Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

The most interesting thing about Dynegy's $3.3 billion deal to buy a slew of power plants is the fact it is selling about 10 percent of itself to do it.

When you are already leveraged to the tune of 7 times Ebitda, acquisitions get complicated. So Dynegy has teamed up with private equity firm Energy Capital Partners to buy French utility Engie's U.S. fossil-fuel generation portfolio in a joint venture called Atlas Power.

ECP will contribute a third of the $1 billion equity check. On top of that, though, it is also providing a $400 million bridge loan at a heady charge of 11 percent, which can also be ultimately converted into equity in the joint venture. Plus, it is buying $150 million worth of new shares in Dynegy itself, effectively funding roughly a fifth of the power company's own check. If you're confused, this chart from Thursday's presentation will no doubt clarify things:

Screen Shot 2016-02-25 at 8.20.34 AM

One way to think about ECP's role here is as the hired muscle you bring in when things look dicey.

For starters, it is bridging a funding gap. Along with master limited partnerships and exploration and production companies, the merchant generation sector's combination of high borrowing and exposure to commodity prices -- natural gas in this case -- has made it pretty toxic for many investors. Before Thursday's news, Dynegy's shares had fallen 72 percent over the course of 12 months, making it the worst performer in a terrible sector. Announcing a new deal worth more than three times its own market capitalization without some outside help probably wouldn't have gone down terribly well.

Shorted
Indexed stock price performance
Source: Bloomberg

ECP's bridge loan, meanwhile, was crucial to getting another set of outsiders on board -- namely, the banks providing the $1.85 billion secured loan funding more than half of the deal. The high coupon and payment-in-kind provision attached to ECP's loan reflects that fear factor.

Equally, though, ECP's willingness to also write two equity checks suggests it expects financing conditions to ease and sees that bridge loan getting refinanced pretty quickly.

Indeed, it is ECP's equity checks that form the most fascinating aspect of the deal.

As a private equity firm, the standard play is to buy power assets when they are unloved in the public markets, with a view to paying down the debt over time and selling them several years down the line. With these plants, both Dynegy and ECP could use a recovery in natural gas prices, which hit an 18-year intraday low on Thursday. Sure, shale gas has suffocated many an optimistic bet on recovery in the past five years. But the assets being acquired are generating free cash flow even in this environment, so even a very slow improvement in gas prices from here should allow the joint venture to pay off debt over time.

They should also benefit as further shutdowns of coal plants let gas-fired plants take market share, especially as they can ramp up quickly to balance intermittent power from renewable sources such as wind and solar power. Greg Gordon, an analyst at Evercore ISI, estimates that even if you strip out the coal and peaking-power plants -- 34 percent of the portfolio -- the remaining capacity is being bought for less than half its replacement cost. 

Beyond the joint venture, though, ECP has also become the biggest shareholder in Dynegy itself, with a 15 percent stake and a board seat. ECP is buying the new shares at $10.94 apiece, a 31 percent premium to Wednesday's closing price (albeit, also where the stock was trading roughly two weeks ago). And by getting the deal across the finish line, ECP is also helping to transform Dynegy from a coal-heavy generator to one where more than half the portfolio consists of natural gas plants.

This is an important signal in an environment where, despite the collapse in valuations across the oil, gas and power sectors, buyouts have been strangely quiescent.

The Buyers Abide
Private equity acquisitions in the pummeled oil, gas and power sectors haven't jumped
Source: Bloomberg

Now there are signs of life. My colleague Gillian Tan wrote earlier this week about the successful launch of a Riverstone Holdings-backed vehicle to scoop up cheap oil assets. And while Berkshire Hathaway isn't private equity per se, Warren Buffett's decision to buy a stake in Kinder Morgan sends a signal that he at least thinks valuations in the pipeline sector may be nearing a bottom, even if they remain too closely tied to oil prices for comfort.

The intriguing twist for Dynegy in all this is that, if public markets remain ambivalent to the stock, it now has a major shareholder that just might be willing to take it off their hands.   

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net