The logic behind Emera’s $14.3-billion acquisition of Canadian Utilities is murky so far

At the heart of the big Canadian merger between power companies Emera Inc. and Canadian Utilities Ltd., there is a simple question: Is bigger actually better?

So far, the answer’s pretty murky.

When the two companies announced the $14.3-billion all-share marriage on Tuesday, their leaders justified it by wrapping themselves in the Canadian flag. Bringing two industry champions together was the right thing for the country, they said, because their merger would enable growth.

What exactly they meant by that wasn’t quite clear.

One argument is that on their own, neither is large enough to pay for the massive infrastructure investments utilities face in the years ahead. If they combine, their cost of capital could fall, helping them compete with rivals like pension funds. The combined companies would have an enterprise value – their debt plus equity – of $72-billion and would create one of the 20 largest utilities in North America.

At the same time, U.S. companies are getting bigger by merging. If Halifax-based Emera and Calgary-based CU are left standing all alone, they might be minnows in a hyper-concentrated industry.

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U.S. power mergers, though, are starting to face political backlash, which means they might not get approved, or major concessions might be needed to get the green light. And Emera and CU largely operate in very different places – Florida and Alberta. Merging will diversify their revenue mix, but there is little-to-no overlap between their operations, so they can’t learn all that much from one another or share resources.

Their geographies also complicate cost savings, something both companies were up front about. “Combinations like this really aren’t about synergies,” Emera chief executive Scott Balfour said on a conference call Tuesday.

What, then, should investors be excited about? Shareholders seem to be asking the same thing. Emera’s shares are down 4.3 per cent since the deal was announced, while CU’s are down 2.6 per cent. Not exactly panic, but no one is particularly enthused.

For both companies, the timing matters. Governments and think tanks talk extensively about the need for new power generation plants to meet growing demand, particularly from data centres, and they urge extensive new transmission and distribution infrastructure to get that power to end users.

The existing grid also needs to be modernized to enhance remote monitoring and allow bi-directional electricity flows. And billions of dollars of upgrades will be needed just to maintain aging existing infrastructure and harden it in anticipation of more extreme weather events.

Mr. Balfour addressed this when justifying the deal. “This transaction creates a stronger company positioned to invest in the infrastructure needed to support electrification, industrial development, energy security, data centres, and the growing demand of customers across North America,” he said.

The problem is that language like this was used repeatedly, with few tangible examples of how exactly the combined size will help the two companies. When they were provided, they weren’t so clear cut.

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Emera, for instance, said the transaction will “improve credit rating thresholds, providing greater financial flexibility,” but after the conference call the outlook was a bit more mixed. Rating agency Moody’s Investors Service said the deal was at least neutral for Emera’s credit rating, but Fitch Ratings said it might actually be a slight negative for CU, which has the more favourable rating of the two companies.

And on the same scale front, the threat of losing out to U.S. rivals that are getting bigger by merging, including NextEra Energy, Inc. and Dominion Energy, Inc., who are pursuing a US$67-billion combination, may not hold up. U.S. mergers are starting to face political backlash, and Virgina’s governor make seek concessions, such as measures to keep bills down and promises to pursue clean energy development, the Financial Times reported this week.

The core issue, though, seems to be the geographic distance. Emera expanded into Florida in 2016 by acquiring Tampa-based TECO Energy Inc., and 72 per cent of its adjusted net income now comes from the Sunshine State. Investors have been enthused by the potential for data centre growth there.

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CU, meanwhile, is heavily exposed to Alberta, and as TD Securities analyst John Mould wrote in a note to clients, the province authorizes lower utility returns than Florida, which can hinder profits. (Utilities are highly regulated and are often only allowed to make a certain level of return, which prevents them from price gouging.)

“We believe that reduced relative exposure to Florida (a high quality jurisdiction for utilities) will be a disappointment for some investors,” he wrote.

Couple that with Emera and CU’s acknowledgement that cost synergies are unlikely, and it can feel like two second-cousins are being made to look like siblings.

The reality: There likely are some benefits, they were simply glossed over in the big deal announcement. Florida and Alberta have two uncorrelated economies, which might give rating agencies more comfort when it comes to the combined company’s debt. That could lower the combined company’s cost of capital, and help it compete on government contracts against giants like Berkshire Hathaway.

And for Emera investors, Alberta isn’t some backwater. The province’s population growth rate was higher than Florida’s over the last five years, and Alberta wants to encourage data centre construction, as well as expand its natural gas distribution network. The province also permits elevated returns over and above the approved returns if they are shared with customers.

The issue may be that none of this was telegraphed to investors beforehand. Companies tend to give their shareholders some guidance on where they’re looking to expand, but neither Emera nor CU had floated the potential. In Emera’s case, investors were just getting comfortable with the company again after it spent years selling assets to pay down debt, and they were finally getting excited about the potential in Florida.

If it is true that some benefits have been overlooked, it’s on the companies to explain themselves, because their first stab at it this week wasn’t all that encouraging.