Dynegy, Once Sunk by Cheap Power, Seeks $6.25 Billion Redemption

Aug 23, 2014 12:00 am ET

Aug. 23 (Bloomberg) -- Power producer Dynegy Inc. is betting on the same growth strategy that pushed the company into bankruptcy three years ago after electricity prices collapsed.

This time will be different, promises Chief Executive Officer Robert Flexon.

The Houston-based company is spending $6.25 billion to acquire 19 new plants, increasing its generating capacity nearly twofold. The expansion also magnifies Dynegy’s exposure to the vagaries of a power market that rises and falls on supplies of natural gas, one of the industry’s primary fuels.

Dynegy is staking its future on a wave of coal plant closures that have increased demand for gas-fueled generation, which in turn is helping push up gas prices. Its purchases deepen its presence in the U.S. Northeast and in New England, where prices soared last winter on colder-than-normal weather and fuel shortages.

The deal “will create more value for Dynegy shareholders with less risk,” Flexon said in a conference call with investors yesterday.

The CEO’s gamble shows a bullish faith in the merchant electricity segment of the power industry. These so-called independent generators are different from utilities, which rely on regulators to set prices that provide them a reliable profit. Instead, merchant producers sell their electricity on a wholesale market, often to the utilities, at prices that fluctuate on a daily basis.

19 Plants

Dynegy is buying 10 of its new plants from Duke for $2.8 billion as the larger utility sheds those riskier assets. Other utilities including Edison International, Ameren Corp. and PPL Corp. have sold or spun off independent plants.

Dynegy is paying $3.45 billion for another nine plants from private-equity firm Energy Capital Partners.

Three years ago, Dynegy was pummeled by losses when the shale drilling boom created a glut of gas that deflated prices. The company first sought bankruptcy protection in 2011 after recording losses in four of the previous eight years. In 2012, gas prices dipped below $2 per million British thermal units to a 10-year low.

To survive, independent power producers have been consolidating and shifting toward more gas-fired power production as coal falls out of favor because of stricter environmental rules. NRG Energy Inc., the nation’s biggest independent producer, bought power plants from the bankrupt subsidiary of Edison International for $2.64 billion earlier this year. NRG said this month it will convert some of those coal units to burn natural gas.

Post-Bankruptcy

Dynegy shed the last of its bankruptcy cases last year. Since then Flexon has been growing the company through acquisitions, picking up five coal-fired power plants in Illinois from Ameren in December 2013.

Dynegy will be adding about $5 billion in debt to fund its latest purchases, more than twice the company’s current level.

“Dynegy’s financial profile will be weaker due to these acquisitions,” Moody’s Investors Service said in a research note yesterday.

Nevertheless, the ratings agency gave a “stable outlook” for the company based on improved market conditions, said Swami Venkataraman, Moody’s vice president and senior credit officer. Earlier this month, Moody’s raised its outlook for the merchant power industry from “negative” based on a recovery in gas and power prices, he said.

Gas prices have doubled since hitting their 2012 low, in turn helping strengthen power prices.

Cash Flow

“The additional leverage is coming along with additional cash flows,” Venkataraman said in a telephone interview. “They are doubling the size of the company.”

The greater scale and diversity offered in the deal reduces risk and improves the overall business profile, he said.

After the Duke and Energy Capital transactions, natural gas plants will account for 54 percent of Dynegy’s generating capacity, up from about 45 percent, according to postings on the company’s website. In addition, Dynegy will have 60 percent of its capacity in the Northeast and New England in 2015, markets where generators are paid a fee to guarantee supplies in addition to electricity sales.

“From a strategic point of view, this gives them a much needed boost to fuel diversity from their mostly coal-based fleet now,” said Andy DeVries, a New York-based analyst for research firm CreditSights Inc..

Dynegy said the purchase will more than double its adjusted earnings before interest, taxes, depreciation and amortization and increase its free cash flow per share by 220 percent by next year.

Dynegy climbed 8.8 percent to $32.32 at the close in New York yesterday, the most since March 2013. Duke dropped 0.2 percent to $72.87.

Adding Risk

The strategy still brings additional risk. Unlike utilities that operate in regulated markets, merchant generators must absorb rising costs as well as contend with volatile commodity prices.

Earlier this month, NRG Chief Executive Officer David Crane told investors that the future for wholesale power producers is “bleak,” particularly for owners of coal-fired generation, given weak overall power sales expectations.

Independent power producers “lack the iron dome of rate- based regulation protection that covers the investor on utilities,” Crane said during an Aug. 7 earnings call with investors. NRG Energy is the largest independent power producer in the U.S. with about 53,000 megawatts of capacity.

--With assistance from Naureen S. Malik in New York.