How can I break it to the investor? I’m sorry but Dynegy (NYSE:DYN) is terminal. After losing almost 90% of its value, Dynegy’s common stock has entered its final stage of loss.
Carl Icahn, Seneca, and others think Dynegy can be resuscitated. A basic analysis of its cash flow says otherwise. The unsecured Dynegy bonds, which trade at significant discounts, seem to agree that it is terminal.
The best way to assess Dynegy is by keeping it very simple. Let’s review the situation:
- EBITDA. 2010 EBITDA ended up at $539MM. 2011 EBITDA was last estimated at $405MM and 2012 EBITDA was pegged at $348MM (or, 35% lower than last year).
- Interest Expense. 2010 interest expense was $358MM. It is unlikely that interest expense will be much lower in 2011 based on the company’s statement in the 2010 10K about insufficient cash (and cash flow) to fund the 2011 capital expenditure program and debt service requirements. Further, it will likely rise as it takes on more debt at higher rates.
- Maint. Capex. Based on actual costs and expectations, it appears that Dynegy spends an average of $120MM/year maintaining its power plants.
- The DNE Lease* Cash Drain. Dynegy includes $50MM for its DNE lease expense in its EBITDA. However, Dynegy is now entering a 5-year period where it will have to make cash lease payments of almost $144MM/year (on average) which increases the core CASH operating expense by an additional claim of $94MM/year.
So, what should be perfectly clear from the summary above is that DYN has "fixed" cash operating costs of over $620MM/year for the next five years (see items 2, 3, & 4). These are the core costs that are required to be covered to just keep operating it business. With a projected EBITDA of ~$400MM or less, Dynegy’s core operations will be losing cash at a rate of over $200MM per year. This unsustainable operating environment prompted Dynegy’s auditor to include the rare "going concern" language in its 2010 annual report.
Before moving on, it is critically important to highlight the burden of the DNE Lease*. If the lease payments are not made, it could trigger a termination payment of $816MM (as of 12/31/10) according to the 2010 annual report. Further, Dynegy would also be subject to a make whole premium of $109MM for the underlying pass-through trust certificates. If terminated, the total cost of this lease could run as high as $925MM. This is significantly higher than the current reported obligation of $590MM and would have a materially negative impact on the value of Dynegy’s common stock. Unfortunately, this lease is a real burden on cash flow but, it could get much worse for the Dynegy shareholder if a default were to occur.
So, how much cash will they need?
Dynegy had $397MM at 12/31/10 and it will likely have to cover a cash outflow of almost $495MM which consists of (i) a cash operating loss of ~$200MM (as noted above) (ii) environmental capex of $145MM and (iii) debt service requirements of $148MM. These numbers match up with presentations and the annual report. The cash outflow will likely reach the $500MM range again in 2012 with lower environmental capex offsetting lower projected EBITDA.
Consequently, there will likely be a cash outflow of up to $1B in just the next two years. Of this amount, $500MM will come from operating cash losses and environmental capex costs while the other $500MM will be for reductions in debt and lease obligations. This means "net debt" (i.e. total debt less cash) will increase $500MM (or >$4/sh.) over this period of time. Unfortunately, there is nothing on the horizon that suggests these projected operating results would change in any material way or that the cash outflow slows down in 2013 and beyond. The additional debt will "crowd-out" any remaining value in the common stock.
So, as the net debt increases from over $4.1B to over $4.6B by 12/31/12, future EBITDA will have to cover "fixed" cash operating costs that increase from the current $620MM/yr to something closer to $700MM/yr by 2013 due to the higher interest expense that is likely to come with higher debt balances and more expensive credit facilities.
Finally, to those who think a recovery in natural gas and power prices will save Dynegy, please look at page 13 of the "Dynegy Investor Presentation" dated 10/19/10 (located on their website). They use a forward natural gas curve that starts at $5.88 in 2012 (vs. ~$4.72 today) and gradually rises to $6.43 by 2015. The EBITDA tied to those prices reaches no more than $557MM in 2015 and will likely be significantly less considering the current pricing of the forward natural gas curve. With "fixed" operating costs increasing from $620MM to upwards of $700MM by 2013 as more debt is added to the balance sheet, it seems clear that any future recovery in natural gas and power prices will do little in helping EBITDA cover the ever-increasing financing costs of operating their business.
So, in the end, current shareholders should prepare for this final stage of their Dynegy ride (or sell).
*The DNE Lease is an off-balance sheet, asset-backed, sale-leaseback transaction related to certain generation plants located in New York that is guaranteed by Dynegy.
Disclosure: I am short DYN.