Dynegy Deal a Dead Man Walking — A Preliminary Postmortem

It appears Blackstone will not succeed in its buyout attempt of Dynegy, the Houston energy company specializing in power plant operations.

In reference to a meeting discussing the proposed takeover, The Journal writes:

"The meeting was recessed a week ago to give shareholders time to consider a revised offer Blackstone made. Facing intense opposition from Carl Icahn and hedge-fund operator Seneca Capital, Blackstone raised its bid to $5.00, a 50-cent increase over the August merger agreement, in an attempt to sweeten shareholder sentiment. "

But to no avail.

And the opposition of Icahn, as well as Seneca Capital, was indeed the rub.

According to Bloomberg:

"Icahn, Dynegy’s largest shareholder, opposed the Blackstone offer because he said it undervalues the company. He has offered the company a $2 billion line of credit and said on Nov. 16 he may be willing to bid for it."

Furthermore, Dynegy will continue to seek other suitors:

"'We will immediately engage interested parties, including Seneca Capital and Icahn Associates, who may have an interest in making an offer to acquire Dynegy,' Bruce A. Williamson, chief executive officer of Dynegy, said in the statement."

Let's not forget the reason Dynegy's board of directors has been shopping the company in the first place.

In a letter to shareholders, dated October 19, 2010, Dynegy put forth the case for why it believed selling the company to Blackstone was necessary. Among the reasons:

• Dynegy’s $1.1 billion in negative projected cash flows would be increased by an asset sale by $365 million, resulting in a total negative cash flow of $1.5 billion over the next five years;
  
• Proceeds of an asset sale would need to replace Dynegy’s existing collateral needs and help fund the $1.5 billion of projected negative cash flows on Dynegy’s remaining assets over the next five years;
  
• Dynegy’s leverage and overall financial risk would increase, limiting its future access to the capital markets; and
  
• Dependence on the Midwest coal market would increase, exacerbating Dynegy’s risks associated with regulatory and environmental uncertainties and sensitivity to delivered coal costs."

That doesn't exactly paint a pretty picture for Dynegy.

Of course, Dynegy directors weren't the only ones to recognize the obvious risks of a total negative cash flow of $1.5 billion over a five years time horizon. This, from a Moody's research report dated October 1, cited in the same letter to shareholders:

"DHI's speculative liquidity rating remains unchanged at SGL-4 reflecting our concern about DHI's internal liquidity sources over the next four quarters given the amount of negative free cash flow expected to be generated by the company, and the expected increased reliance by the company on cash on hand or borrowings under its secured revolving credit facility to fund negative free cash."

Moody's supplements its traditional letter ratings with an additional 'speculative grade' distinction. Here is Moody's own description of the SGL-4 rating: "Issuers rated SGL-4 possess weak liquidity. They rely on external sources of financing and the availability of that financing is in Moody's opinion highly uncertain."

And that description of Moody's SGL-4 rating sounds precisely like the problem with Dynegy, according to Dynegy's board of directors.

On November 12th, Reuters reported Icahn and Seneca's opposition to Blackstone initial bid of $4.50 per share. (This was before Blackstone had raised their offer an additional 50 cents per share, to their "Best and Final Offer" of $5.00 per share.)

"Icahn and hedge fund Seneca Capital, Dynegy's two largest shareholders, believe the private equity firm's $543-million bid for the company is too low, threatening the deal. Seneca has argued that the company would have more value on its own, but Dynegy has said it could face dire financial problems."

And the next two grafs in the Reuters article—even then—seemed to be speculating about Icahn's intentions:

"The Icahn companies, which have billions of dollars of liquidity, will today contact management to make available a $2 billion line of credit if Dynegy management cannot obtain other financing," Icahn said in a regulatory filing.

"Icahn also said he had acquired call options that would enable him to raise his stake in Dynegy to 12.9%. In October, he held nearly 10%."

While it may not have been terribly difficult to read between the lines, the Bloomberg article states that Icahn didn't formally announce his willingness to bid for the company until November 16th—but the writing was clearly already on the wall when Reuters reported on the story on the 12th.

And finally, to round out the picture, we learn this from today's New York Times DealBook:

"Dynegy also said that it had instituted a shareholder rights plan, a move meant to cap the stakes of its two biggest holders, Seneca Capital and the billionaire investor Carl C. Icahn. Together, the two hold a roughly 22 percent stake in the company."

Indeed.

Post Script: Don't weep for Blackstone's deal team just yet.

Bloomberg reports: "Blackstone, the world’s largest private-equity firm, will be eligible to receive a $16.3 million merger termination fee if Dynegy is sold for more than $4.50 a share within 18 months, said David Byford, a spokesman for the power producer."

While it is not exactly a windfall by private equity standards, $16.3 million is not a bad fee for enduring a 'termination' and just walking away.

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