Fitch Places Southern on Negative Watch & AGL on Positive Watch Following Acquisition Announcement

NEW YORK--()--Fitch Ratings has placed the 'A' long-term Issuer Default Rating (IDR) and senior unsecured debt ratings of The Southern Company (Southern) on Rating Watch Negative. The actions follow today's announcement of a definitive agreement to acquire AGL Resources (AGL) for $8 billion in cash.

Southern should benefit from the greater scale and diversity from the addition of predominantly low-risk natural gas distribution businesses. However, these benefits will be partially offset by the increase in the company's near-term leverage given the primarily debt driven acquisition financing and a measured pace of deleveraging through 2019.

Prior to today's action, Southern's Rating Outlook was Negative. The ratings of Southern's subsidiaries are unaffected by this transaction.

Fitch has also placed AGL's 'BBB+' long-term IDR on Rating Watch Positive. Fitch will likely maintain a one-notch differential between the IDRs of Southern and AGL. Post-closing, AGL will become a second-tier holding company of Southern and will remain as the direct parent of its two operating utilities, Atlanta Gas Light Co. (AGLC, 'BBB+' IDR), and Northern Illinois Gas Company (Nicor Gas, 'A'). Given the close parent subsidiary rating linkages, Fitch has placed AGLC's IDR on Rating Watch Positive as well. Fitch has affirmed the IDR of Nicor Gas with a Stable Outlook. Fitch expects Nicor Gas' credit metrics to remain strong for its rating category with sufficient headroom to absorb potential regulatory concessions required for merger approval.

Southern is planning to acquire AGL for $8 billion in cash or $66 per share, which implies a 36% premium over the closing price on Aug. 21, 2015. The cash offer will be predominantly financed with debt at close, but permanent financing is expected to include $3 billion of equity issuances that start in fourth quarter of 2015 and run through 2019. Including assumed debt of approximately $4 billion, the transaction value is $12 billion or 11x AGL's LTM June 30 EBITDA.

KEY RATING DRIVERS

Southern:

Majority Debt Funding of the Acquisition: The proposed acquisition results in a meaningful increase in consolidated leverage compared to Southern's current and projected stand-alone financial condition. The rise in leverage is driven by the combination of the acquisition debt to be issued by Southern, the assumption of existing AGL consolidated debt and a measured pace of deleveraging to reach a permanent acquisition financing mix of 63% debt and 37% equity by 2019. Fitch expects consolidated cash flow leverage and fixed charge coverage measures of the combined entity to meaningfully weaken in the short to medium term compared with Southern's standalone credit profile. Based on a preliminary analysis and excluding benefits of any potential synergies, Fitch forecasts pro forma adjusted FFO leverage to be in the 4.5x - 5.0x range and FFO fixed charge coverage in the 4.5x - 4.75x range over the forecast period.

Improved Business Profile: The acquisition of AGL meaningfully reduces Southern's risk profile, in Fitch's view. Fitch generally views gas distribution businesses as low risk and AGL's utilities are generally well managed with numerous supportive regulatory mechanisms in place. AGL's rising investments in inter-state pipelines carry moderately higher competitive market risks, but these are offset to a large extent by long-term offtake agreements with credit worthy counterparties. While the non-regulated retail and wholesale businesses of AGL are volatile, the exposure is somewhat contained given these will be a small part of the combined company.

Southern gains tremendous scale and geographic diversity with this acquisition and its inaugural pursuit of natural gas businesses can smooth out earnings and cash flow of its predominantly summer peaking electric utilities. The combination also lowers the contribution of its non-regulated, albeit conservatively managed, Southern Power Company in the overall business mix as well as that of its utility subsidiary, Mississippi Power Company, which is undergoing significant stress related to the construction cost overrun and inadequate rate recovery for the Kemper Integrated Gasification Combined Cycle (IGCC) project.

New States and Businesses Induce Uncertainty: Fitch's concerns primarily lie with Southern's first regulatory foray outside the southern states. Southern will add five new state regulatory jurisdictions, which includes some tough jurisdictions such as Illinois and New Jersey.

Regulatory Approvals: Apart from AGL shareholders approval, state regulatory approvals are required in Georgia, Illinois, New Jersey, Maryland and Virginia. The transaction is also subject to clearance under the Hart-Scott-Rodino Antitrust Improvements Act. Southern expects to close this deal in the third quarter of 2016.

Resolution of the Rating Watch: Fitch expects to resolve the Rating Watch either at or close to the transaction completion, which will take approximately 12 months. The regulatory approval process and the pace of equity issuance by Southern will be the key data points to monitor. In parallel, Fitch will continue to track the progress of the Kemper IGCC project, which includes successful completion (currently estimated in first half of 2016) and operations of the plant, resolution of regulatory uncertainty in Mississippi (order on the permanent rate recovery for the in-service portion of the plant scheduled for early December 2015), and issuance of approximately $1 billion in securitization proceeds at Mississippi Power Company (Fitch's expectation is early 2017). Fitch will also track the construction program of the Vogtle 3 and 4 units by Georgia Power Company based on the current costs and schedule and continuation of regulatory support in Georgia as demonstrated through future Vogtle Construction Monitoring proceedings and the next general case to be filed in mid-2016.

AGL:

Enhanced Scale and Financial Flexibility: AGL's existing 'BBB+' IDR takes into consideration the low-risk profile of AGL's utility operations which represents approximately 70% of the consolidated earnings. The Rating Watch Positive reflects the financial and operational benefits from becoming part of Southern. Besides improved scale and likely synergy savings, Fitch believes that this transaction will particularly benefit AGL's aggressive pursuit of pipeline projects and provide more diverse funding sources. AGL has announced definitive plans to participate in three pipeline projects totaling nearly $700 million investments, supplying its gas customers in Georgia, New Jersey and Virginia. The majority of the pipeline capacities are contracted to highly-rated offtakers. The projects are expected to complete in the 2017 and 2018 timeframe. The company also concluded a non-binding open season for the proposed Prairie State Pipeline which would serve customers in Illinois. Although these projects appear to expand its midstream footprint, high level of contractual commitment and expected balanced financing structure help neutralize the competitive market risks.

Manageable Non-utility Exposure: While results from the non-utility businesses are volatile, the exposure is somewhat contained, given their relatively small contribution to the combined entity.

Rating Linkages Between AGLC and AGL: AGLC's ratings reflect its close linkage to AGL. The linkage is driven by AGLC's reliance on AGL for access to capital and liquidity, and AGL's dependence on upstream dividends from AGLC to service holding company-level debt. All AGL's subsidiaries except for Nicor Gas participate in a corporate money pool arrangement for short-term borrowing needs. Georgia's regulatory framework does not limit AGLC's ability to upstream dividends to AGL.

Nicor Gas's Ratings Unaffected: Fitch has affirmed the ratings and Stable Outlook for Nicor Gas. Fitch believes any synergy benefit will likely be small for Nicor Gas due to the lack of geographic overlap with Southern's utility subsidiaries. Additionally, Illinois has a history of political interference with merger approvals and typically imposes rate freezes. Fitch believes Nicor Gas' credit metrics are strong enough to withstand likely merger concessions in the approval process.

Resolution of Rating Watch: Although Fitch acknowledges the strategic and financial benefit for AGL as a result of the transaction, a rating upgrade at AGL will also depend upon the resolution of Southern's Negative Rating Watch to ensure that proper rating deferential between AGL and Southern is maintained. As previously stated, Fitch intends to maintain a one-notch differential between the IDRs of Southern and AGL.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Southern are as follows:

--No material retention of synergies from the AGL acquisition;

--Issuance of $3 billion in equity proceeds from 4Q2015 through 2019 in a ratable manner;

--At Alabama Power Company, modest increases in Rate Stabilization & Equalization (RSE) rates over 2015-2017, 1.5% increase under environmental rates in 2015 and 2.5% in 2016 and 0.5% increase in electricity sales in 2015 and 2016;

--At Georgia Power Company, 1.5% increase in electricity sales, rate increases as authorized in last base rate case, Nuclear Construction Cost Recovery (NCCR) tariff increases of 0.3% in 2015, and between 0.5%-1% over 2016-2017; and Vogtle 3 & 4 in-service in 2019 and 2020; --At Gulf Power Company, a decline in sales by 1% in 2015, 0.5% growth in 2016 and 1% in 2017 and rate increase per the last rate order;

--At Mississippi Power Company, ROE of 9.7% for 2015-2017, 100% ownership of Kemper IGCC with 85% of the project recovered through regulated rates, Permanent rate recovery for in-service assets in-line with interim rates approved, securitization of $1 billion in January 2017, Kemper IGCC commercial operations date (COD) by June 2016 within the current budgeted costs, modest Performance Evaluation Plan (PEP) and Environmental Compliance Overview (ECO) rate increase over 2016 - 2017, and 1% electricity sales growth over 2015-2017;

--At Southern Power Company, growth projects as announced and balanced funding of growth capex.

Fitch's key assumptions within the rating case for AGL are as follows:

AGL:

--Capex spending at utilities averages approximately $975 million from 2015 through 2018;

--Non-utility capex averages approximately $120 million per year including pipeline construction projects;

--Percentage of rider capex at utilities averages nearly 50% from 2015 through 2018;

--Dividend $250 million from 2015 to 2018.

RATING SENSITIVITIES FOR SOUTHERN

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

--Pace of deleveraging such that FFO adjusted leverage sustains at or below 4.0x;

--COD of Kemper without any material escalation in currently projected capital costs followed by successful operational performance;

--Constructive outcome in Mississippi Power Company's pending rate filings;

--No material cost and/or schedule escalation for Vogtle units and any adjustments to the overall project costs deemed recoverable by the Georgia PSC;

--Continued regulatory support in Georgia regarding the VCM filings and next general rate case to be filed mid 2016.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--Regulatory concessions in excess of those assumed in the financial forecasts or a reduction in equity issuance could have an adverse effect on ratings;

--Significant time/cost overrun at Vogtle and/or Kemper projects that are primarily debt financed and negative regulatory actions on the recovery of those costs;

--FFO adjusted leverage weakens to 4.5x or higher on a sustained basis.

RATING SENSITIVITIES FOR AGL AND SUBSIDIARIES

AGL, AGL Capital and AGLC

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

--AGL and AGL Capital's ratings could be upgraded, if Southern Company's IDR is stabilized at A.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--Material debt-funded expansion or shift towards non-utility businesses;

--Negative regulatory developments in the states that AGL's utilities operate, including material concessions for merger approvals;

--AGL's adjusted debt/EBITDA above 4.75x and/or FFO fixed charge coverage below 3.75x on a sustained basis.

Nicor Gas

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

--An upgrade at AGL as a result of this transaction will not warrant a positive rating action at Northern Illinois Gas Company due to expected low level of synergy benefits for Nicor and relatively restrictive Illinois regulations.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--Adverse change in regulatory environment;

--Stronger parent subsidiary linkage through dividend or other financial support provided to AGL that is disproportionate to its earnings;

--Adjusted debt-to-EBITDA above 3.75x and/or FFO fixed charge coverage below 4.5x on a sustained basis.

FULL LIST OF RATING ACTIONS

Fitch has placed the following ratings on Watch Negative:

Southern Company

--Long-term IDR 'A';

--Short-term IDR 'F1';

--Commercial paper 'F1';

--Senior unsecured notes 'A'.

Fitch has placed the following ratings on Watch Positive:

AGL Resources Inc.

--IDR 'BBB+'.

AGL Capital Corp. (guaranteed by AGL)

--Senior unsecured notes 'BBB+';

--Commercial paper 'F2'.

Atlanta Gas Light Company

--IDR 'BBB+';

--Senior unsecured medium-term notes 'A-'.

Fitch has affirmed following ratings with Stable Outlook:

Nicor Gas

--IDR at 'A';

--Senior unsecured notes at 'A+';

--First mortgage bonds at 'AA-';

--Short-term IDR at 'F1';

--Commercial paper at 'F1'.

Date of Relevant Rating Committee: Aug. 24, 2015

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=989866

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=989866

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Contacts

Fitch Ratings
For Southern Company and Subsidiaries:
Primary Analyst
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Julie Jiang
Director
+1-212-908-0708
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
For AGL Resources and Subsidiaries:
Primary Analyst
Julie Jiang
Director
+1-212-908-0708
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
For Southern Company and Subsidiaries:
Primary Analyst
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Julie Jiang
Director
+1-212-908-0708
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
For AGL Resources and Subsidiaries:
Primary Analyst
Julie Jiang
Director
+1-212-908-0708
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Shalini Mahajan, CFA
Managing Director
+1-212-908-0351
or
Committee Chairperson
Dennis Pidherny
Managing Director
+1-212-908-0738
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com