerating energy-merchant business. Considering that U.S. wholesale energy sales are expected to increase by 45% by 2005, Tulis argues that Aquila represents a buying opportunity at a discount. UtiliCorp shares recently were trading at a price-earnings multiple of just 15, based on a stock price of $35 and earnings per share of $2.20.

Another notable utility IPO -- although pricier than Aquila -- is Houston-based Reliant Resources, a spin-off of Reliant Energy's unregulated generation and wholesale trading assets. Led by Goldman Sachs and Credit Suisse, the offering is expected in early May. Reliant Resources recently raised its estimated price range to $26 to $28 a share -- the third time the price has been hiked since the company filed to go public late last year. If the offered 52 million shares go for $28 each, the company could raise as much as $1.5 billion. The stock will trade on the New York Stock Exchange under the symbol RRI.

Reliant Energy is an electricity and energy services provider that recorded revenues of $29.3 billion in 2000. The traditional electricity business is the company's biggest revenue source, but its once-nascent wholesale energy operation has turned into a substantial moneymaker. In 2000, $19.2 million, or about 65%, of Reliant's operating revenues stemmed from wholesale energy.

CALIFORNIA IMPACT.Reliant Energy is trading at a modest multiple of 16, based on a share price of $48 and EPS of $2.93 -- despite the phenomenal growth of its wholesale trading business. Given time, analysts expect Reliant Resources and Aquila to trade at multiples in line with their top peers, which include El Paso Energy (EPG), and Williams Cos. (WMB). Both trade at multiples in the 20s.

One wild card in this rosy scenario is California's energy crisis. Reliant Resources originally planned to go public in February but held off because of stock market volatility related to the crisis. However, analysts say both Reliant Resources's and UtiliCorp's exposure to the Golden State is minimal. In September, 2000, UtiliCorp reduced its wholesale-power trading activities in the state, but it has continued to operate approximately 83 megawatts of generating capacity at independent power projects in California. Overall, UtiliCorp has more than 6,300 MW of generating capacity.

Reliant, meanwhile, says it's owed about $370 million for power sold in California. The company established a $39 million reserve against debts in the fourth quarter of 2000 and will continue to reserve appropriate funds.

If you're still on the fence about utility IPOs, don't wait too long. Catherine Zaharis, a utility fund manager at Invista Capital Management, believes these stocks will climb steadily after their debuts (for more, see this video Q&A with Zaharis). Fast-forward two years or so when the supply side of power finally catches up with demand, and these shares could be far pricier than they are today. By Heesun Wee in New York


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