If buyout rumors were bankable, Dynegy Inc. would be pure gold. They aren't and it isn't:
The last time I wrote about Dynegy, back in October, the stock was trading at almost $13 amid unrealistic speculation that the company could make a great target for a leveraged buyout. One lack-of-LBO later, the stock has fallen by half.
Such speculation has resurfaced. Citigroup published a research report earlier this week positing that Dynegy, along with other merchant generators, might merge if a natural-gas rally doesn't show up soon (higher gas prices tend to mean higher power prices). Meanwhile, the recent emergence of Vistra Energy Corp. out of the TXU bankruptcy has caused some flutters of M&A anticipation, mainly because Vistra has that rare thing in this sector: a clean balance sheet.
There are some understandable reasons for the buyout speculation, chief of which is that someone could offer a 30 percent takeover premium for Dynegy and the equity check would still come in at only $1.1 billion. Cheap, right?
Such thinking sort of ignores that pesky balance sheet, though: about $8 billion in net debt. And, as analysts at CreditSights point out, any change of control would trigger puts at above par for Dynegy's outstanding bonds, leaving any buyer with an even bigger refinancing headache.
Consider Vistra, just as an example. Say it offered that 30 percent premium. Assume it would be entirely in stock, as cash is a precious resource in this business and, at about $8.40 a share, Dynegy's shareholders would only be receiving a price equivalent to where the stock was trading two months ago.
Assume also that Vistra could chop out half of Dynegy's overhead for annual synergies of about $80 million. Based on current guidance, Vistra's free cash flow would rise from the equivalent of almost 13 percent of its market cap to just more than 15 percent of its pro-forma market cap.
Bye-bye to that sparkling balance sheet, though.
Net debt would jump from about 2.6 times 2017 Ebitda to a pro-forma 4.3 times. In fact, unlevered free cash flow as a proportion of enterprise value -- before interest costs, a more pertinent measure given the amount of debt involved -- would stay flat at about 11 percent.
Vistra's chief selling point is that it has the flexibility that comes with its post-bankruptcy balance sheet; it just borrowed $1 billion to pay a dividend. This deal would not exactly do wonders for that story, so Vistra would be well advised to steer clear of it.
This isn't to say Vistra wouldn't be interested in parts of Dynegy. Vistra could use some diversification away from Texas -- which despite a growing market has its own challenges -- and Dynegy needs to sell power plants to meet its target of cutting net debt to 4.5 times Ebitda by the end of next year.
Indeed, such blocking and tackling is what really sustains Dynegy. On the plus side, the company is focused on the right thing, namely selling assets and deferring spending to reduce its debt. And it does have a savvy trader and operator of power plants, Energy Capital Partners LLC, as its largest shareholder following an unusual deal struck last year. These provide some sort of foundation for an equity story.
Against this, however, are strong, structural headwinds, including flat electricity demand in most of the U.S. and erosion of the economics of merchant generation by both the penetration of renewable energy sources and political efforts at both the state level and the Trump administration to keep older coal and nuclear plants open. What these mean is that while the sector's woes point to plants closing and not being built -- thereby tightening the market -- there is also a good chance that political and technology trends defer that anticipated rebalancing.
In the face of this, another wild card that periodically tempts money into Dynegy's stock -- or causes it to flee -- are those gas prices Citi's report focused on. Of all the listed merchant generators, Dynegy has the most leverage to the gas market. To get an idea of how levered it is, consider the spread between the highest analyst price target and the lowest for Dynegy and its peers:
The net result is that Dynegy's stock remains an option perched atop a big hill of debt -- an option chiefly on gas prices and self-help. Betting on wholesale M&A looks like even more of a gamble.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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