Opinion on  Calpine Corp. (CPN)
Calpine Corp is a buy

NRG’s current market capitalization is about $10B and its proposal values CPN at approximately $11B.

NRG and CPN have roughly the same power generating capacity but CPN is superior to NRG in terms of its asset portfolio. The average age of CPN’s plants is under 10 years while NRG plants are over 35 years old. CPN uses clean NG and even cleaner geothermal for its power while NRG relies on a mix of sources including nearly 40% from coal. In the face of greater scrutiny in regards to emissions control, coal power generation could face costlier emission controls that NRG would have to allocate for. NRG's assets that utilize coal would decline in value while CPN's should rise. CPN is also entrenched in some of the best geographies in terms of power demand due to hotter summers relative to the rest of the country, as well as changes in regards to nodal pricing. CPN also has three new plants that will come online in the coming years that will boost its production capacity by roughly 10%.

Despite these differences, NRG believes CPN is worth just $1B or so more than its current valuation, implying the two are worth virtually the same even though CPN’s asset base is incredibly superior to NRG and in fact, all independent power producers (“IPPs”). Just a quick review of the asset differences should make investors and the Board question why NRG is offering such a low price.

The answer is tied to a few factors. The first is that CPN was restructured under Robert May’s leadership and May will not remain as permanent CEO. NRG is trying to seize on the lack of permanent leadership at CPN through this lowball offer. The second factor relates to NRG expecting investors and the Board to rely on the noisy historical financials that, even once scrubbed for one-time items and restructuring charges, belie where CPN's operating results can be in the coming years.

As previously discussed, the Company is poised to benefit from a variety of industry tailwinds and company-specific drivers. These factors, combined with a leaner company that is not burdened by poorly performing non-core assets, should result in CPN producing operating results that exceed its historical performance by a wide margin. In January 2008, CPN revealed that it expected to generate about $1.75B in adjusted EBITDA for 2008 which is a 25% increase over its 2007 adjusted EBITDA and probably did not account for the spike in gas prices that is currently being experienced.

IPPs with high debt loads such as DYN and MIR trade for 17-18x EV/EBITDA, which is where CPN currently stands based on its LTM adjusted EBITDA. However, CPN is poised to increase EBITDA by 25% if not more. Assuming shareholders hold out for the next 12 months, shares in CPN could be valued at $35 per share. Given the discrepancies in capital structures among IPPs, valuing CPN off EV/Revenues could provide a useful tool. Peers such as NRG, MIR, and DYN trade for 3-4x EV/LTM Revenues. Using CPN’s LTM revenues as of March 31, 2008, the Company would be valued between $30-$45 per share on a fully diluted basis (500MM shares) based on its peer's comparable range.