Company to acquire DPL carrying considerable debt

Golden parachutes for DPL execs

AES Corp. of Arlington, Va., the company poised to acquire Dayton Power and Light Co. parent DPL Inc., carries considerable debt despite a $1.58 billion investment last year by a branch of the Chinese government, which owns 15 percent of the company.

AES has suffered from poor financial controls and has corrected its annual financial statements six times since 2003, analysts noted. And 65 percent of its revenues come from Latin American countries facing political, economic and currency instability.

Meanwhile, DPL’s growth is jeopardized by a stagnant local population, the potential for rate reductions by Ohio regulators, and the likelihood that DPL, which is almost totally reliant on coal-fired electrical generation, will be further affected by increasingly stiff regulations to limit carbon emissions.

Those are the conclusions of energy industry analysts who, along with some DPL shareholders, question AES’ planned $3.5 billion acquisition of all of DPL’s common shares, a deal that also includes an assumption by AES of $1.2 billion in DPL debt. AES is offering $30 cash per DPL common share.

Some individual shareholders told the Dayton Daily News they plan to vote against the merger. At least four filed lawsuits last week seeking to block it, saying DPL’s directors didn’t get a fair price and are seeking to enrich themselves at shareholders’ expense.

Large DPL institutional shareholders who also have big investments in AES declined to comment or did not return phone calls.

DPL Chairman Glenn Harder said he hopes shareholders keep an open mind. DPL is preparing a new proxy statement, to be sent to shareholders within two months, that will make the company’s case for the deal. DPL shareholders will likely vote on the deal in mid-July.

AES, a Fortune 500 company, owns Indianapolis Power & Light Co., but a large part of its business is in the generation and distribution of electric power on five continents.

DPL and its subsidiaries, including Dayton Power and Light, are to become part of AES when the deal is closed in six to nine months, assuming shareholder approval, company officials said. DPL is to maintain its name, staffing levels, Dayton offices and current level of philanthropic giving for at least two years, under terms of the deal. Electric rates for Dayton Power’s 500,000 customers in west-central Ohio are locked in through 2012, under a plan that Ohio utility regulators previously approved.

Five senior DPL executives, led by president and chief executive officer Paul Barbas, stand to collect a more than $23 million under existing DPL provisions that would apply if there is a change of control of the company, according to a proxy statement distributed to shareholders and filed with the Securities and Exchange Commission in March.

In addition to Barbas, the DPL executives are Frederick Boyle, Scott Kelly, Daniel McCabe and Gary Stephenson. That would complement the millions they and DPL directors stand to receive when AES buys DPL’s stock.

Since the April 20 announcement of the sale, structured as a merger, analysts with Morningstar Inc. and Citi Investment Research & Analysis, part of Citigroup Global Markets Inc., have weighed in with reports questioning the deal.

AES said it has paid down $1.8 billion in corporate debt during the past two years and has raised $1.6 billion in new capital.

Morningstar analyst Patrick Goff applauded the paydown of debt, but noted that AES is still spending on acquiring energy operations and is buying back its own stock to boost share prices.

“With the acquisition of DPL, for example, we think it is clearly a negative that AES is financing the vast majority of the purchase with debt,” Goff wrote in a report issued Monday.

AES appears to have overcome chronic problems with its internal controls over financial reporting, but that needs to be watched, Goff wrote.

“The company had to restate its annual financial statements six times since 2003 to correct errors,” he wrote. “We would like to see at least a few more years without restatements before we are fully comfortable with AES’ financial reporting.”

AES said it now uses a high-tech financial reporting system and hasn’t had a restatement in four years.

Goff also noted that AES’ revenues are largely derived from countries, including Brazil and Argentina, with considerable economic instability.

But Citi analyst Brian Chin said many AES investors bought the stock because of its international business, and the DPL merger doesn’t seem like a good fit.

Chin described AES as a “theme” stock for investors hoping to capitalize on growth in international energy distribution. Acquiring DPL “dilutes the very reason” most investors own AES stock by pushing up the percentage of AES’ earnings derived from its U.S. operations to 40 percent, Chin wrote.

AES’ borrowing for much of the DPL acquisition will likely limit its ability to make other large acquisitions in emerging markets like Turkey, Chin wrote. “We question whether this is the optimal use of capital,” he said.

AES reported debt of about $3 billion last year, part of overall liabilities of $8 billion. It had total revenue in 2010 of $16.6 billion, with net income of $1 billion.

The company remains highly leveraged despite the injection last year of a $1.58 billion investment by Terrific Investment Corp. Terrific is a wholly owned subsidiary of the state-owned China Investment Corp. of Beijing.

Under the March 2010 deal that allowed Terrific to buy a 15 percent share of AES, the Chinese investors agreed to vote their shares with the recommendation of the company on all matters involving election of directors and executive compensation.

George Dent, a professor of corporate and securities law at Case Western Reserve University in Cleveland, said that provision is designed to prevent the Chinese investors from pressuring management to make decisions for political, rather than economic, reasons. For example, he said a Chinese investor could pressure a company to use Chinese suppliers.

DPL’s share price went just above $30 on the New York Stock Exchange after the merger announcement and has remained there, causing some to wonder aloud whether DPL officials might ask AES to sweeten the offer. But DPL said last week that AES’ $30 per share offer is part of the binding merger document agreed to by both companies.

On Friday, DPL’s stock closed at $30.29. Dent said the stock may be trading at above AES’ $30 offer because investors know they’ll receive dividend payments until the deal closes. Investors will continue to get dividends on a prorated basis until the deal closes, officials of both companies say.

AES doesn’t pay dividends, and some DPL shareholders say they count on DPL’s dividends for retirement income. The dividends will end after the sale.

DPL has committed not to solicit any competing offers, but outside bids are possible, Barbas has said.

Dent said Ohio law makes it difficult for competing bids to succeed without the approval of the company being acquired. Directors of Ohio corporations are free to consider the interests of stakeholders other than shareholders in determining whether a competing bid is superior. “Probably they (DPL board members) are not receptive, and if the board is not receptive it would be very difficult,” Dent said.

American Electric Power Co. and Duke Energy, two of Ohio’s largest electric power utility companies, declined to say last week whether they have considered making offers for DPL. There was speculation that Duke Energy might consider a bid for DPL in 2006, after Duke absorbed Cincinnati-based Cinergy Corp., but an offer never materialized.

Morningstar set the probability of the merger’s passage at 80 percent. DPL has declined to say which company first approached the other to open the merger discussions.

Three of DPL’s largest institutional shareholders — the Vanguard Group, Blackrock Institutional Trust Co. and State Street Corp. — also are major holders in AES. State Street had no comment on the deal, and the others did not return phone calls.

If DPL shareholders approve the merger, AES said it won’t have any problem with financing it. AES said it has interim financing of the DPL transaction from Bank of America Merrill Lynch. Permanent financing is to include re-issued AES corporate debt that was temporarily paid down in 2010, plus other debt and available cash, AES said.

DPL has been rumored as a takeover target for about a decade, but the company’s performance was clouded for years under the leadership of ousted executives Peter H. Forster, Caroline Muhlenkamp and Stephen Koziar. Forster quietly tied up a quarter of DPL’s assets in a $1 billion investment portfolio that included risky bets on a variety of non-utility ventures in foreign lands.

In 2002, DPL had to restate its financial reports to write down losses on investments in Argentina. A lengthy scandal followed, with accusations of self-dealing by the former executives, lawsuits and plunges in the company’s stock price and credit ratings, which dropped to junk status.

New leaders began rehabilitating DPL’s core business after Forster and his team were forced out in 2004. Morningstar analyst Travis Miller praised DPL for having reduced its long-term debt between 2005 and 2010. DPL also has made itself more attractive as a buyout target by completing a $600 million installation of emission-control equipment on its largest coal-fired generating plants, maintaining its market share, and by reaching a settlement in 2007 with the three former DPL executives, analysts wrote.

Bob Maxey of Alexandria, Va., a DPL shareholder since 1982, likened the AES merger deal to Forster’s past dealings, saying the current crop of executives are seeking to enrich themselves without regard to shareholder interests.

“The (current) operating officers and the board of directors are taking actions that aren’t in my interests, and I’m losing a stream of income. I’m outraged by it,” Maxey said.

Dallas Watkins of Germantown, owner of about 1,000 DPL shares, agreed. He is concerned about AES’ financial management, noting that its stock price collapsed after the company bought the parent company of Indianapolis Power & Light Co. a decade ago.

“I’m going to vote against it,” Watkins said of the DPL merger. “I am absolutely terrified of this deal.”

He said he feels let down by DPL’s senior management.

“Their concern is supposed to be (for) the stockholders.”