Silver Point Capital: Buy PG&E Equity And Debt
Edward Mule, the co-Founder, CEO, and Portfolio Manager of Silver Point Capital, was one of the leading speakers at this year’s Invest For Kids conference.
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Q3 2020 hedge fund letters, conferences and more
Silver Point is a private investment firm focused on credit, distressed and special situations.
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Managing approximately $10.5 billion of invested and committed capital across several funds, Mulé and his team of 50 investment professionals spend their time searching for attractive bankruptcies and distressed situations. And they are spoilt for choice right now.
However, at the conference, the hedge fund manager only picked out one investment idea; PG&E equity and bonds.
Silver Point on PG&E
PG&E is a regulated utility serving northern and central California. The firm filed for bankruptcy last year due to rising liabilities from wildfires caused by its equipment. It emerged from bankruptcy over the summer but has struggled to attract investors.
Mulé explained that the idea is a “classic post-reorganization story,” where a company goes through bankruptcy, and the market does not appreciate the differences between the pre and post-bankruptcy business.
He noted that despite the firm’s progress over the past few months, the utility’s equity “trades at a 50% discount to its peers,” which makes it “the cheapest large-cap utility available by a good bit.”
Further, he noted that PG&E bonds are “trading roughly 170 basis points wide of comparable secured bonds and other utilities and 130 basis points wide of Southern California Edison.”
The team at Silver Point believes that the market “doesn’t fully appreciate several beneficial attributes” PG&E shows after emerging from bankruptcy. It is more concerned about future wildfires and the company’s liability from such events.
The first of these “beneficial attributes” was, according to Mulé’s presentation, the new wildfire fund created by the California legislature.
This new fund “limits the potential liabilities that California utilities could have in the event of a utility-caused wildfire.” The firm’s maximum liability, he went on to add, “translates to only 40 cents per share per year.”
What’s more, if PG&E “caused a catastrophic wildfire or wildfires to happen, and only if they also acted unjustly and unreasonably if they didn’t act unjustly and unreasonably, there’s no hit to earnings at all.”
“The costs are just covered by the wildfire fund,” the fund manager summarized.
The second positive development was the “billions of dollars that are being funded by PG&E and the state of California and the federal government to mitigate wildfires.”
This new investment will lower the risk of new fires. PG&E is also now allowed to “de-energize power during the highest risk periods,” which should further reduce risk.
Thirdly, “it is critical for California to have a strong utility sector with a low cost of capital to achieve their nation-leading green energy goals,” Mulé noted.
Despite these positive attributes, the Portfolio Manager of Silver Point Capital noted that PG&E’s bonds are “trading at incredibly wide spreads.”
He stated that the firm’s analysts believe the company’s exchange bond, which was issued to facilitate its exit from bankruptcy, “should tighten at least 73 basis points.” If this occurred over a six month period, “which is what we expect,” it could “generate an IRR of 27%.”
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These estimates were based on sector comparisons, which do not take into account the fact that PG&E will “deleverage faster than its peers because it is retaining more earnings, growing faster and benefits from a $7 billion NOL that it expects to securitize in the second quarter of next year.”
“The important thing here,” he opined, “is that these bonds are first mortgage bonds, they’re secured, and they come ahead of any past or future wildfire claim. So they get paid 100 cents on the dollar plus all their interest before any unsecured other claims get paid.”
Silver Point also owns the utility’s equity. Mulé noted that the firm owns the stock because it’s not only undervalued, but the firm is also a “growth equity” as well.
“That’s what’s so unique about the story,” he stated.
“The rate base is expected to grow at 8% for 2024, largely due to wildfire mitigation, investments, grid monetization and maintenance and electric vehicle infrastructure. And we think that will continue post-2024,” the fund manager said.
On the topic of the stock’s valuation, the manager explained:
“When we look at PG&E relative to its closest competitor, which is Southern California Edison, which covers the Los Angeles area on a 2022 earnings basis, PG&E trades at a 24% discount. When you look at it relative to all utilities, the XLR, which is the S&P Utilities index, PG&E trades at a near 50% discount; 9.3 times earnings versus 18 times for the XLR.”
This article first appeared on ValueWalk Premium.