Constellation Energy: A closer examination

Constellation energy is a debt ridden company which has just been taken over by Warren Buffet's Mid American. Being a debt ridden company, it is no wonder that during a credit crisis and a crisis of confidence such as what we are experiencing today, its shares have plummeted to end december 2001 levels, a dramatic fall caused by liquidity concerns.

When a company like Constellation is taken over by Warren Buffet, it sure warrants a closer examination. It has approximately 5.7 billion in debt and it has a enterprise/ebitda of approximately 5 times. At a PER of 5.5, it has an earnings yield of 18% while a 20 year AAA Municipal Bond only has a yield of 4.97%. By Benjamin Graham's Standard, it has more than met the criteria of double a AAA Bond Yield. However, lots remain to be see about what this company can do to increase shareholder value.

Constellation Energy is in the business of providing energy for the masses and it operates through Baltimore Gas & Electric company and a merchant energy business. It happens to be a close fit in terms of its business model to that of Midamerican which also happens to be in the same industry and MidAmerican is a subsidiary unit of the ever famous Bershire Hathaway, Buffet's Baby.

Constellation has had an growing Ebitda of 1.4 billion to 1.9 billion in its latest financual year end, an impressive CAGR of 10 %. However, its debt too has been growing and its latest balance sheet figures show a debt of 5.7 billion dollars.

5.7 Billion dollars worth of debt is scary in a credit crisis like this but it will be comforting to note that it has an interest cover of approximately above 4 times. Plagued by downgrades in credit,what the analyst have forgotten is it has a huge asset base that it can sell off to provide for liquidity. Its asset base is 29 billion huge. And chances are under MidAmerican, we could see some deleveraging of its balance sheet taking place. We could take comfort in the fact that at today's prices, dividend yield is an excellent 7%. You are essentially paid to wait for the price value gap to narrow.

The company has a firm business model and should still be a going concern. The only problem right now that should be tackled is the problem of liquidity and working capital issues.

Possible catalyst:

1) Selling off of assets to pay down debt - When its substatial Plant, property and equiptment are sold off to pay down debt, we could see a reduction interest expenses.

2)Selling the energy trading business that causes further liquidity problems

3) Potential dividend hike and growth of book value when debt is paid down

So if you look at it carefully, what we have is an investment at attractive prices. Not only is it trading at approximately 5 times EV/Ebitda but you also have an inbuilt catalyst around Warren Buffet.

Warren Buffet is a "catalyst" to effecting any of the several above catalyst which would help in unlocking shareholder value. Besides, buying over Constellation would merge MidAmerican and constellation energy's balance sheet into one making it a stronger one.

One point to be wary of though is that Warren's Preferred equity stake in Constellation would be good for him but buying commom equity for us might be dilutive to a certain extent for the book value of common will dwindle. Preferreds always have priority for any form of dividends and hence you can expect some form of dilution of intrinsic value. Still this is an interesting play that is worth studying and learning from.

Best regards,
Lucas