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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

LS Power 4 and CPV, are not new, but are in a new growth pattern of actively pursuing acquisition targets and new development projects.

Additionally, there is a growing interest in U.S. energy assets from foreign investors in Japan, the UK, Australia, and other countries. Despite all the turmoil and uncertainty in our energy industry, the United States is still a stable, transparent, and business-friendly environment for foreign capital. These investors, such as JPower 5 and Diamond Generating, are looking for investment opportunities in the United States. Others, such as Macquarie, have a more diversified investment strategy and a broader objective—U.S. infrastructure investment.

M&A Activity

As the industry recovers from the bust cycle, we are seeing a significant number of asset sales, new generation proposals, and merger and acquisitions (M&A). Despite the failed Exelon-PSEG and FPL-Constellation mergers, we expect the level of M&A activity to stay high, with more assets changing hands as the markets recover. Figure 5 summarizes the asset transaction amounts since 2004. The “Unregulated/Diversified” category consists of unregulated generation assets of major utilities and independent power producers.

Asset sales by financial and private-equity groups have been rising. Clearly, some of these players are cashing in on the investments they made during the buyers-market bust cycle. In the future, we expect to see more of this group’s assets coming to market. In fact, we expect that many of these assets will be flipped several times as different potential owners pursue various portfolios with different perceived value streams.

Assets also are changing hands as some newly formed investment companies develop their asset portfolios, while other players divest non-core assets and reshape their holdings. Two players in particular, Mirant and Calpine, are working hard to emerge from bankruptcy with “the right stuff.”

The story in the Southeast region is a bit different. The liquidity in this market is still low, and there are several assets still owned by banks or other debt holders. Several banks and debt holders have set up operating companies to manage their assets until the market is more liquid or until they can adequately recover some or all of their debt. However, a significant amount of debt has been traded since the bottom of the bust cycle, and several banks have cleaned up their portfolios or limited their exposure. Because there still are significant risks in this region, potential buyers are emerging just now.

The other major problem with Southeastern transactions is the issue of market power. For example, when Entergy tried to acquire the Perryville plant, located within its territory, the deal generated controversy over Entergy’s perceived market power.

Today’s energy investors clearly understand the need for economies of scale and adequate diversification of their portfolios. Good examples of this are the recently announced LS Power/Dynegy merchant generation joint venture and NRG’s acquisition of Texas Genco. Today, with the uncertainty of fuel prices and regulatory pronouncements, a larger portfolio with both fuel and geographical diversification may be the best way to obtain more extrinsic value from generation assets.

The Same Mistakes?

The next-generation build cycle, which we