M&A

Dynegy CFO Makes Case for Asset Sale

Finance chief Holli Nichols dissects the electric-power company's $1 billion sale of nine plants, contending that it bought the company autonomy an...
David KatzAugust 12, 2009

As Holli Nichols, the CFO of Dynegy Inc., tells it, the seed of the company’s $1 billion deal with LS Power announced Monday was planted in her treasury department.

However, the transaction mushroomed in significance into something that went far beyond treasury and into corporate structure, financial strength, and business strategy. After all, the deal includes a Dynegy buyback of about 25% of its equity from LS Power, a private-equity firm. That will enable the Houston-based electric-power generator to finally become a public company, with all the flexibility that entails, according to the finance chief. And with the $1.025 billion in cash that Dynegy stands to pick up if the deal wins regulatory approval, it can pay down its looming 2011 and 2012 debt maturities.

Those maturities were on the mind of folks in the company’s treasury organization when they hatched the notion of selling assets to offload some of that debt, according to Nichols. In the deal announced this week, which is expected to close in the second half of this year, LS Power will get eight Dynegy power plants and the company’s remaining interest in a project under construction in Texas.

Besides the $1.025 billion in cash, Dynegy will get 245 million of its Class B shares from LS Power. Such shares give LS Power, currently a 40% owner of Dynegy, privileges under a special shareholder agreement that owners of regular Class A shares don’t get. They include the right to sign off on changes to the corporate charter and bylaws, changes of control, and major financings. (LS Power did not return a phone call by CFO.com seeking comment on the deal.)

Holli Nichols“I think the markets today value liquidity and financial strength to a higher degree than they ever have in the past.”
Dynegy CFO Holli Nichols

When the transaction is closed, the parties will ditch the existing shareholder agreement. Dynegy will convert the remaining 95 million Class B shares held by LS Power into the equivalent number of regular Class A shares (about 15% of Dynegy’s Class A common stock outstanding).

Many analysts saw the deal as a salve to Dynegy’s current wounds, observing that it may have brought the company back from the brink of a bad situation. A J.P. Morgan North American Equity Research report noted, in fact, that Dynegy faced a “potential (if unlikely) bankruptcy risk” before the deal was struck. Indeed, on the same day the LS Power deal was announced, the company reported a net loss of $345 million for the second quarter of 2009, compared with a net loss of $272 million for the same period a year ago.

Not all analysts were so welcoming, arguing the company may have given up important revenue streams in return for near-term safety. Macquarie Research, for example, called the transaction a “fire sale of assets.” While the sale of the power plants temporarily “addresses the company’s liquidity problems and reduces the share count,” the firm said in a report, “it stripped [Dynegy’s] shareholders from a future upside which they could have realized when markets start valuing power plants closer to their replacement value.”

In a telephone interview Tuesday, however, Nichols made a strong case that Dynegy was shedding assets that were ill-equipped to benefit from the improvements in the economy and in commodity prices that she expects to occur in time. An edited version of the interview follows.

What’s been your role in putting together this deal?
Certainly, as CFO, I’ve been very focused on liquidity and financial strength. The level of cash that we’ll be bringing in will allow us to manage our debt-maturity profile. We’ll be very busy thinking about how to put this cash to work. We’ll be focusing on our near-term debt maturities and overall debt reduction.

But also, importantly, the transaction leaves us with a group of assets that we think are best positioned to perform well as the economy and as commodity markets improve. I needed to ensure that I retain the assets that are most levered to the improvements that we think will come about in the marketplace.

Another very important aspect was bringing in our equity at a time when we think it’s been quite undervalued. We’ve had private investors as part of our capital structure essentially since inception. These are good companies, good investors, but to have a fully public company is also something we desire when we think about our strategic flexibility. It’s important to have this autonomy of sorts; we can probably be a little more nimble and ensure that we’re making decisions that are in the best interest of our public shareholders.

What potential pitfalls do you see in the transaction? Is there a possibility that you may have given up too much in the way of assets to get the liquidity you needed?
I don’t think so. In today’s market, the types of assets that we sold are not necessarily levered to the economy improving and the commodity markets improving like the assets that we’re retaining. They probably have more value over the longer term (those are the types of assets that I gave up), but I’m getting liquidity today. And I think the markets today value liquidity and financial strength to a higher degree than they ever have in the past.

So you’re not thinking long term?
Oh gosh, I think we’re absolutely thinking long term, and that’s why we retained the assets that we did. Liquidity in the near term is what we’ve been able to bolster with assets that are not really contributing much today. Now could they contribute more in the future? I think certainly there’s some argument that they will. But if they’re contributing, that means that the assets we have retained are really doing very, very well.

Of the Arizona assets that we are going to convey to LS Power as part of this transaction, for example, one of them has a contract that starts next year for 10 years and the other one just recently started a contract that’s for 10 years. So for the next 10 years, regardless of what happens to the economy — which should improve, with increased demand as well as commodity prices — those assets won’t necessarily benefit from that.

The current base that we’ll retain now is levered to those types of events; the assets we’re selling won’t have that type of opportunity. Their cash flow and their earnings profile are fixed.

Is there a risk that by restructuring your debt now, you’ll have to refinance your debt at higher rates six or so years from now?
When you look at our capital structure now, our next significant maturity, after we’ve been able to address our 2011 and 2012 maturities, is 2015. I think that sometime certainly between now and then capital markets will have good, healthy times, and we’ll have plenty of time to deal with those maturities when we get there.

From a finance perspective, how did this arrangement come about?
Earlier this year, internally, as a treasury team, we started looking forward and thinking: OK, we are facing a lower commodity-price environment. What does that mean for us? We have maturities in 2011 and 2012 — and, by the way, a lot of companies have maturities in ’11 and ’12 that are going to hit the market — and we are not very interested in retaining that refinancing risk.

What are the different alternatives we have to start planning for that? A natural option had to do with asset sales, especially if you consider that LS Power has three members on our board. Similar to us, they’re looking for ways to execute and create value for shareholders, obviously being the large one that they are.

Interestingly enough, it started within the treasury organization. But then it truly evolved into something that would satisfy a lot of our capital structuring questions and then into something that would be actually quite strategic for us: taking us into being a fully public company.