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UBS believes FirstEnergy will offload generation business

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UBS believes FirstEnergy will offload generation business

FirstEnergyCorp. is likely to sell its generation business as the companylooks to improve its credit metrics following anticipated regulatory approvalof a distribution modernization rider, according to UBS Securities LLC.

"While the Street is focused in the near term onprospects to gain approval from the [Public Utilities Commission of Ohio] on adistribution modernization riderthat would bolster [FirstEnergy's] consolidated credit position by[approximately $200 million per year], we are increasingly looking beyond thislikely positive development in coming weeks towards tackling its remainingportfolio," UBS analyst Julien Dumoulin-Smith wrote in a Sept. 26 report.

FirstEnergy President and CEO Charles Jones Jr. said in Julythat the company will look at "allalternatives" for its competitive business, including the saleor deactivation of units, in response to challenging conditions in the market. Jonesalso said the company "[does] not intend to infuse additional equity intoour competitive business in order to supportcredit ratings."

"We believe the company will need to consider spinningoff, shutting or selling [FirstEnergySolutions Corp.] assets to improve credit metrics,"Dumoulin-Smith wrote. "While the bulk of the assets are saleable, we seethe thorniest issues around the nuclear plants in [Ohio and Pennsylvania]."

UBS estimates the value of FirstEnergy Solutions' core oil,coal and natural gas assets at $200/kw, or approximately $900 million, with thebulk of the value tied to the 545-MW West Lorain gas plant in Ohio. The brokerage, however,said it is excluding any value for more than 4,000 MW of capacity tied to theDavis-Besse,Perry andBeaver Valleynuclear assets given future uncertainty.

"We don't see the state as necessarily poised to moveto save or transfer the units to another party," Dumoulin-Smith wrote.

UBS said company affiliate likely hasthe "most valuable assets" in the competitive generation portfolio,with the fleet valued at approximately $1 billion. Allegheny Energy's 713-MWstake in the Bath Countypumped hydro facility in Virginia would likely yield the highest multiple, withthe more than 900 MW of natural gas capacity owned by Allegheny Energy inPennsylvania also providing decent valuations, Dumoulin-Smith wrote.

The analyst added that UBS views a full shut down ofFirstEnergy's competitive generation as "largely unpalatable" with asale the most likely option.

"The company has stated explicitly that it wants tobecome a fully regulated utility in the future," he wrote, noting recentmerchant deals indicate "large scale M&A is still in play."

FirstEnergy could also take part in 'sefforts to restructureOhio's regulatory market and provide income certainty for generation.FirstEnergy also could seek support in Pennsylvania for its Beaver Valleynuclear plant, but could be met with resistance, according to UBS.

The brokerage views a third, spin-off scenario of merchantgeneration as unlikely given the cash flow needs.

UBS added that it's unlikely that FirstEnergy will donothing with its competitive fleet given approximately $550 million in equitythat would be needed to maintain acceptable credit metrics.

Dumoulin-Smith said he expects FirstEnergy management toprovide further guidance around its regulated and competitive plans in Novemberat the Edison Electric Institute's 51st Financial Conference.

"We suspect investors have failed to appreciate theneed to divest the generation business in order to limit future equity needsand as such fail to appreciate the downside should [management] falter,"he wrote.