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FirstEnergy takes significant step in divesting merchant business

FirstEnergy Corp.'s sale of nearly 1,600 MW of merchant generation involves more cash proceeds than expected and is seen as another significant step in the exit from the competitive business. The company, however, still faces plenty of hurdles ahead.

"[FirstEnergy] still has plenty of wood to chop as management works to completely divest the company of its competitive energy operations (CES) over the next 12­-18 months," Wells Fargo analyst Neil Kalton wrote in a Jan. 20 note.

FirstEnergy announced Jan. 19 that it reached an agreement to sell four natural gas plants in Pennsylvania and its ownership in a Virginia hydroelectric plant to Aspen Generating LLC, a wholly owned subsidiary of LS Power Group affiliate LS Power Equity Partners III LP. The LS Power unit will purchase the facilities for approximately $925 million in the all-cash transaction, according to the terms of the agreement.

The power plants are owned directly or indirectly by FirstEnergy competitive subsidiaries Allegheny Energy Supply Co., or AES, and Allegheny Generating Co., with a total capacity of 1,572 MW. Wall Street analysts said the deal values the assets at nearly $600/kW.

"All told, we viewed yesterday's announcement favorably as the cash proceeds were higher than we estimated for AES's portfolio (excluding Pleasants)," Kalton wrote. Wells Fargo said the cash proceeds are about $150 million to $300 million higher than the brokerage expected.

Evercore ISI, which maintained its "buy" rating on FirstEnergy in a Jan. 19 research report, said most of the value is likely in the Bath County hydroelectric plant.

FirstEnergy, in a Form 8-K filed in early December 2016, revealed that AE Supply entered into exclusive discussions involving the sale of its gas and hydroelectric assets, which have a combined net book value of about $1.2 billion. FirstEnergy said it anticipated an $885 million purchase price for the assets, along with about $305 million of debt to be assumed by the buyer once the deal closed.

FirstEnergy indicated in a Form 8-K filed Jan. 19 that it will issue a "make-whole" payment related to the $305 million in debt, which based on current interest rates is estimated at about $100 million.

"It is expected that proceeds from the sale will be invested in the unregulated money pool and may be used for the repayment of debt and general corporate purposes," the company wrote.

"We believe the cash proceeds will be used to extinguish AE Supply's (AES's) existing debt obligation of [$621 million] — ­­we think there could be [approximately $200 million] of proceeds remaining after taking into account make­-whole premiums," Kalton wrote.

Evercore ISI noted that assuming the transaction closes, FirstEnergy would then have a little more than 1,400 MW of AE Supply assets left to sell, including the Pleasants coal plant in West Virginia, the Buchanan Generation LLC gas plant in Virginia and ownership in the Clifty Creek and Kyger Creek coal plants. The firm said these plants would have to sell for about $220/kW for FirstEnergy to break even given the remaining debt at AE Supply.

In calling the 1,300-MW Pleasants coal plant "a valuable asset," Evercore ISI said the likely scenario is that FirstEnergy utility Monongahela Power Co. purchases the asset, "resulting in incremental rate base growth opportunity as well as a cash flow up to the parent."

FirstEnergy management indicated on the company's third-quarter earnings call in November 2016 that the competitive business was under strategic review and could be forced to file for bankruptcy. FirstEnergy was also "open to exploring the sale of any or all of these assets," the company's top executive said, specifically identifying gas and hydro generation at Allegheny Energy Supply.

"AES was the CES subsidiary where we perceived there to be positive value," Kalton wrote. "[FirstEnergy Solutions Corp.], which has roughly [$3 billion] of debt, is another matter — and we continue to believe that FES could end up filing for bankruptcy protection (though there are other possible exit scenarios that do not involve such a filing)."

Evercore ISI decreased its price target on FirstEnergy to $34.50 from $35.50 and said it expects the company to be fully divested from the merchant business by year-end 2018.

The AE Supply transaction is expected to close in the third quarter and is subject to customary and other closing conditions, including approval by FERC and other agencies, as well as third-party consents.

The sale involves the 88-MW Allegheny Energy Units 1 and 2 and 550-MW Allegheny Energy 3, 4 and 5 units, jointly referred to as the Springdale plant; 88-MW Allegheny Energy Units 12 & 13, or Chambersburg facility; 88-MW Allegheny Energy Units 8 and 9, or Gans plant; the 45-MW AE Hunlock 4 plant; and the competitive units' 713-MW ownership interest in the Bath County hydro plant.