Friday, December 5, 2008

Mainstream Press / Analysts Don't Get It

Per the Wall Street Journal, the EDFI deal presents a number of hurdles.  Let's look at at some of the assertions.

First, Andy Baker:
Constellation shareholders are scheduled to vote Dec. 23 on whether or not to approve MidAmerican's offer. That meeting could become critical to EDF's proposal, said Andy Baker, special situations trading strategist for Jefferies & Co.

Constellation Energy said Wednesday its board would review the offer "as soon as practicable." The company also said it hasn't withdrawn, modified or qualified its recommendation for its shareholders to vote in favor of the deal with MidAmerican.

Baker said a vote against the buyout would show support for EDF's proposal
However, if you read the prospectus, you will notice that EDFI had agreed last summer to vote its shares with the board. The 9.5% EDFI ownership plus shares controlled by the board would amount to about 20% of the shares.

Anyone that would have voted yes to the proposal would have been well advised to sell this week at $28/share. Why vote for a proposal that is LOWER then the current share price?

The prospectus describes the mechanism which would result in the board NOT recommending the Mid American Proposal. In summary, if the board is presented with a "Superior Offer" and it has a duty to shareholders to recommend that proposal, the change in the board's recommendation triggers MidAmerican's termination compensation.

At that point, MidAmerican has the right to submit a counter proposal within five days, or walk with its generous compensation of a breakup fee, 10% of the stock, about 1/2 billion cash, plus conversion of the 8% preferred to a 14% senior note due Dec 31, 2009.

Realistically, the vote doesn't particularly matter. The key is the recommendation of the board. Which should include input from the larger stock holders and institutions.

Then,  Les Levy weighs in with the insight:
But shareholders could see the continuation of Constellation, even with EDF's infusion of capital, as a more risky proposition than $26.50 a share cash offer, said Les Levy, a merger and arbitrage analyst for ICAP Corporates.
I'm wondering why Les didn't consider the wisdom of anyone preferring a certain $26.50 buyout to simply sell for $28 or higher. Maybe ICAP's arbs would rather wait 9 months for $26.50 (plus a buck and a half dividend), deal with uncertainty, instead of simply selling for $28 (plus) over the last two days. 

Then the Journal finds a skeptical analyst:
Also, questions remain about the value EDF puts on the deal. Deutsche Bank analyst John Kiani maintained a $30-a-share price target for Constellation in a note to clients Wednesday, writing he isn't convinced the implied price of $52 a share EDF claims is correct.
If the offer is between $26.50 and an implied valuation of $52 -- I would expect something more then "not convinced."  EDFI didn't just create the $52 out of thin air.  They go through a reasonably straight forward valuation that seems both solid and in some respects conservative.   The details of the valuation are available in an attachment to the offer letter[see annex a].  I would like to know which assumptions that John finds unconvincing and his alternative analysis that would lower the valuation to the extent that $26.50 seems superior.

Moody's weighs in its own questions in another short Journal piece:
Additional clarity is needed on EDF's offer to assess its impact on Constellation's credit rating, but initial information on the company's liquidity may result in an investment grade rating, Moody's said.
I can understand Moody's being cautious given the severe criticism it has received following its massive failure to anticipate the risk in billions of CDO's containing sub prime mortgages. However, it is hard to see how a few billion dollars in increased liquidity would be grounds for DOWNGRADING CEG.  It's comforting to know that billions of dollars of added liquidity might prevent a downgrade.

Given the reputation of Mr. Buffett, I am sure that his ownership of 20% of Moody's has no impact on their rating decisions.  However, this is a situation where Moody's might consider the appearance of objectivity by exhibiting extreme caution regarding their comments on competing proposals involving Mr. Buffett.

In addition, one of the reasons that CEG was forced to take Buffett's tough offer was the extreme time constraints that CEG was dealing with.  Moody's was inadvertently a contributor to some of the problems.  
In an attempt to satisfy the conditions of EDFI’s proposed equity investment, Messrs. Collins and Thayer contacted S&P and UBS Finance, each of which provided EDFI with the requested assurances. However, when Messrs. Collins and Thayer contacted Moody’s, they learned that Moody’s had already completed its credit review and was prepared to announce a two-notch ratings decrease to Baa3 (one notch above sub-investment grade), with a negative outlook. Constellation Energy urged reconsideration of the pending ratings downgrade and discussed with Moody’s the possible EDFI and MidAmerican investment proposals. Messrs. Shattuck, Collins and Thayer then made a subsequent call to Moody’s seeking to persuade it to change its view. On a subsequent call, Moody’s indicated that its rating committee had convened and was unable to resolve the company’s rating that evening and would take the EDFI proposal back to its committee again on the morning of September 19. However, Moody’s stated that it would not comment on whether a transaction with EDFI would alter its decision to lower Constellation Energy’s credit rating.
CGE was desperately trying to raise capital, and got cooperation from S&P. However, Moody's had already made a determination to downgrade two notches, was unable to discuss it's decision until the next morning, and refused to comment on the impact of CGE's obtaining an additional $500 million in capital in any event. I suppose that Moody's was under a great deal of pressure, but their inflexibility compared to S&P, delayed a potentially critical injection of $500 million in capital.

Moody's had essentially signed a death warrant on CEG, and was unable and unwilling to discuss remedies that could have allowed the company to maintain its independence. As the 3Q financial statements of CEG showed no significant trading losses, the entire issue was driven by a rating change triggering collateral calls. Moody's had gone from selling what amounted to indulgences on CDO deals to a guillotine happy Committee of Public Safety.

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