Dynegy: The Countdown Begins - Analyst Blog

Houston-based merchant generator, Dynegy Inc. (DYN) is moving towards being acquired by an affiliate of The Blackstone Group L.P. (BX). Post-acquisition, Blackstone will sell a portion of Dynegy’s generation assets to NRG Energy Inc. (NRG), which is proactively looking at increasing its presence in California. Blackstone plans to close the transaction by the end of 2010.

Federal Trade Commission Approval

On Wednesday, the Federal Trade Commission, in an early termination notice under the Hart-Scott-Rodino Antitrust Improvement Act, approved the deals and said that neither the acquisition deal nor the intended asset sales to NRG Energy presents any breach of antitrust regulations.

Background

On August 13, 2010, Blackstone announced that it would acquire Dynegy for $4.7 billion (including debt). Under the deal, Blackstone will pay $4.50 per share (a 62% premium on the closing price of $2.78 on August 12) in cash for about 120.6 million outstanding shares of Dynegy. In addition, Dynegy will get a 40-day period to solicit better bids for its shareholders.

Blackstone also declared that concurrently and contingent upon the agreement, it plans to sell four natural gas plants of Dynegy to NRG Energy for $1.36 billion. The four gas plants include the Casco Bay facility in Maine and the Moss Landing, Marro Bay and Oakland facilities in California.

Bourses on Fire

Dynegy’s proposed acquisition by Blackstone set the stock price heating up; it has spiked 40% over the past month. The deal is a win-win for both parties, with Dynegy’s shareholders hit hard by mark-to-market losses from forward power sales, enjoying near-term valuation upside.

On the other hand, Blackstone is eyeing Dynegy’s generation assets a portion of which would be sold to NRG Energy while the rest would be margin-accretive once the Midwest power market improves.

Dynegy, after having a dream run on the markets in August, seems to have run out of steam. The acquisition offer from Blackstone had given a 40-day time frame to solicit alternative bids, which ends on September 21, 2010.

The bullishness is reflected with the stock closing at $5.03 on September 8,2010, or at 11.8% premium over a market apprehension of another bid as it seems that the present bid values Dynegy at a discount. However, to date no alternative bids have come.

A Premature Ode to Dynegy

Dynegy’s wholesale electric power -- which is supplied to utilities, cooperatives, municipalities and other energy companies in the Midwest, the Northeast and the West Coast -- provides a relatively stable and growing earnings stream. Geographic disparity in the target markets of Dynegy has resulted in a portfolio that is well-positioned for capitalizing on regional differences in power prices and weather-driven demand.

Dynegy’s low-cost, well-operated power generation portfolio, which spreads across six U.S. states, is a diverse mix of coal, oil and natural gas. Diversified generation assets give the company’s cost structure a natural hedge against the impact of volatile commodity prices.

Dynegy’s prudent financial management has helped minimize generation dispatch costs. To cater to its coal-based generation assets, the company has contracted substantially all its coal requirements until 2012. Also, in a smart move, it inserted a non-fuel price escalator until 2013 for its coal transportation contract through rail.

Recent Trepidations in Financial Performance

In the second quarter of 2010, Dynegy on the revenue front witnessed a slide to $239 million from $450 million in the year-ago period, compared with the Zacks Consensus Estimate of $494 million. The company digested mark-to-market losses associated with forward power sales of $262 million in the quarter.

In the near-term, the Zacks #3 Rank (Hold) stock is expected to digest losses due to weak forward natural gas prices and tepid forward Midwest power prices. The company expects net loss in the range of $165 to $205 million in fiscal 2010.

The near-term outlook is no different for other Zacks #3 Rank (Hold) U.S. based independent power producers like RRI Energy Inc. (RRI), Calpine Corporation (CPN) and Mirant Corporation (MIR).