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IPPs detail cost-cutting, refinancing plans in dog days of sector shuffle

Cost-cutting and refinancing initiatives in the competitive power sector, detailed during the second-quarter earnings season, could represent tactical moves ahead of anticipated large-scale strategic transactions.

Fresh off solid second-quarter results, competitive generators swiftly reaffirmed full-year earnings guidance into the second half of 2017, a period that may see the culmination of due diligence and sell-side assignments that have dogged independent power producer management teams and their advisers since early spring.

Whether Calpine Corp. will ultimately go private, or Vistra Energy Corp. and Dynegy Inc. agree to tie-up, or the extent to which NRG Energy Inc. sells off pools of assets all depend on the bid premiums that emerge in the market, and whether such bids satisfy management teams, directors and shareholders. For these companies, the overlap between operations and the effort to cut costs and slash debt could help generators polish their balance sheets and add to their rationale for corporate-level transactions.

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Microscope on costs

With many competitive power deals in recent years driven by the cost synergies of merging large generating portfolios, it's no surprise weak power prices have steered attention back to achieving scale, corralling operational resources and carving off redundant administrative expenses. The value creation of such synergies has been observed by chief executives at Dynegy and Vistra amid speculation the two firms are in talks.

IPPs identifying areas of cost synergies could suggest arms length negotiations are afoot. Dynegy this month launched the latest iteration of its hallmark PRIDE program, scrutinizing cost in field operations. Dynegy has also hired consulting firm McKinsey & Co. Inc. to carry out the analysis, Deutsche Bank said in an Aug. 4 note, asserting that, "engaging outside expertise to take a fresh look at the cost structure and operations is a good idea."

The study carried out by McKinsey will look to identify areas within Dynegy's daily operations ripe for efficiency improvements, with emphasis on ramp rates, heat rates and general procurement. Dynegy President and CEO Bob Flexon believes the study could yield cost cuts of at least $100 million out of $2.6 billion in overall costs. For every $25 million in savings, the company says it can achieve a 0.1x reduction in debt-to-EBITDA, pegging the $100 million target at about 0.4x off Dynegy's leverage ratio, for which it is targeting 4.5x by the end of 2018.

Vistra is also examining field operation costs through its operations performance initiative, or OPI, relying on internal and external expertise, Vistra COO James Burke said Aug. 4.

"It is clear that both management teams see value in the significant synergies," among other drivers, Citi Research said Aug. 7. "In the end, we think it's a win-win outcome for both companies and we are surprised the bid-ask hasn't narrowed."

NRG's experience drilling into its own cost structure resulted in surpassing initial savings estimates. NRG's cost analysis in its business review was carried out by Boston Consulting Group, sources said, which ultimately helped identify $1.065 billion in recurring cost and margin improvements detailed in the company's recent transformation plan. Those reductions are underway, with the company cutting at least 100 jobs in Texas, the Houston Chronicle reported Aug. 9. NRG's planned cuts stem largely from sales and general and administrative costs, compared to Dynegy's focus on operations, but still equate to more than double the cuts NRG was able to achieve on its own in 2016.

Capital shuffling

The cost cuts NRG suggests it can achieve, tied with asset sales, are part of an effort to cut as much as $13 billion in net debt toward a 3.0x leverage ratio by 2018. Dynegy this week moved to cut its $2.1 billion 2019 debt maturities, making a $1.25 billion cash tender offer, which was upsized on the back of strong investor interest in an $850 million private placement due 2026.

Private generators are also capitalizing on availability of credit for power sector borrowers. Eastern Generation LLC, a subsidiary of ArcLight Capital Partners LLC, launched a repricing of its $1.64 billion term loan due in 2023, in an effort led by Morgan Stanley and Goldman Sachs, according to a report by S&P Leveraged Commentary and Data on Aug. 9.

Healthy access to credit is a good sign for merchant power investors looking for financing above asset-level transactions, among them Energy Capital Partners, which is said to be in advanced negotiations with Calpine over a sale. ECP's 15% equity interest this week caught investors' attention when Dynegy filed a shelf registration for the ECP shares, coinciding with speculation the private equity firm could be looking for liquidity needed to finance a deal for Calpine.

Analysts ultimately dismissed the filing, however, as a routine requirement. Evercore ISI analysts on Aug. 8 characterized the filing as a, "red herring" given the six-month mandate for such filings under securities law. Still, ECP's interest in Dynegy may continue to badger the company's stock, at least until it becomes economic for ECP to monetize the shares it owns at a $10.94 cost basis. Dynegy's stock finished at $8.37 on Aug. 10.

"There will always be the threat of [an] ECP sell-down of Dynegy shares, especially as a buyout of Calpine is on the horizon," Tudor Pickering Holt analysts observed on Aug. 9.