Frank Napolitano joined Credit Suisse in June as global head of power and utilities. He leads a team that has seen a wave of departures as it moves into an era of deals that are being dominated by a host of new players. Napolitano called Managing Editor Holly Fletcher from the road to talk about why corporate M&A will drive asset-based M&A.
Napolitano: Sure, again, that’s a good one and something our clients are asking about. The gas from Marcellus/Utica into the Southeast is a longer-term macro fundamental play that speaks to the eventual retirement of coal-fired plants, and possibly even nuclear plants, in some of those markets. Load growth in the southeast market, particularly around the edges, probably can’t get met solely by renewables, which really haven’t penetrated that market. So true baseload and mid-merit power will be required. The fuel of choice on the margin looks to be gas, which I think is correct. The gas supply can be available to that region and simply the question becomes how do you get it to the market of power gen consumption? Pipes are required. We have seen several public announcements of folks looking to build pipes to that market to effectively de-bottleneck that gas and create customers for that gas. The risk is that too many pipes get built and that depresses the basis or not enough pipes get built and that creates an arbitrage. We will see what the capital markets will permit in terms of how many parallel projects will ultimately come to fruition. But it does look to be a very sensible move on behalf of infrastructure owners who are either long bias in the Marcellus gas story and/or short supply in the Southeast consumption story.
PFR: In terms of the structured finance realm. We haven’t really touched on that—there are a lot of gas-fired projects out there in the queue but there’s also a good amount of solar and wind. How do you see the balance and what are you looking for?
Napolitano: Clearly the commercial banks and the term lending community are excited about the continued contracted profile of the renewable assets that come to market, be it wind and solar, or the occasional contracted gas-fired project. The funded term loan market is going to do very well by those assets.
The size of some deals speaks to the need for additional structures. Whether it’s the large genco acquisitions like we’ve recently seen Dynegy be involved in or it’s the LNG liquefaction facilities that we’ve seen a number of parties be involved in, these are going to cross multiple financing markets. They will cross the commercial bank market, potentially the high yield bond market, they will cross the investment grade bond market, the term loan B market. Just to give you a size of the deals and the different points of their gestation, the credit quality clearly gets better the further they get toward operation and they transition their capital structures from non-investment grade to investment grade over that time. Everyone is sort of getting involved. The assets are great because they are contracted.
On the merchant plant story, clearly there has been a B loan market to date. If at some point those interim hedges that folks have entered into can be replaced with longer-term hedges or PPAs with entities that are more highly rated or closer to the end-use portion of the spectrum, then that may enable those plants to get refinanced in the commercial bank or private placement market.
I see a continuum of financings from the stage of construction to the stage of several years of operations, migrating with the quality of the revenue picture that supports each of these assets over time. As a result bankers, whether they’re commercial bankers, investment bankers or project finance bankers are all together working the space on a very frequent basis.
We’ve got everything going on in our space right now, which makes it a busy time.
Just to digress on M&A for a bit. Do you mind?
PFR: Please, be my guest. I like M&A.
Napolitano: Clearly around the asset players, those who might use structured financing and project financing, etc., to buy or build thermal generation or renewable generation, there’s clearly a number of different ways that these assets can ultimately find places with public companies. Whether it’s the growing set of IPPs or the growing set of yieldcos, the market has been supportive of both strategies and that has created a good buy-sell dynamic on existing assets and the funding of new assets.
On the corporate side, on the more regulated utility side, clearly we are in a wave of consolidation that is being driven by many reasons, which the markets are supporting all those reasons with a thesis that size and scale and economies of scale absolutely matter for long-run winners and that is creating its own set of activity that can create follow-on, ancillary activity due to market power considerations.
A good example can be the track record of PPL which has grown from an Allentown, Pa., utility to one that transacted with E.ON to acquire the Kentucky properties then transacted with E.ON to acquire the U.K. properties and is now seeking to transact with Riverstone to create a new genco that would be a listed company. In the formation of that genco, due to market power considerations a number of thermal assets will need to be sold. The cause and effect of corporate M&A and follow-on activity of asset M&A with the financing is creating a wave of activity. It’s just another example of why there seems to be a wide range of activity by different kinds of players in the space today.
PFR: A few years ago M&A was really driven by the private equity life cycle as there were several funds coming to an end. That seems to be less of a driver today and how is private equity involved in the asset level M&A?
Napolitano: The larger portfolios are likely to be the result of a corporate M&A cause-and-effect. The smaller portfolios or the single asset deals are likely to be due to fund cycling because of tenor limitations. In that case, it gives the buyers a choice, if one had a medium-sized or large portfolio, the ability to tuck in a strategic asset here or there could make you a premium priced buyer because you have synergies here or there. It could be a good time to sell or as a buyer, a good time to buy.
For the smaller assets, there are plenty of private equity funds that continue to look to build portfolios of assets, either in a piecemeal or wholesale fashion. We have not seen an issue with being able to bring an asset to market—it’s got to be of a certain size in order to attract market attention—and to not find a buyer or a set of buyers to suit all needs.
For a discussion of new entrants in the M&A space and the emergence bilateral deals, please see the first installment of this Q&A at www.powerfinancerisk.com.
