Calpine 9.65% first priority s CPN-NOTES
December 05, 2004 - 5:27pm EST by
2004 2005
Price: 100.25 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 800 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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I think that CPN 9.65% First Priority Senior Secured Notes represent a compelling investment opportunity. They only yield around 9.5% but are very well covered by the underlying assets and I don’t see how you don’t get paid in full even if CPN files for Ch. 11, which I think it may ultimately have to do. If a quite low risk 10% isn’t sufficient IRR for you, then I’d suggest levering the trade to a 15% IRR. The risk doesn’t increase that materially with small amounts of additional leverage.

Calpine is a very complex beast both operational and financially, for which I have very detailed break outs, however, I’m going to try to simplify it as much as possible and use rough metrics to get the initial point across. We can follow up in the Q&A.


Calpine owns a portfolio of natural gas fired power plants mostly in the U.S. They are a merchant generator which means that they have to sell their power to local transmission companies on a commercial basis (i.e they bear the risk/reward of getting a return on their assets) rather than as a utility that is guaranteed a return on its investment.

Investment thesis:

I think the assets of CPN (worth conservatively $12-15 billion) cover the bonds to point where there little risk of not getting par, even in bankruptcy. As secured notes, they are very likely to continue receiving interest in bankruptcy. 10% with this little risk seems very generous, though you potentially may need to hold these notes through bankruptcy.

Where these bonds stand in the capital structure:

These bonds rank behind the project level debt, but ahead of all the remaining capital structure. Here’s a rough break out of the capital structure.

Project Debt 6.5 billion
First Priority Senior Secured 0.8 billion
Second Priority Senior Secured 3.7 billion
Unsecured 6.8 billion

Total Debt 17.8 billion

Equity Mkt. Cap 1.9 billion

Note: Only a portion of their assets have project financing, these bonds have first claim on a substantial pool of assets.

Rough Asset Valuation:

The type of plant that CPN operates cost between $500-600 per mw to build. In areas where there capacity is tight they will be able to generate cashflows whose present value exceeds this replication cost and in areas where there is overcapacity they will generate cashflows whose present value is less than this amount. I’m going to give specific commentary for some of their larger markets and lump the remaining assets into other and give them average valuations. Note: This asset valuation will be for their entire portfolio including assets under construction (roughly 20%), as I deduct in the liquidity section below the cost to complete the projects.

WECC: This is the market that includes California and is a very tight market where capacity is valued at a premium. Valuation per MW = $650

ERCOT: The Texas market is currently oversupplied, but demand growth has been coming in stronger than expected. While currently oversupplied, this market will be in balance in the 2007-2008 time frame, and valuations will rise to the $500/ MW level. Today’s Valuation per MW = $300.

SERC: This region is in the southeastern U.S. and is massively overbuilt. While the assets do have some minor value from reusing the turbines etc, I place no value on these assets. Valuation per MW = $0

Other: There are many different assets in different markets lumped in here and I value these at an average multiple. Valuation per MW = $500.

Contracts: In addition to the value of their hard assets, CPN had signed long term contracts to sell power to utilities at rates that will be above market. On these contracts we take the company’s value of $ 3 billion. I don’t believe this is stated in present value terms, so you can adjust this as you see fit.

Asset MWs (000s) Price per MW Valuation ($billions)
WECC Region 8.3 650 5.4
ERCOT 7.6 300 2.3
SERC 6.3 0 0
Other 9.7 500 4.9
Contracts 3.0

Total Valuation 12.6-15.6


Having recently sold natural gas assets to raise cash and having issued a very creative convertible security, CPN will end the year in a very liquid position with around $2.2 billion on its balance sheet. This should be enough to last easily through 2005. It’s not clear how they will be able to meet the debt amortization requirements in 2006, 2007 and beyond, but the company’s been amazing at getting the funds they’ve needed to in the past. I could spend more time on some of their options, however, since this investment work both in scenarios where they do and don’t have to file, I’m going to move on.

2005 2006 2007

EBITDA 1,150 1,570 1,680
Cap Ex (850) (400) (400)
Int Exp (1,350) (1,350) (1,350)
Working Capital (140) (70) (70)
Project Financing 475 - -
Debt Amortization (886) (730) (1,800)

Cash Burn (1,601) (980) (1,940)

Starting Liquidity 2,238 638 (342)
Ending Liquidity 638 (342) (2,282)

Why this exists:

While I highlight what I think is a compelling investment case based upon the hard asset value of the business, there is a chance you will have to hold this investment through ch11, which many investors shy away from. In addition, CPN had historically not treated its bondholders well, being very creative in doing things that the bondholders might have thought that CPN was prevented from doing. They have alienated many traditional bond investors.


You will realize your return by clipping coupons....the longer the better.
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