Southern Company: In the Blink of an Eye
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
A Power Empire
When James Mitchell took over as President at Alabama Power more than a century ago, he had a vision to power America’s southeast with the hydro potential of Alabama’s rivers. After years of restructures, mergers, and dissolutions, Alabama Power is held by what is known today as The Southern Company (Southern). Since James Mitchell’s founding dream, Southern has built itself upon what it proudly describes as “big bets.”
Today, Southern is the second-largest utility company in the U.S. by customer base and a leading provider of U.S. electricity and natural gas. Through its subsidiaries, including Alabama Power, Georgia Power, and Mississippi Power, Southern owns and operates 125 power generation facilities in the Southeastern U.S., providing 43.5 gigawatts of generating capacity.
Big Bets or Bad Bets?
In 2016, Southern paid approximately $8.0 billion to acquire AGL Resources, a natural gas provider to more than 4.5 million customers in seven states. Post-merger, AGL Resources was renamed Southern Company Gas and the merger served as an accelerated expansion into the distribution of natural gas. Southern described the resulting combination of the two companies as being “well-positioned to compete for growth across the energy value chain.”
While the AGL transaction did add $3.9 billion in annual revenue to Southern’s top line, the company’s financial strength suffered. The 2016 issuance of $16.4 billion in long-term debt represented a near doubling of the $24.7 billion held at the end of 2015. As a result of this increased leverage, the company’s interest coverage fell from 5.1 in 2015 to 2.3 in 2018.
From 2016 to 2017, net income dropped from $2.45 billion to $842 million, caused by a number of poor investments and grid defection. In Kempur, Mississippi, the company’s attempts to build the CEO-acclaimed “world’s cleanest coal plant” exceeded the initial $2.3-billion budget by $5.2 billion. After writing off a reported $6.4 billion in losses, Southern decided to cancel the proof-of-concept project in 2017, reverting the clean-coal plant back to natural gas. Another attempt to expand the company’s joint-venture Plant Vogtle nuclear power station also saw expenses balloon from an initial estimate of $14.3 billion to more than $25 billion.
While these ambitious bets were made with the intention of helping Southern achieve aggressive growth, failed projects have hindered that goal while simultaneously causing a massive accumulation of debt. Despite Southern’s net income rebounding to $2.2 billion in 2018, the company’s financial position has struggled. In looking to manage its debt, the company has turned to the sale of core assets.
Current Efforts to Reduce Debt
In 2018, Southern announced its decision to sell its Florida utility subsidiary, Gulf Power, and related assets to NextEra Energy, owner of Florida Power & Light Company. While the $6.5-billion deal relieved Southern of $1.4 billion of debt, it resulted in the company’s near-complete exit from the Florida market and the loss of more than $1.2 billion in annual revenue. The company was also forced to sell one third of its solar portfolio for $1.2 billion, one of Southern’s few profit-generating centres.
For Southern, continued asset sales will precipitate a disastrous cycle for investors. They will result in temporary debt relief, but at the cost of the business’ long-term prospects. The ability to use cash flow from operations to pay down debt is furthermore limited; approximately 35 per cent of this stream is directly diverted to common shareholder dividends and the remainder is channelled into fixed asset investments. With $29.0 billion in debt principal maturing after 2023 and $25.8 billion of interest payments due over the same time period, Southern must find a solution to manage its debt once it comes due.
A Venture Into EV Charging Stations
A timely opportunity exists for the company to capitalize on a growing and related industry. Electric vehicles (EVs) have experienced tremendous adoption in recent years. As of 2017, EVs—including plug-in hybrid, battery, and hybrid electric—accounted for more than three per cent of global auto sales. As affordability, efficiency, and range capabilities of EVs improve, this figure is expected to swell to 30 per cent by 2025. Global electric vehicle sales reached 1.2 million in 2017, exhibiting a compound annual growth rate of 50 per cent over the preceding five years.
Compared to the average new gasoline vehicle, EVs emit half the carbon dioxide emissions per mile based on U.S. EPA national electricity generation data. In an effort to promote environmentally-friendly behavior, governments have been introducing legislation to facilitate the adoption of these vehicles. In the U.S., these initiatives have begun at the state level; a California-led coalition of states has introduced the Zero-Emission Vehicle Standards, which requires automakers to sell a quota of zero-emission vehicles proportional to overall sales.
Public Utility Moves into EV
The emergence of EVs as a viable and attractive substitute to traditional internal combustion engine vehicles has major implications for public utility companies. Energy used for transportation—historically provided through gasoline, diesel, and other fuels—is now increasingly drawn from the electricity grid. Utilities must consider how to plan for the increased power usage, shifts in when this power is drawn, and infrastructure required to support electric vehicle charging.
In certain U.S. markets, wholesale power distribution is facilitated through regional independent system operators (ISOs), federally-regulated entities responsible for control and coordination of power distribution. In others, power can be sold directly to consumers and as a result, utilities tend to be vertically integrated. Where vertical integration is possible, EV infrastructure is a natural adjacency for electric utility companies.
Some American utility companies have begun to approach EV infrastructure. Early stage adopters have installed EV charging infrastructure like workplace charging for utility fleets and access to charging stations at office locations as a pilot test. Other utility companies have moved into EV charger sales: San Diego Gas & Electric, for example, sells EV chargers directly to consumers.
Similarly, Southern can share in the EV industry’s growth by entering the public EV charging space. The company’s southeast markets allow for vertical integration, aligning with the core power business, and the immense growth this industry exhibits implies a reliable, recurring stream of cash to pay down debt when Southern’s substantial borrowings ultimately mature.
The Blink Opportunity
Given that many charging stations use proprietary technology, it is preferable to buy, rather than build, an infrastructure network. Southern would benefit from proven technology that it could scale quickly. The U.S. is currently dominated by four networks that own 60 per cent of the total 21,000 public charging stations: ChargePoint, Tesla, Blink Charging (Blink), and SemaConnect. This includes both Level 2 AC and DC charging stations. AC chargers are cheaper to build, requiring similar electrical requirements as common household appliances. In contrast, DC chargers deliver the fastest charging speed available but due to their high implementation costs, are less feasible for residential ownership. Blink, which operates 7.2 per cent of the Level 2 AC chargers and 3.4 per cent of the DC fast chargers, is the largest network for which an acquisition would be feasible.
ChargePoint, the industry leader, recently raised $240 million of series H funding and so would not require financial backing. The Tesla network, on the other hand, is owned and operated exclusively by the EV manufacturer for its ecosystem. Lastly, SemaConnect lacks a presence in DC fast charging, which has the highest projected demand of all charging stations. Other potential acquisition targets such as Greenlots and EVgo—although dominant in the DC fast charging space—lack substantial size, each with less than 1,000 stations in the U.S.
Blink owns and operates charging equipment, and manages installation, maintenance, and related services. The company has built its business model on revenue sharing agreements with apartment, retail, and workplace properties partners; the company has been immensely successful in building stations in urban centres, establishing high-profile partnerships with companies such as Whole Foods Market and Hubject, a joint venture between companies including Siemens, BMW, Volkswagen, and Daimler.
From Southern’s perspective, Blink’s valuation makes it an attractive acquisition target. As of mid-March 2019, the company had an equity value of approximately $70 million and controlled approximately 7.2 per cent of the nation’s Level 2 AC charging infrastructure. This acquisition would provide Southern with substantial growth potential without exacerbating the company’s already pressing debt load.
Impact on Southern
The immediate benefits of the Blink acquisition would be relatively small. Because the EV industry is in its infancy, Blink will initially contribute a mere $2.5 million to Southern’s annual revenues, a negligible amount compared to the $23 billion currently generated. While not immediately material, the acquisition holds great potential for growth. With an anticipated 47.9 million EVs on U.S. roads by 2025, if Blink were to retain its current market share of 7.2 per cent, Southern would realize incremental revenues of just under $1.0 billion from this transaction alone.
Blink would also add value to Southern through the benefit it brings to Southern’s power generation assets. Given that current EV batteries have capacities of up to 100 kWh, the electricity required to fully charge most EVs exceeds the average daily consumption of the typical American household. This acquisition would provide Southern with granular data on this electricity demand, which could be used to optimize the company’s assets.
With this data, Southern could better predict future electricity demand and decide when to bring its plants online so as to maximize profitability. In addition, Southern could influence EV charging behavior by modifying Blink’s charging price based upon the time of day, incentivizing electric vehicle owners to draw on power during non-peak hours. As a vertically-integrated power producer, Southern’s ability to directly provide electricity to end users positions the company to particularly benefit from this information.
The acquisition furthermore aligns well with Southern’s strategy: in 2016, the company acquired PowerSecure, a provider of energy infrastructure products. Such technologies are aimed at utility companies and help balance load through energy storage, solar energy, and microgrid solutions. The Blink acquisition can be used to better understand EV charging demand and influence consumer behavior, enhancing the impact of such technologies.
Electric Roads Ahead
Building out EV infrastructure is a capital-intensive endeavour and could prove challenging given Southern’s already stressed financial position. However, Blink’s strategy to date has focused on giving partners the option to share in the EV charging infrastructure and installation expense. Additional expansion would, therefore, be less capital-intensive than if Blink were to have complete ownership in the infrastructure. This partnership nature furthermore benefits Southern as in its key geographies, the company obtains more data on electricity use for each dollar spent building out EV charging infrastructure.
Southern’s big bet on AGL Resources may have been a smart business decision, but it incurred mountains of debt. Southern’s current strategy of selling off major assets is unsustainable; the company must turn to other tactics to address its debt. The proposed acquisition plan will allow Southern to develop an ancillary revenue stream in time to pay off its debt when it eventually matures while entrenching the firm’s vertical integration and enhancing its core power business.