Utilities Plus

Portfolio Highlights
  • Attractive Risk-Reward Profile
    Local utility monopolies are historically low-correlated investments that provide cash flow above market averages from dividends, plus opportunity for growth of income and principal. The portfolio favors mid-cap utilities that are not “too big to grow” or be acquired, possess attractive “below the radar” assets, and have multiple company-specific catalysts.
  • Positioned to Benefit from M&A and Business-like Expansion
    Stock selection considers factors that affect the likelihood of utility industry M&A, a key to long-term returns. Since inception, over one third of the portfolio’s stocks have been taken over, at an average premium to cost of about 50%. Further, some companies benefit as acquirees, extending their reach into other utility-related business lines.
  • Demonstrated Expertise in the Industry
    There are many issues and opportunities unique to regional electric, gas, water, and telecom utility investing. Utility business models continue to evolve, and Miller/Howard draws upon almost three decades of experience in evaluating opportunities that are driven by new technologies, “MLP-able” assets, management changes, and other special situations.
Portfolio Overview

Our focus is on investments in public securities of mostly small and mid-capitalization utility companies that we believe are both undervalued and potentially subject to acquisition or some other value-creating catalyst, such as consolidation benefits or development of subsidiary assets. Importantly, while we focus on companies with special or hidden value, we also want to be comfortable holding these stocks for an extended period of time, even if the appearance of a catalyst is delayed. Holdings generally have organic moderate growth, an attractive dividend yield, and sell at a low multiple of earnings and book value compared to other companies. Our portfolio emphasizes distribution (“wires and pipes”) companies that deliver services for a monthly charge. These companies benefit from the stability of local monopoly status.

Investment Philosophy

Deregulation and competition within the industry are the drivers behind consolidation of the utility sector. The trend began in 1997, with the repeal of the Public Utility Holding Company Act (PUHCA), which paved the way for nonutility purchasers to participate in acquisition of utility companies. Since that time, many utility acquisitions and mergers have occurred. We believe that the small and midsized gas and electric distribution companies are the most attractive acquisition candidates.

Portfolio Objective

We seek to generate alpha by investing in utility companies that we evaluate as likely takeover candidates and that offer a substantial potential price appreciation based on their projected acquisition value.

Portfolio Strategy

The key driver is our evaluation of the potential attractiveness of a particular company to another utility company as an acquisition, and the potential profit we may derive should a transaction occur, based on current market prices. The initial universe begins with broadly defined utility companies that trade on the major exchanges in the United States. We narrow the universe to attractive acquisition candidates that possess meaningful upside potential from their current valuations. We compare all stocks in the universe to a model of private market value based on the numerous transactions that have already been completed in the industry. If we believe a company can be acquired at a premium, we then evaluate the regulatory environment that might enhance or impede a potential deal. We also analyze a company’s strategic fit with potential acquirors, and the problems or burdens that could hinder a deal. We further investigate management’s view of consolidation, and the proportion of shares held by investors who might be congenial to a transaction.

Preference is given to companies with monopoly-like characteristics and recurring revenues, which may be attained through strategic geographic positioning, or market dominance. Attention to the broad utilities sector is most important. We attempt to find stocks that are supported by our general view of the economy within the utility sector, with bottom-up stock selection being of primary importance.

Stocks are held indefinitely in anticipation of a transaction, or may be sold in the event that current market pricing comes into equilibrium with potential private market valuation. In addition, stocks may be sold if management voices a clear antagonism toward a deal, or if company fundamentals deteriorate sufficiently to alter the potential private market value.

Strategy Inception Date: December 1998
Portfolio Manager: MHI Investment Team

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Quarter Report

Utilities Plus Overview