NEW YORK--(BUSINESS WIRE)--Fitch Ratings has placed SourceGas, LLC's (SGL) 'BB+' Issuer Default Rating (IDR) on Rating Watch Positive following the announcement that Black Hills Corp. (BKH; rated 'BBB+'; Rating Watch Negative by Fitch) has entered into a definitive agreement to acquire SGL's parent, SourceGas Holdings LLC (SGH; not rated by Fitch). A complete list of rating actions follows at the end of this release.
BKH is acquiring SGH from investment funds managed by Alinda Capital Partners and GE Unit GE Energy Financial Services for a total consideration of $1.89 billion, including reimbursement of an estimated $200 million in capex through closing and the assumption of $720 million of debt projected at closing. The acquisition is subject to regulatory approvals and is expected to be completed in the first half of 2016.
Fitch expects to resolve its Positive Rating Watch on SGL's ratings after the acquisition is closed. If the acquisition is completed as currently planned, Fitch expects SGL's IDR and senior unsecured rating to be upgraded and equalized with those of BKH.
KEY RATING DRIVERS
Acquisition by BKH: Fitch considers the acquisition by BKH to be positive for SGL's credit quality, given BKH's stronger financial profile, larger scale and scope of operations, and better financial flexibility as a publicly-traded entity. Fitch expects BKH to consolidate SGL's operations and debt under BKH, as BKH did when it acquired the Aquila natural gas utilities in 2008. SGL's utility business would therefore benefit from improved leverage metrics as well as enhanced access to capital to help fund growth.
Low-Risk Utility Business: SGL conducts its regulated natural gas distribution businesses in four states: Arkansas, Colorado, Nebraska, and Wyoming. Regulated activities account for over 90% of gross margin. Commodity costs are a straight pass-through to customers via recovery mechanisms. Fixed service charges and base load represent over 60% of revenues and SGL has weather normalization in Arkansas, further reducing earnings and cash flow volatility.
Elevated Capital Investment Program: SGL's capital investment budget is expected to remain elevated over the five-year forecast period and amount to approximately $738 million over 2015 - 2019, about 38% higher than during the previous four years. Rate base growth is projected at 22% over the same time horizon.
Utility Leverage Pressured: The elevated capex spend will continue to pressure leverage. Fitch expects SGL's equity base to be maintained at 50% to 51 % over the forecast period. SGL benefits from recovery riders on capital investments for system upgrades for meter and pipe replacements that cover approximately 60% of capital investments but the rapid growth will continue to result in a timing lag between investment and recovery on investment.
Leveraged Holding Company Structure: SGL is a wholly-owned subsidiary of SGH, the ownership vehicle created by affiliates of General Electric and Alinda Investments LLC to execute the leveraged buyout of the regulated natural gas business from Kinder Morgan in 2007. SGH is managed to a total debt-to-capitalization level of 70%. SGH is reliant on dividends from SGL to service its debt; SGL in-turn is reliant on SGH for equity to support its capital structure during the elevated capex spend period. The constraints on credit quality associated with this leveraged holding company structure would be alleviated by the acquisition by BKH.
Financial Flexibility: Fitch considers SGL's financial flexibility to be constrained as a private company and by a relatively short-dated debt maturity structure. SGL's debt maturities, primarily consisting of $235 million of term debt due in 2016 and $325 million of notes due in 2017, present a degree of market risk at the time of refinancing. The acquisition by BKH would greatly improve SGL's financial flexibility and is expected to result in a restructuring of SGL's capital structure.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for SGL include:
--Completion of BKH's acquisition of SGH in the first half of 2016;
--Rate base growth of 21.7% in 2015 and 4.7% by closing in 2016;
--EBITDA growth of 6.7% in 2015 and 13.0% by closing in 2016.
RATING SENSITIVITIES
Positive: Fitch expects to resolve its Positive Rating Watch on SGL's ratings after the acquisition is closed. If the acquisition is completed as currently planned, Fitch expects SGL's IDR and senior unsecured rating to be upgraded and equalized with those of BKH.
Negative: A meaningful increase in leverage at either SGL or SGH, and failure of the acquisition to be completed combined with higher up-stream dividends from SGL to SGH or deterioration in operating performance from regulatory outcomes that prevent timely and adequate recovery of invested capital.
LIQUIDITY
Liquidity is adequate. SGL has access to a $175 million revolving credit facility that expires in 2016. The facility is used to fund cyclical working capital needs and capital investments not met by internally generated funds, and for general corporate purposes. There were $15.5 million of borrowings outstanding at June 30, 2015.
FULL LIST OF RATING ACTIONS
Fitch has placed the following ratings on Rating Watch Positive:
SourceGas, LLC
--Long-term IDR 'BB+';
--Senior unsecured notes 'BBB-'.
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Recovery Ratings and Notching Criteria for Utilities (pub. 05 Mar 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=863298
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=987848
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=987848
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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