Monday, August 16, 2010

Dynegy and Irony

In an interesting transaction, private equity company Blackstone acquired Houston-based power generator Dynegy in a deal worth about $4.7 billion.  In truth, Blackstone acquired Dynegy for nothing and will get a bank account seeded with an additional $800 million for its trouble.  Here's how:  Blackstone agreed to pay $543 million for the stock of Dynegy while simultaneously selling four of the company's natural gas power plants to NRG Energy for $1.36 billion.  Blackstone assumed Dynegy's $4+ billion of debt, but that's not an upfront expense since there were no change of control provisions.  I wonder how soon after closing we will hear about a big dividend paid to Dynegy's new shareholders.

It's a really interesting deal for a lot of reasons.  Dynegy, which started life in 1984 as a natural gas trading company called the Natural Gas Clearinghouse and then got into pipelines, trading and power generation, will become a company increasingly dependent on coal.  The company will be selling natural gas facilities in Casco Bay, ME; Moss Landing, CA; Morro Bay, CA; and Oakland, CA, thus increasing its exposure to coal from 26% to 37% (see map below). The new Dynegy will be much less focused on natural gas and will have a footprint dominated by the upper Midwest.



It is not surprising to see a private equity company like Blackstone taking the plunge in a deal like this.  First, it covered its financial downside out of the gate by quickly selling off assets. Second, coal generation has become an unloved asset.  With the potential for increased regulation of both carbon and air pollution, coal is definitely in a tough spot.  It is almost worse for the coal industry to see climate legislation delayed.  They probably would rather see a heavily diluted bill passed sooner rather than later to relieve the uncertainty.  Most investors hate uncertainty more than bad news because they are conceited enough to believe they can "price in" bad news.

But the basic economics of coal generation are hard to beat.  Looking at Dynegy's investor materials, for 2010 it is assuming delivered costs of $6.15/MMBtu for natural gas, while coal delivered from the Power River Basin in WY/CO will cost $1.50/MMBtu.  The operating costs of the plants are different, but it is clear why coal is the choice for baseload generation.  The chart below illustrates the cost differential by fuel for the Midwest Independent Transmission System Operator (MISO).


If the regulatory environment remains uncertain for longer, I think you might see some similar deals for coal plants.  Utilities are hyper-conservative because they survive on their high credit ratings.  Private equity guys are sitting on tons of money and love to buy big ticket assets at a discount.  They have made tons of money doing this and the egos are unbelievable.  They clearly see an opportunity worth the risk, especially if they can buy on the cheap.

What scares me just a little is to see a bunch of these deals.  All of a sudden you've got a bunch these billionaire investors with friends in high places sitting on major coal-dependent assets.  What happens to the energy policy discussions then?  I guess the other side of that coin is that many of the same guys are becoming heavily invested in natural gas transportation assets as well.  Perhaps the greed and ego will be cancelled out by portfolio diversification.  Or maybe I'm just paranoid.

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