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Could Dark Horse Unseat NRG's Bid for Calpine?

NRG Energy, which launched an $11 billion bid to take over Calpine Corp., could face some competition from unlikely sources, including possible back-door suitors Dynegy Corp. and Reliant Energy, energy analysts said.

Dynegy, much smaller today than when it made a daring and ultimately failed attempt to buy Enron Corp. as it neared bankruptcy in late 2001, was named as a possible competitor for NRG's buyout of Calpine. RBC Capital Markets energy analyst Lasa Johong said in a note to clients Thursday that it would be "feasible" for Dynegy to make an offer despite Dynegy's smaller size.

Based on stock prices Thursday, NRG's offer of 0.534 shares for every Calpine share would be about $1 below where Calpine's shares were trading. The market appears to believe that NRG will have to raise its offer or that another bidder could move in.

Since the news of the offer broke late Wednesday, Calpine's share price has risen in heavy trading. At close on Thursday Calpine was selling for $23/share with more than 20.8 million shares trading hands. The stock closed last Monday at $21.64; 2.1 million shares were traded that day. Friday afternoon the stock price hovered around $22.90 on volume of around 3.6 million.

According to Calpine, Princeton, NJ-based NRG made an offer to Calpine in a May 14 letter to Calpine's board. The offer was said to follow a meeting between NRG CEO David Crane and Calpine senior officials. Calling it a combination "the likes of which the industry has never seen," NRG said it expects to be able to do its other needed due diligence within a three-week period of its private offer, which Calpine decided to make public Wednesday.

A combination of the two power companies -- one centered in the East with a large portion of coal-fired and some nuclear generation, and the other with western and heavy natural gas and geothermal ties -- would result in an independent generator with 129 facilities, totaling nearly 48,000 MW. NRG currently has 47 plants totaling 23,951 MW, and Calpine has 82 plants totaling about 24,000 MW, according to their individual website summaries. Calpine emerged from Chapter 11 bankruptcy in late January, and NRG had done so more than four years earlier in December 2003.

NRG's Crane said the combination of the two would be "the culmination of what we in this industry have aspired to become." The proposal is "the right deal, at the right point in time, between the right partners."

The proposed combined company, said NRG, would be "archetypal for the U.S. wholesale power generation sector -- multi-regional, multi-fuel, across-the-merit-order and appropriately scaled. It creates four regional generation businesses, each consisting of at least 8 GW and puts the combined company in an ideal position to execute a "strategy based on intrinsic growth."

"Indeed, the strategic benefits are so numerous that we have attached our own short list of top 10 strategic benefits of the merger," Crane and Cosgrove said in their letter. The merger's benefits, they wrote are scale with purpose; merit order and fuel diversification; regional diversification; management; stock liquidity; tax optimization; general administrative savings by combining the two companies' substantial Houston-based operations; financial and credit enhancement; growth platform; and carbon and other policy advocacy.

"We have deep experience and a very strong record in the positive assimilation of other businesses (including their operating and management personnel) as demonstrated by our highly successful (on all levels) combination with Texas Genco in 2006," the NRG senior officials wrote.

Even though NRG will likely succeed in its Calpine bid, the combined NRG-Calpine would own about 40% of the power generation market in Texas, and the state's regulators could cause problems, said Johong. Regulatory issues then could lead other suitors stepping forward, and Johong said that despite their smaller size, Dynegy could be a possible bidder, and Johong said Reliant Energy is another. Both Dynegy and Reliant have market values of between $8 billion and $9 billion, the analyst noted.

Mirant Corp.'s name also was touted by some analysts Thursday. Mirant is about the same size as NRG and could offer a stock-for-stock deal to Calpine's shareholders. However, recent history appears to make a bid by Mirant less likely. Two years ago Mirant made an unsolicited bid for NRG that Mirant's shareholders did not like. It was only four months out of bankruptcy at the time, and now it could be wary of a bidding war with a former takeover target.

Some of the European power companies also could be interested. The Euro is strong compared with the U.S. dollar, and a bid by a European company could give it an edge against NRG. And Calpine's assets could be worth more to another bidder besides one like NRG, which has an extensive hedging program in place, Johong noted. NRG's hedging program would cap the value of Calpine's business, the analyst noted. Calpine emerged from bankruptcy more than $10 billion in debt, which gave it a debt-to-equity ratio of around 50%. When it entered bankruptcy in 2005 Calpine's ratio was around 95%.

In any case, Harbinger Capital Partners, which owns 24% of Calpine, is expected to be a major voice in any deal, said Johong. Harbinger already is urging Calpine to negotiate with NRG, Johong wrote.

In related news, Kenneth Derr, who chaired Calpine from November 2005 until January, resigned from Calpine's board late Thursday. Derr wants to "focus his time and energies on other business and personal matters," Calpine stated. With Derr's resignation, Calpine's board would have eight members. Derr had been a Calpine director since May 2001, and he was acting CEO before CEO Robert P. May was hired. Derr retired as chairman and CEO of Chevron Corp. in 1999.

Goldman Sachs & Co is serving as financial adviser to Calpine, and Skadden, Arps, Slate, Meagher & Flom LLP is legal counsel.

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