Fitch Places Westar on Negative Watch Following Acquisition Announcement

CHICAGO--()--Fitch Ratings has placed the 'BBB+' Issuer Default Ratings (IDRs) of Westar Energy, Inc. (Westar) and Kansas Gas & Electric Co. (KGE) on Rating Watch Negative following the announcement of the proposed acquisition by Great Plains Energy Inc. (GXP; not rated by Fitch) for $12.2 billion, including $3.6 billion of assumed debt. Westar will become a direct wholly owned subsidiary of GXP upon deal closing, which is expected to occur by Spring 2017. A full list of rating actions is at the end of this press release.

Fitch's primary concern is the level of GXP consolidated leverage following the acquisition, inclusive of $4.4 billion of parent-level debt plus an undetermined amount of hybrid securities (Fitch typically assigns 50% to 100% debt value to hybrid structures prevalent in the utility sector). Fitch estimates that consolidated funds from operations (FFO)-adjusted leverage could exceed 6.5x following the merger, which is significantly weaker than the 5x average for utilities rated in the 'BBB' category. Fitch typically limits the notching difference between the parent and its subsidiaries to one or two notches, depending on the level of operational, functional and financial ties. Thus, elevated leverage at GXP would negatively weigh on Westar's and KGE's ratings and could result in a one or two notch downgrade. GXP's long-term financial policy, the amount of hybrids used to finance the acquisition, GXP's deleveraging plan as well as the level of integration and/or ring-fencing going-forward will become key criteria in assessing Westar's and KGE's credit profiles after the acquisition is completed.

GXP plans to acquire Westar for $7.3 billion in cash plus $1.3 billion of GXP common stock. At $60/share, the purchase price represents a 36% premium over the closing price on March 9, 2015, when rumours of a potential transaction surfaced. The transaction value of $12.2 billion, including assumed debt of $3.6 billion, represents a 12x multiple to Westar's latest 12 months (LTM) EBITDA at first-quarter 2016. GXP has secured $8 billion of committed financing and $750 million of mandatorily preferred convertible equity commitment but intends to ultimately finance the transaction using a mix of debt and equity, including equity-like hybrids.

KEY RATING DRIVERS

High Consolidated Leverage: The sheer size of the acquisition compared to GXP's current balance sheet will weigh on GXP's financial profile. Fitch notes that the acquisition-related debt of $4.4 billion, excluding hybrid securities, is larger than GXP's consolidated reported debt of $4.2 billion at March 31, 2016. Adding Westar's existing debt of $3.6 billion, Fitch estimates that pro forma consolidated adjusted debt will likely exceed $13 billion while consolidated EBITDA will be close to $2 billion resulting in adjusted debt to EBITDA of about 6.5x. Fitch's estimates are roughly consistent with management's guidance of 13%-14% FFO-debt leverage post-merger. These metrics typically equate to a 'BB' rating category, absent a firm and credible commitment to deleveraging.

Business Profile Mostly Unchanged: The combination of GXP and Westar brings together similar business models likely to generate synergy savings while presenting low integration risk, in Fitch's opinion. GXP and Westar operate contiguous service territories with significant connecting transmission lines and co-ownership of large generation assets. Improved scale and greater integration of these assets will likely result in significant synergies. While synergies are unlikely to be retained by Westar or GXP, they should create headroom in the retail rates for further rate-base investments and earnings growth. Furthermore, GXP is already familiar with the regulatory construct in Kansas through its ownership of Kansas City Power & Light (KCP&L).

Regulatory Approvals: State regulatory approval is only needed in Kansas, where the Kansas Corporation Commission (KCC) has 300 days from filings to judge whether the proposed acquisition is in the public interest based on an established list of criteria. The transaction will also need approval from the Federal Energy Regulatory Commission, the Nuclear Regulatory Commission as well as from Westar and GXP shareholders, amongst others. Management expects the transaction to close in Spring 2017.

Stable Stand-Alone Credit Metrics: Under its base case scenario, Fitch anticipates Westar's credit metrics will remain relatively stable over the rating horizon with adjusted debt to EBITDAR and FFO-adjusted leverage estimated at 3.5x-3.7x over the 2016-2019 forecast period.

Parent/Subsidiary Rating Linkage: KGE is a wholly-owned operating utility of Westar and its ratings are the same, reflecting highly centralized operations with shared employees, treasury and corporate functions, and a consolidated capital structure for rate-making purposes. Business is also conducted under the Westar names in contiguous geographies and WR's revolving credit facilities are collateralized by KG&E's first mortgage bonds, which include cross default provisions.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--Compound annual kwh sales growth of 0.50%;

--Rate increase of $78 million effective October 2015 and with incremental rate increase of $15 million effective July 2017;

--Return on equity on FERC-regulated assets of 10.3%;

--Capex of about $1.100 billion in 2016, $800 million in 2017, $750 million in 2018 and $700 million in 2019; and

--Debt/equity maintained around 53/47;

--Acquisition financing includes $750 million of mandatory preferred convertible equity (assigned 100% equity credit), $1.35 billion of hybrids (assigned 100% debt credit), $2.3 billion of equity and $4.4 billion of long-term debt as well as assumption of Westar's existing debt.

RATING SENSITIVITIES

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

No positive rating action is anticipated in the near term given the pending acquisition and incremental parent leverage.

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

Fitch believes that the completion of the acquisition, based on the proposed financing structure as disclosed, would result in a one or two notch downgrade of Westar's ratings. Fitch would consider a one-notch downgrade if GXP presents a firm and credible path to deleveraging to a capital structure consistent with a 'BBB-' rating and/or if regulatory approval of the acquisition results in effective ring-fencing of Westar. On the other hand, Fitch would consider a two-notch downgrade if GXP relies heavily on hybrid issuance to finance the acquisition, follows an aggressive financial policy, and/or there is limited regulatory ring-fencing of Westar post-merger.

FULL LIST OF RATING ACTIONS

Fitch has placed the following ratings on Rating Watch Negative:

Westar

--Long-Term IDR 'BBB+';

--Senior secured debt 'A';

--Senior unsecured debt 'A-';

--Short-Term IDR 'F2';

--Commercial paper 'F2'.

KGE

--Long-Term IDR 'BBB+';

--Senior secured debt 'A';

--Pollution control revenue bonds 'A';

--Short-Term IDR 'F2'.

Additional information is available at '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

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1005447

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Maude Tremblay, CFA, +1-312-368-3203
Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Philip W. Smyth, CFA, +1-212-908-0531
Senior Director
or
Committee Chairperson
Craig Fraser, +1-212-908-0310
Managing Director
or
Media Relations
Alyssa Castelli, +1-212-908-0540 (New York)
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Maude Tremblay, CFA, +1-312-368-3203
Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Philip W. Smyth, CFA, +1-212-908-0531
Senior Director
or
Committee Chairperson
Craig Fraser, +1-212-908-0310
Managing Director
or
Media Relations
Alyssa Castelli, +1-212-908-0540 (New York)
alyssa.castelli@fitchratings.com