| | | Neutral (US$60.00 price target) | | UBS Research THESIS MAP | a guide to our thinking and what's where in this report | | | Q: Will Great Plains successfully complete its acquisition of Westar? We do not anticipate a higher bid for Westar as the 23x 2018E P/E represents a premium over other recent utility transactions. Great Plains is uniquely positioned to extract synergies from Westar given its adjacent geography and shared ownership in multiple power plants. | | The combination of Westar Energy and Great Plains Energy further concentrates the electric utility industry in Kansas and presents synergy opportunities with the companies sharing a geographic footprint. We see a counteroffer unlikely at the 23x 2018E P/E offered by GXP. State regulatory approval is only required in Kansas which makes a transaction easier to execute compared with a target having multiple state jurisdictions. | | We examined recent electric utility transactions from 2014-2016 indicating an average forward P/E multiple of 20-22x. GXP-WR is the second highest premium in recent years below only DUK-PNY. | | WR is currently trading at ~$57, a 5% discount to the $60 offer price, implying that investors are embedding a modest spread versus the disclosed takeout price but the collar mechanism and future dividends complicates the calculation. | | 
more→ | | Westar Energy (WR) is the largest electric utility in Kansas, providing electric generation, transmission, and distribution services to approximately 700,000 customers in most of... more → |
| | | UPSIDE / DOWNSIDE SPECTRUM | return ↑ | 
| WR is trading
at US$56.50
(as of 31 May). |
Source: UBS Risk to the current share price is skewed (1:3) to the downside WR is trading at US$56.50 (as of 31 May). Although mechanically we see more downside than upside we believe it is more likely than not that the merger with GXP will be completed. Raise PT $13 to $60 for the takeout price; maintain NeutralOur new price target represents the purchase offer price from GXP. Our valuation is based on the $60 purchase offer price from GXP. Figure 1: WR Valuation: Now based on 100% probability of a deal | 
| Source: Company Filings, FactSet, and UBS Estimates |
For more detail on these issues, please see our other recent reports: 3/21/16 Considering the Options 2/29/16 Bonus Blows Away Some Wind Growth 11/5/15 Fair Winds into 2016 10/8/15 A Compassionate Clean Power Plan 8/6/15 Where will the ROE Land? 5/7/15 One ROE Revision Reflected, One To Go
5/6/15 Taking A Dose of Transmission Medicine
3/2/15 Entering the Bullring
10/2014 "Koncerned about Kansas"
Pro Forma EconomicsWe see the deal as modestly accretive by 2019. Figure 2: Accretion Math for WR/GXP Deal | 
| Source: Company Filings, FactSet, and UBS Estimates. * Convertible equity is treated as straight common equity for simplicity. |
Other Key Considerations• We don’t expect another bidder to come forth. At 24x 2017 earnings, this was meaningfully ahead of Street expectations (following EDE at ~20x 2017). WR commented on the call it saw a "very competitive" process. • Converts: Mgmt notes the $750 Mn issued to OMERS will be mandatory convertible in three-years. We treat it as all equity above (Day 1), but don’t reduce Net Income for Dividend/Interest (the 7.25% * $750 Mn = $54 Mn) is not taxable. We emphasize management has left the door open to a further mandatory convert component of its equity financing plan. • Don't see a Missouri look-through either: Mgmt remains adamant that there is no legal precedent for a look through at the holding company in Missouri to impute it down its operating companies. We suspect this will feature as a key question in the future round of rate cases. • What kind of credit metrics? Levering up the Balance Sheet: Mgmt was confident the pro-forma deal would arrive at 13-14% FFO/debt equity, at the lower end of the investment grade utility sector. Mgmt was confident it would hold onto Investment Grade credit metrics at both the OpCo's and HoldCos. We see the total convert financing as a moderating factor on the immediate impact to the consolidated credit profile of the deal. We note the mandatory Moody's notching to the HoldCo is a key consideration for mgmt. • Dividend Policy: Mgmt promises 5-7%, below that of EPS growth given it is already at the higher end of the stated 60-70% payout range. • What does this mean for other deals? Small-cap acquirers here we come: We see the acquisition of WR by GXP as opening up a potential new avenue in M&A in the sector, with smaller companies now open to acquire larger companies to open up growth. We emphasize despite GXP's size, the bulk of the compensation for WR will come in cash consideration rather than share for share. • Deal adds wind exposure to GXP: The combined entity will be 60% Kansas jurisdiction and 40% Missouri, with FERC transmission exposure dropping to 12% from WR's standalone 19%. The combined power supply mix will be only 5% renewable vs WR's standalone 9% (although WR's had been projected to grow to 22% in 2017 with recent wind deals). Preference is not to do a bill credit or rate freeze (any explicit of sharing of synergies in the interim), with usual cadence of rate cases to extract the uplift. Overall, mgmt appears to suggest it will be able to earn its ROEs across its jurisdictions as a function of this deal. • Rate case timing? The regulatory dynamics: GXP commented it would hold intact the rate cycle for both companies right now (despite the potential for meaningful synergies). This is notable as WR had seen a 2019 case to recover wind capex as crucial to maintaining its ROE. Abbreviated cases are contemplated for both utilities in KS later this year, although a broader rate settlement for deal approval could yet impact these cases. The WR case is specifically on prudency of spend rather than ROE. Mgmt explicitly stated it would be open to a settlement to gain KCC approval; no Missouri PSC approval is required. • Ameren: Winner here too. Following weeks in which the company was seen as the key acquirer of WR in the media, we suspect the potential for a multi-day rally as the overhang dissipates. We look towards nuance of July Missouri rate case filing for next datapoints to bolster shares further. The rate design impact from the closure of Noranda's smelter is a key uncertainty in the case. Comparing recent transactionsPlease see our recent 2/23/16 note "Searching for Clues in Utility M&A" for further discussion of these transactions. Figure 3: Recent Utility M&A Transactions | 
| Source: Company Filings, FactSet, SNL Energy, and UBS Estimates; Note: forward multiples as of deal announcement dates |
We note for deals inked in 2014 compare best to 2016E P/E multiples, whereas deals penned in 2015/2016 (and first month of 2016) compare best to 2017E. We note the time series does lend itself towards a bias for earlier deals to have cheaper implied values on near years. Upside (US$60): Our upside case is the same as our base case – that Westar is acquired by Great Plains at the $60/sh announced transaction price. Base (US$60): Our base case is premised on the announced Great Plains transaction closing as originally structured with Westar shareholders receiving $51 in cash and $9 in GXP stock at the completion of the transaction as long as GXP’s average price is between $28.59-$33.23 due to the collar mechanics. If GXP’s average stock price is outside the range, the exchange ratio will be fixed and the total stock value can fluctuate. Downside (US$44): Our downside case is based upon a stand-alone valuation for Westar assuming that the GXP transaction is unsuccessful. In this scenario we value GXP using a sum-of-the-parts methodology with P/E multiples applied to core utility operations. We believe this scenario is less likely than if Westar is acquired by Great Plains in accordance with the announced terms.
| | | COMPANY DESCRIPTION | return ↑ | Market Cap | US$7.5bn | Shares Outstanding | 142m (COM) | Industry | Utilities, Regulated | Region | Americas | Website | www.westarenergy.com |
Westar Energy (WR) is the largest electric utility in Kansas, providing electric generation, transmission, and distribution services to approximately 700,000 customers in most of east and east-central Kansas. In south-central and south-eastern Kansas, it provides regulated services under its wholly owned subsidiary, Kansas Gas and Electric (KGE). Westar has approximately 6,200 MW of generation and 35,000 miles of transmission and distribution lines. In May 2016 Great Plains Energy (GXP) announced it would be acquiring Westar for $60/sh. Industry outlook The electric utility industry is projected to experience weak or negative electric demand growth in coming years as a tepid economy and energy efficiency dampen demand. In the unregulated merchant power space, we see limited potential for a meaningful recovery from currently low power prices due to limited projected demand growth, growth of subsidized renewables, and potential for only modest further retirements. At regulated utilities, we believe rising interest rates and robust valuations are a challenge to the sector, particularly as earnings growth stalls once EPA-mandated growth capex slow mid-decade. We expect cost-cutting and strategic planning to be a key theme across both regulated and competitive companies, with M&A at modest (at best) premiums designed to extract cost synergies. We believe utilities with high parent leverage will disproportionately suffer, as they are unable to recoup from rising interest rates. | Current Ratebase Projection (Feb 2016) 2015A-2020E 
Source: Company reports, UBS Current Capex Forecast, 2015A-2020E 
Source: Company reports, UBS |
| | | | | | | | | | | Forecast returns | Forecast price appreciation+6.5% | Forecast dividend yield2.8% | Forecast stock return+9.3% | Market return assumption5.9% | Forecast excess return+3.4% |
| Valuation Method and Risk Statement Risks for Westar Energy (WR) include but are not limited to: (1) potential inability to deliver on its regulated capital expenditure program; (2) adverse political/legal/regulatory actions; (3) unfavorable weather and natural resources yield [wind generation]; (4) operational and construction risk; (5) inability to access the capital markets on attractive terms; (6) declines in customer demand and population; (7) failure to close pending M&A transactions; (8) natural disasters or nuclear accidents; (9) change in macroeconomics; and (10) other unforeseen changes. Valuation is based on the announced purchase price from Great Plains Energy.
Risks to Ameren (AEE) include but are not limited to: 1) decreases in economic activity and sales volume; 2) unfavourable weather; 3) natural disaster or nuclear accidents; 4) inability to access the capital markets on attractive terms; 5) unfavorable regulatory/legal/legislative developments; 6) failure to close pending or prospective M&A transactions; 7) change in macroeconomics and interest rates;, 8) inability to meet debt obligations as due; 9) financial challenges at its regulated customers such as Noranda; 10) changes in the dividend policy; 11) inability to execute on its regulated capital expenditures plan; 12) inability to have its nuclear licenses extended; and 13) other unforeseen risks. Valuation is based on a 2018E sum-of-the-parts analysis. Required Disclosures This report has been prepared by UBS Securities LLC, an affiliate of UBS AG. UBS AG, its subsidiaries, branches and affiliates are referred to herein as UBS. For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request. UBS Securities Co. Limited is licensed to conduct securities investment consultancy businesses by the China Securities Regulatory Commission. UBS acts or may act as principal in the debt securities (or in related derivatives) that may be the subject of this report. Analyst Certification: Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner, including with respect to UBS, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report. UBS Investment Research: Global Equity Rating Definitions 12-Month Rating | Definition | Coverage | IB Services | Buy | FSR is > 6% above the MRA. | 49% | 32% | Neutral | FSR is between -6% and 6% of the MRA. | 38% | 26% | Sell | FSR is > 6% below the MRA. | 14% | 19% | Short-Term Rating | Definition | Coverage | IB Services | Buy | Stock price expected to rise within three months from the time the rating was assigned because of a specific catalyst or event. | <1% | <1% | Sell | Stock price expected to fall within three months from the time the rating was assigned because of a specific catalyst or event. | <1% | <1% |
Source: UBS. Rating allocations are as of 31 March 2016.
1:Percentage of companies under coverage globally within the 12-month rating category.
2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months.
3:Percentage of companies under coverage globally within the Short-Term rating category.
4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months. KEY DEFINITIONS: Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months. EXCEPTIONS AND SPECIAL CASES: UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece. Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are not registered/qualified as research analysts with FINRA. Such analysts may not be associated persons of UBS Securities LLC and therefore are not subject to the FINRA restrictions on communications with a subject company, public appearances, and trading securities held by a research analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any, follows. UBS Securities LLC: Julien Dumoulin-Smith; Michael Weinstein; Paul Zimbardo. Company Disclosures Company Name | Reuters | 12-month rating | Short-term rating | Price | Price date | Ameren Corp. | AEE.N | Neutral | N/A | US$48.11 | 27 May 2016 | Great Plains Energy Inc. | GXP.N | Not Rated | N/A | US$31.00 | 27 May 2016 | Westar Energy, Inc. | WR.N | Neutral | N/A | US$52.92 | 27 May 2016 |
Source: UBS. All prices as of local market close.
Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date 6.This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and investment banking services are being, or have been, provided. 16.UBS Securities LLC makes a market in the securities and/or ADRs of this company. Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report. For a complete set of disclosure statements associated with the companies discussed in this report, including information on valuation and risk, please contact UBS Securities LLC, 1285 Avenue of Americas, New York, NY 10019, USA, Attention: Investment Research. Ameren Corp. (US$) 
Source: UBS; as of 27 May 2016 |
Great Plains Energy Inc. (US$) 
Source: UBS; as of 27 May 2016 |
Westar Energy, Inc. (US$) 
Source: UBS; as of 27 May 2016 |
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