OREANDA-NEWS. Fitch Ratings has placed the 'BBB+' Issuer Default Rating (IDR) of Black Hills Corporation (BKH) on Rating Watch Negative following the announcement of a definitive agreement to acquire Source Gas Holdings LLC (SGH, not rated by Fitch) from investment funds managed by Alinda Capital Partners and GE Energy Financial Services. In addition, Fitch has affirmed the IDR of BKH's wholly-owned regulated electric utility subsidiary, Black Hills Power, Inc. (BHP) at 'BBB+' with a Stable Rating Outlook.

The Negative Watch for BKH reflects a material increase in consolidated leverage at BKH partially offset by increased scale of utility operations and higher regulated mix in overall earnings and cash flows. The purchase price of $1.89 billion includes assumption of $720 million of debt at closing. While BKH has obtained a fully committed bridge facility, permanent financing is expected to consist of equity and equity linked securities of $575 million- $675 million and acquisition debt financing of $450 million - $550 million. Consequently, with debt comprising 65% - 70% of the total transaction value, BKH's leverage will increase materially with this acquisition. Fitch will update its financial forecasts once there is greater clarity on post-acquisition debt structure but considers it unlikely that BKH's pro forma funds from operations (FFO) adjusted leverage could stay below 4.0x over the medium term, which was Fitch's prior expectation.

Qualitatively, the acquisition of SGH is positive for BKH's business profile, in Fitch's opinion, since it increases the utility business mix to approximately 82% of EBITDA in 2016, from approximately 78% previously. BKH operates in three of the four SGH states with largely supportive regulatory constructs. Regulatory approvals are required in each of the states SGH operates in, i.e. Colorado, Nebraska, Wyoming and Arkansas. BKH anticipates consummating the acquisition by the first half of 2016.

Fitch will resolve the Rating Watch Negative concurrent or close to the completion of the acquisition. The post-acquisition capital structure along with management intent to pay down the acquisition debt, the terms of the regulatory approvals in each of the four states, and the trend in pro forma credit metrics will be the key decision factors for Fitch. In addition, Fitch will continue to monitor BKH's proposed 'cost of service gas' proceedings. If approved, it would be a credit positive for BKH since it would materially lower the risk of BKH's natural gas exploration and production business by supplying BKH's utilities with 50% of their annual gas consumption though long-term contracts. The acquisition of SGH approximately doubles the amount of natural gas that can be contracted under the cost of service gas provision. A successful outcome in the cost of service gas proceeding could mitigate the one-notch downward pressure arising due to the SGH acquisition.

BHP's ratings have been affirmed since Fitch believes this acquisition will not alter the company's financial profile. BKH intends to house SGH under a separate BKH subsidiary, Black Hills Utility Holdings, Inc., which currently is the second-tier holding company for four natural gas local distribution companies and Colorado Electric. These utilities are relatively small and share centralized treasury functions with working capital financed through a utility money pool, in which BHP also participates.

KEY RATING DRIVERS FOR BKH
Low-Risk Business Profile
BKH operates regulated electric and natural gas utilities in seven states, all of which allow for pass-through of commodity and/or purchased power costs and many feature other riders or recovery mechanisms that enhance timely recovery of expenses and invested capital. Transmission investments are regulated by the Federal Energy Regulatory Commission (FERC) or state regulatory commissions with most capital expenditures eligible for rider recovery. The diversity by regulated jurisdiction further enhances the predictability of cash flows and minimizes the effects of exogenous factors. Non-regulated investments consist of a legacy upstream energy exploration and development business. Fitch considers BKH's coal and competitive generation businesses, which are largely contracted to BKH's utilities, as possessing relatively low risk. BKH's utilities, coal, and merchant generation businesses have a large degree of operational and financial integration, with jointly owned or contracted generation and common call centers.

Evolving Oil and Gas Strategy
BKH has interests in the Mancos shale play and is committing relatively large capital investments in order to further assess and prove its potential reserves in the area. BKH's proposal to place a portion of its natural gas assets into a nonregulated exploration and production subsidiary, which would supply its utilities with up to 50% of annual gas consumption through long-term contracts, if successful would reduce the inherent risks and volatility of the non-regulated oil and gas business segment and would be viewed positively by Fitch. BKH has traditionally managed this business in a conservative manner and uses swaps and other instruments up to two years in duration to hedge pricing risk.

KEY RATING DRIVERS FOR BHP
Stable Credit Metrics
BHP exhibits a solid financial profile with strong earnings and cash flows. BHP's FFO coverage and leverage ratios for the latest 12 months (LTM) period ending March 31, 2015 were 4.8x and 3.4x, respectively, and reflect new rates offset by milder than normal winter weather. Fitch projects EBITDAR coverage to approximate 5.0x and EBITDAR leverage to remain under 3.8x, respectively, through 2015-2017, commensurate with the current rating category. Fitch notes that BHP has a conservative capital structure with equity representing 53% of capitalization as of March 31, 2015.

Declining Capex
BHP plans to spend $217 million on capex through 2017, levels approximately 10% higher than the preceding three year period. With the Cheyenne Praire Generating Station now online, Fitch expects BHP's capex will decline significantly in 2016 and average $51 million per annum through 2017 with the expected completion of the 230KV Teckla to Osage transmission line in 2016. Given that BHP's coal fired generation fleet is relatively modern, future environmental expenditures are expected to be modest. Going forward, Fitch expects BHP to be modestly free cash flow (FCF) negative through the forecast period and Fitch anticipates future funding needs will be primarily financed through the utility money pool.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for BHP include:

--$6.9 million rate increase effective Oct. 1, no rate cases through 2017;
-- Capital expenditures of $217 million through 2017;
--No long-term debt maturities through 2017.

RATING SENSITIVITIES
BKH

Positive: Future developments that may, individually or collectively, lead to a stabilization of ratings at the current level include:

--Total adjusted debt/EBITDAR and FFO adjusted leverage at 4.0x or below;
--Constructive outcome in the proposed 'cost of service gas' proceedings;
--Regulatory approval for SGH acquisition at reasonable terms.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--Pro forma FFO fixed-charge coverage sustained below 4.75x;
--Pro forma total adjusted debt/EBITDAR and FFO adjusted leverage sustained above 4.0x;
--Material claw back of potential synergies arising from the SGH acquisition;
--A weaker business and financial risk profile from larger investments in oil and gas drilling and/or unfavourable outcome in the proposed 'cost of service gas' proceedings.

BHP

Positive: A positive rating action for BHP is not anticipated at this time given the Rating Watch Negative at the parent and Fitch's preference for a one-notch separation between the IDRs of BKH and BHP.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--FFO fixed-charge coverage sustained below 4.75x and total debt/EBITDAR sustained above 3.75x;
--Unexpected adverse regulatory decisions.

LIQUIDITY
Sufficient Liquidity
Fitch considers BKH's liquidity adequate. BKH had $438 million of liquidity available under its $500 million unsecured revolving credit facility including $63 million of unrestricted cash and cash equivalents, as of March 31, 2015. The credit facility can be upsized to $750 million with the consent of the lenders and matures in May 2019. The credit facility is subject to a maximum debt to capitalization ratio of 65% and BKH was in compliance with a debt to capitalization ratio of 54% as of March 31, 2015. Maturities through the forecast period are minimal and consist of a $300 million dollar term loan due April 12, 2017 which Fitch expects to be refinanced upon expiry. BKH's $500 million bank credit facility contains covenants that trigger cross-default if BKH or its subsidiaries fail to make timely payments of debt obligations.

FULL LIST OF RATING ACTIONS

Fitch has placed the following rating on Rating Watch Negative:

Black Hills Corp.
--Long-term IDR 'BBB+'';
--Senior unsecured debt 'BBB+';
--Short-term IDR 'F2'.

Fitch has affirmed the following ratings with a Stable Outlook:

Black Hills Power, Inc.
--Long-term IDR at 'BBB+';
--First mortgage bonds at 'A';
--Short-term IDR at 'F2'.