Calpine Power Income Fund Cf.un
December 19, 2005 - 6:55pm EST by
2005 2006
Price: 8.23 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 508 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Calpine Power Income Fund has fallen more than 30% from its highs of the year on fears of how a Calpine bankruptcy will affect the company. Thorough research through the complicated organization of the Income Fund and its relationship shows that the fears are misplaced. The fund currently offers a 12% yield based on investor confusion, tax loss selling and institutional year end selling. Not only is the distribution not at risk, but there is a substantial opportunity for the Calpine Power Income Fund to become the logical purchaser of distressed Calpine assets on a very accretive basis. When the selling stops and investors fully understand how the Income Fund is protected, the share price will climb back towards its Net Asset Value (NAV) of C$13 a share, offering investors a total return of 70% and maybe more if the fund gets to buy assets on the cheap.

Four natural gas power plants owned

The power plants that the Trust owns or partially owns are:

1) Whitby Cogen: This is a 50 MW plant that has a twenty year contract to sell power to Ontario Hydro, owned by the Government of Ontario. This facility is owned through a 50% participation loan. Calpine Corp. owns the other 50%.

2) Island Cogen: This is a 240 MW facility that has a twenty year contract to sell power to BC Hydro, owned by the government of British Columbia.

3) Calgary Energy: This is a 300 MW facility that has a twenty year contract to sell to Calpine Corp. (More on this later).

4) King City: This is a 120 MW facility that sells power to PG&E for twenty years, but it is leased to Calpine Corp. to operate (More on this later).

Organizational Structure

The organizational structure that the plants are operated in is complex. It is crucial to the understanding as to why the distribution will not be disrupted. I highly recommend that you go to the Calpine Power Income Fund’s website and print the following organizational structure out to better understand it:

The first three power plants listed above: Whitby, Island and Calgary are all owned by an entity called Calpine Power L.P. (from this point forward referred to as “the L.P.”). Calpine Power Income Fund owns 70% of the L.P. in the form of A shares and the Calpine Corp. owns 30% in the form of B shares in the L.P. The King City Facility is 100% owned by the Calpine Power Income Fund.

Whitby and Island Cogen produce C$0.70 in cash flow by themselves

Excluding the other two plants that represent the risk in the minds of the market, Whitby and Island generate enough to produce C$0.70 in distributions (61.7 million units outstanding) all by themselves. That means that if we were to assume the Calgary and King City went away, were mothballed and went dark, the Trust would still be able to pay a sizable distribution. Attaching a 7.5% to 8% yield to that would give you a valuation of C$8.75 to C$9.33 a share. This should show you how undervalued this situation is, and how much upside there is.

The Calgary Energy Facility represents most of the risk

The Calgary Energy Facility represents the most risk because the entity that buys the power is Calpine Corp. Calpine currently is obligated under the contract to pay a tolling agreement of C$38 million a year regardless whether the power is needed. The plant offers power during peak demand. And the fear on the street is that Calpine will default on the contract.

Here are the following reasons that the risk to the Fund is much lower than investors believe and understand:

1) Calpine Corp. is subordinated to the Fund on the L.P. level
2) A new coal power plant temporarily depressed the Calgary power market
3) The Alberta power market is the fastest growing in North America
4) The Calgary off-take contract could be very valuable
5) The L.P. is sitting on C$30 million in cash

Calpine Corp.’s subordination and the L.P.’s threshold

The market assumes that the Calgary Energy Facility is a C$38 million risk that could go away. But that doesn’t consider the fact that Calpine’s B units are subordinated to the Fund and that there is a threshold level whereby the Fund has to get paid first before Calpine Corp’s B units receive a dollar. For example, assume that the L.P. earns $100. Under the current arrangement, The Fund gets $70 and Calpine Corp. gets $30. However due to the subordination and the threshold terms, the money flows in up to $70 and goes straight to the fund. Only then at $71 does Calpine Corp. start receiving its share.

Basically, the threshold is the current payment levels. Calpine Corp. is on track to earn $21 million over that threshold and that is what Calpine Corp. keeps for owning the B units. However, if there is a $38 million shortfall at the L.P. level, Calpine Corp. is the one to take the hit, because the amount of money the L.P. receives would not meet the threshold. So, the real shortfall to the fund is $38 million minus $21 million, or only $17 million. Now if Calpine Corp. walks away from that contract, all the Fund would have to do is find someone to take the off-take contract for $17 million a year and the Fund would keep all of its payments. (This is how you can figure out that the Fund could still pay $0.70 in distributions even without Calgary)

But further analysis of the Calgary power market and of this plant shows that it is not in Calpine Corp.’s best interest to walk away from this contract and that the current off take agreement could be sold for $100 million, money that Calpine Corp. desperately needs.

The Alberta power market is the fastest growing market in North America

The Alberta power market should grow 4% this year, making it the fastest growing power market in North America. Why is it growing this fast? Think of all the mining for metals, minerals and energy that is going on in the region. Especially think of the dramatic energy needs of the oil sands projects going on.

The stunning thing to consider is that some analysts think power demand could have grown 7% this year, but was muted by several one time extraordinary events. There was massive flooding in the region the likes of which have not been seen for over 100 years. There were also lots of tornados, which brought down power lines and depressed demand. And finally, the Suncor (NYSE: SU) oil sands facility had a deadly fire that substantially reduced output and reduced the demand for power from the plant. Without these events demand would have grown 7%, a very large figure. This continued growth makes this market a very valuable one to be involved in.

Further the capacity reserve in Alberta is shrinking even considering new plants coming online. Its a simple fact of supply at most growing at 3% while demand grows at 4% plus.

Why investors are underestimating the value of the Calgary plant

Why don’t other investors see the value of having a plant in Alberta? Because a brand new large coal power plant came online in q2, and demand for the excess power from Calgary fell to almost zero, causing losses for Calpine Corp. and its off-take agreement. Remember that the Fund earns its tolling agreement of C$38 million regardless of the usage of the plant. However, because the Alberta market is growing so fast, by November the Calgary facility was being used at 30-35% of capacity and again was profitable for Calpine Corp. In six months, the power market strengthened that much and should show the value as the demand for power keeps growing through capacity.

Calgary would experience brownouts without the Calgary Energy Facility

A more important point to consider is that at the current time, if Calpine Corp. were to walk away from its contract and the Calgary Facility were to go dark; there would be brownouts in the region. Do you really think that the government of Alberta or the city of Calgary is going to let that happen? As mentioned before, demand has been depressed this year due to crazy weather and Suncor. The power market in Alberta should be extremely strong and the spark spreads should trend higher next year. According to one analyst who tracks the market closely there are five entities that would step in almost immediately and start buying power on a short term basis if Calpine Corp. walked away. But, if the Alberta market is so strong, shouldn’t Calpine Corp.’s off-take contract be worth a sizable chunk of change to someone?

The Calgary Contract Is Valuable to Calpine Corp.

In a recent transaction TransCanada bought an off-take contract in Alberta for a high cost coal plant for 15 years for $585 million. Now there are several differences between that contract and the Calgary contract, which would substantially lower the price. Regardless it shows that these off-take agreements are worth money and sometimes substantial amounts of money. Earlier this year the Calpine off-take agreement wouldn’t have been worth much, but with the Alberta market continuing to heat up and the off-take agreement making money again, this will draw interest.

With the Alberta market tightening in 2006, Calpine could get $50 million to $100 million for this contract according to at least one analyst covering the stock. So, if this contract has value or the potential for value in the future, why in the world would Calpine Corp. default on it and walk away? The answer is they won’t.

The L.P. is sitting on hidden cash

But let’s imagine the worst case scenario, Calpine Corp. defaults and walks away. Note the L.P. is sitting on close to C$30 million in cash. The purpose of which is to make up for shortfalls in the distribution. Remember that the shortfall is C$17 million to the Fund. In a worst case scenario, CF could make current distributions for almost two years before finding someone to take over the contract. This is a safety net that investors are not appreciating. Add in the $8 million sitting at the Trust level and the Income trust has almost $40 million to get through “hard times.” This is not even to mention the $120 million credit facility that is untapped.

King City Facility risk is covered

The King Facility is not as big a deal as it only represents about C$15 million a year in a lease to Calpine Corp. and a $35 million facility loan to Calpine Corp. A very important thing to understand is that the facility loan is backed up with the subordinated B shares as collateral if Calpine Corp. walks away. Further, if the Fund had to takeover the running of this facility it would only reduce current income to C$9 million, a loss of only C$6 million. Of interest to note is that the fund has been generating about C$7-C$8 million a year above the distribution that it makes.

Yet, again the Fund is covered and protected from Calpine defaulting.

Calpine may stick it out for longer than expected

On Thursday, December 15th, Calpine Corp. told the Delaware Supreme Court that it can repay the money that it misspent on fuel earlier than the Jan. 22 deadline imposed by a lower court. This may be a piece of news that indicates that they are going to stick it out for longer than expected, which would be a boon for shareholders, as Calpine Corp. will look for assets to monetize. And the Fund would be the perfect entity to buy assets.

Opportunities to buy assets on the cheap from Calpine Corp.

The Fund is the logical buyer of some of the assets the Fund and Calpine Corp. own together. For example, the fund is the logical buyer of the 50% it doesn’t own of the Whitby Facility. And even further, the Fund is really the only buyer of the subordinated B units. Both of these could be wildly accretive to A unit holders.

Remember that the Fund only has a debt to capitalization ratio of around 12%, so it could very easily lever up and acquire assets. There also may be additional Canadian assets that Calpine Corp. would like to sell to raise money. The key is that none of this opportunity is even remotely reflected in the stock price.

Comparable Trusts and their Valuations

The closest comparable power trust is the Northland Power Income Fund ( Toronto: NPI.un). Northland has cogeneration plants and it also has a wind. Northland Power Income Fund (Toronto: NPI.un) is trading at a distribution yield of 6.8% (versus 11.8% for CF.un), a price to 2006E earnings of 18.1x (versus 9.4x for CF.un), EV/EBITDA of 12.3x (versus 10.2 for CF.un), and is trading at 14% above its estimated NAV (versus 36% below its NAV for CF.un).

The average power income trust has a yield of 7.8% and trades around their respective NAV. At these multiples Calpine Power would trade close to C$13 a share, close to 60% higher than current prices. At the Northland multiple, Calpine Power Income Trust would sell over C$14.40 a share, 75% higher than current prices. Add in the fact that you will be receiving a 12% yield and investors may see a 70% to 87% total return.


With a convoluted structure, investor confusion and a soiled parent’s name, the Calpine Power Income Fund has been punished unfairly and offers investors substantial opportunity to receive a 12% yield with the opportunity for upwards of a 70% capital gain as the situation becomes clearer.

Next year with or without a Calpine Corp. bankruptcy, the Calpine Power Income Fund will have a new entity off-taking its Calgary facility’s power. And when that event happens the fund will not possess a 12% yield, but will have a much higher valuation and a lower yield. And one day the Fund will have a new name besides Calpine and the distributions will not have fallen, instead they will be much higher than current levels. Take advantage of this while the tax loss selling and the investor confusion continues, it won’t continue for long.


1) Distribution keeps getting paid every month
2) Calpine Corp. sells its contract at Calgary to another entity
3) Calpine Corp. goes bankrupt but doesn’t default on Canadian assets
4) Calpine Corp. defaults on Canadian assets, but the Fund gets new customers
5) The Fund buys the 50% of Whitby it doesn’t own on an accretive basis
6) The Fund buys out Calpine Corp.’s B units for an accretive price
7) Contrary to beliefs, distributions actually rise
8) Alberta power market continues to strengthen
9) Calpine Corp. staves off bankruptcy for another 6-9 months
10) The Fund removes the name from Calpine from its name
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