ENE--DYN--SSB good insights........
November 12, 2001
DYNEGY Inc. (DYN)#
DYN: ENE MERGER -- HIGH OCTANE -- BUT, 1H (Buy, High Risk)
SHARP CURVES ON ROAD Mkt Cap: $14,445.1 mil.
November 12, 2001 SUMMARY
* DYN/ENE merger offers large potential benefits for
POWER & NATURAL GAS DYN, including #1 market share, earnings accretion,
Raymond Niles industry-dominant position.
* But, significant "curves on road" exist:
governmental approval hurdles, costs of lawsuits, and
merging the workforce at Houston's two leading energy
merchant franchises
* Financially, and in terms of market share, we like
Brian Taddeo the deal: 37% earnings accretion, 15%-20% long-term
growth
* Near-term, we expect merger costs and absorption of
management time to dampen stand-alone performance in
2002
FUNDAMENTALS
P/E (12/01E) 21.1x
P/E (12/02E) 17.4x
TEV/EBITDA (12/01E) 15.1x
TEV/EBITDA (12/02E) 12.3x
Book Value/Share (12/01E) $11.96
Price/Book Value 3.7x
Dividend/Yield (12/01E) $0.30/0.7%
Revenue (12/01E) $30,500.0 mil.
Proj. Long-Term EPS Growth 20%
ROE (12/01E) 14.4%
Long-Term Debt to Capital(a) 50.6%
DYN is in the S&P 500(R) Index.
(a) Data as of most recent quarter
SHARE DATA RECOMMENDATION
Price (11/12/01) $44.31 Current Rating 1H
52-Week Range $57.95-$31.27 Prior Rating 1H
Shares Outstanding(a) 326.0 mil. Current Target Price $54.00
Convertible No Previous Target Price $54.00
EARNINGS PER SHARE
FY ends 1Q 2Q 3Q 4Q Full Year
12/00A Actual $0.26A $0.29A $0.55A $0.32A $1.43A
12/01E Current $0.41A $0.43A $0.85A $0.41E $2.10E
Previous $0.41A $0.43A $0.85A $0.41E $2.10E
12/02E Current NA NA NA NA $2.55E
Previous NA NA NA NA $2.55E
12/03E Current NA NA NA NA NA
Previous NA NA NA NA NA
First Call Consensus EPS: 12/01E $2.10; 12/02E $2.57; 12/03E NA
2002E EPS reflects stand-alone results
DYNEGY / ENRON MERGER - HIGH RISK, HIGH REWARD PROPOSAL -- OVERALL, VIEW
POSITIVELY
In our view, the Dynegy-Enron merger, if successfully accomplished, will be a
large win for DYN, and a win for ENE shareholders. DYN will pole-vault
itself from the No. 6 position to the No. 1 position, in terms of physical
power and gas transacted. However, this merger would combine the two leading
franchises in the industry, in terms of profitability, consistency of
performance, and track record. Both franchises have operated continuously
since the deregulation of the wholesale natural gas market began in
1984/1985, and have grown rapidly since power was deregulated in 1996. We
estimate that the combined entity will have 30%-35% market share of the
deregulated power and natural gas markets.
From ENE's perspective, this merger provides vital cash liquidity at a time
when Enron urgently needs it. We understand that $1.5 billion will be
injected into Enron tomorrow to support Enron's trading operations. This
cash is part of $2.5 billion in planned investment by ChevronTexaco into the
combination. Chevron already owns 26% of Dynegy and, by injecting additional
capital, plans to maintain its ownership stake in the new entity.
The financial end of the deal appears favorable to DYN shareholders. We
estimate pro forma 2002 EPS for DYN in the range of $3.50-$4.00, depending on
the amount of merger savings DYN can achieve. We think the $400 to $500
million in planned synergies is probably on the low side, and note DYN's
success in beating planned merger synergies with its much smaller Illinova
acquisition in 1999.
Using the midpoint of this EPS range, DYN shares are
trading at 11.8x pro forma EPS of $3.75. This is a low-valuation, given a
15%-20% long-term earnings growth rate and the creation of the industry-
leading franchise. Our 12-month price target of $54 projects a conservative
target multiple of 14x-15x.
Salomon Smith Barney is an advisor to ENE in this merger.
CONCERNS ABOUND; BUT DYNEGY HAS AN OUT
If DYN were only buying Enron's Merchant Energy operations, this deal would
be a home run, in our view. However, they are also buying a variety of
financial entanglements that have already caused ENE to restate earnings
downward from 1997-2000 downward by $586 million. As a result of these
financial dealings, which involved the setting up of off-balance sheet
trusts, special purpose entities, and related party transactions involving
the firm's CFO, ENE is subject to a number of class-action shareholder
lawsuits and an investigation by the Securities and Exchange Commission.
However, DYN has an out. Reportedly, if the cost of litigation exceeds $3.5
billion, DYN can opt out of the transaction. Given the ENE purchase price of
$9 billion, even if additional costs stopped just short of $3.5 billion, we
calculate that the deal would still be at least 16% accretive to earnings,
and DYN would still get the benefit of becoming the leading Energy Merchant.
DEAL HIGHLIGHTS
Overview
Dynegy has agreed to purchase Enron in a $24 billion deal, consisting of both
equity and the assumption of Enron debt, that will create the premiere
wholesale power and natural gas firm in North America. Under the terms of the
stock for stock deal, Enron shareholders will receive a ratio of 0.2685
Dynegy shares for each Enron share. Upon completion of the merger, Dynegy
shareholders will own 64% of the combined company, of which ChevronTexaco
will retain 26%, with Enron shareholders accounting for the remaining 36%
stake.
In addition to the share exchange, ChevronTexaco has agreed to contribute
$2.5 billion in equity into the new company, $1.5 billion which should be
injected tomorrow (11/13) and the remaining $1 billion at the close. In
addition, ChevronTexaco retains the right to purchase an additional $1.5
billion of additional shares, if it so chooses, over the next three years.
Chuck Watson, Dynegy's current Chairman and CEO will retain the same position
in the new company. Rounding out the rest of the "new" Dynegy's Office of
the Chairman will be Steve Bergstrom as President and COO and Rob Doty as
Chief Financial Officer (all three currently hold the same titles at Dynegy).
Greg Whalley as Executive Vice President will be the fourth member of the
Office of the Chairman (currently, he is President and COO of Enron). The
board of the "new" Dynegy will contain fourteen members: eleven from Dynegy,
three of which are from ChevronTexaco, and three from Enron.
Currently, Enron has a rating of BBB-/Baa3 with negative implications from
S&P and Moody's, while Dynegy's BBB rating is under negative review.
However, DYN management hopes to retain a BBB/Baa rating from the credit
rating agencies upon completion of the merger.
ChevronTexaco Equity Infusion
ChevronTexaco's Equity $2.5 billion cash infusion into the new company will
come in two stages. ChevronTexaco's initial $1.5 billion investment will
come in the form of a cash injection into Dynegy in exchange for Dynegy
convertible preferred shares. Contemporaneously, Dynegy will then invest the
$1.5 billion into preferred shares in Enron's Northern Natural Gas Pipeline.
The preferred shares may be exchangeable into either common shares of the
parent or equity in the Northern Natural Gas Pipeline.
ChevronTexaco's remaining $1 billion infusion, at the closing of the merger,
will be in exchange for common shares in the "new" Dynegy. In addition,
ChevronTexaco retains the right to purchase an additional $1.5 billion of
additional "new" Dynegy shares, if it so chooses, over the next three years.
Required Approvals
Besides gaining approval from both Enron and Dynegy shareholders, the deal
must also be approved by the SEC, the Federal Energy Regulatory Commission
(FERC) and receive approval under the Hart-Scott-Rodino Antitrust
Improvements Act.!!
Timing
We anticipate the closing of the deal within the 3Q2002. This is due to the
length of the time related to the regulatory approvals process.
Financial Implications
The acquisition of Enron is at least $0.93 accretive on a pro forma basis for
2002, assuming the companies were together for the entire year; this assumes
no cost savings. Assuming cost reductions of $450 million, we estimate that
the combined company will be accretive to Dynegy shareholders by $1.47 over
that same period. We have assumed the combined company will maintain the
bulk of the market that the two companies would have controlled
independently. A modest reduction in market share will occur due to
intercompany eliminations and customer overlap.
From a cashflow perspective, we anticipate that that the new company will
generate approximately $3 billion in operating cash flow, an increase of over
$1 billion above our stand alone Dynegy estimate of nearly $2 billion.
SSB Estimate Of Proforma Earnings Per Share (excluding $450 million in cost
savings)
EPS Shares Net Income
Dynegy Inc. @ 32.14 $ 2.55 339 864
Enron Corp. @ 8.63 $ 1.50 860 1,292
Combined Net Income 2,156
Reduced Interest Expense (after tax) 100
Adjusted Combined Net Income 2,256
Combined EPS ~ 648 million shares $
3.48
Accretion from $2.55 to $3.48 $
0.93
SSB Estimate of Pro Forma Earnings Per Share (including $450 million in cost
savings)
EPS Shares Net Income
Dynegy Inc. @ 32.14 $ 2.55 339 864
Enron Corp. @ 8.63 $ 1.90 860 1,638
Combined Net Income 2,501
Reduced Interest Expense (after tax) 100
Adjusted Combined Net Income 2,601
Combined EPS ~ 648 million shares $
4.02
Accretion from $2.55 to $4.02 $
1.47
Exit Provisions
One of the most important, and cloudy, considerations of this deal, in our
opinion, is the ability of Dynegy to withdraw from the deal in case Enron's
financial and legal situation should deteriorate further. The contract does
contain Material Adverse Change (MAC) clauses, however it is our
understanding that they are general in nature, and without specific trigger
mechanisms.
If Dynegy were to exercise its option to exit the transaction, it would have
claim on the company's Northern Natural Gas Pipeline, estimated to have a
value of $2.25 billion. Our main concern regarding the claim on these assets
is the fact that these are the same assets which back the recent $1 billion
credit facility that Enron entered into last week.
INVESTMENT THESIS
DYN is one of our Top Picks. As the second most profitable Energy Merchant,
Dynegy is targeting global opportunities driven by deregulation of the power
and gas markets. Energy Merchants manage price risk and sell power and gas
to wholesale commodity markets. We estimate that the global energy commodity
market opportunity exceeds $800 billion, of which less than 20% has been
commoditized so far. Dynegy has successfully leveraged its Energy Merchant
platform across commodities and geographies, from natural gas (No. 2 U.S.
player), to power, and from the United States to Europe. Dynegy is also
among the early movers targeting the commoditization of bandwidth, a market
opportunity which we expect to grow significantly over the next several
years. Long-term, we see annual EPS growth potential of 15-20%. We see DYN
as a core long-term holding; our 12-month price target is $54 per share.
COMPANY DESCRIPTION
Dynegy (DYN-1H) is a diversified Energy Merchant that provides energy risk
management services throughout North America, the United Kingdom and
continental Europe. They use market knowledge from their trading desk to
extract commercial value in a variety of commodity pricing environments,
leveraging their integrated power/natural gas position. As one of the first
movers into the deregulating natural gas and power markets, we believe Dynegy
is well positioned to capture market share in immature markets and establish
their reputation and customer relationships in an increasingly competitive
marketplace. Dynegy is active in trading and marketing of a number of
commodities, including power, natural gas, coal and emissions allowances.
They are also one of the first movers into the developing bandwidth commodity
market, which we expect to grow significantly over the next several years. |
