Dynegy last week said it will pick up a bundle of Midwestgeneration assets to accelerate its energy convergence strategywhen it acquires Decatur, IL-based Illinova Corp. The combinedcompany will be called Dynegy and will own/control more than 15,000MW of gross domestic generating capacity, average more than 9 Bcf/dof gas sales, and serve more than 950,000 retail customers.

Significantly, Illinova has filed with the Illinois CommerceCommission to transfer its fossil-fuel generating assets to aseparate, unregulated subsidiary.

“While our combined company will be larger in scale, the primarybenefit of this merger results from the scope and skills we willhave to effectively compete in the national energy marketplace,”said Dynegy Chairman and CEO Chuck Watson, who will hold the sametitle at the new company.

Ed Tirello, an analyst with Deutsche Banc Alex. Brown, said helikes the deal. Although Illinova doesn’t have much in the way ofgrowth opportunities, it is a stable utility. Dynegy, which has amuch higher growth rate of 20% to 25%, gets a “nice” retail base inthe middle of the country and a good transmission grid in return,he noted.

Charles Bayless, chairman, president and CEO of Illinova, willbe a non-executive director of the new company. “Since forming ourholding company in 1994, we have worked to develop national andinternational capabilities in the unregulated energy industrythrough Illinova Generating and Illinova Energy Partners.”

Both companies are independent power developers and producers.The combined company’s generation portfolio will be among thenation’s most geographically diverse. Illinova’s gas and electricutility subsidiary serves 650,000 customers, and Dynegy is thelargest marketer of gas liquids in the United States.

“This merger advances our strategic plan through the addition ofstrategically located generation assets, which will enable Dynegyto enhance its position as one of the nation’s leading energymerchants,” Watson said. “The combined company will have controlover the assets needed to compete across nearly the entire energyvalue chain – from generation, to delivery, to wholesale and retailmarketing and trading.”

Carol Freedenthal, a principal with Jofree Corp. in Houston,said the deal is interesting as it has a non-regulated companybuying a regulated one. “On the surface, at least to my knowledge,it does a lot of good for Dynegy. It puts them in an area wherethey can generate the electricity they might need in some of theirmarketing.” The deal also gives Nova Chemicals and BG Plc. – whohave elected to take cash rather than stock – an out from theirDynegy investments, something the companies have wanted.

Dynegy is buying Illinova for two reasons, according toPaineWebber’s Barry Abramson. “One reason is to get the stabilityof earnings from the regulated [transmission and distribution]business, and the other is to get those power plants that theyhave, which fit very well with Dynegy’s portfolio. If you look atDynegy’s portfolio, there seems to be a big hole in the middle ofthe country.”

The new company is expected to generate about 70% of itsearnings and cash flow from non-regulated activities, based onestimated results for 2000. The contribution from non-regulatedactivities is expected to grow as the new company invests in newgeneration assets as part of a capital expenditure program of about$1 billion per year over the next five years.

The companies intend to use Dynegy’s marketing, trading and riskmanagement capabilities to integrate Illinova’s physical generationassets in the Midwest with a multi-regional supply perspective.Earnings from the regulated transmission and distribution businessare expected to provide a stable platform from which to pursuestrategic growth opportunities.

The companies anticipate the elimination of about 5% of thecombined 6,500-person work force over time and will seek tominimize work-force effects of the merger through reduced hiring,attrition, voluntary separation programs and other measures.

The new company will adopt an initial annual dividend of 60cents/share. Illinova shareholders who stick around will see theirdividend cut by more than 50% as the deal with Dynegy transformstheir company from an income to a growth investment.

Annual pre-tax revenue enhancements and cost savings between$125 million and $165 million are expected. About two-thirds ofsynergies are attributable to revenue enhancement related toIllinova’s generation assets, and one-third is attributable to costsavings related to staff cuts and elimination of duplicatecorporate programs. The merger is expected to be accretive to theearnings of both shareholder groups in the first year.

The boards of each company approved the deal, which is supportedby Dynegy’s industrial shareholders, who hold 76% of theoutstanding stock. The merger would create a parent company toacquire all Dynegy and Illinova shares for a combination of stockand cash. About 60% of the consideration received by Dynegy’sshareholders will be stock. Dynegy shareholders may elect toexchange each Dynegy share for 0.69 share of the new company, basedon a fixed exchange ratio, or elect to receive $16.50 per share incash consideration, subject to proration. In aggregate, the cashportion of the consideration will be about $1.06 billion. Illinovashareholders will exchange their shares on a share-for-share basis.Following the transaction, Dynegy’s shareholders will own slightlymore than 50% of the new company. The combination will be accountedfor as a purchase of Illinova by Dynegy.

Chevron USA, which owns a 29% interest in Dynegy, voted in favorof the merger and has elected to take all stock. Chevron also willinvest $200 million of new equity capital in the combined companyand up to an additional $40 million, subject to terms andconditions. “We are pleased to be taking another major step forwardin our strategic relationship with Dynegy,” said Peter Robertson, aChevron vice president and member of the Dynegy board of directors.”This additional move into the energy convergence businessrepresents an exciting earnings growth opportunity for Chevron.”

NOVA Chemicals and BG, which each currently own about 24% ofDynegy, agreed to vote in favor of the merger and have elected toreceive all cash in the transaction, subject to proration based onthe cash election of Dynegy’s public shareholders. BG and NOVAChemicals have also agreed to hold their remaining ownershipinterest in the combined company in the form of new convertiblepreferred stock, which is expected to represent no more than about25% of their current holdings.

The merger, expected to close by the end of the first quarter2000, is conditioned on the completion of the pending sale ofIllinova’s Clinton Power Station and federal, state and stockholderapprovals. Joe Fisher, Houston

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