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13 Steps to Investing Foolishly / PDS: Const. Trd. Debt


Subject:  Re: Possibility of Merger Termination Date:  12/2/2008  4:39 PM
Author:  TMFCanuck Number:  8 of 14

Hi Nick,

As of June 30, 2008, Common Shareholders' Equity was $6.5 Bn which is what I assume they mean by "net economic value". $400 MM is 6% of $6.5 Bn.

Given the Closing Date is likely 9 months away, this seems like a big risk.

Sorry this has been so long in responding.

I'd not confuse shareholders' equity with economic value. For one thing, CEG might have $6.5B of equity....but MidAmerican is buying then for $4.7B - so out of the gate you have a fairly large disparity. Shareholders' equity is an accounting convention. Economic value is (presumably) the value of all future cash flows discounted at an appropriate rate. A lot of CEG's business is very annuity-like - power generation at regulated rates, gas distribution in what are 'monopoly' pipes. That's going to have a pretty stable value.

Could the merger fall apart? Sure - that's arguably why the debt has traded at a discount to par since the MidAmerican merger announcement. But it's important to note that - if MidAmerican does walk away, the $1 billion in preferred securities they injected to shore up CEG is probably toast, as is the subsequent $350MM liquidity injection - so the cost to them is potentially far above that $400MM economic value change.

And I think that's the probable hurdle rate - if MidAmerican believes that the value of the assets has deteriorated below where they'd get lose not only that $400MM of economic value, plus take a BIG haircut on those preferreds, then it makes sense to walk. However, failing that, I think this thing closes as scheduled.


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