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30 July 2020

NRG lands Centrica prize US jewel, but pays a pretty penny for it

The tone of the webcasts either side of the Centrica sale of US company Direct Energy to NRG Energy, could not be more different. NRG sounded like it had just pulled of the deal of the century, while Centrica was all grown up and responsible and heaving sighs of mostly relief.

This is the end of Centrica’s meandering in and around the globe, and as it sells off what was originally a competitive energy retailer in the US, in considerably better shape then it bought it, and it followed getting out of most European markets – Netherlands, Belgium and Spain, as well as the Goldfish credit card, and selling insurance. Now it supplies energy and strong residential home services – mostly gas appliance maintenance.

New Centrica CEO Chris O’Shea has been installed for about 3 months, and has already made two massive moves to fix the tilted ship left behind by Iain Conn, the previous CEO, who presided over the business’ biggest ever losses of both customers and cash. O’Shea cut 5,000 jobs in middle management almost immediately and now has sold his US operation for $3.625 billion, and will offset some of that against the £2.4 billion of pension deficit liability he inherited. He does not believe in hanging about.

But listening first to Mauricio Gutierrez CEO of NRG, a business that only came into being in 2000, and which has already bought 11 other energy companies – it has already around 2.9 million retail customers in Texas, Connecticut, Delaware, Illinois, Maryland, Massachusetts, New Jersey, New York, Pennsylvania, Ohio, and the District of Columbia and with this deal doubles in size.

What it’s bought is another hodge-podge of companies, built around the Direct Energy brand, which Centrica paid $912 million for, which at the time in 2000, was just £406 million in sterling. It immediately added another £437 million on Enbridge, and has strengthened as it goes since then with service operations.  The purchase was all in cash, funded by a combination of cash in hand, debt and securities. For NRG it is about getting to where it promised shareholders it would be, far sooner, adding 3 million gas and electricity customer to NRG and it will be immediately accretive. The deal should close before the end of 2020.

Gutierrez promised a combination of owned generational assets, PPAs and wholesale to fulfil energy requirements, promising not to be dogmatic about it. And after debt is paid down to return to a 50/50 strategy of 50% of excess cash to the business, 50% to the shareholders either as dividends or share buy backs. “This deal reduces our carbon intensity because Direct Energy has no generational assets,” which means Gutierrez can push it towards zero carbon quite easily, certainly by 2050, by signing key strategic PPAs with renewables.

Meanwhile at Centrica this is a “stick to your knitting” announcement, and the rump of the business which was originally British Gas is now 9 million gas and electricity users, and 4 million service customers.

Instead of gimmicks, O’Shea is promising more bodies on the phones to customers, better web interfaces, and end to all the customer losses, and a simplification of how the company does business. That’s a starter. He went on to promise to take a long hard look at getting early into hydrogen, to deliver on heat pumps and to add significant EV charging. But this is a turnaround situation, and Centrica’s stock has not budged since the announcement on Friday, as investors take a “wait and see” view on the new CEO. Rethink energy could not disagree with anything he said, but a single quarter where customer numbers increase, would go a long way to creating more believers.

One comment that O’Shea made was very insightful, suggesting that in the past the company had more people on doing business between one part of the group and another, than it had facing customers.

For NRG all those new customers are in Texas and the North East of the country and Canada, so a good match for its existing base and it says it now has customers in all 50 states and 6 Canadian provinces, and given that this is two profitably businesses going into one, but no shares have changed hands, then the same number of shares will be sharing twice as much profit.

Because Direct Energy was a competitive retailer with no generational assets it has a great retail platform and much nodding and congratulations were made of this throughout the call, just making a better route to market.

The acquisition is expected to create $300 million in annual run-rate driven by leveraging NRG’s operational platform and a well-established cost discipline.

This deal has to go before Centrica investors, the Federal Energy Regulatory Commission (FERC) in the US and will have to hurdle anti-trust regulation in the US as well as the FTC, but we can see few problems.

Centrica has very little debt for a company of its size around £2.8 billion, but we would expect some of that to be reduced with some of the cash, but O’Shea has promised he will complete negotiations with the trustees of the pension fund before applying any of it elsewhere.