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NRG Ripe For the Picking

Posted: Oct 23, 2008 14:09 PM by Ben McClure

Tickers in this Article: MCO, BP, DB, CEG, BRK.A, EXC, NRG

Takeover deals normally leave me cold. The motivations that drive acquisitions are often misguided and gains for shareholders elusive. But power utility Exelon Corporation's (NYSE:EXC) $6.2 billion unsolicited bid for NRG Energy (NYSE:NRG) may be an exception to the rule. If Exelon can pull off the deal, its shareholders will have plenty to cheer about.

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What the Deal Means
NRG is ripe for the picking. The credit crunch combined with falling power prices have prompted the market to push NRG stock down more than 45% to just $24.62, a level that most investors would have considered unthinkable a year ago. Exelon's $6.2 billion bid values the company at just 6-times the ratio of enterprise-value-to-EBITDA, the preferred metric for assessing utility stocks. (To learn more, see A Clear Look At EBITDA.)

A successful deal would create the nation's largest power company. It would also give Exelon leading edge carbon-capture technologies plus a wind power joint venture with BP (NYSE:BP) now in the works. Exelon would also get NRG's South Texas Project nuclear power facilities. One of the newest nuclear power plants in the country, it currently produces about 2,600 mega watts of electricity. According to various estimates, building the same nuclear power plant from scratch would cost Exelon anywhere from $3.1 billion to $5.2 billion. In other words, the South Texas Project facility, alone, is nearly worth the $6.2 billion that Exelon has offered to pay for the whole company.

NRG doesn't appear to have the kind of financing problems that pushed Constellation Energy (NYSE:CEG) into the arms of Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) last month. According to Deutsche Bank (NYSE:DB) analysts, NRG ranks as top tier among U.S. utilities for its cash flow and liquidity. In the near-term, the company has only a few minor debt maturities coming due. With about $1.4 billion in cash on its balance sheet and a $1.5 billion credit facility, its liquidity situation looks good. The company's free cash flow yield should be well above 12% next year. (For the dark side of cash flow, read How Some Companies Abuse Cash Flow.)

Despite its solid cash flow and liquidity, NRG's debt is nonetheless rated as "junk" by credit agencies Strandard & Poor's and Moody's (NYSE:MCO). As such, its covenants demand that it must devote most of its free cash flow to creditors and capital expenditures. Exelon's credit rating is much better. Acquiring the whole of NRG, including its $8.6 billion in debt, Exelon could renegotiate those covenants and, possibly, redeploy some of NRG's juicy cash flow for its own shareholders advantage. Increased cash flow and an expanded balance sheet would give Exelon a chance to snap-up more power companies at bargain-basement prices, too.

Bottom Line
In my view, a successful deal would represent quite a coup for Exelon and its shareholders. Of course, whether the same holds true for NRG shareholders is another matter entirely.

By Ben McClure

Ben McClure is director of McClure & Co., an independent research consultancy. Before founding McClure & Co., Ben was a highly-rated European equities analyst at London-based Old Mutual Securities. He also spent several years as a business/technology journalist at the Economist Group. McClure graduated from the University of Alberta School of Business with an MBA.

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