CALPINE CORP CPN
February 02, 2015 - 1:51pm EST by
ruby831
2015 2016
Price: 21.50 EPS 0 0
Shares Out. (in M): 403 P/E 0 0
Market Cap (in M): 8,664 P/FCF 0 0
Net Debt (in M): 8,142 EBIT 0 0
TEV: 16,806 TEV/EBIT 0 0

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  • Natural gas
  • Electric Utilities
  • Competitive Advantage
  • Great management
  • Buybacks
  • Capital Allocation
  • Potential Acquisition Target
 

Description

CPN is America’s largest generator of electricity from natural gas and geothermal resources. Despite being an independent power producer (“IPP”) operating in unregulated markets, CPN’s assets actually produce steady, predictable and growing cash flows – much like a regulated utility. With investors focused on plunging oil prices, spark spreads, and troubled energy companies, we believe a producer of energy with essentially no exposure to a commodity is an excellent investment opportunity that is being overlooked by the market. CPN is trading at a 2015 free cash flow yield of over 10%. It is our view that given CPN’s inherent competitive advantages, the stability and continued growth of its cash flows and its high quality management team, the company should be valued at a significant premium to its IPP peers or more in line with power utilities. The management team has a proven track record of creating value and is using capital allocation to unlock the underlying value of CPN. We expect that with growing cash flows from asset acquisitions and a shrinking share count as a result of an aggressive stock buyback program, the stock could trade substantially higher over the next 12-18 months.

Business Summary

“…unlike virtually every other competitor, the risk of a lower gas price environment over the next couple of years does not threaten our business model. In fact, it provides us opportunity.” – CEO Thad Hill

CPN produces power in 3 key regions of the U.S. – Texas, the East (including Pennsylvania, Delaware, New York, New Jersey, Massachusetts), and the West (mainly Northern California). Other than a small portfolio of geothermal assets in California, CPN is a producer of electricity using natural gas. Given the availability of natural gas in this country and its low cost, it has become the key driver of electricity prices in power markets. CPN benefits from a natural hedge, given its power is produced and sold based on the price of the same commodity – this has positioned CPN with a significant competitive advantage versus other IPPs.

As such, CPN has posted steady financial results in essentially all environments. Despite fluctuations in the price of natural gas, adjusted EBITDA has, for the most part, consistently grown for the past 8 years. Due to CPN’s stable, yet growing, stream of free cash flow, the company looks more like a regulated utility than an IPP. However, CPN also benefits from a competitive advantage versus regulated utilities. Given the high importance of a utility’s balance sheet, credit rating and cost of capital, most of these regulated energy providers sell their power, or “hedge,” several years into the future to improve visibility and lock in cash flows. Because there are fewer buyers of power 3 years from now versus 1 year from now, utilities typically sell electricity at a discount. Outside of generating revenue from 20-year power purchase agreements and capacity reliability fees, CPN sells its electricity up to 1 year forward, where demand is rich and the price being paid is more reflective of fundamentals.

“Our clean, modern, efficient and flexible fleet is poised to benefit from the secular trends playing out in the U.S. power generation industry.” – CEO Thad Hill

CPN is also well situated from the perspective of its fleet and the increasing scrutiny being directed toward other forms of power production. CPN’s power plants are significantly younger, environmentally cleaner and more efficient than the plants of its competitors, which are powered by other sources of fuel including oil, coal and nuclear energy. Furthermore, along with the environmental costs associated with coal-fired power production, the recent drop in the price of natural gas could also drive users of coal-fired electricity to switch to cheaper natural gas.

Management & Capital Allocation

“Our foremost objective is to maximize levered cash-on-cash returns to equity… while being prudent with the balance sheet.” – CEO Thad Hill

CPN’s management team, headed by Chairman Jack Fusco and CEO Thad Hill, is focused on unlocking value through share repurchases and asset acquisitions in the company’s 3 target markets. Hill believes that CPN is considerably undervalued and should be valued on a free cash flow per share basis. Simply put, he views CPN as a utility. However, rather than pay a utility-like dividend, the company continues to repurchase shares at these low valuations , with already $1 billion worth of stock repurchased through the first 3 quarters of 2014. Hill’s main priority is shareholder returns, and is focused on creating value in the stock.

But actions speak louder than words; this management team has successfully used this playbook before. In 2004, after the de-regulation of the Texas power market, several private equity firms including Hellman & Friedman, Texas Pacific Group, Blackstone and KKR, joined forces to take a company owned by Centerpoint Energy (“CNP”), called Texas GenCo Holdings (“TGN”), private for $3.7 billion – $900 million in equity and the remainder financed with debt. The consortium of private equity firms hand-picked Jack Fusco and Thad Hill to run the company. In February of 2006, Fusco, Hill and the consortium decided to sell Texas GenCo to NRG Energy (“NRG”) for $8.3 billion. With $5.8 billion netting to the equity holders, Fusco and Hill oversaw a $4.9 billion equity return, or 550%, in just 18 months. We think Fusco and Hill are using a similar formula at CPN of manageable leverage to produce outsized equity returns over time. Additionally, should a large utility wish to integrate regulated and unregulated assets, it could acquire CPN in an accretive, transformational deal. And most importantly as a CPN shareholder, we believe Hill would be willing to sell at the right price, as he’s done in the past.

Valuation

“We think our stock is a great buy.” – CEO Thad Hill

The value proposition at CPN was recently highlighted by management in a new slide in the November 6, 2014 Third Quarter 2014 Earnings presentation. The new slide, on page 6, displays both CPN’s stable adjusted EBITDA despite volatile gas prices and CPN’s free cash flow yield being at a 5-year high. Given the track record of this management team, we view the addition to its slide deck as a material inflection point in getting investors and sellside analysts to value the stock appropriately.

“This valuation gap illustrates the shortcomings of EBITDA multiple valuations, which may not fully capture underlying free cash flows, net asset values, or potential upside.” – Chairman Jack Fusco

At today’s stock price, CPN is trading in line with IPP peers at ~9x 2015 EBITDA. However, as Hill has said, “not all EBITDA is created equal.” We agree with management’s view that the stock should trade more in line with utility stocks and on a multiple of free cash flow per share. With a net operating loss balance of over $12 billion, GAAP EPS does not fully reflect the earnings power of this business. As Hill has said, he runs the business for cash and not for accounting metrics. At 15x 2016 free cash flow of $2.65/share (vs utility stocks with P/E multiples in the high teens), CPN stock could trade for $40/share in the next 12 months. We also expect free cash flow per share to grow to over $3/share in 2017 as new capacity starts up and more shares are repurchased – potentially leading to a stock price of $45/share or greater in 18 months.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Share repurchases
  • Asset acquisitions
  • Stable and growing financial results
  • Potential sale of the company
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    Description

    CPN is America’s largest generator of electricity from natural gas and geothermal resources. Despite being an independent power producer (“IPP”) operating in unregulated markets, CPN’s assets actually produce steady, predictable and growing cash flows – much like a regulated utility. With investors focused on plunging oil prices, spark spreads, and troubled energy companies, we believe a producer of energy with essentially no exposure to a commodity is an excellent investment opportunity that is being overlooked by the market. CPN is trading at a 2015 free cash flow yield of over 10%. It is our view that given CPN’s inherent competitive advantages, the stability and continued growth of its cash flows and its high quality management team, the company should be valued at a significant premium to its IPP peers or more in line with power utilities. The management team has a proven track record of creating value and is using capital allocation to unlock the underlying value of CPN. We expect that with growing cash flows from asset acquisitions and a shrinking share count as a result of an aggressive stock buyback program, the stock could trade substantially higher over the next 12-18 months.

    Business Summary

    “…unlike virtually every other competitor, the risk of a lower gas price environment over the next couple of years does not threaten our business model. In fact, it provides us opportunity.” – CEO Thad Hill

    CPN produces power in 3 key regions of the U.S. – Texas, the East (including Pennsylvania, Delaware, New York, New Jersey, Massachusetts), and the West (mainly Northern California). Other than a small portfolio of geothermal assets in California, CPN is a producer of electricity using natural gas. Given the availability of natural gas in this country and its low cost, it has become the key driver of electricity prices in power markets. CPN benefits from a natural hedge, given its power is produced and sold based on the price of the same commodity – this has positioned CPN with a significant competitive advantage versus other IPPs.

    As such, CPN has posted steady financial results in essentially all environments. Despite fluctuations in the price of natural gas, adjusted EBITDA has, for the most part, consistently grown for the past 8 years. Due to CPN’s stable, yet growing, stream of free cash flow, the company looks more like a regulated utility than an IPP. However, CPN also benefits from a competitive advantage versus regulated utilities. Given the high importance of a utility’s balance sheet, credit rating and cost of capital, most of these regulated energy providers sell their power, or “hedge,” several years into the future to improve visibility and lock in cash flows. Because there are fewer buyers of power 3 years from now versus 1 year from now, utilities typically sell electricity at a discount. Outside of generating revenue from 20-year power purchase agreements and capacity reliability fees, CPN sells its electricity up to 1 year forward, where demand is rich and the price being paid is more reflective of fundamentals.

    “Our clean, modern, efficient and flexible fleet is poised to benefit from the secular trends playing out in the U.S. power generation industry.” – CEO Thad Hill

    CPN is also well situated from the perspective of its fleet and the increasing scrutiny being directed toward other forms of power production. CPN’s power plants are significantly younger, environmentally cleaner and more efficient than the plants of its competitors, which are powered by other sources of fuel including oil, coal and nuclear energy. Furthermore, along with the environmental costs associated with coal-fired power production, the recent drop in the price of natural gas could also drive users of coal-fired electricity to switch to cheaper natural gas.

    Management & Capital Allocation

    “Our foremost objective is to maximize levered cash-on-cash returns to equity… while being prudent with the balance sheet.” – CEO Thad Hill

    CPN’s management team, headed by Chairman Jack Fusco and CEO Thad Hill, is focused on unlocking value through share repurchases and asset acquisitions in the company’s 3 target markets. Hill believes that CPN is considerably undervalued and should be valued on a free cash flow per share basis. Simply put, he views CPN as a utility. However, rather than pay a utility-like dividend, the company continues to repurchase shares at these low valuations , with already $1 billion worth of stock repurchased through the first 3 quarters of 2014. Hill’s main priority is shareholder returns, and is focused on creating value in the stock.

    But actions speak louder than words; this management team has successfully used this playbook before. In 2004, after the de-regulation of the Texas power market, several private equity firms including Hellman & Friedman, Texas Pacific Group, Blackstone and KKR, joined forces to take a company owned by Centerpoint Energy (“CNP”), called Texas GenCo Holdings (“TGN”), private for $3.7 billion – $900 million in equity and the remainder financed with debt. The consortium of private equity firms hand-picked Jack Fusco and Thad Hill to run the company. In February of 2006, Fusco, Hill and the consortium decided to sell Texas GenCo to NRG Energy (“NRG”) for $8.3 billion. With $5.8 billion netting to the equity holders, Fusco and Hill oversaw a $4.9 billion equity return, or 550%, in just 18 months. We think Fusco and Hill are using a similar formula at CPN of manageable leverage to produce outsized equity returns over time. Additionally, should a large utility wish to integrate regulated and unregulated assets, it could acquire CPN in an accretive, transformational deal. And most importantly as a CPN shareholder, we believe Hill would be willing to sell at the right price, as he’s done in the past.

    Valuation

    “We think our stock is a great buy.” – CEO Thad Hill

    The value proposition at CPN was recently highlighted by management in a new slide in the November 6, 2014 Third Quarter 2014 Earnings presentation. The new slide, on page 6, displays both CPN’s stable adjusted EBITDA despite volatile gas prices and CPN’s free cash flow yield being at a 5-year high. Given the track record of this management team, we view the addition to its slide deck as a material inflection point in getting investors and sellside analysts to value the stock appropriately.

    “This valuation gap illustrates the shortcomings of EBITDA multiple valuations, which may not fully capture underlying free cash flows, net asset values, or potential upside.” – Chairman Jack Fusco

    At today’s stock price, CPN is trading in line with IPP peers at ~9x 2015 EBITDA. However, as Hill has said, “not all EBITDA is created equal.” We agree with management’s view that the stock should trade more in line with utility stocks and on a multiple of free cash flow per share. With a net operating loss balance of over $12 billion, GAAP EPS does not fully reflect the earnings power of this business. As Hill has said, he runs the business for cash and not for accounting metrics. At 15x 2016 free cash flow of $2.65/share (vs utility stocks with P/E multiples in the high teens), CPN stock could trade for $40/share in the next 12 months. We also expect free cash flow per share to grow to over $3/share in 2017 as new capacity starts up and more shares are repurchased – potentially leading to a stock price of $45/share or greater in 18 months.

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

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