Dynegy (DYN)

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Dynegy (NYSE: DYN) is a holding company that engages primarily in power generation in the Midwest, Northeast and Southwest. The company operated primarily by producing wholesale energy then packaging and selling it to retail utility companies. With approximately 11,000 Megawatts (MW) of energy capacity, Dynegy is a serious industry player. Revenues in fiscal 2006 were just short of $2B.

Over the past few years, Dynegy has undergone serious restructuring, recovering from a series of bad missteps in the early 2000s. Originally known as Natural Gas Clearinghouse, the company took a turn for the worse when it rebranded itself Dynegy in 1998, in the spirit of the much heralded "New Economy." As part of this shift, Dynegy began to rapidly expanding to areas like energy trading and broadband internet, adopting the strategies of its larger rival Enron. Dynegy would almost follow Enron into bankruptcy after an investigation revealed fraudulent accounting practices in 2001.

Fortunately, Dynegy avoided a trip to bankruptcy court by shedding assets and selling off its haphazard array of business ventures. Since announcing its restructuring plan in 2002, the company has significantly reduced operating expenses and recently illustrated a renewed focus on growth and expansion with its acquisition of LS Power, a privately held energy generation company. Analysts have lauded the acquisition as a leap forward to Dynegy because of the improved geographically diversity and cash flow the deal will provide. In all, the combined company will have over 20,000 MW in generation capacity.

[edit] Company History

Dynegy began in 1984 as Natural Gas Clearinghouse, a marketer of natural gas . The company first entered the business of energy production in 1997, when it acquired Destec Energy Inc, a former subsidiary of Dow Chemical with a strong presence in the Midwest energy production market. In 1998, Natural Gas Clearinghouse rebranded itself Dynegy and pushed to cast itself mold of the "New Economy." As part of this aggressive move Dynegy closely mimicked its older peer Enron, launching several business ventures including energy trading platforms and a broadband internet division. In 2001, the company made an unsuccessful bid for then troubled Enron which soon filed for chapter 11. Dynegy almost followed Enron bankruptcy; in 2002 the company became ensnared in an accounting scandal. The company avoided a trip to bankruptcy court only by selling off assets, eventually shedding everything but its core merchant power division. Today, Dynegy remains focused on energy production. In 2006, the company made a successful bid to acquire privately held LS Equities another large energy producer.

[edit] Corporate Overview

After several unloading unrelated businesses to avoid bankruptcy in 2002, Dynegy continued to strip assets to pay down debt, shedding its natural gas pipeline operations and regulated utility business in 2004 and 2005. Today the company is focused exclusively on generating and selling energy from its 20 plants located throughout the United States which have a production capacity of 11,739 megawatts (MW). The company is organized as a holding company that conducts its business primarily through its subsidiaries. The company focuses its efforts on the generation and sale of energy from its 20 plants which are located throughout the country and can produce 11,739 MW of energy. Dynegy's plants all burn natural gas, coal or oil . The company organizes its energy production into three regions.

[edit] Midwest

The Midwest region represents the bulk of Dynegy's generation capacity. When examining energy generation portfolios, power plants are usually divided by capacity factor or the typical of percentage of total generation capacity a plant will use during a year. "Baseload" plants constantly produce energy and have high capacity factors whereas "peaking" plants have a low capacity factor because they only approach full generation capacity when baseline plants are strained during high demand periods. In the Midwest, Dynegy maintains a power plant fleet with over 4,200 MW of baseload generation capacity. Importantly, 3000 MW of the total capacity come from plants that use low-cost coal as fuel. Also, because coal dominates Dynegy's production methods in the Midwest, the region benefits when wholesale energy prices increase due to rising oil or natural gas prices. Because of these factors, the Midwest segment contributes the majority of Dynegy's cash flow. In 2006, Midwest had operational income of $208M. In addition to its baseload capacity, Dynegy has over 4000 MW of peakload capacity in gas-fired plants; high gas prices have limited income from these plants.

[edit] Northeast

Dynegy also has a small presence in the Northeast energy production market. Its Northeast portfolio currently consists of 2,800 MW of capacity. Two of the company's primary Northeast facilities have dual capacity for both coal and oil prices. Because of this dual capacity, the plants benefit when wholesale energy prices increase due to higher natural gas prices.

[edit] South

Dynegy also has facilities in the Southern region of the United States with just over 1,520 MW of capacity. Recently, Dynegy's Southern assets have been its worst performers, due to an unfavorable operating environment in the wholesale energy market. Barring an improvement in market conditions in the South, Dynegy's current assets in the South may continue to shed dollars for years to come.

[edit] LS Power Acquisition

In 2006, Dynegy announced plans to acquire LS Power, a privately held company focused exclusively on power generation. In its 2006 Annual Report, Dynegy Chairman and CEO Bruce Williamson described as a "significant growth initiative" that would "increase the scale, scope and diversification of Dynegy's power generation." After the merger, Dynegy will have a generation capacity of nearly 20,000 MWs. The synergies between Dynegy's and LS Power's portfolios seem likely to strengthen the company's position in its different regions and promise a stronger cash flow. Despite the size of the acquisition, Dynegy does not predict a significant increase in selling, general and administrative costs. The company projects a 14% SG&A cost increase despite a 70% increase in assets under management.

[edit] Background LS Power

LS Power was established 16 years ago and has maintained an exclusive focus on developing, financing and purchasing generation capacity. Since its founding, the company has developed and financed approximately 6,000 MW in new plant production capacity. Additionally it has purchased plants in operation with over 8,000 MW of capacity. LS Power is notable for continuously standing at the edge of innovation in energy production. Over the years, it has used its broad experience and understanding of the energy industry to quickly and effective capitalize on new, emerging trends and forces. LS Power's status as an industry leader is evidenced by the fact that it already has plans in development for a slew of new coal-fired generation facilities. Coal-fired plants only recently regained popularity as a cheaper to alternative to gas and oil fired plants in the face of rising fossil fuel prices.

[edit] The Benefits of Dynegy-LS Power Merger

[edit] Short & Medium-Term Benefits

In the short to medium-term, Dynegy's acquisition of LS Power represents an important transition from restructuring to a new strategy for growth and expansion. LS Power should prove to be a strong asset for many reasons. First, the addition of LS Power's assets promises a steadier stream of cash flow from existing operations. Additionally, as of 2006, 75% of LS Power's wholesale energy deliveries were contracted. After the merger, 50% of the company's energy deliveries will be contracted. Contracted prices insulate energy companies from fluctuations in the energy markets and provide a more predictable cash flow which should enhance Dynegy's value to investors. The deal will be immediately accretive to the company's operating income; Dynegy estimates that its earnings before interest, taxes, depreciation and amortization (EBITDA) will surpass $1B in FY 2007. The LS Power acquisition also promises to further diversify Dynegy's regional presence and give it access to more favorable energy markets.

[edit] Long Term Benefits

In addition to large immediate benefits, the LS Power acquisition should prove to be wise long-term strategic investment. Mike Segal, Chairman and President of LS Power, believes that the merger will favorably position the company to benefit from two fundamental trends in the power generation industry: consolidation and increasing energy demand. Indeed, a greater regional presence in key energy markets should allow the company to better benefit from increasing energy demand. Additionally, the new company's more stable cash flow will make it a more attractive take over target and will allow it to leverage more debt for an acquisition of its own. In the long-term, LS Power also brings a significant development pipeline to the table. As of 2006, LS power had 7,6000 MW of projects in development.

[edit] Dynegy/LS Power: A Glance

The merger promises to significantly diversify Dynegy's energy portfolio regionally, by dispatch type and by % fuel type:

[edit] Trends & Forces

[edit] Rising Fossil Fuel Prices

Over the past decade the price of natural gas and oil has risen significantly, approximately tripling since the year 2000. These price increases stem from a host of different forces including rising global energy demand, limited refining capacity and geopolitical tensions. These huge price increases translate into much higher operational costs and oil and gas-fired plants. Although there have been dramatic increases in natural gas and oil prices, coal prices have remained relatively stable due to abundant supply in the United States. The environment of rising fossil-fuel prices have made coal , particularly low sulfur coal, the power plant fuel of choice over the past few years. Dynegy's diversified portfolio of gas, oil and coal-fired plants mean that changes in the price of one fuel type i.e. natural gas will have an adverse affect on some operations and a positive effect on others.

[edit] ‎Wholesale Power Market Prices

Dynegy's profitability is a function of the difference between wholesale market prices for electricity and the cost of production. Most of Dynegy's production capacity is characterized by dispatched market structures where the market price is based on the price required to justify production of the last megawatt needed to balance demand. In this structure market prices are usually determined by natural gas prices because more costly natural gas-fired peaking plants are used to satisfy extra demand. Because of this market structure Dynegy has seen mixed effects from the run-up in oil and natural gas prices. On one hand, Dynegy's large coal-fired baseload facilities in the Midwest have benefited from increased natural gas prices. On the other hand, increased natural gas prices raise operational costs at Dynegy's gas-fired peaking facilities.

[edit] Weather

Another important factor that determines market prices in any given market is the weather . Typically, summer and winter weather extremes cause increased electricity consumption due to increased use of cooling and heating devices. On the other hand, milder weather during the spring an fall months tend to result in lower demand and lower market prices.

[edit] Global Warming & Environmentalism

Over the past few years, global warming has moved from the fringes to become one of the single greatest challenges facing the world today. A growing body of scientific evidence ties carbon dioxide emissions to rising global temperatures. As a result of growing popular awareness of the risks of global warming, many large corporations have stepped up their efforts to project greener images. Additionally, and more importantly, the US government has been enacting more stringent legislation limiting carbon emissions. Because all of Dynegy's facilities are carbon-fired, tightened emissions standards will raise the cost of operation across most of its facilities and put pressure on profit margins.

[edit] Increasing Demand & Consolidation

Two fundamental trends bode well for Dynegy: increasing energy demand, and consolidation in the energy industry. Over the past few years, there has been a steady increase in energy demand in Dynegy's major regions of operation. This increase demand is slowly absorbing the excess generation capacity available in regions such as the Midwest, West and Northeast. Concurrently, local, state and federal governments are loosening regulation of the energy industry after decades of tight control. In response to this, there has been rapid consolidation in the energy industry due to benefits of large scale such as increased pricing power, stronger cash flows, and regional diversity. If demand continues to rise and consolidation proceeds unfettered they will both result in a more favorable pricing environment for Dynegy.

[edit] Comparison to Competitors

Although wide variation in their operations makes a direct comparison of utility companies difficult. However, Dynegy has a few objective advantages over its peers. First, for its size Dynegy has impressive regional diversity. The acquisition of LS Power will enhance this diversity giving Dynegy a major presence in three major markets: the Northeast, West and Midwest. Regional diversity protects utility companies from local market fluctuations. Additionally, Dynegy has shed most of its prior business ventures including its regulated retail energy business making it more of a pure play on energy generation. Dynegy also has a few disadvantages. Most notable, natural gas-fired plants account for over 70% of Dynegy's total generation capacity. Because of this high exposure to natural gas, the company is exposed to the risk of further increases in the price of natural gas which will pressure operating margins. Dynegy's comparatively smaller operating margins are testament to this fact.

 Dynegy

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American Electric Power Company (AEP)	2007	$12.1B	Add	$3.99B	$2.67B	$2.91B	$192M	722M	37B
Dynegy (DYN)	2007	$3.1B	Add	Add	Add	Add	Add	Add	Add
Entergy (ETR)	2006	$9.06B	Add	$3.19B	$2.63B	$2.32B	$612M	70M	Add
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[edit] Bulls & Bears

[edit] Bulls

• Dynegy has greatly improved its operations since bad missteps in the early 2000s. Restructuring has significantly brought costs while shedding varied business ventures has allowed it to focus on its core business of energy generation.

• The acquisition of LS Power should add tremendous value to Dynegy. The merger will improve cash flow, diversify dispatch types and regional presence while allowing Dynegy to capitalize on two key trends: consolidation and growing demand for energy.

• Dynegy seems to be one step ahead of increasing natural gas and oil prices Oil Prices with its c[[Coal Power|coal-fired plant fleet. Low cost coal-fired plants benefit from increasing natural gas prices and provide steady cash flow. Additionally, LS Power has development plans for billions of dollars worth of new coal-fired plants.

[edit] Bears

• Dynegy is highly leveraged with high debt to cash flow ration. The LS Acquisition will increase its debt burden.

• Over 70% of Dynegy's generation capacity is in natural-gas fired peaking plants. Higher prices for natural gas make operating these plants more expensive than in the past.

• The US government is likely to continue to heighten emissions standards to lower carbon emissions. Dynegy will have to bear increasing costs if such legislation is passed, particularly at its coal-based plants.

[edit] Annotations

05/22/2007 - 05/25/2007: Dynegy's share price suffers after Chevron announced that it will sell its 12% stake in the company for $980M.

02/01/2007 - 04/05/2007: Dynegy rising among general optimism surrounding its acquisition of LS Power which official closed on April 7, 2007.

06/22/2007 - 06/24/2007: Dynegy and LS Power announce plans for a $1.1B coal-fired plant, capitalizing on high natural gas prices.

[edit] References

1. ↑ ^{1.0 1.1 1.2 1.3 1.4} AEP,2007,10-K, Pg-na ,item 1
2. ↑ AEP,2007,10-K, Pg-na ,item 2
3. ↑ AEP, 2007 10-K Report, Item2: Properties
4. ↑ DYN,2007,10-K,page-34,item 6
5. ↑ ^{5.0 5.1 5.2 5.3 5.4} ETR,2006,10-K,page-47,item na
6. ↑ ETR,2006,10-K,page-173,item na
7. ↑ ^{7.0 7.1 7.2 7.3 7.4} POM,2007,10-K,page-46,item 7
8. ↑ POM,2007,10-K,page-47,item 7
9. ↑ ^{9.0 9.1 9.2 9.3 9.4} PSD,2007,10-K,page-na,item 1