Utility holding companies are days away from setting off a multi-billion dollar round of hybrid financings that will be used partly for share buybacks. “Three to four billion will be easily done in the next couple months and we expect a steady flow thereafter,” says Walter Hulse, managing director at UBS Securities.
“People are trying to drive up their EPS. With their strong cash flow, they feel like they don’t need quite as much capital in their capital structure so they’ll be looking to fund share buybacks with the proceeds,” says a senior debt capital markets banker at a bulge bracket firm. The executive added the more recent threat of activist hedge funds pushing for higher valuations at companies whose nuclear, gas and coal assets are generating significantly higher cash than they were in the past has adds an incentive to take preemptive measures.
Moody’s Investors Service‘s change in methodology on hybrid capital last year and the subsequent race at some top firms to develop equity-like tax deductible securities has given issuers a new tool that bankers say help satisfy this need. “Share repurchases will be one of the uses for this kind of issuance,” says Wylie Collins, head of debt capital markets at Merrill Lynch.
But despite a spate of issuance from financial firms such as U.S. Bancorp, Lehman Brothers and Wachovia, and a small number of industrials such as Burlington Northern Santa Fe, none of the utilities have ventured into the hybrid space to take advantage of the new rules. “Everyone’s waiting for the first one to jump,” says one banker. “The rating agencies gave the last hybrid structure significant equity credit but then effectively changed their minds about it.” In December Lehman said it was preparing to help bring up to $3 billion in hybrids for utilities around this time.
Coverage bankers agree the first to launch will come from one of the top 10 power utilities in the country. One official who says he wouldn’t be involved in the first issuance suggested companies such as Southern Co. and Williams are likely candidates for an offering because they have recently had EPS diluted by a conversion of outstanding bonds into equity. Representatives at those companies didn’t return calls.