UIL Holdings Corp. has agreed to acquire three natural gas utilities — Southern Connecticut Gas Co. (SCG), Connecticut Natural Gas Corp. (CNG) and The Berkshire Gas Co. — from a unit of Spain’s Iberdrola SA for $1.296 billion in cash less net debt of $411 million.

The acquisition will more than double the UIL customer base and adds natural gas to the company’s existing electric utility operations. UIL’s board approved the acquisition from Iberdrola USA Inc.; the deal is expected to close in the first quarter of 2011. It will create a diversified utility company with 694,000 customers. The three local distribution companies (LDC) being acquired serve more than 333,000 customers in Connecticut and 36,000 in Massachusetts.

“This transaction immediately transforms UIL while adding organic growth opportunities,” said UIL CEO James P. Torgerson. “It’s an excellent strategic fit for UIL and the gas LDCs.”

Torgerson told financial analysts during a conference call last Tuesday that adding the gas utilities makes UIL a company with summer peak demand (power) and winter peak demand (gas), which will help levelize earnings and cash flow. There also are growth opportunities on the gas side “through efficient expansion of customer gas utilization,” he said.

The acquisition is expected to provide enhanced cash flow per share accretion to UIL immediately upon closing and earnings per share accretion beginning in 2012, UIL said, noting that these provide continued support for UIL’s dividend.

UIL is based in New Haven, CT, and is the holding company for electric utility The United Illuminating Co. (UI), which serves 325,000 customers in the Greater New Haven and Bridgeport areas of Connecticut. Approximately 130,000 SCG customers reside in the service territory already served by UI. UIL’s existing technical infrastructure and associated processes are well positioned to support the planned addition of the gas LDCs, UIL said.

“The acquisition of regulated gas LDCs is expected to diversify UIL’s revenue mix and create excellent opportunities for growth through efficient expansion of customer gas utilization,” UIL said, noting that it expects no impact on electric rates as a result of the transaction.

The company intends to issue debt and equity to fund the cash portion of the acquisition, which is about $885 million. Torgerson added that it is an important objective for UIL to maintain the investment grade credit rating for the holding company.

SCG serves 176,000 customers in 22 cities and towns. It has 133,000 miles of pipeline, access to 10.5 Bcf of gas storage capacity with long-term lease providing an additional 1.2 Bcf of liquefied natural gas (LNG) storage capacity. The utility’s average rate base is $438 million and the 2009 allowed return on equity (ROE) was 9.26%.

CNG serves 157,000 customers in 21 cities and towns. It has 125,000 miles of pipeline, access to 10.6 Bcf of gas storage and owns one LNG storage facility that provides 1.2 Bcf of capacity. The utility’s average rate base is $351 million and the 2009 allowed ROE was 9.31%.

Berkshire serves 36,000 customers in 20 cities and towns. It has 738 miles of gas mains, access to 1.1 Bcf of storage capacity and owns one LNG storage facility that provides 30 MMcf of capacity. The utility’s average rate base is $64 million and the 2009 allowed ROE was 10.5%.

Post acquisition, the three acquired LDCs will account for 45% of UIL’s average rate base, 37% of adjusted earnings before interest, taxes, depreciation and amortization and 41% of adjusted net income.

SCG and CNG have 2009 rate case decisions that are under appeal; the cases have been stayed pending determination on the appeals.

The utilities were among those acquired by Iberdrola USA when it bought Portland, ME-based Energy East for $4.5 billion in a deal announced three years ago (see NGI, Sept. 22, 2008; July 2, 2007).

Moody’s Investors Service affirmed its ratings and stable outlooks for UIL and UI, citing the anticipated use of a “reasonably conservative mix of debt and common equity” to fund the purchase.

“The rating affirmation also considers the increase in size, scale and scope of consolidated regulated utility operations and anticipated cost savings that would likely materialize as the LDCs come under UIL’s ownership, while also diversifying the mix of reasonably predictable revenues and cash flows between gas and electric transmission and distribution operations and better balancing of summer and winter peaks,” said Kevin Rose, vice president of Moody’s.

Moody’s also affirmed its ratings and stable outlooks on Iberdrola USA and its utility subsidiaries. “The affirmation of ratings considers Moody’s view that the lost revenue, earnings, and cash flow from former LDC operations would be balanced by the reduction of approximately $411 million of LDC net debt and the receipt of approximately $900 million of gross cash proceeds from sale of these LDCs”, Rose said.

However, Standard & Poor’s Ratings Services (S&P) revised the outlook to negative from stable on UIL and UI and affirmed the corporate and issue credit ratings for UIL and UI.

“…[T]he negative outlook on UIL reflects concerns that the company can successfully finance the proposed transaction in a balanced manner, including the proposed issuance of about $500 million of common equity. Without this, the financial profile will be highly leveraged, leading to a one-notch downgrade to ‘BBB-‘ for UIL and United Illuminating. [A] negative CreditWatch listing on SCG, CNG, and Berkshire reflects that upon successful completion of the transaction, we will lower their corporate credit ratings to that of UIL given the lack of any meaningful provisions that prevent the free flow of cash throughout the organization or any ring-fencing provisions,” S&P said.

“UIL’s acquisition of CNG, SCG, and Berkshire should solidify its overall excellent business risk profile through the doubling of the customer base and a focus on electric and natural gas transmission and distribution operations that have low operating risk. In addition, a measure of operating and revenue diversity will benefit the consolidated business risk profile.”

Connecticut regulators must approve the acquisition of SCG and CNG, while regulators in Massachusetts are expected to review the acquisition of Berkshire; however, Torgerson said the deal can go forward with only the approval of Connecticut regulators. The acquisitions also need federal antitrust clearance, UIL said.

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