Power Company Privatization will Lead to Unintended Consequences

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Auvila_QN_2017_05_15_IPP_Privatization

Excerpt:

CPN: Market Price (5/15/2017): $12.63/share; ST-Target: $18/share; NIV: $32/share

NRG: Market Price (5/15/2017): $15.08/share; ST-Target: $22/share; NIV: $40/share

  • Lately there has been talk about privatizing power companies, including both CPN and NRG, and while we believe that the most rational course for these companies may be to go private – given the lack of “enthusiasm” for these names in the public markets – we are certain that the end result will not be either what the market expects nor what the regulators, politicians and, most of all, what the consumers desire
  • The assumptions we are making in our analysis are as follows:
    • Private equity (PE) investors are not unintelligent and will act in their own self-interest
    • Virtually all of the market (public and private) believe in the theory of “all else being equal”
    • Market forces move along least resistant path absent paradigm shift, typically externally imposed
    • As reserve margins dip below 12% market prices become more volatile and margins begin to expand at an accelerated rate
    • PE investors will be betting on the reduction of debt from internally generated free cash flow and asset sales, supplemented by cost reductions, to increase the equity value of its investments with the option value of changing market dynamics to further boost its rate of return
  • The first thing that PE investors are likely to do is to make the assumption that the underlying market forces and conditions don’t/can’t/won’t change for the foreseeable future
  • Based on these underlying assumption, PE investors will be able to figure out which plants they buy will remain profitable, which won’t and which are on the margin

 

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