Deals

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.

As we near the halfway mark for 2016, we already have a contender for deal of the year: Energy Capital Partners' (almost) joint venture with Dynegy.

For effectively no money down, the private equity group will get $225 million in cash and a 10 percent stake in Dynegy in the space of less than a year.

First, a recap: Back in February, Dynegy announced a $3.3 billion deal to buy a slew of U.S. power plants from French utility Engie. Already sporting leverage of about 7 times Ebitda and having seen its stock collapse by two-thirds over the prior six months, Dynegy needed a little help.

A Friend in Need
Source: Bloomberg

Enter ECP. It had already built up a stake of about 5 percent in Dynegy as the shares tanked. To help do the deal, it offered to buy $150 million of new Dynegy stock, fund about a third of the $1 billion equity check for the Engie plants via a JV called Atlas Power, and provide a $400 million bridge loan at 11 percent. Dynegy, meanwhile, got an option to eventually buy out ECP's stake in Atlas at a minimum price of $519 million.

Since then, two things have happened. First, Dynegy's share price has roughly doubled. Second, bondholders have become quite a bit more forgiving.

Cut Me Some Slack
Dynegy's cost of debt has fallen sharply since February

So on Wednesday, Dynegy announced new terms. It will now raise $2.4 billion by issuing convertible debt and raising a new term loan, as well as drawing on other sources such as its revolver.

ECP, meanwhile, will still buy $150 million of Dynegy's stock to take its overall stake to about 15 percent, making it the largest shareholder. And, instead of Dynegy paying $519 million to buy it out of Atlas, ECP will relinquish its stake for $375 million.

Wait, a private equity firm just gave up $144 million? Has the world gone mad?

No. Think of it this way. It was the promise of ECP's support that enabled Dynegy to get its acquisition on the books. That promise effectively cost nothing. In return, when the deal closes -- likely in the fourth quarter -- ECP will buy 10 percent of Dynegy at an agreed price of $10.94 per share, or $150 million. But, simultaneously, Dynegy will pay ECP $375 million to buy it out of Atlas. So ECP will get $225 million in cash, net, plus 10 percent of the company for, effectively, a promise. That's worth taking the haircut on Dynegy's buyout option now, especially in such a high-risk business.

Now, you could argue ECP had to buy 5 percent of Dynegy initially just to show willingness. Fair enough. But assume it bought that stake in the run-up to February's deal when Dynegy's stock was trading at $10 or less, implying a total cost to ECP of less than $60 million. In return, it still gets $225 million in cash and an overall 15 percent stake in Dynegy worth, at today's price, around $170 million. That's a return of almost 7 times the downpayment in less than a year. You'd probably still take that.

As for Dynegy itself, it gets to do a transaction -- which significantly reduces its exposure to coal-fired generation in favor of natural gas -- that it couldn't have done without ECP's help. The new deal also allows it to take full control of the Engie plants at a cost that is $144 million less than the terms agreed to in February, saving $40 million a year in interest costs, too. 

Would Dynegy have preferred to do all this without having to effectively hand ECP a check and a big equity stake for no money down? Sure.

But the merchant energy business, with its dizzying highs, terrifying lows and perennial need for cash, has always been about timing and access to capital. Those are ideal conditions for private equity to play in.

What's more, even if the rally in natural gas prices has helped the entire sector since February, Dynegy's shareholders have clearly benefited more so far.

Spring Cleanup
Dynegy's stock has soared since February
Source: Bloomberg
Note: Performance indexed to Feb. 24, the day before the Engie deal was announced.

 

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

  1. And, not to belabor the point, the biggest of those shareholders will soon be ECP.

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