Exelon Could Grab NRG for a Song

Details are beginning to emerge of the possible combination of energy firms Exelon (EXC) and NRG Energy (NRG). Exelon is offering $6.2 billion in the all stock deal, which equates to an offer of $26.43 for each share of NRG. While the offer does represent a 37% premium over NRG’s Friday closing price, the stock has been absolutely crushed in the bear market—it was trading above $40 as recently as July. NRG is in need of capital which is very difficult to find in this environment.

Clearly Exelon is trying to beef up its nuclear capabilities—it is already an US industry leader—and some have speculated that under more normal economic circumstances NRG’s Texas nuclear plant would be worth more than Exelon has offered for the entire firm. EXC announced intentions to produce 24 additional nuclear reactors, but purchasing NRG’s nuclear power plants could be a much cheaper way to expand its reach in nuclear power into Texas. At present, Exelon generates power mostly for Illinois and Pennsylvania. Nuclear power is a cheap alternative to energy produced by natural gas and its “carbon footprint” is much smaller. According to the New York Times, earlier this year NRG was the first utility in over thirty years to approach the Nuclear Regulatory Commission about building two new nuclear plants. However, the credit crisis makes those projects extremely difficult to fund. Interesting how, after many years on the back burner, volatile crude oil prices and the quest for energy independence have brought interest in clean and safe nuclear power back to the forefront.

Exelon

The question now becomes, will the NRG board and shareholders accept the merger? We think that the pair would fit together nicely and Exelon should be pleased to get a strong company at such a discount to its price over the summer. Remember, famed value investor Warren Buffett thought the company had a lot of potential when he bought 3.24 million shares at around $40 each in June. Also, NRG could really use Exelon’s balance sheet in securing loans (improved credit rating) for the expansion of its nuclear operations. The combined company would be geographically diverse and would have a diverse set of energy sources (i.e. nuclear, natural gas, oil, coal, etc).

NRG Energy

At Ockham Research, we rated NRG as Greatly Undervalued as of Friday’s close. With the share price now approaching Exelon’s offer price, we are getting closer to a neutral or Fairly Valued rating. Based on what the market has historically been willing to pay for NRG for given revenue and cash earnings results, we think that—based on current fundamentals—NRG should trade in the range of $22 to $32. So, the offer price fits nicely in that range, but with the possible synergies of these two companies and the potential of the nuclear energy component, the deal seems like a good buy for Exelon.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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