Berkshire Ruminations

Thursday, December 18, 2008

Doing the math on CEG (back of the envelope)

I post this not as any type of authority, but just to figure it out for myself. Can anyone explain better than I have here why CEG stock fell yesterday?

This past summer MidAmerican Energy agreed to acquire all outstanding shares of Constellation Energy Group (CEG) at a price of $26.50 per share in cash, or $4.7 billion.

EDF came along a few weeks ago and offered to pay $4.5 billion to acquire half of CEG’s nuclear division.

In 2007, the nuclear division generated about 60% of CEG’s revenue. So, effectively, EDF was offering to pay approximately as much for 30% of CEG as MidAmerican was offering to pay for the entire company. EDF emphasized that this offer priced CEG stock at a minimum 100% premium to its market price.

Before the EDF offer, CEG stock languished at around $23.50, about a $3 discount to the MidAmerican’s cash offer price of $26.50. Upon the offer, CEG stock shot up to around $28, clearly because EDF’s offer was so superior.

Yesterday, both companies confirmed that MidAmerican was terminating its agreement to acquire CEG. As part of this termination, CEG was to pay MidAmerican a breakup fee of (approximately) $500 million plus shares equaling 10% of CEG’s equity. Upon the announcement of the termination and subsequent details of the breakup, CEG fell 12%, to less than $24/share.

If EDF is offering to pay $4.5 billion for 30% of the company, then the company as a whole should be worth $15 billion minus the breakup costs, assuming of course EDF is not overpaying. With 178 million shares outstanding, this would be about $84/share minus breakup costs.

At its current price, CEG has a market cap of $4.3 billion. In other words, it is about to sell part of one of its units for more than you could buy the entire company for today. Were you to buy CEG today you would (theoretically speaking) get all your money back upon the consummation of the EDF deal, leaving you with half of the nuclear unit and all the rest of CEG as gravy, but also with the obligation to pay MidAmerican $500 million in cash (about $3/share) as well as shares equal to 10% dilution of the stock (if we assume intrinsic value before dilution is 84 – $3 = $81 then this would be $8.10/share).

So what do we have? CEG should be worth $84 – $11.10 = $72.90? Is this right?

I think it may be, but that doesn’t make it a buy. Not in this market anyway. I mean, the stock soars when the EDF deal was proposed, then tanks when the deal was confirmed. This is just nutty.

The logical explanation for CEG’s fall yesterday is that investors simply will not buy anything in this environment that does not have an identifiable and imminent catalyst. There is value all over the place right now, so CEG is not alone with its unfairly low valuation. Because of this, and because the market is so nutty anyway, investors just don’t want to put up with owning the stock now that they know they won’t be getting their $26.50 cash payout.

These are amazing times. Ben Graham is smiling from the heavens I am sure.

3 Comments:

  • Haven't checked the numbers but, if CEG has significant debts/liabilities, then selling assets is not the same as selling equity. You'd need to net off the proportionate share of debt attributable to those nuclear plants sold.

    By Blogger Jeremy, at 18 December, 2008 14:25  

  • I am working on a post about the failed acquisition on my site buylikebuffett.com. I think that the stock fell for a number of reasons. CEG has to pay over 1 billion to Buffett for breaking the deal and repay the 1 billion dollars that he gave CEG. Constellation Energy may still face liquidity issues despite the capital infusion from EDF. CEG will spend the next few years trying to reduce debt while facing reduced earnings power. CEG just sold off over one half of its valuable nuclear energy business. CEG is also slashing its dividend by 55%. CEG is a utility company and a dividend is one of the most attractive features of a utility company.

    Mark

    By Blogger thelex2007, at 18 December, 2008 16:56  

  • CEG crashed because most of the shareholders as of last week were people playing the buyout (like me) I bought at 22 with Buffet's cash on the line at 26.50 for over a 20% gain.

    there was another offer on the table at that point, so there was a slim probability that shares would go for more.

    so from my perspective I had a 90% chance of getting a 20% return, probably more, and a ten percent or less chance of getting a little more.

    SO, when the other offer came through, and I had a chance to cash out for a 25% gain at 28 dollars or so, I was out of there.

    thus, I didn't want shares in a utility company formally having financing issues with a bunch of fresh french cash that was worth somewhere between 28 and 64 dollars, I was in it for the cash, and Buffett's cash is worth more than most people's at this point.

    CEG is certainly worth more than today's price to Buffett, but is it worth more with the management currently in charge?

    I'm glad I got my 28 dollars and change and got out of there.

    A small victory in a year of losses.

    I imagine there were a lot of other people like me.

    I hope that helps.

    By Blogger Ellis Clarkson, at 18 December, 2008 21:30  

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