By Michael Kuser and Rich Heidorn Jr.

Vistra Energy will acquire Dynegy in a $1.7 billion all-stock deal that will create a power generation and retail giant owning 40 GW of capacity and serving nearly 3 million customers, mainly in ERCOT, PJM and ISO-NE, the companies announced Monday.

In a conference call, Vistra CEO Curt Morgan said the companies planned to close the deal by April 30, 2018, allowing six months for regulatory approvals from FERC, the New York Public Service Commission and the Public Utility Commission of Texas.

Dynegy’s combined cycle gas turbine fleet and geographically diverse portfolio were a big attraction for Vistra.

Morgan said the deal “should create a more stable earnings profile and offers some downside earnings protection, especially when combined with our retail operations.”

The CEO had previously indicated Vistra would consider a large-scale acquisition outside ERCOT “if it was all stock, there were substantial value levers, quality assets in PJM and ISO-NE, and also a large natural gas fleet to move us to a gassier portfolio and preserve balance sheet flexibility. In short, this deal does that.”

It will be structured as a tax-free reorganization and will not trigger change-in-control provisions in either entity’s credit or bond agreements. The combined company will have a market cap around $10 billion.

Vistra’s executive team, including Morgan, Chief Operating Officer Jim Burke and Chief Financial Officer Bill Holden, will lead the combined company, based at Vistra’s headquarters in Irving, Texas. Morgan said he will announce his full team within a few weeks.

The new board is expected to have 11 directors: the current eight members of the Vistra board and three members from Dynegy’s board. Dynegy CEO Bob Flexon will continue to serve until April 30, 2019, or the date the transaction closes, whichever comes first.

Flexon said the deal was “an incredibly compelling opportunity” for Dynegy and its shareholders.

The combined company projects streamlining to achieve approximately $350 million in annual savings before interest, taxes, depreciation and amortization (EBITDA) within a year. Morgan said it will maintain Vistra’s “balance sheet strength and discipline. … Vistra would not be entering into this transaction if that were not the case.”

De-Levering

Morgan said the deal provides Dynegy “instant de-levering.” The combined company will have a net debt-to-EBITDA ratio of about 3.2 by the end of 2018, which is projected to decline to 2.6 by the end of 2019 and 2.4 by the end of 2020. It will have $3.9 billion in liquidity as of April 2018.

“Three times gross debt-to-EBITDA is the right long-term leverage target in this industry given the high degree of commodity price exposure and the necessity to maintain dry powder on the balance sheet in order to be able to transact at opportunistic times in market cycles,” Holden said.

Analyst Neel Mitra of Tudor, Pickering, Holt & Co., said it is a good deal for both companies, saying the $350 million in synergies, tax savings and the addition of PJM assets benefit Vistra. “At the same time, Dynegy’s EBITDA contribution should trade at a higher multiple given that its over-leverage issue is corrected by Vistra’s pristine balance sheet,” he said by email.

ERCOT Market Power

Morgan said the company will need to shed about 900 MW in ERCOT to remain under the 20% market share limit. “We’ve got two paths that we can go down. We will be kicking off a divestiture process that we’ve already started and will be going out in the market,” Morgan said. “But there’s also another avenue that I won’t get into in too much detail here … where we wouldn’t have to do any divestiture at all. You guys will see that in the marketplace. We can execute that in the six-month period that we’re talking about getting [regulatory] approval. And we will have a mitigation plan in place when we file with the [Texas] PUC for approval.”

PJM Outlook

Morgan said the company was assuming no improvements to capacity or energy prices in PJM, but it also did not expect prices to fall further.

“It takes a substantial amount of net megawatts — meaning net between new additions and retirements — to actually move the capacity curve. It’s such a flat curve. It takes on a net basis about 6,000 MW of additional [capacity]. I don’t think 6,000 MW on a net basis is going to come into this market. That’s why we are looking at capacity being relatively flat.”

He said the projections do assume some new generation in the RTO “because for some reason people are still investing. But I think this last [capacity auction] clear put a chilling effect. … And also, capital going into PJM projects is beginning to dry up. I’ve heard that from a number of people. So, I think the market there is beginning to discipline itself.”

Morgan said the company will be “opportunistic” in seeking additional generation, predicting “there’s going to be just a ton of assets that come into the market.”

“But that’s not going to be a primary [focus]. … What we would like to do, we think we have this tremendous platform to grow our retail business.” The company will begin with 240,000 commercial and industrial customers and 2.7 million residential customers.

Generation Mix

Morgan said the move to a “gassier portfolio” would give the combined company the lowest-cost structure in the industry, with wholesale costs as low as $9/MWh and retail costs as low as $45 per residential customer equivalent.

The combined company will have more coal — 32% — than Vistra’s current 28% share. But the deal will boost its natural gas share to 61% from 54% while reducing nuclear from 17% to 6%. It will also provide more geographic diversification, reducing Dynegy’s PJM exposure (45%) to 29% in the new company. Of the combined company’s 40 GW of installed capacity, 84% is in Texas, PJM and New England.

Terms

Under the terms of the agreement, Dynegy shareholders will receive 0.652 shares of Vistra common stock for each share of Dynegy common stock they own, resulting in Vistra and Dynegy shareholders owning approximately 79% and 21%, respectively, of the combined company. Based on Vistra’s closing share price of $20.30 on Friday and the agreed exchange ratio, Dynegy shareholders would receive $13.24 per Dynegy share.

Price Formation

Morgan said he is hopeful that the Department of Energy’s Notice of Proposed Rulemaking will result in FERC actions boosting the company’s generation and noted that Vistra has introduced a price formation proposal in ERCOT as an alternative to the Calpine-NRG Energy whitepaper. (See ERCOT, Regulators Discuss Need for Pricing Rule Changes.)

“With the DOE action taken I do think there is some pressure for PJM and ISO-NE and others to come forward with something around price formation because that was very prominent in the DOE [proposal],” he said. “I don’t think DOE will get implemented, obviously, the way that it was put in.

“But more importantly I think that FERC will be inclined to act on whatever the ISOs bring forward. You hate to handicap things, but it sure seems like there’s a good chance — a better chance than not — that if there is something brought forward, which I expect there will be around price formation, that it will ultimately be approved by FERC.”

— Tom Kleckner contributed to this article