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NRG Debt Refinancing a Boon for Equity Buyers: Corporate Finance

NRG Energy Inc. CEO David Crane
David Crane, president and chief executive officer of NRG Energy Inc., said "even in the currently subdued commodity price cycle, the company is demonstrating a high-teen free cash flow yield.” Photographer: Brendan Hoffman/Bloomberg

NRG Energy Inc.’s plan to refinance $7 billion of debt will require lenders to loosen their claim on the largest U.S. independent power producer’s cash that may allow it to finance a stock buyback.

The transaction proposed by Princeton, New Jersey-based NRG in a May 5 regulatory filing would replace leveraged loans and junk bonds with new debt while relaxing covenants restricting investments and mandating the use of excess cash flow for senior secured fixed-income repayments.

NRG is seeking to further reward shareholders following a 23 percent rally in the company’s stock price this year. After the transaction, NRG’s debt to earnings before interest, taxes, depreciation and amortization would increase to 4.7 times from 3.8 for the trailing 12-month period, Andy DeVries, an analyst at independent fixed-income research firm CreditSights Inc. in New York, said in a May 5 report.

“Typically, any time shareholders win bondholders lose,” said Travis Miller, a utility analyst for Morningstar Inc. in Chicago. “If NRG were able to refinance and loosen the restrictions on the bonds that would be a benefit to shareholders.”

NRG plans to raise $1.6 billion through a term loan due in seven years and $2.3 billion from a new revolving credit line, Chief Financial Officer Christian Schade said in a May 5 conference call with analysts and investors to discuss first-quarter earnings. NRG will “simplify” its capital structure and delay debt maturities by also refinancing its senior secured notes maturing in 2016 and 2017, the regulatory filing shows.

‘Ultimate Goal’

“The ultimate goal of this program is to put us in a position where we have the opportunity to use a good chunk of the company’s excess liquidity to increase the stake of the company’s existing shareholders,” Chief Executive Officer David Crane said during the May 5 conference call.

NRG, which has the lowest leverage among its peers, had $2.7 billion in cash as of March 31. The anticipated jump in the ratio takes into account a 20 percent decline in Ebitda, DeVries wrote.

The company’s leverage compares with 8.9 times at Dynegy Inc., the third-largest U.S. independent power producer that spurned takeover offers from Blackstone Group LP and Icahn Enterprises LP, 6.7 times at Houston-based GenOn Energy Inc. and 6 times at Calpine Corp., which exited bankruptcy in 2008, according to CreditSights.

Boosting Cash

Since emerging from bankruptcy in December 2003, NRG increased cash on its balance sheet 10-fold to $2.95 billion at the end of last year, according to data compiled by Bloomberg. The company said it repurchased $130 million of shares during the first quarter and plans an additional $50 million this year.

“As part of this refinancing, we expect to replace restrictive covenant packages with a more flexible structure allowing us to return value to shareholders,” Schade said on the call. “Our primarily goal in this process would be to eliminate investment basket restrictions, cash flow sweep restrictions and mirror the covenant packages currently in the indentures governing our most recent bond issuances and specifically those in 2018, 2019 and 2020.”

All of NRG’s outstanding debt will have a common covenant package after the transaction, Schade said.

NRG’s cash declined by $240 million during the first quarter as it bought back shares, paid down $149 million of its term loan and redeemed $945 million of senior notes due 2014 at 102 cents on the dollar, according to the company.

Gas Prices

A drop in natural gas prices is driving competitors such as Houston-based Dynegy to renegotiate debt to avoid a default.

“There’s no question that it’s a volatile commodity market and we’re presently experiencing a tough cycle,” Paul Patterson, a New York-based utility analyst at Glenrock Associates LLC, said in an interview. “Anybody who is getting a large amount of their money in sales in the wholesale market is facing challenges from lower power prices.”

Natural gas, a plant fuel that helps set power prices, is down about 70 percent from three years ago, Bloomberg data show. It fell to $4.24 per million British thermal units in New York Mercantile Exchange trading as of May 6, reversing three consecutive weekly gains. Natural gas prices will climb to $4.75 by year-end and breach $5 in 2012, according to the median forecast of 19 analysts surveyed by Bloomberg.

Stock Rally

“Even in the currently subdued commodity price cycle, the company is demonstrating a high-teen free cash flow yield,” NRG’s Crane said. “As we go forward, we want to have the ability to protect and enhance that yield, not only by increasing free cash flow, but also by significantly reducing the number of shares outstanding.”

NRG has 241 million of shares outstanding, giving the company a market capitalization of $5.81 billion as of May 6, Bloomberg data show. Since the record earthquake and tsunami in Japan triggered a crisis in Tokyo Electric Power Co.’s Fukushima Dai-Ichi nuclear power station on March 11, NRG has rallied 22 percent to $24.09 on the New York Stock Exchange.

On April 19, NRG said it would write down about $481 million before taxes and cease investing in a $10 billion joint venture with Toshiba Corp. to build two nuclear reactors in Texas.

“When NRG is looking at a multi-billion dollar investment need for a new nuclear plant and then it decides to cancel that construction project it frees up a lot of long-term cash,” Morningstar’s Miller said in a telephone interview. “The cancellation certainly improves near-term cash position.”

Long-Term Debt

NRG said it had $10.4 billion in long-term debt and funded letters of credit as of March 31. It owes about $612 million on a term loan due Feb. 1, 2013. The debt pays interest on the loan at 1.75 percentage points more than the London interbank offered rate, the company’s annual report shows. A $1 billion term loan due Aug. 31, 2015, has a margin of 3.25 percentage points more than Libor, a rate banks charge to lend to each other.

The company also has $800 million outstanding on a letter of credit facility due 2015 and $500 on a loan due 2013, paying the same interest rates with the term loans due on those dates, the filings show.

Citigroup Inc. and Morgan Stanley led banks in 2006 to arrange the credit facility, according to Bloomberg data. The loans also include an $875 million revolving credit line due Aug. 31, 2015, according to company filings.

NRG’s $2.4 billion of 7.375 percent notes due 2016 rose 0.19 cent to 104.06 cents on the dollar after the company announced its refinancing plan, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

‘Potential Negative Impact’

The debt became callable at 103.69 cents in February, Bloomberg data show. The call premium drops to 102.46 cents in February 2012, to 101.23 cents a year later and to par in 2014.

NRG can’t redeem its $1.1 billion of 7.375 percent notes maturing in 2017 until February, according to Bloomberg data. The debt gained 1 cent to 105.75 cents on the dollar after the refinancing announcement, according to Trace.

“We understand the obvious potential negative impact to credit quality from the decision to replace restrictive covenants with less onerous ones but we do not believe the move represents a desire by management to operate the company with more leverage,” DeVries of CreditSights said in the report. “Should the market overact and sell off due to the news of a less stringent covenant package, we would consider going long the bonds.”

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