Tuesday, December 9, 2008

EDF vs CEG/Mid American Valuation

This is a first step comparison between the EDF pro forma valuation in their proposal letter and the CEG fairness valuation.

There is a big difference.  $5 billion vs. $10 billion.  

I put them on a spreadsheet for your enjoyment.

This is the first time I have linked a blog to a spreadsheet.  I'm hoping to add some depth and give people a little more for their time.  

I am only going to comment on the single biggest difference.  The fairness calculation used a minus $2 billion or $10/share for the energy trading valuation.  

Here is what the proxy narrative says:
In an effort to estimate the potential value that the company’s equity holders might realize if the company were to file for bankruptcy, Messrs. Collins and Thayer, together with other members of Constellation Energy’s finance department, estimated the potential fair values of the company’s businesses, other than the global commodities business, at between $12.0 and $13.0 billion. The estimates of fair value of the company’s businesses that were used reflected management’s knowledge of the company’s businesses and of the potential range of market values for such businesses. Such values did not reflect any material discount for the potential negative effects of a bankruptcy filing. Management did not value the global commodities business because it believed that the value of such business was highly unpredictable and would be subject to the greatest degree of volatility and uncertainty in a bankruptcy, however, it did take into account the potential change in valuation resulting from fluctuating commodity prices and the cost of capital. Management believed that it was reasonably possible that the global commodities business could generate a net loss of more than $2.0 billion following a bankruptcy filing, and therefore management concluded that a loss of this magnitude was the most appropriate number to utilize in its estimate of the potential fair value of Constellation Energy. In light of these estimates, management observed that if the global commodities business, following a bankruptcy filing, generated a net loss (and thus had a negative value) of more than $2.0 billion, then after repayment of Constellation Energy’s then-outstanding indebtedness of approximately $6.0 billion, the aggregate equity value for holders of Constellation Energy common stock would likely be less than $26.50 per share or $4.8 billion in the aggregate. Management’s conclusions reflected the following, which did not include any reduction in values to reflect the substantial expenses of a bankruptcy process or the disruptive and damaging effects on business that management expected would result from a bankruptcy filing:

• Fair value of businesses other than global commodities                 $ 12.0-$13.0 billion
• Less repayment of outstanding indebtedness                                    $ (6.0 billion )
• Less net loss (negative value) of global commodities business       $ (2.0 billion )
• Net equity value (before costs and expenses)                                     $ 4.0-$ 5.0 billion  

• Net equity value per share (before costs and expenses)       $ 21.82-27.39

Management observed that it could not reasonably assess the magnitude of potential deterioration in the value of the company’s businesses as a result of a bankruptcy filing, particularly if the company had to make an immediate filing without having a substantial debtor-in-possession loan in place to provide needed liquidity, or the impact of disruption to the business and the substantial costs and expenses of a bankruptcy process. Management also observed that the impact of a bankruptcy filing and of significant liquidity constraints would likely be most severe on the global commodities business. In addition, Mr. Collins expressed his belief that Constellation Energy would have difficulty managing its global commodities business as a result of the likely loss of counterparties willing to transact business with Constellation Energy following the initiation of bankruptcy proceedings. Additionally, Constellation Energy’s ability to manage its competitive supply business also would likely be materially impaired, as customers likely would not be willing to enter into new contracts, and Constellation Energy might not be able to manage the supply requirements of its existing customers. Management concluded that, in light of this information, and taking into account the uncertainties and costs of the bankruptcy process and the significant potential for such process to negatively affect the company’s business, it was likely that the $26.50 per share price proposed by MidAmerican was more than the company’s existing shareholders would receive in the event of a bankruptcy filing. Management also observed that a bankruptcy filing brought with it the potential to damage recovery by the company’s creditors, whereas the transaction proposed by MidAmerican was likely to avoid such a result. Management reviewed its estimates with Morgan Stanley.

From my perspective -- these are the key points

1. The last comment about creditors -- all well and good, but if bankruptcy is off the table, then it is no longer relevant.

2. $26.50 is a good number compared to bankruptcy -- ok, but bankruptcy is again off the table.

3.  the -$2 billion valuation for Energy Trading was based on bankruptcy.

Once again:
Management believed that it was reasonably possible that the global commodities business could generate a net loss of more than $2.0 billion following a bankruptcy filing
Reasonably possible doesn't mean highly likely. It doesn't mean probable. And it didn't explain exactly how this reasonably POSSIBLE value would occur.  Frankly, BK is bad and a lot of bad things are reasonably possible.  Still, in the 3Q financials, there were no material trading losses.  Right now, I would say that the negative $2 billion needs to go to zero.

There needs to be a serious consideration regarding how energy trading would be supported to guarantee no collateral induced meltdown.  

That leaves us with a $3 billion gap.  Or I would say more like a $4 billion gap.  That is -- EDF has a big Buffett haircut in the post deal valuation.  Plus, CEG's fairness opinion doesn't include a big cash sale of 1/2 the nuclear assets.  I would put the net of those at about $1 billion.

So we need to figure out if the Fairness number more accurate then the EDF number and by how much.

A key number is the valuation of BG&E at $4 billion.  Reasonable or optimistic as hell?  I'll save that for another post.

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