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Merchant power makeovers may spark war for portfolios of IPPs

With most everything on the table for possible sales, the independent power sector is poised to enter its latest corporate reincarnation as competitors consider the potential acquisition and consolidation of peer portfolios.

While NRG Energy Inc. this week unveiled an overhaul of its own strategic vision, one that includes the divestment of its renewable holdings and select noncore thermal assets, a similar strategic review at Calpine Corp. is also said to be nearing its final phases. Calpine has reportedly narrowed prospective buyers to Energy Capital Partners, Global Infrastructure Partners and Carlyle Group LP, according to a report by industry outlet SparkSpread on July 13.

Meanwhile, Dynegy Inc., having found buyers for a pair of peakers in New England and another in PJM, appears to be busy behind the scenes evaluating its own strategic future, the least of which might entail the follow-on sale of a large, combined-cycle gas-fired asset in PJM Interconnection or ISO New England. "We continue to assess the market to see if any future premium asset sales make sense," Dynegy CFO Clint Freeland said in a July 12 statement to S&P Global Market Intelligence.

The rising tide of the sector's strategic makeover has helped to lift stock prices for all, thus raising the enterprise value of each company in the past week as investors have rushed back into IPP equities. NRG saw its share price rise more than 35% over the week, relative to its closing price of $22.18 on July 14, representing the lion's share of the company's more than 81% share price rise year-to-date.

'Ugly duckling' upside

With NRG's new outlook suggesting it could have as much as $6.3 billion in excess cash following its paydown of roughly $13 billion in debt through 2020, the generator is once again seen as more predator than prey in the market for large acquisitions. NRG's expressed interest in expanding its Northeast and PJM footprint to include more mid-merit assets and retail books also aligns well with the portfolio offerings held by Dynegy.

Analysts were quick to point out that NRG may offer a challenge to Vistra Energy Corp. as a potential suitor in the mix for Dynegy, elevating Dynegy's status from "ugly duckling" of the IPP peer group to an attractive and highly sought after portfolio with low regulatory risk, Tudor Pickering Holt analysts said July 12.

"With NRG and Vistra both holding less than 3x debt/EBITDA ratios, both can absorb Dynegy's higher leverage with a stock for stock exchange and extract more than $200 [million] of synergies," Tudor analysts observed, consistent with views that corporate deals will lean toward stock and cash rather than debt. "Dynegy has the most upside as Vistra and NRG will likely have competitive bids pushing up the purchase price for Dynegy."

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Following its exit from GenOn Energy Inc., Morgan Stanley also believes that NRG may square off against Vistra on the block for Dynegy, assigning what it sees as roughly $300 million in operational synergies to be extracted by either buyer, a major lever observed by Dynegy CEO Bob Flexon in a recent interview with S&P Global Market Intelligence on prospective corporate M&A.

"We see several potential positives to such a deal, including improved cash flow from synergies, portfolio diversification and deleveraging, with the hypothetical combined entity likely having stronger credit metrics than Dynegy stand-alone," Morgan Stanley said in a July 13 note. "If a transaction was announced with either company, we would expect it to be structured as a stock-for-stock basis due to change of control considerations on Dynegy's debt."

Noncore exodus

Indeed, while the competition for Dynegy may elicit higher bids, the market for portfolios divested via larger strategic restructurings are also bound to fetch immense interest, likely among opportunistic private buyers that are willing to pay premiums for contracted generating assets.

Barclays analysts estimate that a sale of 100% of NRG's interest of 85.48 million class A shares in NRG Yield, along with NRG's remaining ownership interest equal to 1,120 MW of renewable capacity, could altogether lead to as much as $2.2 billion in cash proceeds when taken at the $17.60 share price of NRG Yield at close July 12. That would leave about $1.8 billion in remaining proceeds targeted by NRG's asset sale push, and with 6,000 MW of conventional generation on the table, that could entail an average sale price of about $299/kW for the fleet to fill out the $4 billion goal.

"Everything is on the table in terms of timing and structure and we have no doubt there are buyers for these contracted renewable generation assets," CreditSights said July 13 following a call with NRG Treasurer Gaetan Frotte. "We assume they are talking to private equity, infrastructure funds and the existing YieldCos and maybe even the local utilities on the other side of the PPA."

Deutsche Bank on July 12 said a slew of comparable transactions between institutional investors and infrastructure funds "are an indication of the depth of the potential buyer market," with NRG's thermal assets likely to fetch interest from private equity investors of all stripes.

"PJM assets of all shapes and sizes also have a fairly robust buyer pool, even if the price may not always be great, Deutsche said, also noting NRG's reported sale of its Southeastern fleet outside of Texas. "The private equity buyer pool is relatively deep for gas-fired CCGT assets, such as Cottonwood."

An analysis by Goldman Sachs analysts July 10 surveying the enterprise price for IPPs' noncore assets suggests that Calpine's noncore fleet could average about $1,826/kW in average implied enterprise value, with NRG's noncore fleet representing the highest implied average EV upside of about $2,009/kW. The bank pegged Dynegy at $591/kW on average for implied EV of its noncore assets, the lowest among peers.

"We believe Calpine appears as one of the names that shows the greatest opportunity to divest non-core assets and use the proceeds to deleverage," Goldman noted in its downgrade of the company to "neutral." "We find that Calpine could raise [approximately] 12% of its total enterprise value by divesting its non-core power plants in the South East, West Coast, and New York."