NRG Energy is back, in style. The same company that filed for chapter 11 bankruptcy protection in 2003 recently acquired Texas Genco for $8.7 billion. NRG's priorities today differ greatly from those of three years ago, however. Gone are the days of fighting for additional notches in the megawatt belt, regardless of cost to the company. NRG has learned that economic profit should be the focus, and not the "bragawatts".

In a Project Finance interview in 2002, NRG's previous CFO said the company's priority was to be 'in the top three of any country's generating market'. Now that goal has changed, and NRG has a new outlook and approach to financing its ventures. "Random assets around the world, or even around the country do nothing for us now" says NRG's CFO Robert Flexon "our mantra is to build on the regions we have. We want to be in the competitive power market with a portfolio rather than a series of one-offs".

NRG's previous approach, chasing megawatts and growth, was a large part of the cause of its descent into bankruptcy three years ago. In 2001 NRG was one of the world's leading independent power producers (IPPs). The company held a capacity of 28.927GW and was a key player in the power sector, ahead of Edison and PG&E's NEG. By August 2002, Fitch had cut NRG's debt below investment grade and one US commentator predicted that NRG was the 'next overnight bankruptcy waiting to happen'. The predicted bankruptcy filing took place in May 2003. But NRG emerged from chapter 11 by December 2003, only seven months later.

NRG emerged as an entity independent from its former parent Xcel Energy, with $510 million in corporate debt and $4.4 billion in project debt. On exiting it issued 100 million shares of common stock in the new company, and finalised $1.2 billion of secured financing. 2004 was spent aggressively hiring and reorganising the entire corporate organization, which accounts for the relatively new staff (90% have been at NRG for less than two years). Two years on, NRG now has completed its acquisition of Texas Genco – agreement was reached in the third quarter of 2005 and finalised on 2 February this year, four months later.

Morgan Stanley and Citigroup were lead arrangers in the $9.8 billion debt and equity financing. The final purchase price comprised $4.4 billion in cash, $2.7 billion in assumed Texas Genco debt and 35.4 million shares of NRG common stock. Texas Genco's previous owner was CenterPoint Energy, which sold it in 2004 to a consortium of Blackstone, Hellman and Friedman, KKR and Texas Pacific for $2.8 billion. The private equity owners were initially looking at an initial public offering for the asset before NRG made its approach. NRG chose its arrangers from the small pool of banks that were not part of the IPO preparations.

Cathy Cunningham talks to NRG's Flexon about the walk back from the brink, and its new asset approach.

Project Finance: Seven months is a very quick recovery time from bankruptcy...
Flexon: One of the advantages of going into bankruptcy was being able to quickly get out of bankruptcy. This showed how quickly NRG could recover, as opposed to Mirant, whose bankruptcy lasted 2 years. Calpine is now in the midst of bankruptcy and the expectation is that it could last several years. Our aim was to get out as quickly as possible with a restructured balance sheet, to move forward quickly and get first mover's advantage.

The first year out of bankruptcy was characterised as 'back to basics'. We needed to create the basic profits that every company has, which are forgotten in bankruptcy. In bankruptcy you're running after cash. When you come out of it you have to start thinking about financial planning, recreating hedging operations and long-term objectives about what you want the company to be. In spring 2004 we decided 'let's run the company now with a future' and by fall 2004 our focus was re-staffing company headquarters, developing corporate profits that had been lost in the bankruptcy period and re-establishing linkage with the plants.

PF: Have your perceptions changed since the bankruptcy proceedings? What has it taught you?
RF: The one thing that David [Crane, NRG's CEO] and I stand shoulder to shoulder on is that we now manage the company through the balance sheet. Pre-bankruptcy our mantra was 'let's grow, let's acquire, let's expand the number of megawatts we have'. To say that you want to grow is one thing. To say that you want to grow profitably is a very different thing. For any investment decision we make, whether it's Genco, or West Coast Power or reinvestment in a project, we now look at economic profits and keeping the balance sheet in order. Not whether revenue or gross margin is going up. Before, our structure was simply geared towards adding megawatts.

You have to be prepared for a downturn. Whether gas is running up and you have to pull cash collateral, or prices are coming down and your cash flows from your own hedge portfolio are a lot lower; you have to have a balance sheet which can absorb these swings. Keeping a balance sheet in line is very different to growing recklessly, which is what IPPs have done before.

PF: How do you feel your relationship with investors is these days?
RF: The philosophy that we've told the investment community from the start is 'we're not going to horde cash on the balance sheet'. When we came out of bankruptcy, in 2004 we had a very successful year, generated a lot of cash, sold a lot of existing assets to eliminate about $1.5 billion debt off the balance sheet, and the cash balances were building up. But we decided, we're not going to horde the cash, we're going to return it to our stakeholders. Then if we need money because we have a great project we're going to come back to them.

By the end of 2004 we had bought back 13 million shares from Matlin Patterson, our largest shareholder at the time, and reduced debt at the same time. In 2005 we bought back six million shares in the open market and at the same time we bought back debt. We've tried to establish a relationship where we'll keep the capital structure balanced but at the same time we're going to keep it balanced to what we need and return it to the share-holders. That means making sure we don't become too levered on the debt side.

PF: Did the Texas Genco deal help the relationship?
RF: Going through the Texas Genco acquisition established a rapport with Wall Street again. They know the way we operate: we're going to borrow the big funds, we're going to keep the debt at the right level, and on the equity side when we have opportunities to do return on capital, we'll do it. I think that's built up a lot of good will over the past two years. When we did our first buy-back we could have priced it more aggressively than we did. We made a conscious decision to leave a little on the table for those who came in and bought the preferred security, to let them know we're looking to establish a relationship.

In the Texas Genco deal we also could have been more aggressive in the pricing but we wanted to balance getting the right pricing for the company with making sure the investors got a fair deal. The fundamental thing was to establish a rapport with Wall Street, where there is capital flow in both directions. If we need it, we'll ask for it, if we don't they'll get it back.

PF: Speaking of pricing, this was a major transaction. Why do you believe you arrived at the best valuation for Texas Genco? The previous owners paid $2.8 billion as opposed to your $8.7 billion.
RF: Things have changed since Texas Genco last changed hands. One major change has been that the gas price environment has dramatically changed. Natural gas has become more volatile. The Texas market is highly correlated to natural gas prices and we're buying coal and nuclear plants, which affected the valuation. Subsequent to the sponsors originally buying TGN they exercised first refusal to increase ownership on the nuclear assets and got them at a very good price. Finally, the sponsors did a great job of getting in there and restructuring the company, eliminating $130 million out of costs.

PF: Who were you competing against?
RF: We don't know who we were competing against on price, but we fundamentally believe we were competing against Texas Genco's IPO. In marketing the IPO, the best we could see in terms of feedback is that the IPO is priced on near-term earnings. The earnings for Texas Genco, particularly in 2007, are hedged out at a much lower level than the current market value in terms of natural gas and power prices. It kept the prices down plus the sponsors could only reduce their holdings by about 20% and keep 80% in stock so it would be a gradual sale for them of the company over time. What we could offer was the inverse of that. They could monetize 80% of their position, and have 20% of the combined company. This is why they saw the same value as we saw, and why they were willing to take 35 million of our shares.

PF: What was NRG's initial thoughts on undertaking an acquisition of this size? Was there a feeling of apprehension?
RF: We're always looking at different opportunities. We're always aware of others' performance in the sector and considering whether we want to be involved with them. A lot of the time it doesn't make sense to collaborate with company X because it would mean a lowering of our company credit profile, and we're stronger as a company alone. Texas Genco was unique. When we looked at the two companies we saw we're actually going to be stronger from doing the combination. That showed in the market when Moody's upgraded our rating. Standard and Poor's kept us the same. But in the worst case we were neutral in S&P's eyes, but in both Moody's and Fitch's we were stronger companies.

We looked at the balance sheet, the cash-flows, the valuations and we felt that our stock would trade up. The day we announced it, we went back to see how our stock traded. It's an amazing day when 85 million shares outstanding and 13 or 14 million shares trade that day. Plus our stock prices went up from 42 to 49. When you have a transaction like that, banks all want to be your best friend.

A number of bankers emailed us saying that they had never seen the scenario before where you announce an acquisition one day and your stock trades up 15%, simply because of it. We viewed that as an overwhelming endorsement that Wall Street was seeing what we were seeing. From a company perspective we'll always be wary about acquisitions as the buyer usually loses, the seller normally wins. But we really felt that both sides were coming out with a good deal.

PF: NRG has said that this deal will provide NRG with a 'significant presence in all key competitive wholesale power markets in the US'. What aspects of the deal do you think lead to these benefits?
RF: Firstly there's the quality of the assets: it's a very young generation fleet. Publicly it featuress the youngest nuclear, and the youngest coal plant around. The reliability rates are best in class so the performance is exceptional. In the Houston marketplace this gives us decent size. It's a competitive market with bilateral deals. When you've got size in the market and the scale where you can leverage one plant with another, if one plant goes down for maintenance you have others to back it up. So it's a nice set of assets that supports itself very well in a competitive market. With a reliability rating, and a very gas-dependent market that's a good formula for a successful operation.

PF: What's your preferred approach to financing assets these days?
RF: We want to keep our balance sheets balanced. We target the structure that a BB company would have, the right mix of debt and equity. Looking at debt to total capital, the highest we want is 60%, and the lowest about 45%. If we had another large acquisition we'd have to have a piece of it with debt, and a piece with equity. We always want to keep that balance. We don't want to just leverage the company up and put the shareholders at risk and ultimately make the debt more expensive.

We knew the first lien debt would be the easiest to place; it's a very deep market and we provided a lot of collateral, so even though it was the largest institutional loan ever placed, we felt confident we wouldn't have problems with it. The financing we believed was most sensitive was the unsecured $3.6 billion offering. It was the largest offering since the RJR deal in 1989, and we had to be careful with it. You have to have so much equity underneath it in order to make it successful because in talking with investors, if ratings go down to CCC status it would be very difficult to place.

PF: What do you believe the banks saw in this deal?
RF: A bank's job is to raise money and this is a huge transaction. We paid $250 million in bank fees. This must be one of the biggest transactions for the banks in 2006. That said, they had the same belief that the combination of the two companies is an absolute winner. Credit to MS, they were in the deal from day one. They understandably didn't want the deal to be contingent on us going to the market for debt and equity, and I don't blame them. They didn't want to bear the risk of financing. They wanted investment banks that were going to stand behind us and say "we'll give them the bridge-financing, and the commitment letter. If they need to draw down on the commitment letter, we will issue the money to you and then we'll work with NRG on the permanent financing structure".

MS signed up for a $10 billion commitment on day one, three days later they decided to share half of that with Citigroup, so they really put their balance sheet on the line as well. They demonstrated their belief in this deal in making that $10 billion commitment.

PF: When you compare NRG nowadays to NRG in the 90s, what are the key differences?
RF: The number one difference is chasing megawatts at any cost. We're not doing it. We don't see other IPPs doing it, although there's a lot of private equity money chasing individual assets. Any time we get involved in a bidding situation we get cut off pretty early because we're not willing to pay these prices. In comparison to the other IPPs, the biggest difference is staying away from the 'bragawatt' approach.

PF: What else is in the pipeline for NRG at the moment?
RF: We'll continue to make sure we understand the competitive market – what companies are working on and whether things make sense. There have been three phases over the last two years at NRG. Year one was focused on getting the company settled down, re-establishing corporate process, and doing the final trimming around the portfolio to get ready for the road. Year two we acquired Texas Genco, and the other half of West Coast Power assets from Dynegy in California. The third phase I see now is the importance of brownfield development. Taking the portfolio we have in each of these regions and using the sites for brownfield expansion. Down at South Central we're looking to build a new coal-fired plant and possibly one in Texas, or a combined-cycle investment on the west coast, or possibly one with clean coal technology in the north east. So brownfield is the third phase for us.

Also there's the lien structure. How do you support your commercial operations group? Historically if IPPs want to protect their cash flow they have to hedge. If you're not investment grade and you hedge you have to post collateral. But if you're highly leveraged how do you get the money to post collateral? That's the problem IPPs have.

With Genco in place, we've left the second lien structure open in this company. So we do long-term strategic hedging rather than putting cash out all of the time to the extent that power prices move above the level at which the hedges were put in place. This means the counter-party takes the second-lien position on the assets, so it's cashless to us and a dramatic difference. We're not investment grade, we're a merchant generator, so we have to use this to adapt to our collateral environment. That was the second-lien structure that Genco invented, we've adopted and we've also implemented.

PF: Do you have a blueprint for financing projects these days?
RF: We're looking at a coal-field plant in Louisiana and there will be equity participants in there with us, and we'll be looking at project financing to do the job. In terms of technology and combined-cycle projects most of these will need long-term power purchase agreements. They're going to have to be tight enough so we can do project-financing on the projects. You need PPAs just to make that happen.