July 20, 2009

Exelon Corp. hungers to buy NRG Energy. But its "final" offer may still be inadequate. NRG's board is urging its shareholders to reject the hostile bid, noting that the utility has exceeded expectations while Exelon has not.

Exelon's July 2 proposal to buy the merchant generator that sells its power at market prices comes eight months after its first bid. But this time, the Chicago-based conglomerate has upped the ante by 12 percent and thereby pegged the total value at $7.73 billion in stock. And while Exelon has said the reason it increased its bid is because it has identified an additional $1.5 billion in synergies, the reality is that NRG's share price has graduated higher than the original bid.

Exelon says that it will pay about $28.10 a share or an 8 percent premium over its close as of July 1 of $25.01. Despite the increased offer, NRG is trying to persuade its shareholders in advance of their annual meeting on July 21 to say "no." With an economy that is expected to rebound and the demand for power anticipated to rise as a result, the Princeton, N.J.-based merchant says that it can do better on its own.

"Exelon's exchange offer, as inadequate as it was when first proposed on October 19, 2008, is even more inadequate today because of NRG's dramatic value creation over the past eight months," write chief executive David Crane and Board Chair Howard Cosgrove. "You should assess any offer from Exelon against the value of NRG's existing portfolio, taking into consideration NRG's continuing track record of additional value creation."

The two go on to say that, in the eight months since Exelon's first hostile bid, NRG has completed the acquisition of the retail electricity business of Reliant Energy and has begun construction of a 150 megawatt wind project and 400 megawatt peaking facility, both of which are in Connecticut. They added that, during this same period, it is not apparent what, if any, comparable value creation Exelon has achieved.

NRG, which spent seven months in bankruptcy in 2003, has been a success story. Unlike other merchant facilities that rely mostly on natural gas, it has a diversified portfolio. The utility says that it plans to spend $16 billion building modern natural gas, coal and nuclear facilities in Texas, where it already has a sizable operation. It says that furthermore it will add another 10,500 megawatts of electric generation across the country by expanding its existing assets.

Merchants, generally, lack the financial wherewithal and the size to increase productivity and efficiencies. Through consolidation, those independent power producers can achieve gains -- all within the context of expected generation shortages combined with projected upticks in demand. NRG's purchase of Reliant's retail business is premised on this thinking. Risks still exist, however, as uncertain regulations, creeping construction costs and a serious credit crisis continues to hurt the economy.

Formidable Force

To be clear, NRG has not said it is uninterested in matching with a bigger suitor. It has said, however, that any such offer must sufficiently compensate its shareholders -- not those of the acquirer. Along those lines, an 8 percent premium over the current share price won't cut it. Just what the threshold may be remains to be seen.

If Exelon and NRG were to combine, they would be a formidable force. Together, they would own 48,000 megawatts of generation all over the United States. Critics of any merger have said that it would wield too much market power and hurt consumers who would have fewer choices. Toward that end, Exelon Chief Executive John Rowe has said that he recognizes that the any such deal would have to satisfy state regulators. Therefore, the combined entity would likely have to shed assets.

Exelon says that its offer would create immediate value for NRG shareholders and a commensurate value for Exelon shareholders. NRG will benefit from Exelon's stronger investment grade balance sheet, low-carbon nuclear fleet, operating excellence, and a $600 million share in the synergies resulting from the combination. Likewise, Exelon would benefit from NRG's assets, cash flow, and its own share of the synergies.

"Together, the two companies would become the first national generation company," says Rowe. "There is no model that can do more for shareholders of both companies than an Exelon-NRG combination." To cover part of the cost of the transaction, Exelon has said it would get rid of $1.6 billion in assets, sell $1.1 billion in common equity and then finance the rest.

Rowe goes on to say that he has listened carefully to NRG's concerns about any merger and that the latest offer incorporates them. He says that Exelon has been able to increase its earlier bid because of the new-found synergies that NRG will realize from its merger with Reliant's retail business. He adds that Exelon has shown itself to be a dependable partner, pointing to its merger of Unicom and PECO that has delivered optimal value. Likewise, Exelon would integrate NRG into its enterprise before it ultimately "transforms" it. He emphasizes that this $7.73 billion offer is the company's "last and best."

Exelon, one of the nation's strongest utilities, has obviously under-estimated NRG's resolve. NRG stood strong last October and its shareholders have not regretted it. And while the latest foray by Exelon is a little sweeter, many analysts suggest that it is still too little. Exelon will therefore have to take back its word and dig a little deeper. Otherwise, it might risks losing this potential buy to another powerhouse that needs unregulated, modern and base-load generation.

 

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Ken Silverstein EnergyBiz Insider Editor-in-Chief
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