S&P Lowers Outlook on Southern Co. (SO) to Negative Amid Plans to Acquire AGL

Standard & Poor's Ratings Services said today that it revised its rating outlook on Southern Co. (NYSE: SO) and the company's subsidiaries to negative from stable. At the same time, we affirmed our ratings on the companies, including the issuer credit ratings.

The proposed acquisition of AGL offers a slight improvement to our "excellent" business risk profile assessment of Southern by adding a modicum of very low-risk natural gas local distribution companies to the company's stable of regulated, integrated electric utility properties. "Adding AGL would provide operating and regulatory diversification benefits and diffuse the effect of AGL's higher-risk activities across a much bigger platform," said Standard & Poor's credit analyst Todd Shipman. "However, those benefits could be more than offset by the probable debt-heavy funding of the merger." Southern has not released details of its plan, but it appears that the company plans to use about $3 billion of common equity over a very extended period (through 2019) to cover the $12 billion transaction.

Our expected forecast of the pro forma effect of the transaction suggests that funds from operations (FFO) to debt could fall to the 15%-16% range from the 18%-19% range, based on the debt Southern intends to employ.

We also see added risk that the protracted pursuit of regulatory and other approvals could distract Southern's management at a critical time in the company's Kemper and Vogtle construction projects. Completing Kemper and getting the costs permanently into rates, and pressing on in the crucial halfway point for the nuclear construction, are challenging without the considerable diversion of Southern senior management's time and attention for regulatory and integration efforts at AGL. Any missteps on those high-profile endeavors in the midst of the AGL merger process could pressure ratings.

Under the group rating methodology criteria, we view Southern as the parent of a group that includes "core" subsidiaries (GPC, Gulf Power Co., and Alabama Power Co.), a "highly strategic" subsidiary (MPC), and a "strategically important" subsidiary (Southern Power). The 'a-' consolidated credit profile of Southern, as parent of the group, becomes the group credit profile and leads to an 'A-' issuer credit rating.

The negative outlook on Southern and its subsidiaries reflects our baseline projections that the organization's regulated electric utility and merchant power operations will continue generating sufficient cash flow to consistently achieve credit measures that support the "significant" financial risk profile assessment, including FFO to debt of approximately 16%. We expect Southern's financial condition to erode slightly due to the AGL transaction as its large capital spending program, which includes construction of new nuclear plants in Georgia and an integrated gasification combined-cycle unit in Mississippi, peaks in 2015 and winds down over the rest of the decade.

We could lower the ratings on Southern and its subsidiaries if the regulatory and plant construction issues at Georgia Power Co. (GPC) and Mississippi Power Co. (MPC) worsen and that risk, in conjunction with the AGL merger process, materializes in deterioration in credit measures, including FFO to debt consistently below 16%. Outsized growth at merchant power subsidiary Southern Power Co. could also eventually lead to a downgrade if it is substantial enough to change our view of the consolidated company's business risk.

Given the AGL merger, the company's large planned capital spending program of almost $15 billion over the next three years, the elevated construction risk with nuclear and integrated gasification combined cycle (IGCC) projects, and the uncertainty over the ultimate ratemaking treatment of those projects, we would not expect to raise the ratings until those issues are resolved. The organization's core credit metrics would have to improve to a level that supports an "intermediate" financial risk profile, such as FFO to debt durably above 23%.

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