Big changes could be on the way for the second largest water service in the country. In October 2018 Aqua America (NYSE: WTR) announced plans to acquire Pittsburgh's Peoples natural gas utility worth approximately $ 4.3 billion. If approved by the regulators, the transaction is expected to be finalized in mid-2019.

It was a strange gesture for a slow and steady public water supply, built on much smaller acquisitions of local water infrastructure networks. Moreover, Wall Street was not sure of the financial implications of this deal. How could a public water distribution service of $ 6.4 billion finance such a gigantic market without jeopardizing the balance sheet?

Investors did not miss good questions. Management has already provided some answers, and when the company reports its results for fiscal 2018 in mid-February, it will likely offer more. A deeper analysis of the details and possibilities of the Peoples property shows that the proposed deal has a lot to offer – in fact, I think it makes Aqua America a good buy this month before the profits.

A plant that grows in a coin pot.

Source of the image: Getty Images.

In numbers

The proposed acquisition is $ 4.3 billion, but this includes a $ 1.3 billion debt from Peoples. In other words, Aqua America needs to fund only the remaining $ 3 billion. He proposed doing so with a term debt of about $ 0.8 billion and shares of $ 2.2 billion, such as common stock or stock-related securities, such as bonds or convertible debt.

This should not be taken lightly for a water distribution company whose market capitalization is currently about $ 6 billion. However, it is important to note a few points. First, the acquisition will add more assets than debt and, in reality, inferior Aqua America's debt ratio and offers greater financial flexibility. Secondly, any stock offer should have a moderate effect on the stock price, as the company 's market capitalization will increase in line with the number of shares.

Another important consideration: Peoples is owned by SteelRiver Infrastructure Partners, which is owned by pension and insurance funds that promote stability. This means that they will probably not seek to offload the Aqua America shares received as part of the transaction and may prefer convertible bonds to common shares, which would have the effect of spreading the dilution of stocks over time.

Natural gas meters on the outside of a building.

Source of the image: Getty Images.

The acquisition looks rather favorable to investors

The merged company, which would be trading under a new name, would offer its shareholders an intriguing growth potential because of its size. More importantly, it would be more efficient to generate profits from its rate base than America America can do alone.

This is because Peoples operates in one of the country's best natural gas markets and also has infrastructure that supplies large industrial and commercial customers. Given the Appalachians' low renewable energy potential, current technology and abundant natural gas reserves, fossil fuels are expected to have considerable long-term autonomy. This helps explain why the natural gas utility is growing faster than a public water supply service.

Metric

Aqua America

peoples

Combined company

Value of the company

$ 9.0 billion

$ 4.3 billion

$ 13.3 billion

Rate base

$ 5.0 billion

$ 2.2 billion

$ 7.2 billion

Annual growth of the rate base, 2019-2021

7%

8% to 10%

7.3% to 7.9%

Customers

1 million

743,000

1.74 million

Annual EBITDA

$ 489 million (estimate 2018)

$ 289 million (est 2019)

~ $ 778 million

Annual EBITDA as a% of the rate base

9.8%

13.1%

10.8%

Source: Investor Presentation.

The pro forma company would have no trouble maintaining the series of dividends paid by Aqua America for 74 consecutive years, including 28 increases over the past 27 years. The dividend yield is now at a historically robust 2.5%.

In addition, the company resulting from the merger could make an effort to help privatize Pittsburgh's public water supply service. The troubled public service has tackled a myriad of problems: it has accumulated a debt of one billion dollars, blocked alone the state budget in recent years and endangered the health of its customers from leaching of lead to microbial contamination.

Aqua America and Peoples had previously proposed to replace the city's water pipes whenever a natural gas pipe is replaced, which represents a saving of time and money for residents. In return, each new water pipeline would belong to Aqua America and / or Peoples, who were also proposing to build a solar-powered wastewater treatment facility to further modernize the infrastructure of the facility. Pittsburgh. City officials rejected the proposal, but a combined public service could strengthen the arguments. And with over 100,000 water consumers in the area, that would be a huge boost for public service.

A bird's eye view of a sewage treatment facility.

Source of the image: Getty Images.

Investors will win if this deal closes

The acquisition of Peoples is not guaranteed. The next steps are to complete the appropriate regulatory filings, obtain financing through equity and debt investments and obtain approval from the State of Pennsylvania. Given the fact that the 2018 fiscal year results will be announced nearly four months after the initial announcement of the acquisition and that the transaction is expected to be finalized by mid-2019, investors could find that Expect management to provide a more detailed calendar soon for the future.

Even without this, the information available to date indicates that expansion into natural gas will provide a positive potential for long-term Aqua America shareholders. The pessimism of Wall Street also appears a little exaggerated. If management manages to dispel some of the uncertainty that caused Market during the earnings conference call later this month, the stock could return to its expected rise.