Did Duke Get Enough in Midwest Asset Sale to Dynegy?

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Duke Energy Corp. (NYSE: DUK) and Dynegy Inc. (NYSE: DYN) struck a deal on Friday for coal and natural gas generation in the Midwest. Unfortunately, Dynegy seems to have come out on top in the deal. If Dynegy wasn’t a clear winner then it may simply be that it has evolved into somewhat of a non-event for Duke. That is at least what the action in the stocks would indicate, after you see the breakdown of what Duke is really getting out of the deal.

Dynegy agreed to purchase $6.25 billion worth of Duke’s Midwest power plant assets. This agreement came on the heels of Duke’s plan to exit the Midwestern region as announced earlier this year by President and CEO Lynn Good. Of the $6.25 billion, some $2.8 billion went to Duke and $3.34 billion was going to Energy Capital Partners. Good had once said, “Our merchant power plants have delivered volatile returns in the challenging competitive market in the Midwest. This earning profile is not a strategic fit for Duke Energy and we have begun a process to exit the business.”

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Duke is the largest utility provider in the United States, with a $51.5 billion market cap, exponentially higher than Dynegy’s market cap of $3.2 billion. Because the purchase agreement is about double Dynegy’s market cap, Dynegy has turned to debt financing by issuing $5 billion in senior notes to pay for it. The company is also issuing $1.25 billion in equity and equity-linked securities.

Dynegy might seem to be the obvious winner as its share price jumped almost 9% on Friday and Duke’s share price closed down almost 1% on the day. Still, maybe it is just a situation that Duke wanted out of, and perhaps the price was less important than the actual exit. The Dynegy jump was caused by Dynegy adding 12,500 megawatts, which ultimately doubled its total capacity to nearly 26,000 megawatts. This deal also further opens Dynegy’s footprint in the Midwest.

Since Duke’s announcement to sell assets in the Midwest back in February, the share price has made steady gains on the year, having risen as high as $75.13 in April. Duke’s solid earnings report also acted as a stabilizing mechanism for the stock. Dynegy has posted very strong gains over the past six months — it rose and nearly doubled to $36.57 in June from its low of $19.80 in February.

Dynegy was up $2.60 or 8.75% to close Friday at $32.32. The consensus analyst price target was $28.60, with the highest target at $33.00. Its 52-week range is $18.11 to $36.57. Duke fell $0.61 or almost 1% to close at $72.87 on Friday. The consensus analyst price target is $76.31, and its 52-week range is $67.16 to $75.13.

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Moody’s opined on the deal as being ratings-neutral to Dynegy even though Dynegy’s financial profile will be weaker after the deal. Moody’s said:

These transactions are transformative for Dynegy as they result in a substantial increase in scale and geographical diversification, resulting in an improvement in the overall business profile. While the transaction is heavily leveraged, the fact that Dynegy is quite strongly positioned at its current B2 CFR, along with its improved business risk profile, allows us to maintain its B2 rating despite the expected weaker financial profile. Going forward, future M&A transactions will continue to be a major driver of credit quality. However, the evolution of Dynegy’s policies on hedging, leverage, dividends and retail risk management will also be key drivers.