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NiSource's pipelines make it a prime takeover target

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Indiana-based NiSource Inc., the owner of natural gas pipelines and utilities in the upper Midwest, is a prime acquisition candidate for companies seeking to profit from the shale-gas boom.

NiSource shares surged to an all-time high last week amid takeover speculation fueled by a December report that Dominion Resources Inc. was raising money for a purchase. An all-cash deal for NiSource would give Dominion complementary gas assets and boost its earnings, even if it paid a 20-percent premium to NiSource’s closing price Jan. 17 of $33.89 per share, according to Sanford C. Bernstein & Co.

NiSource is the parent of Northern Indiana Public Service Co., or NIPSCO. Headquartered in Merrillville, NIPSCO has more than 786,000 natural gas customers and 457,000 electric customers across the northern third of Indiana. It is the largest natural gas distribution company and second largest electric distribution company in the state.

Utility owners are looking to boost returns by expanding in shale-gas markets. NiSource, owner of pipelines and storage systems serving producers in the gas-rich Marcellus and Utica formations, is projected by analysts to post record operating profit this year, according to data compiled by Bloomberg. If Dominion isn’t interested in the $10.6 billion company, a deal may make sense for Canadian pipeline owners Enbridge Inc. and TransCanada Corp. because they’re eager to collect fees for processing and transporting U.S. shale gas, KeyCorp said.

“NiSource has attractive assets, there is no denying that,” Paul Ridzon, a Cleveland-based analyst at KeyBanc Capital Markets, a unit of KeyCorp, said. “If you are a utility who wanted some shale exposure, you could get an expanded utility platform and a very nice shale platform.”

Extracting gas

Mike Banas, a spokesman for NiSource, said the company doesn’t comment on speculation, when asked whether it’s been approached by buyers or is considering a sale.

Ryan Frazier, a spokesman for Richmond, Va.-based Dominion, also said the company declined to comment on speculation, as did Shawn Howard, a spokesman for Calgary-based TransCanada, and Graham White of Enbridge.

Shale refers to the dense rock formations deep within the ground that producers drill through to extract trapped oil and gas. The shale is cracked open with a powerful injection of a mixture of water, sand and chemicals. Pipelines, such as NiSource’s, transport the recovered fuel.

NiSource’s Columbia Pipeline Group operates about 15,700 miles of lines that stretch from Louisiana to New York. NiSource also owns gas utilities that serve 3.3 million customers in seven states and the electric utility in Indiana.

Takeover speculation

NiSource was among the stocks that rallied Dec. 20 after Mergermarket, citing unidentified people, said that Dominion is in “advanced stages” of raising more than $10 billion in debt to buy a publicly traded Midwest utility company. Mergermarket didn’t cite NiSource as a target.

When asked at the time about the story, Dominion’s Frazier said the company is “committed to and focused on executing our diverse, long-term regulated infrastructure growth plan.”

Dominion’s market value of about $38 billion makes it the second-largest U.S. utility owner. Duke Energy Corp. is the biggest at $48 billion.

“Both Dominion and NiSource are heavily involved in natural gas transportation in, out of, and through the Marcellus and Utica Shale plays,” Philip Adams, a Chicago-based analyst at Gimme Credit LLC, wrote in a Dec. 23 report. That means that while a deal could result in synergies, a tie-up also might concern antitrust regulators, he wrote.

Power demand

The deal speculation comes as power companies face tepid electricity demand. Average electricity sales per home are projected to fall 1.1 percent this year and 0.4 percent in 2015, according to the U.S. Department of Energy. More than 80 percent of Dominion’s revenue is tied to electricity, data compiled by Bloomberg show. NiSource gets more than half of its revenue from its gas assets.

“Local gas distribution companies look to have a level of long-term rate base and volume growth that’s simply not happening for most electric companies,” Robert Zabors, CEO of Chicago-based energy and infrastructure consulting firm Enovation Partners, said.

Dominion, in an attempt to unlock the value of its gas assets, said in September that it will form a master limited partnership in 2014 that will initially include a liquefied natural gas terminal and its stake in a Utica Shale joint venture. MLPs don’t pay federal income taxes and distribute most of their cash to owners of their units, which trade like shares in a corporation.

Pipeline appeal

Adding NiSource’s gas transmission and storage systems would boost the value of Dominion’s planned MLP, according to Hugh Wynne, a New York-based analyst at Bernstein.

NiSource CEO Robert Skaggs said in October the company was also considering forming an MLP with its transmission and storage assets.

NiSource “has a growing pipeline business that has appeal, both fundamentally and to those who could conceivably use financial engineering to extract even greater value,” William Ferer, a money manager and director of research at Jersey City, N.J.-based W.H. Reaves & Co., said. The firm, which oversees about $3 billion, owns NiSource shares.

NiSource already fetches a higher valuation than most of its peers. Its price-earnings ratio last week of 23 compares with a median of 18 for U.S. utility networks valued at more than $1 billion, data compiled by Bloomberg show.

“You have a potential to grow a business in which investors have placed a valuation premium,” Wynne said in a phone interview.

Earnings accretion

Based on NiSource’s Dec. 20 closing price of $32.86, Dominion could pay a 20-percent premium in cash and increase its earning per share 11 percent, Wynne wrote in a Dec. 23 report. If Dominion could cut costs after a deal, earnings would rise even more, he wrote.

A 20-percent premium to the Dec. 20 price would value NiSource at more than $12 billion, not including its $8.4 billion of net debt, according to data compiled by Bloomberg.

For TransCanada or Calgary-based Enbridge, which each have market values exceeding $30 billion, buying NiSource would be a “pretty easy way to get a quick, relevant foothold” in the Utica shale, though the rich valuation could be a hurdle, KeyBanc’s Ridzon said.

“Someone is going to have to want the assets pretty badly to pay at these levels,” he said.

NiSource also has the electric utility, NIPSCO, which won’t appeal to buyers as much as its gas business, according to Bill Bunn, a Cincinnati-based money manager at Fort Washington Investment Advisors Inc., which owns NiSource bonds. Fort Washington’s parent Western & Southern Financial Group oversees about $45 billion.

There may be suitors drawn to NiSource’s gas assets though, particularly because of the connection to the Utica shale basin, Bunn said. The Utica contains natural gas liquids, which have other uses such as making plastics and detergents and can sell for a higher price than gas, he said.

“There are dozens of companies out there that would be excellent M&A targets, and NiSource is certainly one that is out there,” Bunn said. “The presence of that electric utility just makes it a little complicated.”

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