Monday, November 30, 2015

Hawaiian Electric: NextEra Merger, ASB Hawaii Spinoff

Hawaii Electric Industries (HE) is the primary electric utility serving over 95% of the state's residents, interestingly they also own the third largest bank in Hawaii, American Savings Bank.  Oil is used to generate Hawaii's electricity (already more expensive than natural gas or coal) and given the islands remote location, additional transportation costs lead to resident's electric bills being very expensive, up to 3x more than the average household on the mainland.  Environmental and political pressures have led to the ambitious goal of generating 100% of the state's electricity from renewal sources by 2045, with interim goals between now and then.  It's admirable goal, however Hawaiian Electric is a small inefficient utility and isn't up to the task both operationally and financially, they need a bigger partner.

In December 2014, they announced a merger with NextEra Energy (NEE) with Hawaii Electric shareholders receiving a combination of NEE shares, cash, and most appealing to me shares in Hawaiian Electric's thrift bank subsidiary, American Savings Bank (ASBH).  Federal banking laws restrict commercial businesses from owning banks, however Hawaiian Electric's ownership of American Savings Bank had been grandfathered in leading to an odd pairing of an electric utility and a sleepy saving bank.  But with the merger, the grandfathered status goes away and HE/NEE is forced to spinoff the bank to shareholders as a condition of the merger.

The merger details are as follows, on the closing, Hawaiian Electric shareholders receive:
  • 0.2413 shares of NextEra Energy (NEE)
  • $0.50 special dividend
  • 0.3333 shares of ASB Hawaii (ASBH)
Hawaii is a lovely place to visit, but it's an odd place to do business, especially as a government regulated utility serving the state.  Many residents in Hawaii are extremely protective of their unique culture, history, and way of life - politically its a hard sell to have a mainland utility come in and takeover the largest publicly traded Hawaiian company.  They also view the utility as a communal company and not a for-profit corporation which needs to serve the best interest of their shareholders.  The governor is publicly opposing the merger, there are many websites devoted to blocking the merger, and yet, they also want to free themselves of fossil fuels and generate more of their power within the state.

So what's likely to happen is each interest group is going to extract a promise or two out of NextEra, to not lay people off, to keep electricity prices low, to invest a certain amount of dollars into clean energy infrastructure, etc.  Eventually this deal gets done, it's just a matter of when.  The last and biggest hurdle is getting approval from the Public Utilities Commission in Hawaii, they're currently conducting hearings through December 26th and have committed to a ruling by June 2016, but it could come sooner.

American Savings Bank Hawaii (ASBH)
In Hawaii there are four banks that control the market and none of them are branded as the big money center banks that you would typically see in other US markets, this goes back to Hawaiian's maintaining their unique culture.  The two largest are Bank of Hawaii (BOH) and First Hawaiian Bank which is owned by Bank of the West which is then owned by BNP, a distant but still meaningful third and fourth place are split between American Savings Bank and Central Pacific Financial (CPF), which is also publicly traded.

Hawaii is a pretty attractive banking market, it's seen healthy mid-single digit growth in both loans and deposits in recent years in an otherwise growth strained national banking backdrop.  The real estate market is strong, relatively constrained by their island geography and having much of the land zoned as national parks, most of the building is up not out (see HHC's Ward Village).  The economy is driven by two main sectors, federal defense spending and tourism, both of which were reasonably resilient during the 2008-2009 financial crisis.  Plus, I like the added benefit of being remote and a closed off market for other players, it's unlikely that the four banks in Hawaii would see a new competitor come in and start a pricing war.

American Savings Bank specifically is run as a fairly conservative thrift bank, it holds a considerable amount of residential loans (Hawaiian mortgages typically fall under the jumbo category) and its funded exclusively with low cost deposits.  ASBH feels like a combination of a spinoff with elements of a mutual bank conversion.  As part of Hawaiian Electric, American Savings Bank distributed income up to the holding company in order to support the dividend in lean years, as a standalone company they'll have individual discretion on their capital allocation without the outside of interests of a cash strapped electric utility.  There's also an interesting regulatory upside as a result of the spinoff, in 2010 as part of the Dodd-Frank legislation, the Durbin Amendment limited fees charged to retailers for debit card processing.  It contained a waiver for banks below a certain asset threshold, as apart of Hawaiian Electric the bank had it's fees capped, but as a smaller standalone entity, American Savings Bank will no longer fall under the restriction leading to an additional ~$6MM in revenue (mostly falling straight to the bottom line).  Management is likely to become more aggressive as a result of the spin, compensation will be easier tied to the bank's performance and they plan to branch out into more profitable lines of business.

As I'm writing this, NEE trades for $100.03 and HE trades for $28.60, doing some algebra and (of course assuming the deal gets approved) one could synthetically create ASBH for $3.96 per share of HE or $11.89 assuming the 3 shares of HE for 1 share of ASBH ratio.  That equates to a market cap of $426MM for a bank with a tangible book value of $557MM.  As mentioned above, ASBH has two easy public comparables in BOH and CPF that do substantially all of their business in Hawaii.
Bank of Hawaii is a serial share repurchaser, when you buyback shares above BV it reduces the BV per share even if it's otherwise accretive so it appears BOH is trading for a rather absurd BV multiple.  Central Pacific Financial is probably a better comp anyway, they're roughly the same size and have similar performance metrics, if ASBH were to trade for the same P/TBV multiple it would be worth $7.50 per HE share, or almost twice as much as it's being valued today (admittedly much of the discount is the merger arb spread).  If you took CPF's P/E ratio and applied it to ASBH, you'd get $8.69 per HE share.  At the time of the deal, HE and NEE pegged the value of ASBH at $8, so somewhere in that range seems reasonable.

The problem for me at least is how to structure the trade/investment?  One could short 0.2413 shares of NEE for each share of HE, but the capital required to create a meaningful position synthetically in ASBH is somewhat prohibitive.  One could also wait until after the spinoff, there are likely to be many forced sellers (utility focused funds/ETFs) and other retail investors that might indiscriminately sell a small unwanted bank position.  But I'm a little impatient, and have established a medium sized long position in HE (unhedged), with hopes of picking up some of the spread when the deal gets approved and then buying more of ASBH post spin if it's still cheap.

Disclosure: I own shares of HE


  1. Interesting find!

    Assuming ASBH value at $8 and current NEE price of $98.14 / $28.1 for HE, market seems to put odd of deal going through at +80% ($98.14 x 0.2413 + $0.5 cash + $8 ASBH = $32.18 value vs. $28.1 HE price)

    But some analysts seem to think chance of deal going through is 50-50. Are you getting a good deal at this price? Or you have insights as to why this is likely done deal? What do you think downside will be if deal doesn't go through?

    1. I'm far from a merger-arb expert, but aren't you just highlighting the spread and not the probability of the deal being approved?

      If I had to guess, a lot of the spread is the timing of the deal closing, it's likely going to get dragged out until June 2016, maybe longer. It has some headline risk, maybe it gets initially rejected as a negotiation tactic, but it's in best interest of the electric grid in Hawaii for someone with deeper pockets to operate there.

      Utilities as a group seem overheated, but Hawaiian Electric (with ASBH) is trading for 8.5x EBITDA, 17.5x earnings, 1.6x BV, all are toward the lower end of mid-cap utility peers. It doesn't appear to me the market is pricing in much probability of the merger happening at all. On headline of a deal break it will drop the stock, but I'd view that as mostly temporary.

      Thanks for the comment.

  2. Update - I sold HE down to a tracking position. With the market sliding, the risk/reward here doesn't look as good as other positions/ideas.

  3. But you still think the deal goes through?

    1. I do. I still wouldn't be shocked to see it initially get broken just so the state could take another chunk out of NEE before they came to new terms. I trimmed just because the gap to intrinsic value is bigger elsewhere in my portfolio now. ASBH still probably gets sold off initially even if the deal goes through, so there could be a better opportunity timing wise down the road.

  4. hope you're right. Wells Fargo said talked to NEE management, and they're fine with walking away if Hawaii asks for more. say deal is 50/50 now. Seems like market is estimating more like 30% of deal getting done, unless you think HE could fall to 24 if deal falls through


    Deal has been terminated and the ASBH spinoff is off as well.