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Market Price (7/28/2017): $14.57/share; ST-Target: $18/share; NIV: $32/share
We feel CPN already has a deal or is close. Key sticking point is likely SB100 in CA that mandates 100% renewable for retail sales. If passed, SB100 would relegate CPN’s CA CCGTs relatively useless or would have to run as peakers, which diminishes CPN’s value. Our preliminary valuation suggests that CPN’s equity value would be about $0/share if all of its CCGTs were shut-down in CA, $15-$20/share, if run as SCGTs, and over $30/share with normal operations. Therefore, we believe that CPN will be privatized between $17-$18/share, in-line with our ST-Target. If the deal fails then we agree CPN should focus on debt repayment – $1 debt repay is at least $1 accretion to equity value – and Retail. But as we previously noted, it seems macro-economic situation is improving, and we feel it would accelerate into 2018. Target debt repayment of $2.7B translates into at least some $7.60/share. Operationally, we believe that expansion of Retail through organic means is correct given that major pieces of the business is in place. We agree accelerated closure of coal plants is coming, industry is moving more towards reliance on renewable energy, and even the slow improving natural gas prices are all tailwinds for ST-to-MT gain for CPN. Strategically there’s little to criticize, and it seems CPN has disavowed share buybacks. But, in improving fundamental market and aggressive debt repayment, we believe CPN’s hedging program is too aggressive. In MT-to-LT, we believe importance of heat rate will likely dominate IPP valuations.