In the lucrative energy sector -- where prospectors have unearthed so many great finds -- at least one buried treasure remains.
( TGN), a
hidden jewel exposed by
last month, just keeps getting more valuable. The debt-free company, which already owns one of the most profitable merchant energy fleets in the country, is adding new power plants that can produce electricity without using expensive natural gas. Genco is in the process of increasing its stake in a highly efficient nuclear facility that, some experts believe, could increase the company's already surging profits by more than 10% next year.
Genco has essentially turned into a natural gas play, because it sells electricity that is produced by cheap fuels, such as coal and nuclear energy, but which is is priced according to the cost of natural gas. Therefore, it enjoys strong profit margins when other merchants -- relying on expensive gas-fired plants -- are suffering.
But Genco rarely brags. Indeed, the company quietly revealed its new expansion plans in a no-frills press release issued after most investors had already begun celebrating the long holiday weekend late Friday afternoon. Genco has in fact made a habit of keeping a low profile ahead of regulatory hearings that will soon decide the value of the company.
, is attempting to recover $4.4 billion for its "losing" investment in Genco before it sheds the energy generation company in order to comply with a 1999 Texas deregulation law. But CenterPoint critics are in the process of arguing that the big utility has deliberately suppressed the value of Genco's stock so that it can collect huge "true-up" payments for the generation assets and then go on to sell them, at a tidy profit, down the road.
CenterPoint, arguing that it is "simply following the law," refuses to back down.
"Those now opposing our collection of the true-up balance supported the law, which not only provided them billions of dollars in benefits, but also specified the way the true-up balance was to be calculated," said Floyd LeBlanc, vice president of corporate communications for CenterPoint. "Many of these parties have actually supported policies that made the final true-up balance larger."
At the heart of the controversy is Genco's true value. The company's stock rocketed 250% -- making it the 15th-best performer on the
New York Stock Exchange
-- during its first year of trading in 2003. And it has jumped more than 10% since it was officially valued for the regulatory proceedings just two months ago. But some experts believe that the stock, down 1.6% to $39.63 on Thursday, should and will trade even higher in the quarters to come.
Harry Chernoff, an analyst at Pathfinder Capital Advisors who owns stock in Genco himself, has long viewed the company as an attractive investment. But Chernoff is more convinced than ever after some recent developments. Right now, Genco expanding its valuable nuclear generation even as it is being labeled as seriously undervalued by its own critics.
Late Friday, Genco matched a $333 million offer -- and pushed another bidder out -- to increase its ownership in the South Texas Project (or STP) electric generating station that serves such growing cities as Austin, Houston and San Antonio. Genco is exercising its "right of first refusal" to purchase a minority interest in STP that is being sold by
American Electric Power
as part of AEP's own deregulation strategy.
After the transaction, Genco will emerge with a 44% stake in the nuclear facility and continued operational control over the project. Austin Energy, a city-owned utility, has decided to simply maintain its 16% interest in the venture because it is in the process of finishing a new gas-fired plant that will meet its future power requirements. But City Public Service of San Antonio, the third owner of STP, announced plans to expand its investment in the nuclear project even before Genco did -- leaving Genco eligible to buy only about half of the STP interest currently up for sale.
In a press release issued last week, the San Antonio utility said it had decided to increase its stake in STP -- deemed the lowest-cost power supplier in its territory -- after "three months of intense technical, economic and legal analysis by CPS's staff and independent consultants." The city made the decision even though it will require a rate increase and heighten its exposure to nuclear risks.
"How often does a municipal utility choose to increase its nuclear exposure?" marveled Chernoff. "The last time a municipal utility said it wanted more nuclear plants was back when everybody wanted more -- in the 1970s."
But Chernoff understands the city's interest. With natural gas prices high -- and no downturn in sight -- nuclear plants offer a far more affordable means of producing electricity. And the STP nuclear assets, Chernoff says, are especially efficient.
Even Genco, careful not to boast, called the cost of the nuclear assets "reasonable" when questioned by
this week. But the company stopped short of forecasting the acquisition's impact on earnings and stressed that the whole deal "will take a few months" to even close.
In the meantime, Chernoff has offered some calculations of his own. He says that Genco has sold only about two-thirds of its currently available baseload capacity for 2005. He speculates that AEP -- more focused on selling its STP stake than on the power it generates -- has sold even less of its STP electricity for next year. As a result, he believes, Genco should be well-positioned to capitalize on robust natural gas prices -- at even $1 less than current prices -- when it sells its new STP capacity. He uses conservative estimates, ranging from $5 to $5.25, to achieve his forecasts.
"If ... TGN could sell that capacity forward at anything resembling current
Texas electricity prices, this would be a phenomenal deal," he said. "The acquisition will be immediately, and materially, accretive."
All told, Chernoff expects STP power sales to boost the company's 2005 earnings per share and cash flow by 10% each, to more than $4.40 and $5.25, respectively. But he says the company itself has yet to issue -- let alone raise -- guidance for next year. And analysts don't cover the company at all.
Critics are currently using Genco's relative obscurity against it.
The company stands out as one of few multibillion-dollar corporations that has failed to attract analyst -- or even general investor -- interest. It went public as a "tracking" stock that is still mostly owned and controlled by its parent. It is very thinly traded, with just 60,000 shares changing hands on an average day, because of its small float. It has no debt, unlike the companies that typically attract investment bankers and equity analysts in the process. It pays out such a modest dividend, hoarding cash instead, that it never appears on the radar screens of income investors. And it has shown no signs, prior to the STP expansion, that it plans to be a growth company either.
Skeptics doubt that Genco wound up being an investment outcast by accident.
Expert witnesses, testifying on behalf of Texas utility customers, this week insisted that CenterPoint has taken numerous steps to hurt the value of Genco's stock so that it can seek an overly large refund for its investment in the company. One powerful group, the Texas Industrial Energy Consumers, believes that CenterPoint is entitled to only about $678 million -- or just 15% of the amount it is seeking -- to make up for its investment in generation assets they feel are significantly, and intentionally, undervalued.
But CenterPoint is fighting back.
"There are groups who argue that we should not recover our true-up balance," CenterPoint states on the company Web site. "However, that debate was decided in 1999 when the Texas Electric Choice Act was passed. All that is left is for the Public Utility Commission to determine that we followed the law, ran our business properly and added the numbers correctly."
Still, government officials have chimed in by asking for significant adjustments to CenterPoint's recovery as well. Scott Norwood, a witness for the City of Houston, said that recent asset sale prices -- even for STP -- show that Genco is worth far more that its current market value. He is, therefore, asking regulators to knock $1.6 billion from CenterPoint's refund.
Another expert, testifying for the state of Texas, believes that the corporate governance of Genco -- deemed "quite substantially below the industry average" by an independent firm -- should by itself lower CenterPoint's refund by up to $1 billion. Fully half of Genco's board members also serve as CenterPoint directors charged with maximizing the value of their own company.
"Clearly, Genco's governance issues had a severely depressive effect on its stock price," stated Bryan Johnson, an expert witness with 20 years of experience in the investment banking industry. "Had Genco been as well-governed as its peers, in light of its favorable underlying fundamentals -- positive sensitivity to rising natural gas prices in a
relatively high and rising price environment, in combination with moderate capital expenditures going forward -- its stock price would be substantially higher by the incorporation of a better governance assessment."
CenterPoint fiercely defends the company's governance, however. It insists that Genco has operated its power plants well and has rewarded stockholders with huge returns in the process.
But Johnson believes that Genco's governance may have actually reduced the company's stock value by more than half. He pointed to a number of board decisions that allegedly benefited CenterPoint at the expense of Genco.
For example, he said, CenterPoint decided to spin off 19% of Genco as a tracking stock, even though such distributions "are not generally employed for the purpose of maximizing stock value." Moreover, he said, Genco went public at an "extremely low" price even considering the distressed state of power companies at that time. Afterwards, he said, Genco failed to provide investors with a clear understanding of the company and, instead, disclosed "the minimum required for regulatory compliance." The company then lost big institutional investors, he said, and saw its stock price depressed as a result.
"There is a high degree of correlation between the level of participation by fiduciary institutional investors and higher stock prices," Johnson explained. But "participation in Genco by all types of institutional investors has been astonishingly low in comparison to its peer groups, whether on a capitalization or industry basis."
Johnson went on to cite Morningstar research that showed Genco turning up dead last -- by a large margin -- for institutional ownership among 210 companies in its size group.
is a strong indication that among the most sophisticated and resourceful class of investors ... there were, and continue to be, serious concerns about Genco's governance."
But Chernoff, for one, believes that new investors could eventually flood into the stock. He points out that CenterPoint has told the public -- including ratings agencies wary of the utility's heavy debt load -- that it will sell Genco in an effort to deleverage itself. He expects CenterPoint to shed the company, creating a far more liquid market for the stock, after the regulatory hearings end this summer. By then, he said, CenterPoint will finally have a clear incentive to maximize Genco's value -- and investors should take notice.
"If they have a secondary offering, retail investors will buy it," he predicted. "Institutions will cover it. And it will be treated just like any other stock. ... There are just not a lot of catalysts to get the stock price up right now."