| | | Neutral (US$22.00 price target) | | UBS Research THESIS MAP | a guide to our thinking and what's where in this report | | | Q: What do we think of the Engie deal update? We see the deal as a reflection of improving capital market conditions for both debt and equity. When originally constructed Dynegy was trading below $10/sh and was trying to avoid a public equity issuance and the debt capital markets were equally challenging for commodity-exposed firms. We see a... more→ Q: How will the PJM Capacity Auction impact Dynegy's cash flows? Dynegy is one of the most sensitive companies to PJM with nearly half of its pro-forma capacity in the region. The company has taken efforts to diversify its portfolio but the PJM capacity auction remains a key datapoint. "Commodity Rally Priced-In: Downgrade to Neutral" 6/9/2016→ Q: How well positioned is Dynegy to benefit from improving natural gas prices? At $20/sh further upside for Dynegy is dependent on a commodity recovery compared with earlier in 2016 when we viewed the stock as a value play. We believe Dynegy still has leverage to the upside thesis but as we have seen YTD in 2016 PJM, rallying natural gas prices do not necessarily translate into power prices "Commodity Rally Priced-In: Downgrade to Neutral" 6/9/2016→ | | Dynegy shares will continue to be driven by natural gas views with further appreciation in commodities representing upside to shares; however, we view the risk/reward as more balanced versus sub-$10. | | We expect Dynegy’s capacity revenues to decline $173Mn in 2019/2020 versus the prior planning year representing a ~13% decline in 2018E EBITDA. This could be among the most significant declines out of the impacted companies and is second only to Talen. | | Based upon conversations with investors most are making some form of an adjustment for the negative drag from IPH as it is a non-recourse subsidiary of DYN. We think the recent volatility in in shares could be due to both fluctuations in commodity price expectations and credit markets. | | 
Value drivers | IPH Drag (Add-Back) | EV / EBITDA | PJM ATC Power vs Mkt. | | | $34 upside | ~$0.00/sh | 7.5x | +$5/MWh | | | $22 base | ~$0.50/sh | 6.5x | +$0/MWh | | | $13 downside | ~$2.00/sh | 5.3x | -$5/MWh | | | Source: UBS | | | | | |
more→ | | Dynegy, Inc. (DYN) provides wholesale power, capacity, and ancillary services to utilities, cooperatives, municipalities, and other energy companies in key unregulated US power... more → |
| | | PIVOTAL QUESTIONS | return ↑ | Q: What do we think of the Engie deal update? UBS VIEW We see the deal as a reflection of improving capital market conditions for both debt and equity. When originally constructed Dynegy was trading below $10/sh and was trying to avoid a public equity issuance and the debt capital markets were equally challenging for commodity-exposed firms. We see a positive read through to peers given the confidence reflected in potential to tap high yield markets at reasonable returns. EVIDENCE One of our concerns of the original Engie joint venture from Dynegy’s perspective was the limited free cash flow (FCF) profile of the vehicle due to the significant financing costs (7.6% excluding the revolver) and FCF sweeps – Dynegy addressed this. Yesterday’s update includes ~$40 Mn in improved FCF plus increased ability to distribute cash back to Dynegy Inc. by elimination of the cash flow sweep by shifting the debt financing to Dynegy rather than at the joint venture. The net distributable cash flows from Engie increases to $1,040Mn from $468Mn again due largely to the elimination of the 50% cash flow sweep. WHAT'S PRICED IN? Investors view the Engie transaction and revised capital structure as a positive for shares but sentiment on Dynegy and the broader IPP space has changed significantly in the past week with investors increasingly cautious on commodity prospects. We're surprised by the negative reaction yesterday, given both the confidence in selling its West and New York assets as well as improved availability to tap cash flows. |
| Figure 1: Comparing Commodities and Equities | | Figure 2: TETCO M3 vs PJM ATC 2018 | 
| | 
| Source: FactSet and Platts | | Source: Platts |
What's Changed?Figure 3: Revised Financing Mix – 6/15/16(%) | | Figure 4: Original Financing Mix – 2/25/16 (%) | 
| | 
| Source: Company Filings and UBS Estimates * Treating revolver as debt | | Source: Company Filings and UBS Estimates * Treating revolver as debt |
• The ‘mandatory converts’: Dynegy will issue $400Mn of tangible equity units which will effectively replace the ECP equity financing in the deal. The offering is targeting a 20% premium to shares for conversion and will convert in three-years (July 1, 2019) with 15% debt treatment from the credit rating agencies. Improving Overall FCF Quality • Reducing financing cost considerably: Dynegy now plans to issue $2.0Bn of corporate debt rather than $1.85Bn of secured debt at the joint venture level. Many existing Dynegy creditors had been concerned the deal would impede credit quality to existing creditors; as such the deal addresses a key concern for many investing in Dynegy credit of late. Expectations are for L+350-375. This is vs. prior expectations of LIBOR + 525bp (which also had flex risk flexed of incremental 275bp). Management guided to $40Mn of interest savings compared with the original financing mix which is based on the elimination of the bridge loan ($44Mn) and a net lower rate on the other borrowings even including the cost of the tangible equity units at 5.4% (dividend rate on preferred stock issued for the prior Duke Energy/Energy Capital Partners transaction). Dynegy specifically mentioned asset sales as a potential avenue to assist in financing the transaction. • Might be able to avoid the revolver borrowing: The updated guidance indicates $450M of revolver capacity being utilized and we expect that management will look to finance this component of the transaction on a more permanent basis utilizing a mix of organic cash flows and the proceeds from ‘non-core’ asset sales. Dynegy management has discussed in the past potentially divesting its Independence plant in New York (the only asset owned in NYISO) as well as its California portfolio (8% of pro-forma capacity). The ECP transaction is expected to close by October 1st with the payment to ECP fixed at $375Mn if made on or before January 1st, 2017, indicating time for any transaction to be completed.
Gas Asset SalesDynegy is seeking to exit its sub-scale markets in New York and California We emphasize the latest update reiterates management's confidence in its own ability to close on pending asset sales for both its Western portfolio (see table below) as well as the Independence CCGT. We emphasize this plant continues to benefit from selling into the higher priced upstate NYISO market, relative to sourcing cheaper gas at a modest premium (~$0.30/MMBtu) to Dominion-South gas hub in the Marcellus producing region. We expect the 1.04GW asset to fetch at least $400/kW+, with potential proceeds equal to ~$400 Mn or more. We believe there could be latitude between these two asset sales to paydown the $450Mn in contemplated revolver borrowings, with a potential sale announced prior to even needing to employ the revolver. We emphasize payments to ECP are due only by year end (after the Engie deal is due to close), likely to reflect the timeline for asset sales. We note progress on the pending GT&S case for PG&E (following a recent Proposed Decision before the CPUC) may bolster confidence on the ability to transact this asset (albeit the meaningful rate increase could well temper our sales price expectations articulated below). As a reminder, management has discussed exiting both markets as part of a wider effort to refocus its efforts on greater scale and more competitive underlying frameworks. We view the recent approval of an eventual 50% RPS in New York may have reaffirmed management's decision to exit the NYISO market, in which it presently has only one asset remaining. Figure 5: Potential Sale Value for West | 
| Source: Company reports and UBS estimates |
Figure 6: Engie/Atlas Transaction Revised and Original Capital Structure | 
| Source: Company Filings and UBS Estimates |
Joint Venture EstimatesDynegy expects ~$10/kW of initial synergies vs ~$12/kW on recent transactions. An update is expected after the transaction closes. Our latest estimates of adjusted EBITDA and free cash flow continue to be at the high-end of 2017 and 2018 respective guidance ranges. While our adjusted EBITDA estimates are unchanged, we now see stronger FCF accruing to Dynegy between the buy-out of ECP’s 35% stake and the decision to finance the deal at the Dynegy Inc. level, thereby avoiding the cash sweeps. Our full Dynegy estimates are available on Page 9 which continue to exclude Engie ahead of the transaction closing but the portfolio’s uplift is included in our valuation on Page 10. • Collectively management expects $90Mn of net synergies with $80Mn at the joint venture level, primarily removing $60Mn from the Engie corporate G&A. The balance appears to be largely procurement savings. Dynegy continues to expect a positive revision had previously suggested it could increase synergies above its initial guidance as it has done previously with other deals citing success with IPH and Duke/ECP, the latest update states it intends to raise the initial synergy figure beyond this level with close. Figure 7: Dynegy Engie Portfolio Analysis | 
| Source: Company Filings, Platts, SNL Energy, and UBS Estimates |
Comparing Old and NewThe majority of the improvement in the Engie portfolio’s valuation today vs February is related to commodity movements rather than the renegotiation of the structure. Below we compare the estimated accretion from the original transaction vs the revised transaction prior to dilution on the balance of Dynegy’s assets. We see the deal terms as attractive, given the potential upside to our EBITDA forecast below from increased synergies. We note that the majority of the increase in the higher accretion since February is due to an improvement in ERCOT pricing and New England Expectations which more than offset PJM weakness. We emphasize that relative to our latest published Engie valuation from our report last week there is minimal accretion in our view from an EV / EBITDA approach. Figure 8: DYN/ECP Engie Portfolio (New = Top; Old = Bottom) | June 16th, 2016 Analysis 
February 26, 2016 Analysis 
| Source: Company Filings, Platts, SNL, and UBS Estimates |
Further update takeaways:• Coal out in the cold: After the deal Dynegy estimates that ~90% of its cash flows will come from its gas assets despite gas capacity representing ‘only’ 63% of the pro-forma entity. Given Dynegy's substantial exposure to New England – and hence winter price power and gas economics – the shift towards Texas is welcome and helps diversify back towards 3Q summer oriented capacity. • Market power concerns: Market power considerations will likely be limited and management confirmed this much on Wednesday’s call. Perhaps there will be an issue in Connecticut with ECP's 'Wheelabrator' assets (biomass). • CP Compliance: 3 of 4 CTs in PJM have dual-fuel and two of the units have access to cheap natural gas. Looking more broadly at PJM and ISO-NE, some of the natural gas units are 20+ years old such as Milford (1993), Bellingham (1991), Sayerville (1991), and Hopewell (1990). While we are not overly concerned by this, on the margin this does increase the risk profile. The larger issue is the higher average heat rates for these plants (~8,100 range) vs even 2000-vintage units (~7,400 range). • Turbine Details: Among further nuances to the portfolio is a slightly older vintage of units, many of which are Alstom. We look for discussion on long-term service agreement (LTSA) to feature prominently in future discussions of deal synergies. • Other potential asset uprates? Uprates remain a key piece to future prospects from the portfolio – 28 MWs are initially contemplated, with 100-150MWs possible. We note that the capacity disclosed with the transaction yesterday of 9,058MW is 357MW higher than the original 8,731MW disclosed in February.
| | | UPSIDE / DOWNSIDE SPECTRUM | return ↑ | 
Value drivers | IPH Drag (Add-Back) | EV / EBITDA | PJM ATC Power vs Mkt. | | | $34 upside | ~$0.00/sh | 7.5x | +$5/MWh | | | $22 base | ~$0.50/sh | 6.5x | +$0/MWh | | | $13 downside | ~$2.00/sh | 5.3x | -$5/MWh | | | Source: UBS | | | | | |
| DYN is trading
at US$16.31 as of June 15th. |
Updated Adjusted EBITDA EstimatesOur estimates are unchanged from our report last week except for the announcement last week that Dynegy will bid 260MW of its Hennepin plant into PJM rather than MISO. Figure 9: Updated Dynegy EBITDA Estimates – Engie Presented Separately | 
| Source: Company Filings, ThomsonReuters, and UBS Estimates |
Valuation: Maintaining $22 Price TargetOur valuation remains based on 2018 sum-of-the-parts analysis with an unchanged price target. For additional background on how we approach IPP valuations please refer to our recent sector note ‘Flaring Some Gas in PJM’. Figure 10: Updated Dynegy Valuation – Keeping our $22 Price Target | 
| Source: Company Filings, Platts, SNL, and UBS Estimates |
Upside (US$34): Our upside case assumes that power prices reverse their intermediate-term trend of declining and DYN is able to capture stronger gross margins from its merchant power plants. Base (US$22): Our valuation is based on a sum-of-the-parts analysis using an unchanged ~7x average EV / EBITDA multiple on the merchant generation segments plus the ownership value from its pending Engie joint venture. Downside (US$12): Our downside case assumes that power prices continue their recent intermediate-term trend of declining and that merchant economics deteriorate.
| | | COMPANY DESCRIPTION | return ↑ | Market Cap | US$1.9bn | Shares Outstanding | 117m (COM) | Industry | Utilities, Unregulated | Region | Americas | Website | www.dynegy.com |
Dynegy, Inc. (DYN) provides wholesale power, capacity, and ancillary services to utilities, cooperatives, municipalities, and other energy companies in key unregulated US power markets. The company's power generation portfolio consists of approximately 26,000MW (excluding the Engie joint venture) consisting of base-load, intermediate, and peaking power plants fueled primarily by a mix of coal (37%) and natural gas (63%). Assets are concentrated in PJM (43%), MISO (18%), ISO-NE (15%), ERCOT (13%), CAISO (8%), and NYISO (3%). Industry outlook The electric utility industry is projected to experience weak or negative electric demand growth in coming years as a tepid economy and energy efficiency dampen demand. In the unregulated merchant power space, we see limited potential for a meaningful recovery from currently low power prices due to limited projected demand growth, growth of subsidized renewables, and potential for only modest further retirements. At regulated utilities, we believe rising interest rates and robust valuations are a challenge to the sector, particularly as earnings growth stalls once EPA-mandated growth capex slow mid-decade. We expect cost- cutting and strategic planning to be a key theme, with M&A at modest (at best) premiums designed to extract cost synergies. We believe utilities with high parent leverage will disproportionately suffer, as they are unable to recoup from rising interest rates. | Capacity by Region (Feb 2016) 
Source: Company reports, UBS Capacity by Asset Type (Feb 2016) D  Source: Company reports, UBS
|
| | | | | | | | | | | Forecast returns | Forecast price appreciation+36.4% | Forecast dividend yield0.0% | Forecast stock return+36.4% | Market return assumption5.7% | Forecast excess return+30.7% |
| Valuation Method and Risk Statement Risks for Dynegy Inc (DYN) include but are not limited to: (1) potential increases in environmental capital expenditures; (2) unfavorable commodity movements [natural gas, power, etc.]; (3) adverse political/legal/regulatory actions; (4) unfavorable weather; (5) operational and construction risk; (6) inability to access the capital markets on attractive terms; (7) declines in customer demand and population; (8) failure to close pending or prospective M&A transactions; (9) natural disasters; (10) losses at the retail marketing segment; (11) change in macroeconomics; (12) operational challenges; (13) inability to achieve synergy and other financial metrics; and (14) inability to meet debt obligations as due; and (15) other unforeseen changes.
Valuation is based on a sum-of-the-parts analysis. Required Disclosures This report has been prepared by UBS Securities LLC, an affiliate of UBS AG. UBS AG, its subsidiaries, branches and affiliates are referred to herein as UBS. For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request. UBS Securities Co. Limited is licensed to conduct securities investment consultancy businesses by the China Securities Regulatory Commission. UBS acts or may act as principal in the debt securities (or in related derivatives) that may be the subject of this report. Analyst Certification: Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner, including with respect to UBS, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report. UBS Investment Research: Global Equity Rating Definitions 12-Month Rating | Definition | Coverage | IB Services | Buy | FSR is > 6% above the MRA. | 49% | 32% | Neutral | FSR is between -6% and 6% of the MRA. | 38% | 26% | Sell | FSR is > 6% below the MRA. | 14% | 19% | Short-Term Rating | Definition | Coverage | IB Services | Buy | Stock price expected to rise within three months from the time the rating was assigned because of a specific catalyst or event. | <1% | <1% | Sell | Stock price expected to fall within three months from the time the rating was assigned because of a specific catalyst or event. | <1% | <1% |
Source: UBS. Rating allocations are as of 31 March 2016.
1:Percentage of companies under coverage globally within the 12-month rating category.
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4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months. KEY DEFINITIONS: Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months. EXCEPTIONS AND SPECIAL CASES: UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece. Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are not registered/qualified as research analysts with FINRA. Such analysts may not be associated persons of UBS Securities LLC and therefore are not subject to the FINRA restrictions on communications with a subject company, public appearances, and trading securities held by a research analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any, follows. UBS Securities LLC: Julien Dumoulin-Smith; Paul Zimbardo; Jerimiah Booream. Company Disclosures Company Name | Reuters | 12-month rating | Short-term rating | Price | Price date | Dynegy, Inc. | DYN.N | Neutral | N/A | US$16.13 | 15 Jun 2016 |
Source: UBS. All prices as of local market close.
Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date 16.UBS Securities LLC makes a market in the securities and/or ADRs of this company. Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report. For a complete set of disclosure statements associated with the companies discussed in this report, including information on valuation and risk, please contact UBS Securities LLC, 1285 Avenue of Americas, New York, NY 10019, USA, Attention: Investment Research. Dynegy, Inc. (US$) 
Source: UBS; as of 15 Jun 2016 |
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