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One of the key assumptions in the investment thesis is that the merger with MidAmerican does not fall through.

What the write-up fails to mention is that the Merger Agreement (on EDGAR http://www.sec.gov/Archives/edgar/data/1004440/0001193125081...) has in Sections 8.2(k)/9.1(h) the provision that up until 2 days prior to Closing Date that if if the MidAmerican determines (in its sole discretion) that, since June 30, 2008 to the date which MidAmerican elects to terminate this Agreement pursuant to this Section, either the retail and/or wholesale businesses or assets of the Company, its Subsidiaries and the Company Joint Ventures taken as a whole have materially deteriorated. The parties hereby agree that, solely for the purposes of this Section, an adverse change in the net economic value of such businesses or assets in excess of $400 million from June 30, 2008 shall be deemed material.

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.

Comments?
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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.

Best,

Jim
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