Entergy (NYS: ETR) is getting serious about its core business line. The power utility operator has decided to focus more intently on its power generation operations by spinning off its transmission business to electric grid company ITC Holdings (NYS: ITC) .
Is the deal good from Entergy's viewpoint? Yes seems to be the answer. Let's see how.
Looking at the intention behind the deal, it seems both companies should stand to gain from it.
For ITC, Entergy's transmission lines will add tremendously to its scale of operations and strengthen its position in the business. The deal will almost double ITC's business size as it will add 15,700 miles of Entergy's transmission lines to its portfolio, adding a lot of value to the business and eventually to its shareholders.
As for Entergy, it sees this divestiture as a step toward increasing focus on its core utility business. The electric utility industry may see as much as $2 trillion worth of investments over the next two decades, offering great opportunities to Entergy to expand. Spinning off the transmission business will not only focus Entergy on strengthening its generation and distribution capacities, it will also enable better utilization of available funds.
I say this because the transmission business requires heavy investments related to upgrades and regulations. Since 2006, Entergy has invested around $1.7 billion in transmission, and had planned an additional investment of $2 billion till 2015. Now that it is divesting the business, Entergy can direct these investments toward its other operations where it sees potential for higher growth.
Moreover, under the deal, Entergy will get cash proceeds amounting to around $1.78 billion by raising additional debt, which ultimately will be taken over by ITC. Entergy is planning to use the proceeds to pay off its debt, which looks like a sensible move.
In fact, it's not only core operation growth or debt that Entergy can focus on, but the divestiture could also give Entergy the opportunity to tackle its nuclear plant issues better.
The nuclear challenge
Entergy is the second-largest nuclear power producer in the U.S., and has been facing rough waters since safety of nuclear power plants became the hot topic after Japan's tsunami and the Fukushima nuclear disaster.
Last month, the U.S. Nuclear Regulatory Commission brought Entergy's nuclear plant under scrutiny after it shut down suddenly. This is the second time the company is facing such issues after a similar problem in May.
Entergy is not the only victim of the nuclear safety issue. Peer Progress Energy's (NYS: PGN) reactors also came under the scanner after an unplanned shut down. And very recently, NRC has stepped up supervision at a Duke Energy (NYS: DUK) nuclear plant.
Clearly, companies like Entergy may be required to exercise more caution in such situations. NRC may also lay down more stringent safety regulations for nuclear reactors, which could add to Entergy's costs.
After the transmission business divestiture, Entergy could invest more on these nuclear plants, both in terms of money and attention.
The Foolish bottom line
Overall, Entergy seems to be making a wise move. The transaction is expected to be completed by 2013, and it should be interesting to see the action Entergy takes to grow its core business.
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At the time thisarticle was published Neha Chamaria does not own shares of any of the companies mentioned in this article.Motley Fool newsletter services have recommended buying shares of ITC Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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