New Haven, CT-based utility holding company UIL Holdings Corp. is buying Philadelphia Gas Works (PGW Operations) from the city of Philadelphia for $1.86 billion in cash. PGW is the country's largest municipally owned gas utility and is in the heart of Marcellus/Utica shale country.

The deal will more than double the number of natural gas customers served by UIL utilities, create geographic and regulatory diversity for the holding company and offer opportunities in gas distribution system enhancement as well as liquefied natural gas (LNG) fueling.

Founded in 1836, PGW manages a distribution system of about 6,000 miles of gas mains and service pipes supplying about 500,000 customers in Philadelphia. The acquisition will "significantly expand the size and scale of UIL's natural gas operations and create a more geographically diversified energy delivery utility holding company serving more than 1.2 million total gas and electric customers, including nearly 900,000 gas customers, with proximity to abundant regional gas supply in the Marcellus and Utica shales," UIL said.

"[W]e will upgrade PGW Operations' infrastructure, expand services and increase capital investments to drive growth,” said UIL CEO James P. Torgerson.

PGW has about 1,500  miles of cast iron piping that needs to be replaced, and Pennsylvania offers an "attractive mechanism" for recovering the costs of such work, Torgerson told analysts during a conference call Monday. He said UIL will work with regulators to accelerate the replacement program and roll the costs into the utility rate base.

Further, PGW has two LNG facilities, both of which can vaporize LNG and one of which can also liquefy natural gas, Torgerson said. “We see opportunities in shipping and the long-haul trucking business that could prove to be lucrative [for LNG] in the future…” he said.

"Philadelphia is very focused on developing their energy hub, and we think there is an opportunity for us to participate in that in a very extreme way…

“We have a proximity to the Marcellus and Utica shales, which have an abundant regional supply. We also see opportunities to hopefully expand that and bring those supplies into Philadelphia.

"They look at the opportunity from the shale formations that are in the state just to the west and they want to be able to develop a pipeline system that can bring gas to the city. It's not just LNG, it's also being able to utilize gas to make industries, businesses...more competitive.”

As for converting residential energy consumers to natural gas service, that's mostly been done in the PGW service territory, where the utility enjoys about 90% penetration on the residential side of the business. Torgerson said. 

PGW will be acquired on a cash-free and debt-free basis, UIL said. The deal has been unanimously approved by UIL's board. Upon closing, the acquisition is expected to be immediately accretive to UIL operating and free cash flow. The deal will enable PGW Operations to increase investment in infrastructure and expand its services. The transaction is expected to be initially earnings neutral and long-term earnings accretive to UIL.

Approvals for the deal are needed from the Philadelphia City Council and the PAPUC. UIL anticipates closing by the first quarter of 2015. UIL has secured a $1.9 billion fully committed credit facility to support the deal from Morgan Stanley Senior Funding Inc. and  intends to issue long-term debt to fund the deal.

The company said it will maintain the utility's headquarters in Philadelphia and its six customer service centers around the city. After closing, UIL will maintain dual corporate headquarters in New Haven and Philadelphia. Under the terms of the agreement, UIL will maintain PGW Operations' current base rate structure through 2017. Any future changes to PGW Operations rates will be determined by the Pennsylvania Public Utility Commission (PAPUC) pursuant to its rate case procedures.

On the cash-strapped city's side of the deal, the sale will inject at least $424 million into the city pension fund. Efforts to sell PGW have been under way for some time and culminated in an auction process that attracted 33 interested parties last fall, according to the city.

"When I announced nearly two years ago that the city would begin exploring the sale of PGW, I pledged that I would sign an agreement only if the terms benefited Philadelphia taxpayers and PGW customers," said Mayor Michael A. Nutter.  "This agreement accomplishes those goals and much more. UIL submitted the highest bid for PGW and agreed to contract terms that were important to the city. Our agreement keeps rates frozen for three years, maintains PGW's discount programs for low-income families and seniors, safeguards PGW employee and retiree pensions and positions PGW to take full advantage of the abundant supply of natural gas in Pennsylvania to make our city and region a prime energy hub."

That’s a significant turnabout from just over three years ago when Philadelphia City Council voted to direct PGW to avoid buying Marcellus Shale gas while an Environmental Protection Agency study of hydraulic fracturing was under way (see Shale Daily, Jan. 20, 2011). However, by fall 2012, city fathers had warmed to the Marcellus and at one council member was urging its embrace by PGW (see Shale Daily, Oct. 30, 2012).

A deeper-pocketed parent with broader geographic reach in the energy industry will also benefit PGW, said PGW CEO Craig E. White. "Our company has made major strides over the past several years, but there are constraints as a city-owned utility that prevent us from realizing our full potential," he said. "The ability to react quickly to market opportunities and a greater investment in developing markets will result in a win-win for both the company and its customers and will result in a greater demand for jobs.”

UIL affirmed its consolidated earnings guidance for 2014, which was provided on Feb. 20, of $122 to $134 million ($2.15-2.35/share), excluding the PGW transaction. UIL shares were off more than 3% at midday Monday, trading around $37.43.

UIL serves more than 700,000 electric and natural gas utility customers in 66 communities across two states and has assets of more than $5 billion. It is the parent of The United Illuminating Co. (UI), The Southern Connecticut Gas Co. (SCG), Connecticut Natural Gas Corp. (CNG), and The Berkshire Gas Co., each more than 100 years old. UI provides for the transmission and delivery of electricity and other energy related services for Connecticut's Greater New Haven and Bridgeport areas. SCG and CNG are natural gas distribution companies that serve customers in Connecticut, while Berkshire Gas serves natural gas customers in western Massachusetts. UIL employs more than 1,850in the New England region.

SCG, CNG and Berkshire were acquired by UIL nearly four years ago from Spain's Iberdrola SA for $1.296 billion in cash less net debt of $411 million (see Daily GPIMay 26, 2010).