Inside Exelon’s NRG Bid
Posted on: October 21, 2008 - Email Article - Printable Version
Before the opening of yesterday’s bell, the United States’ largest utility company, Exelon Corp. [EXC: 57.34, 0.00 (0.00%)] made an unsolicited offer to buy NRG Energy [NRG: 23.56, 0.00 (0.00%)] for $6.2 billion or $26.43 a share. The deal, a stock for stock bid, has a fixed exchange ratio of 0.485 EXC shares for each NRG share and represents a 36.7% premium to NRG’s closing price last Friday. After Exelon’s conference call and a few hours to digest, here are some of the pros and cons of the proposal.
Positives:
Scale: In Exelon’s conference call, they made an avid point to investors that the geographic footprint and size of this synergy will propel and sustain Exelon’s long term shareholder value. The combined company will have a market cap of $40 billion and an enterprise value of $60 billion, making it by far the largest power generation company in the United States. Combined assets will total $73.5 billion. Together, the companies will have 18,000 megawatts of nuclear generation and a total generation portfolio of 47,000 megawatts, enough electricity to light about 45 million homes. Furthermore, Exelon will expand its geographical reach into the Western portion of the United States, along with Texas, to coincide with its operations in Pennsylvania and Illinois.
Generating Portfolio: Through the deal, Exelon will significantly diversify its existing generation portfolio. As previous mentioned, EXC will add 23,000 megawatts of generation capacity totaling 47,000 megawatts. On a pro forma basis, Exelon’s generation breakdown will be approximately 38% nuclear, 38% gas/oil, 20% coal, 4% hydro/other compared to today in which the company’s generation portfolio is nearly 70% nuclear.
Long-Term Value: According to Exelon’s estimates, this deal could potentially add $1 to $3 billion dollars in overall value. In addition, the company estimates that NRG could increase Exelon’s unlevered cash flows by 20% on an annual basis on an investment horizon of 5 years. In the short-term, Exelon believes that NRG could be accretive to their earnings within a calendar year, predicting a range of 0% to 5% EPS growth from the merger.
Negatives:
Short-Term Shareholder Value: As with any acquisition, especially a stock for stock deal, there is a near term share dilution that will hurt Exelon shareholders (and help NRG shareholders).
Credit Rating/Financial Implications: In accordance to the deal, Exelon will have to refinance NRG’s debt. Despite having the fortress balance sheet of the utilities sector, the current credit environment makes this process arduous. NRG has a debt portfolio of $8 billion that Exelon will have to refinance at a “double-digit” rate, according to the company’s conference call. That unfavorable rate is a product of today’s credit markets. As a result, Exelon is looking for a cut in its current
BBB+ credit rating. Most analysts currently believe that for every one decreased level of credit rating, a company will need to raise $250-$300 million in collateral. Furthermore, a BBB rating is the lowest level of investment grade. It is possible that Exelon’s rating could fall below that level. Finally, due to the stock for stock aspect of the deal, Exelon has relinquished its $1.5 billion share buyback program, further damaging the near term value of their common equity.
Anti-Trust Problems: Investors should take no solace on the feasibility of this offer passing through regulation. With this deal, Exelon will have the capacity to power half of the households in the United States, which obviously could create monopolistic concerns. Furthermore, the deal warrants the approval of at least 4 and possibly 5 states. This obviously places the approval of the deal behind a few road blocks. On top of all this, it is important to remember that NRG has the right to turn down the offer.
Increased Coal Exposure: While coal is a mainstay in the utilities industry, there certainly is going to be a push towards clean generation legislation. John Rowe, Exelon’s CEO, said on the conference call that he believes “climate legislation” is coming and that he expects the cost of using coal will increase due to this legislation. He believes Exelon is positioned well for this legislation due to their nuclear exposure, but he is neglecting to look at the entire picture. Pre-deal coal made up 6% of Exelon’s generation portfolio, and as mentioned it will now make up 20%. This is anything but an ideal time to expand this business line.
Final Thoughts:
The bottom line is with this acquisition, as like many others, the acquirer will have near term difficulties with long term potential. Exelon has a proven track record with mergers when the corporation formed itself out of the PECO, ComEd merger. However, there is always going to be a varying degree of investor uncertainty. The short term financial implications should make investors weary and may provide extensive downward pressure on the stock. All in all, Exelon has defined itself as the benchmark in the utilities sector, and their iron balance sheet has put the company in a position to consolidate within the industry. With this deal, Exelon has the potential to build a utility empire and place a permanent stamp on the United States electrical generation landscape. But keep in mind, its all potential as of now, and with potential comes a nerving degree of uncertainty that the market may be uncomfortable with in the short term.
-TJ Smith
Disclosure: The mutual fund the author is associated with is long EXC.
The Following Stocks Were Mentioned In This Article: EXC, NRG
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Deal hit a roadblock today as NRG rejected the bid essentially on the financing implications. EXC said when the deal was proposed that they were prepared to go hostile. Well keep a close eye on this one