Houston-based power company Dynegy Inc. (DYN) has struck two separate deals to acquire several coal and gas power generation plants from Duke Energy Corp. (DUK) and private-equity firm Energy Capital Partners to enhance its foothold in two less regulated eastern U.S. markets. These transactions, worth a combined $6.25 billion, pushed Dynegy’s shares by 8.75% in Friday’s trading session to close at $32.32.
The Deals
Dynegy will pay $2.8 billion in cash for 11 power plants in the Midwest and a retail business owned by Duke Energy. These include Killen, Stuart, Conesville, Miami Fort, Zimmer, Hanging Rock, Washington, Fayette, Lee and Dicks Creek. The company is also buying ownership interests in plants in New England, Pennsylvania and the Midwest from Energy Capital Partners for $3.45 billion in cash as well as stock.
Holding a market cap of $3.24 billion, Dynegy has plans to issue about $5 billion in new unsecured bonds and $1.25 billion in equity and equity-linked securities to fund the acquisitions. The deals are slated to wrap up by the end of the first quarter of 2015.
The Synergies
The acquired assets will add 12,500 megawatts (MW) of generating capacity, doubling Dynegy’s total output to about 26,000 MW. The addition of these portfolios will enable Dynegy to have a significant hold in the PJM (Pennsylvania, New Jersey, Maryland) and New England markets. Of the new generating capacity, 5,053 MW will comprise gas-fueled plants, while another 3,793 MW of capacity will come from environmentally compliant coal generation units.
The deals are expected to boost Dynegy’s portfolio in the Northeast and New England to comprise about 60% of total megawatts versus 18% presently.
Financially, the company expects the deals to triple its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2015 while lifting its free cash flow to $4 a share per share in 2015 and beyond. Dynegy also expects the deals to provide $500 million in tax savings, $200 million in related efficiencies and cost savings of more than $40 million per year.
The acquisitions will also help Dynegy to reduce its overhead costs by 34% to $1.10 per MW hour of electricity produced.
Looking Back
Dynegy suffered a major setback in 2011 when the booming shale drilling created a supply glut of natural gas that depressed prices and led to losses. In 2012, gas prices deceased to a 10-year low, below $2 per million British thermal units.
Burdened by costly power plant leases, Dynegy finally came out of bankruptcy in 2012. Since then the company took the inorganic route to spur growth, acquiring five coal-fired power plants in Illinois from Ameren Corp. (AEE) in December last year.
Conclusion
The proposed buyouts will increase Dynegy’s risks associated with the supply of the industry’s major fuel – natural gas. Moreover, the unregulated electricity operations are exposed to descending prices as well as demand in the U.S.
That said, in a deregulated electricity business, utility companies are consolidating and shifting toward more gas-fired power production given stringent environmental regulations. Global concerns about the pitfalls of green-house gas emissions supported by increasing restrictions on fossil-fuel usage have brought a wide array of fuel sources like gas into the limelight.
Increased demand for gas-fueled generation is helping to push up gas prices. Hence, the deals are a strategic fit giving a much needed boost to Dynegy’s fuel mix from its predominantly coal-based fleet now.
Dynegy holds a Zacks Rank #3 (Hold). CMS Energy Corp. (CMS), holding a Zacks Rank #2 (Buy), offers a better investment opportunity.
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