TEXT-Fitch Places NRG's and GenOn's IDR on Watch Negative Following Merger Announcement
NEW YORK, July 23 (Fitch) Fitch Ratings has placed the Issuer Default Ratings (IDR) of NRG Energy, Inc. (NRG) and GenOn Energy Inc. (GenOn) on Rating Watch Negative following the announcement of a stock for stock merger agreement between them. Fitch has also placed the IDR of GenOn Americas Generation, LLC (GAG) and GenOn Mid-Atlantic, LLC's (GMA) on Rating Watch Negative. GAG and GMA are intermediate holding company subsidiaries of GEN. A complete list of rating actions follows at the end of this release.
The Rating Watch Negative for NRG reflects the uncertainty surrounding its capital structure and leverage due to the quantum of put that may be exercised by GenOn's senior unsecured lenders following change of control. GenOn had $690 million of amortizing term loan outstanding at the end of March 2012, which becomes mandatorily payable on the consummation of the transaction. In addition, the $2.5 billion of unsecured notes at GenOn have a put at 101% of par on change of control but it is uncertain how many note holders will exercise the put. As of March 31, 2012, the combined pro forma liquidity was $2.8 billion, which includes $1.9 billion of cash and cash equivalents and reflects $1 billion of projected debt pay down and elimination of $788 million credit facility at GenOn. NRG has also taken a $1.6 billion bridge loan to fund the put. A full exercise of the put exposes NRG to significantly higher parent leverage and material reduction in liquidity in addition to execution risk and transaction costs to replace the bridge loan.
In Fitch's view, NRG's post-merger consolidated credit profile through 2015 is moderately weaker than its standalone credit metrics. GenOn's financial profile weakens in 2015 with the loss of above market hedges and lower capacity payments and the projected $1 billion in debt reduction (excluding the put) and $300 million of forecasted synergies and interest cost savings for the combined entity provide only a partial offset. Fitch anticipates NRG's funds from operations (FFO)-to-debt to be in the 11%-13% range and Debt/adjusted EBITDA to be approximately 5.25x or higher by 2015, which remain shy of Fitch's guideline metrics of 15% FFO to debt and 5.0x Debt/adjusted EBITDA for a high-risk 'B+' rated issuer. These credit metrics do not include the three large solar projects that NRG is pursuing with a conditional loan guarantee from the Department of Energy (DOE), i.e. the Ivanpah, Agua Caliente, and California Valley Solar Ranch projects. Fitch has deconsolidated these projects in its rating analysis.
Fitch notes the restrictive payment basket under NRG's 2017 unsecured notes is significantly enhanced as the company issues equity to close the transaction. This will accord management tremendous flexibility to engage in greater shareholder actions beyond the levels it was permitted to in the past. Fitch believes the transaction does improve NRG's overall business risk profile as GenOn's generation portfolio lends geographic diversity, size and scale benefits to NRG's fleet. GenOn's northeast and western generation assets can provide physical backup to NRG's retail aspirations in these markets, thereby lowering costs to compete.
The Rating Watch Negative for GenOn primarily reflects the significant deterioration in GenOn's standalone credit metrics as a result of the sharp secular fall and anticipated tepid recovery in natural gas prices. A merger with a stronger rated entity, $690 million of assured debt reduction and part benefit of synergy and interest cost savings alone seem inadequate to fully arrest the downward rating pressure for the company. The extent of incremental leverage reduction via the exercise of the put will be a key determinant for Fitch to assess if GenOn's financial metrics have stabilized relative to Fitch's guideline metrics for a high risk 'B' issuer. GenOn's outstanding debt will not be guaranteed by NRG.
Fitch expects to resolve the Rating Watch for NRG and GenOn and its subsidiaries upon the consummation of the transaction. The key rating triggers are the extent to which the put is exercised by GenOn's unsecured debtholders, resulting leverage and available liquidity at each of the entities, and future capital allocation goals. In addition, Fitch will continue to monitor the commodity environment such as changes in natural gas prices and heat rates, which have a material bearing on the profitability and cash flows of the combined entity. Trends in environment regulation are also a key ratings driver given the still high coal exposure of the combined portfolio. Under the terms of the merger agreement, GenOn's shareholders will receive 0.1216 shares of NRG in exchange for each share of GenOn, which represents a 20.6% premium on Friday's closing price of $1.82 per share. The pro forma ownership of the combined entity will consist of 71% of NRG shareholders and 29% of GenOn's shareholders. The board of the combined company will consist of 12 directors from NRG and 4 from GenOn.
The transaction is subject to approvals from NRG and GenOn's shareholders as well as regulatory approvals from the Federal Energy Regulatory Commission, Department of Justice and Public Utility Commissions of New York and Texas. Assuming all necessary approvals are obtained in a timely manner, the transaction is expected to close in the first quarter of 2013. The combined company, which would operate under the NRG name, would increase in scale, with approximately 47,000 MWs of generating capacity, to become the largest owner of competitive generation. The combination would benefit from geographic diversity and a growing footprint serving retail load. Recovery Analysis: The individual security issue ratings at NRG, GenOn, GMA and GAG are notched above or below the IDR, as a result of the relative recovery prospects in a hypothetical default scenario. Fitch values the power generation assets that guarantee the entity level debt using a net present value analysis.
The generation asset net present values vary significantly based on future gas price assumptions and other variables, such as the discount rate and heat rate forecasts in ERCOT, Northeast, Southeast and California. For the net present valuation of generation assets used in Fitch's recovery valuation case, Fitch uses the plant valuation provided by its third-party power market consultant, Wood Mackenzie, as an input as well as Fitch's own gas price deck and other assumptions. Fitch calculates the value of NRG's retail business by applying a multiple to stress EBITDA expectations.
Fitch has placed the following ratings on Rating Watch Negative:
NRG Energy, Inc.
--IDR at 'B+';
--Senior secured term loan B at 'BB+/RR1';
--Senior secured revolving credit facility at 'BB+/RR1'; --Senior unsecured notes at 'BB/RR2';
--Convertible preferred stock at 'B-/RR6'. GenOn Energy Inc.
--IDR at 'B';
--Senior secured term loan at 'BB/RR1';
--Senior secured revolver at 'BB/RR1';
--Senior unsecured notes at 'BB-/RR2';
--Short-term IDR at 'B'. GenOn Americas Generation, LLC
--IDR at 'B+';
--Senior unsecured notes at 'BB/RR2'. GenOn Mid-Atlantic, LLC
--IDR at 'B+';
--Pass-through certificates at 'BB/RR2'.
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