Dynegy DYN
June 16, 2011 - 6:47pm EST by
2011 2012
Price: 5.86 EPS -$1.05 -$1.20
Shares Out. (in M): 122 P/E NA NA
Market Cap (in $M): 714 P/FCF NA NA
Net Debt (in $M): 4,063 EBIT 164 139
TEV ($): 4,770 TEV/EBIT 34.0x 47.0x

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Dynegy is an independent power producer (IPP) based in Houston.  Dynegy finds itself in an over-leveraged situation ($4.1bn of net debt including leases vs. ~$500mn of EBITDA due to a series of poor investment decisions made over time including forays into telecom and buying power assets close to the top of the market.)  Dynegy's main assets are 2.2GW of coal-fired power plants in Illinois with top of the line environmental controls, 1.8 GW CCGT plants in the Midwest, 1.0GW of CCGT plants in CA and 1.6GW of CCGTs in the Northeast.  On November 16, 2010 Blackstone bid $5/share for the company, on December 15, 2010 Icahn Enterprises bid $5.50 for the company.  Stock is currently trading at $5.86

Summary Valuation:
Mkt Cap: $716mn
Lease Adj. Net Debt: $4,067mn
TEV: $4,770mn
2011 EBITDA: $490mn
Debt/EBITDA: 8.3x

Investment Thesis:

Cheap long dated option on recovery of power prices.  Higher long dated natural gas and power prices combined with higher capacity markets should bring DYN EBITDA to the $600-700mn level by 2016.  Longer term, as replacement cost economics kick in once new EPA rules cause retirement of a significant portion of the existing coal fleet in the Midwest (MISO) and Midatlantic (PJM) around 2017/2018, DYN could be doing $800mn-$1,000bn of EBITDA. By the time we get to 2016 net debt will likely tick up to ~$4.5bn due to negative free cash flow which would bring TEV to $5.2bn based on today's equity cap.  If you think this company would trade at 8x replacement cost EBITDA of $900mn the stock would be worth ~$23 in 2016.

Capital structure flexibility should ensure staying power as company has essentially no secured debt (revolver is undrawn and is likely to be refinanced in the next month or so) and its first major bond maturity is not until 2015.  The company's assets should be able to support ~3x EBITDA of secured or project level debt which would mean approximately $1.5bn of additional liquidity above and beyond the ~$400mn of cash the company had on its balance sheet as of 3/31/2011.  There is a debt/EBITDA covenant in the undrawn revolver that the company would break in Q3 2011.  However, the company will likley use part of its secured debt capacity to replace this revovler.  Bottom line is that the company has plenty of time to wait for power markets recover.  I do not think the equity analysts who cover this stock appreciate this financial flexibility.

Board of directors is highly shareholder friendly and has two board members who were selected by Carl Icahn.  A key focus of this board will likely be trying to convince bond holders to exchange their bonds into new debt at discounts to face value.  The company has the following bonds with most of them trading between 55 and 83 cents

Security     Amount Coupon Maturity Price YTW
Revolver     0 L+375 4/2/2012    
Term Loan B   68 L+375 4/2/2013    
LC Facility     850 L+375 4/2/2013    
Sithe Notes   225 9.00% 2013    
6.875 Notes due 2011   80 6.88% 2011    
8.75 Notes due 2012   89 8.75% 2012    
7.5 Notes due 2015   785 7.50% 2015 83.3 13.0%
8.375 Notes due 2016   1,047 8.38% 2016 81.0 13.9%
7.125 Notes due 2018   172 7.13% 2018 70.6 13.8%
7.75 Notes due 2019   1,100 7.75% 2019 74.0 13.1%
7.625 Notes due 2026   171 7.63% 2026 71.4 11.7%
Sub debt     200 8.36% 2027 55.0 16.3%
Central Hudson Lease   604   2016    
Total Debt     5,391 4,541      
LC Cash     (850)        
Cash     (291)        
Rest. Cash     (187)        
Net Debt     4,063        

These bonds are all parri pasu and there is minimal secured debt ahead of them (there is a $68mn term loan and a $225mn project level bond at the Independence CCGT).  The bonds have a face value of ~$3.5bn and a market value of ~$2.7bn for a total discount of $800mn.  If the company were to use a combination of debt exchanges into secured bonds and to layer new secured debt into the capital structure I think it would be possible for the equity to crystalize a portion of this bond discount (imagine if you are a bond holder currently pari with ~$4bn of unsecured debt (including lease) and you are about to be layered by $1.5bn of first lien and think that other bond holders may exchange into $1.5bn of second lien, you may be inclined to exchange especially if you bought them below par).  If the equity captured half of this bond discount ($400mn) it would mean $3.27/share of additional equity value. 

Another possibility is that the company might elect to take a portion of the proceeds from raising secured debt and use it to pay a special dividend.  Even a $300mn dividend equal to 20% of secured debt capacity would signficantly de-risk the equity investment (would take out over 40% of market cap) without materially increasing leverage or the long term.  Paying out this dividend may also cause the bonds to trade lower which might facilitate additional exchanges at prices below par.  The company's existing bonds have only investment grade covenants and do not have any restricted payment limitations.

EBITDA could have material upside through cost cutting.  A DYN investor filed an 8K that showed an additional $50mn of cost cutting might be possible by getting rid of traders, moving headquarters from Houston to Baldwin, Illionois and other measures.  At 8x EBITDA this would be worth $400mn or another $3.27/share.

Downside protection seems to be supported by bids from Icahn ($5.50 in December) and Blackstone ($5 in November).  Since this time we have had a favorable capacity auction in PJM and the EPA introduced rules that will increase the cost of non-scrubbed coal plants which should enhance margins for DYN's fullly scrubbed plants. 



Refinancing of revolver this summer
Raising project level debt
Special dividend
Bond exchanges
Higher gas/power prices and capacity prices over time.
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