2nd UPDATE: Calpine To Pay Pepco $1.65 Billion For Fleet Of Power Plants

Calpine Corp. (CPN) will pay Pepco Holdings Inc. (POM) $1.65 billion for a fleet of power plants as Calpine expands into the Mid-Atlantic region, while Pepco focuses on its less volatile utility businesses.

The deal for Pepco's Conectiv Energy includes 18 plants and one that is under construction, making Calpine the nation's largest independent generator by output. It furthers the Houston-based company's bet on natural gas, since most of the plants it is buying run on the fuel, matching Calpine's existing fleet. The company even plans to run Conectiv's two coal-fired plants on gas, though they said they may have to make minor modifications.

The sale of the plants allows Pepco to focus on its regulated, electric- and natural gas-delivery businesses in the Mid-Atlantic region. It no longer wants the earnings volatility and commodity risk that come with operating merchant plants, which rely on market prices rather than regulated rates.

Asset deals have picked up in the U.S. power sector in the last month as a downturn in power demand and wholesale prices stretches on. The soft market has pushed some power companies and private-equity firms to buy, seeing a bottom to asset prices. Yet others are looking to exit, as they hold a dimmer view of the markets--and their risks--after a sharp drop in demand over the last two years and expectations by some for a slow recovery.

"We don't have an overly optimistic view we are going to see the energy markets rebound," said Joseph Rigby, Pepco's chairman and chief executive, in an interview Wednesday.

The deal provides Calpine with entry into what its executives see as an attractive market at an attractive price. The plants are located in the nation's largest power market, the PJM Interconnection, which covers 13 states in the Mid-Atlantic region and parts of the Southeast and Midwest. The company sees an opportunity to grow further in the region by building new units as the U.S. power sector increasingly shifts to gas amid environmental concerns surrounding coal.

During a conference call Wednesday, Calpine executives said the advantages of the Conectiv plants include their location near large population centers, regional transmission constraints that limit supply, and eventual shutdowns of older, coal-fired plants that should make gas-plants more valuable.

"We think coal's time has passed," said Thad Hill, Calpine's chief commercial officer, during the call.

Calpine is pairing its Conectiv deal with the recent sale of two plants for $739 million to Xcel Energy Inc. (XEL) in Colorado. The Conectiv acquisition won't require Calpine to issue new equity, but it does plan to add a $1.3 billion term loan to help finance it.

The deal comes only two years after Calpine emerged from bankruptcy protection. Analysts at Macquarie Capital wrote in a note to clients that the Conectiv acquisition provides "a manageable level of leverage in our view given the strong and very visible cash-flow generation."

Following the deal, Pepco said it expects 90% to 95% of its business to be regulated, with growth coming from infrastructure projects such as advanced electric meters and new, high-voltage lines. The Conectiv sale and liquidation of related contracts and assets will generate about $2.05 billion. Pepco will use the proceeds to reduce its debt and support its dividend. The company also doesn't expect to have to issue equity until at least 2012.

Pepco said it estimates the sale of the Conectiv assets and related actions will result in a loss over the next 12 months of $60 million to $90 million. It also said it would cut 150 jobs centered on its power trading operations.

Calpine also introduced 2011 guidance Wednesday, saying it expects adjusted earnings before interest, taxes, depreciation and amortization--including the Conectiv acquisition--of $1.685 billion to $1.885 billion, and adjusted free cash flow of $365 million to $565 million.

The acquisition is expected to close by June 30.

In recent trading, Pepco shares were up 3.3% at $16.78, while Calpine shares were up 3.9% at $12.65.

-By Mark Peters, Dow Jones Newswires; 212-416-2457; mark.peters@dowjones.com

(Nathan Becker contributed to this article.)

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