As capital markets dry up and the go-go merchant power plant operator-developers attempt to tighten their balance sheets, opportunity knocks for a small handful of large energy concerns to expand their asset base of merchant electric generating plants at below-value purchase prices, according to one Wall Street utility analyst who is bullish on the big, established energy companies.

Firms like AES Corp. that were viewed as the model for merchant generators a year ago are suddenly saddled with “bad projects,” liquidity strains and a nosedive in their stock prices, said Andre Meade, the U.S. utility analyst for Commerzbank Securities, which in February reiterated its “hold” rating on AES following the company’s announcement that it was pursuing new strategies to address recent poor financial performance. AES is basically cutting debt, cutting projects and reorganizing into four new segments headed by four separate new COOs.

“With asset prices below new-entry costs, it is a buyers’ market, and the potential to add value by selectively buying assets over the next 12 to 18 months is pretty high,” Meade said.

While not seeing any sort of substantial “rebound” in gas prices this year, Meade sees no quick turnaround for similar companies currently trying to revise their strategies and finances. There is “a lot of sorting out of assets” in the revision of debt that needs to take place.

“I think the Dukes of the world” (Duke, TXU, Dominion Resources and FPL Corp. among them) are the ones that may be buying more assets from firms like AES,” Meade said. “The smaller companies don’t have the balance sheets to do the acquisitions and they are rapidly cutting back on capital expenditures trying to maintain credit ratings. So the really well-positioned companies are the ones with a balance sheet and a track record of mergers and acquisitions that investors are comfortable with, and Duke is clearly one of them. You might also see TXU, Dominion and FPL, all of which are rumored to be interested in buying assets, too.” He said these companies all have “strong or improving” balance sheets.

While noting that he thinks it will “take time” for AES to “turn itself around,” Meade said its unfavorable projects reside in Latin America and other international markets, but also in various parts of the U.S. where markets have been most fully deregulated. It is in these more competitive environments that he thinks AES has encountered most of its problems, so therefore, that is where the company probably will be selling some assets.

There are other companies, such as San Jose, CA-based Calpine Corp. working through some of the same problems, but for different reasons. Meade calls AES “an acquisition machine,” while Calpine specializes in developing greenfield projects and operating them. AES acquires different types of power plants all around the world, and Calpine develops only natural gas-fired plants, mostly in the U.S.

The parallels are that they are both “highly leveraged and somewhat over-extended, and they either bought or built a lot of assets when prices were high and the fundamentals looked good, so they are now having a hard time withstanding a downturn,” said Meade, noting they are still trying to do different things, but are both worrisome for investors for different reasons.

“AES has a business strategy and organizational structure that is not appropriate for fully deregulated markets in my view,” Meade said.”So they have a hard time competing with the Duke Energys of the world, although they have nevertheless entered a lot of those markets lately.

“I think a lot of AES’s organizational structure worked better when the firm was small. They had a very informal culture and approval process for new projects. Essentially, junior level field employees were encouraged to come up with new power plant proposals and arrange project financing for them. If they did succeed in getting project financing, the odds were the projects went forward whether or not they were formerly approved or disapproved by senior management.

“Now it seems pretty clear, that obtaining project financing does not ensure that a project makes sense or that the amount you pay or the value is a good price. So they are saddled with a number of projects that are not working out, and they are having a hard time cutting costs out of business, integrating assets and basically justifying the purchase prices with earnings. This has led to a collapse of the share price and a strain in their liquidity.

“They are reacting by saying let’s sell assets in fully deregulated markets where we have a hard time competing and use the money to lower debt. At the same time, hopefully you will see less new projects and more emphasis on making the projects they do have, work. They have to revisit their project approval processes.”

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