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.

News of a big deal is usually celebrated as heralding more excitement to come. But the $17.1 billion buyout of Calpine Corp. by private equity firm Energy Capital Partners LLC, announced Friday, feels more like the closing of an era.

The price of $15.25 a share, which works out to $5.5 billion in cash, is a 51 percent premium to the undisturbed price. So, yay for that.

But it's also just about what many expected; I put the takeout price at about $15 in this column from May. And it's below some analyst targets ranging up to $20 (the consensus was $15.56).

Moreover, if you bought Calpine before last summer, then you're probably not celebrating:

Hope You Bought Recently
Calpine has only traded sustainably below the $15.25 takeout price for roughly the past year
Source: Bloomberg

Unless, that is, you're just grateful for the exit. Which would be understandable. Because when a company recommends, after a public sale process of several months, a takeout price roughly in line with where the stock traded only a year ago, it's a fairly clear sign that all is not well.

The structure of the deal is another clue. Calpine is an unusual target for a leveraged buyout because it already carries a ton of debt; $11.6 billion on a net basis at the end of June, or north of 7 times trailing Ebitda.

So one reason shareholders may be feeling that the drinks are pretty diluted at this M&A party is that more of the liquor had to be saved for other guests, namely bondholders and credit-rating companies.

Without resorting to layering on more debt, Energy Capital Partners had to pull together a consortium to pay the equity check. The presence of a large pension pool, Canada Pension Plan Investment Board, helps not only to fund the deal but also persuade rating firms not to downgrade Calpine's existing debt, which would have triggered change-of-control provisions. The buyers also went out of their way to recommit to Calpine's deleveraging plan.

All of which means two things. First, a counteroffer is extremely unlikely; $15.25 is it.

Second, from the buyer's perspective, this deal is all about medium-term options -- options on power prices, disposals and the shape of the balance sheet -- to realize a decent return.

It has been speculated for several months that any buyer would quickly sell Calpine's geothermal assets in California for perhaps $3 billion, effectively paying back more than half of the equity check straight away. That no longer seems a done deal, especially with the deleveraging target maintained.

The usual expectation of simply flipping the company several years down the line also can't be taken for granted with this buyout. Flat electricity demand and the growing threat posed by renewables to wholesale pricing means achieving even the multiple paid of 8.6 times forecast Ebitda could be unrealistic by the mid-2020s.

One obvious lever to pull would be, well, leverage. Using consensus forecasts, Calpine's net debt to Ebitda could drop to 4.5 times by the end of 2019, assuming all free cash flow goes to paying off debt. That would fulfill the company's commitments.

Beyond that, though, it might be possible to layer debt back on. Purely as a theoretical exercise, if net debt was taken back to 5 or 6 times Ebitda in 2020, it would imply freeing up $2.4 to $4.4 billion of cash to potentially pay out to the buyers as a dividend -- provided Ebitda forecasts hold and capital expenditure falls away to perhaps $200 million as growth plans are shelved.

Beyond this, the geothermal assets could be sold down the road and price trends for electricity in key markets such as Texas and California may turn out better than some expect. Or, you know, not.

However those scenarios play out, the key point is that only a private equity buyer can really stomach the risk and pay for that option value at this point. Energy Capital Partners has been doing so for years.

Calpine is selling because public investors won't. Fascination with playing the electricity (read: natural gas) price cycle has turned to fatigue and confusion around seemingly endless shale gas, AWOL power demand growth, whiplash government policy on coal and nuclear power, batteries, solar power, wind power ... the list of inputs goes on.

Add in crushing leverage and you've got more potential outcomes than a roulette table in Vegas. The world, quite simply, has changed.

This is why fellow merchant generator NRG Energy Inc. has, to shareholders' delight and under pressure from activists, forsworn growth in favor of -- guess what -- cutting leverage and squeezing its assets for cash.

It is also why Vistra Energy Corp., emerging from the wreckage of the TXU Corp. buyout and bankruptcy, brandishes its relatively low leverage as a competitive advantage. And it is why Calpine, NRG and Vistra are all trumpeting their retail supply businesses as stable streams of earnings to counterbalance the volatility of straight power generation.

With Calpine gone, the last public target left is Dynegy Inc. Part-owned by Energy Capital Partners -- which got its stake for next to nothing, effectively -- Dynegy is also waiting for a suitor to scoop it up. Vistra seems the likeliest buyer, although NRG might also be interested at some point provided it delivers on its own restructuring plans. 

Another deal in the offing? Sounds like fun. But the thumping beats faded a while back, and this party's well into the slow dances.

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

  1. Private equity does not normally stick with promises made by a company when it was public.

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

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net