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Entergy: Dividend Cut Possible Should ITC Transaction Close

 November 07, 2012 06:46 PM

(By Mani) Shareholders of Entergy Corp. (NYSE: ETR) face a possible dividend cut after it announced its intentions to "right-size" the dividend following the close of its proposed transaction with ITC Holdings Corp. (NYSE:ITC) under which the company would spin-off its transmission business to ITC.

Entergy is an integrated energy company engaged primarily in electric power production and retail distribution operations. Entergy owns and operates power plants with approximately 30,000 megawatts of electric generating capacity, including more than 10,000 megawatts of nuclear power, making it one of the nation's leading nuclear generators.

[Related -Entergy Corporation (ETR) Upgraded To 'Buy' By Deutsche Bank, PT Raised]

Entergy, which has annual revenues of more than $11 billion, delivers electricity to 2.8 million utility customers in Arkansas, Louisiana, Mississippi and Texas.

The latest dividend announcement came as a surprise to shareholders when the deal was announced in December 2011, Entergy indicated that, despite a lower earnings profile absent transmission, it was committed to the current dividend of $3.32. It appears that this is no longer the case. Shares were down about 3 percent on the news.

"We were surprised by management's comments regarding the security of the current dividend post the planned spin-off/sale of Entergy's transmission business to ITC Holdings," BMO Capital Markets analyst Michael Worms wrote in a note to clients.

The company pointed to the fact that, under the ITC transaction, Entergy shareholders would also receive ITC shares and consequently a share of ITC's dividend. This is the first time Entergy speak of the dividend on a combined basis.

[Related -Dividend Roundup: ETR, GPN, LM, MAT, RGS, SCHN]

Entergy recently issued 2013 EPS guidance of $4.60-$5.40. At the midpoint of $5.00, the Utility accounts for $4.70. It is assumed that Entergy's transmission business accounts for about 60 cents of Utility earnings.

"We would expect that proceeds from the transmission transaction (gross cash proceeds of $1.775 billion) would likely be applied toward debt reduction (utility and parent), thereby reducing interest expense by ~$0.30," Worms said.

While not providing specifics, Entergy had mentioned that there were certain dis-synergies related to the merger (certain fixed costs allocated to the transmission business).

"As such, on a net basis, we would expect Entergy's EPS could decline by ~$0.30-$0.40 following the close of the transmission transaction," the analyst noted.

Entergy has stated that the Utility supports the dividend and that its wholesale generation business is not part of the equation. Including parent costs when calculating a payout and, therefore, post the transmission spin-off, utility/parent EPS is estimated at about $3.80-$3.90 and the payout about 86 percent.

"We would expect the rating agencies could balk at a payout of this magnitude, given ETR's exposure and uncertainties related to the merchant business and the current low price environment. This could lead Entergy to cut its dividend rather than risk a rating downgrade at its utility subs," Worms said.

Under the terms of the agreement, Entergy will divest its electric transmission business to a newly formed entity, Mid South TransCo, which ultimately will be merged into a newly created merger subsidiary of ITC in an all-stock, Reverse Morris Trust (tax-free) transaction.

Prior to the merger, ITC expects to effectuate a $700 million recapitalization (expected to take the form of a one-time special dividend to its shareholders of ~$13.70 per share). ITC will issue about $700 million of unsecured debt.

Entergy shareholders will receive 50.1 percent of the shares of pro-forma ITC in exchange for their shares of TransCo, with existing shareholders of ITC owning the remaining 49.9 percent. In other words, ITC is essentially doubling its outstanding shares.

Entergy expects to receive gross cash proceeds of $1.775 billion from debt that it will issue in connection with the transaction and this debt will be assumed by ITC at the close of the merger. Entergy expects to use most of the cash proceeds to retire debt associated with the transmission business at its operating utility subsidiaries' level and the balance for debt reduction at the parent.

The transaction is expected to close in 2013, pending receipt of all required approvals, including ITC shareholders, FERC, and all of Entergy's retail regulators.

Recently, Entergy reported third quarter 2012 earnings of $337.1 million, or $1.89 per share, compared with $628.1 million, or $3.53 per share, for the third-quarter 2011. On an operational basis, Entergy's third quarter 2012 earnings were $347.7 million, or $1.95 per share, compared with $628.1 million, or $3.53 per share, in the third-quarter 2011.



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