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Morgan Stanley says Duke's international segment could fetch $2.1B


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Morgan Stanley says Duke's international segment could fetch $2.1B

MorganStanley Research estimates that the total equity value of Duke Energy Corp.'s international business is approximately$2.1 billion with a potential sale resulting in 3% to 4% EPS dilution, or approximately17 cents per share.

DukeEnergy in February said it was consideringa sale of Duke EnergyInternational LLC, which owns 4,400 MW of mostly hydro generation inCentral and South America. The potential sale will not include Duke's 25% equityinvestment in Saudi Arabian methanol producer National Methanol Co.

DukeEnergy Executive Vice President and CFO Steven Young said in a February interviewthat the international segment has produced strong cash flow, even under adverseconditions, but in 2015 the segment showed a level of volatility "that we hadnot ever seen before." Young said Duke Energy's ability to cash from the international businessfollowing its restructuring coupled with unexpected volatility prompted the decisionto pursue a sale.

The internationalbusiness presented an earnings overhangon the company in 2015 largely because of the impact of the drought and negativeeconomic conditions in Brazil. The international business contributed earnings ofapproximately 60 cents per share in 2013 and 2014, but only about half of that in2015, and Young said the segment is expected to produce earnings of 30 cents pershare in 2016.

Executives,however, still expressed confidence the segment would stabilize and grow modestly, but investors have been wary.

MorganStanley said it estimates a potential equity sale price range with a midpoint of$1.2 billion for the Brazilian hydro assets and approximately $900 million for thenon-Brazil generation. This valuation implies an approximately 6.9 times EV/EBITDAmultiple on the firm's approximately $400 million 2016 estimated EBITDA and is roughly11.7 times the firm's 2016 estimated earnings for the business.

"Assumingthe proceeds are used to repay debt, which management has indicated, we estimatethat a sale at this valuation would be ~3-4% dilutive to 2017e EPS. However, uncertaintyand volatility around the [Latin American] business has been an overhang for thestock, and as a result we believe a sale would result in modest P/E multiple expansion,offsetting the valuation impact of a dilutive sale on our math," analysts wrotein an April 12 report.

DukeEnergy Chairman, President and CEO Lynn Good said the company believes there willbe demand for the internationalportfolio at a "reasonable valuation."

"Webelieve we have very high quality, valuable assets. The asset in Brazil is a hydroasset in Sao Paulo and we believe prospective buyers will share the view of thevalue of these assets and we're confident that we can execute," Good said onthe company's fourth-quarter 2015 earnings call.

MorganStanley said there are a number of foreign players that may be interested in enteringor expanding operations in Brazil, largely because Brazilian utilities are highlyleveraged, with AES Corp.,Engie and among those already positionedin the country. AES President and CEO Andrés Gluski said in late February that the company isn't "lookingat something like a large acquisition in Brazil."

MorganStanley added that the regulatory uncertainties present in Brazil since 2012 "aremostly clear" with the effects of the severe drought "also mostly mitigated."

"Whilethe macro turmoil drove an increase in interest rates and valuation pressure, microconditions in the sector have improved," analysts wrote in the report. "Thelatter can be illustrated by improvements in distribution regulation, better termson the distribution concession renewal, and better conditions for auction of existinghydro plants."

Outsideof Brazil, Morgan Stanley said, "Chile and Peru are showing relative growthstability."

MorganStanley said it expects the sale process to be completed by the first half of 2017.

If DukeEnergy successfully divests its Latin American business, Morgan Stanley said its"consolidated cash flows would be derived almost entirely from regulated utilitiesand long-term USD contracted gas and renewable assets" since the company the merchant generation businesslast year.

The firmhas an "equal-weight" rating on Duke Energy with an $86 price target.