UBS Securities LLC analysts upgraded Vistra Energy Corp. to "buy" owing to an improved outlook on merger synergies with Dynegy Inc., following the bank's earlier coverage initiation on the electric utility sector.
UBS, which initiated coverage on the electric utility sector on Feb. 2 after hiring analyst Dan Ford from Barclays in late 2016, upgraded Vistra to "buy" on March 6 from its "neutral" rating, citing an increasingly positive view on targeted synergies. UBS estimated project synergies of about $350 million could be worth $4 per share, partially informing the analysts' new price target of $27 per share from $21.
Following shareholder votes to approve Vistra's acquisition of Dynegy on March 2, the deal now awaits regulatory approval from the Federal Energy Regulatory Commission and Public Utility Commission of Texas. With regulatory approval appearing likely, UBS is focusing on execution of deal synergies, which Vistra on Feb. 26 pegged at roughly $225 million in projected cost synergies, in addition to $125 million in operational synergies.
But if Dynegy's historical mergers are any guide, cost synergies from its tie-up with Vistra could reach as high as $387 million, according to the UBS analysis, not accounting for the $125 million in operational improvements across the combined fleet. UBS noted that Dynegy's synergies achieved from previous portfolio mergers, including deals with ENGIE North America Inc., Energy Capital Partners, Duke Energy Corp. and Ameren Corp., combined to average about $15.49/kW in savings, or about 72% higher than initial projections.
"We believe retaining Dynegy's operational teams and bringing them in to review Vistra's plants is likely to provide similar synergy opportunities to those seen in prior Dynegy transactions," UBS analyst Dan Ford wrote. "There is also likely significantly more capability to achieve corporate synergies as the prior Dynegy transactions ... involved the acquisition of a fleet of generation assets from an owner, whereas the [Dynegy-Vistra] merger combines two public companies with larger and duplicating corporate structures together."
UBS asserted investors currently do not appear to be incorporating perceived synergies into their valuations, moving Vistra to an enterprise-value-to-EBITDA multiple of about 5.9x, compared to a 7.1x multiple on 2019 earnings embedded in its $27 share price target. That multiple is based on prior valuations of power generation companies dating back to 1993, along with recent corporate transactions via Riverstone Holdings LLC's acquisition of Talen Energy Corp. and ECP's buyout of Calpine Corp. at 6.8x and 7.5x multiples, respectively.
"While some could argue that a lower multiple is deserved during power market troughs, we would argue that cyclical stocks more typically trade at higher multiples during cyclical bottoms all else equal," Ford wrote, noting the 7.1x median sector multiples and lower premiums on private equity deals. "This comparison however, also points out that the Vistra/Dynegy merger is happening at 7.7x and makes synergies and execution on them an essential valuation driver of the transaction."
