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What's That Power Plant Really Worth?

An analysis of current valuation trends explains why some assets command better values than most.

Fortnightly Magazine - January 2007

here.

Figure 2 illustrates the value of a 7,100 Btu/kWh heat rate combined-cycle plant across North America. As noted earlier, this valuation is made using a 15-percent real discount rate on expected merchant cash flows for a 20-year period. In general, the net values have recovered; however, they are still below the new build level in most areas.

Although Figure 2 summarizes the overall values, it does not necessarily give the whole picture in terms of where the value lies, or how much of it is driven by the extrinsic value and future recovery of the market. Figure 3 shows a generic combined-cycle plant’s net revenue projections in the Entergy market. As illustrated, a significant portion of the value lies in the future years. Early year cash flows are driven by the extrinsic value of the plant, which may be hard to realize in these less transparent markets.

The discount rate used in the valuations is a critical factor. Figure 4 illustrates how average asset NPVs vary between the 10 percent and 15 percent real discount rates. Using the appropriate discount rate is particularly important in evaluating mergers and acquisitions, because any management bias on risk perception can affect the transaction and the overall company risk profile. The bottom line: The discount rate captures the risk perception in cash flows. Throughout this article, we generally use a 15 percent real discount rate to present our results.

Industry Players Have Been Evolving

During the down cycle, the industry’s liquidity gap was filled by financial players such as hedge funds, private-equity investors, and other key Wall Street investment banks. These entities traded distressed project debt, founded energy infrastructure investment companies or funds to acquire distressed portfolios, and looked for other various opportunities. Some of these early entrants capitalized on the low market sentiment in the middle of the bust cycle and captured the low-hanging fruit. During the fire-sale period, companies such as KKR-led consortium-acquired Texas Genco assets, Goldman Sachs acquired several NEGT assets through Cogentrix, and Mattlin Paterson’s KGen Partners acquired Duke’s Southeast assets.

The reasons for the sell off are many. Some of these assets are not expected to generate significant cash flow for some time to come. And, in many cases, the original owners did not have the time to await market recovery. At the time, the best option appeared to be a write-off of these investments and the pursuit of a back-to-basics strategy. These entities divested some, or all, of their merchant assets at discounted prices, which probably was fair value at the time.

In some regions the market recovery, driven by high natural-gas prices, came faster than expected. As some of these pioneer financial players see the return on their investment, we expect them gradually to cash out, as recently happened when Texas Genco was sold to NRG. However, other new players just now are coming into the acquisition and development market with serious capital. Some of these companies, such as U.S. Power Gen, Waypoint, and Complete Energy, are comparably new and are backed by private-equity investors. Others, such as