Calpine Corporation

Case Summary
Founded as a wholly owned subsidiary of Electrowatt, Calpine Corporation is currently
one of the largest Independent Power producers (IPP) in US. From 1984 to 1998,
Calpine pursued the construction and operation of Qualifying Facilities (QF) power
plants on the IPP model, creating a new subsidiary to finance each plant as well as
acquiring other IPPs.
From 1984 to 1998, Calpine relied on IPP model for sourcing the funds. Calpine also
issued IPO in 1996 and debt in 1999. Its shares are trading at $36.44 by the end of
1999. Credit Suisse First Boston has proposed an alternate hybrid option to source
Calpine's capital needs by which Calpine would create a subsidiary Calpine
Construction Finance Company, by investing $430 million of equity and borrowing $1
billion from several banks.

In early 1999, Calpines CEO Pete Cartwright adopted an aggressive growth strategy
with the goal of increasing the company's power generating capacity from 3,000 to
15,000 megawatts (MW) by 2004. To achieve this Calpine will have to build or acquire
approximately 25 power plants at a total cost of $6 billion (approximately $500,000 per
1,000 MW). He believed there was a fleeting opportunity to repower America given the
inefficiency and age of current generating capacity as well as the recently granted ability
to compete in wholesale power markets and become the largest power generator for the
US. For a company with assets of $1.7 billion, a sub-investment grade debt rating (BB),
a debt-to-capitalization ratio of 79%, and an after-tax cash flow of $143 million in 1998,
raising this much money is not going to be easy.

Case Facts

Calpine had 22 plants with a combined capacity of 2729 MW operating over 7

states. Between 1994 and 1998, consolidated assets increased from $421 mn to
$1721 mn, revenue grew from $94 mn to $556 mn and net income from $6 mn to
$46 mn. Its goal was to increase the capacity from 3000 MW to 15000 mw by 2004.
For this they will have to build 25 additional plants at the total cost of $6 bn.
Between 19941-1999 Calpine began the policy of retiring the subsidiary project
debt by corporate debt issues and issued 5 corporate bonds as its debt rating
improved from B to BB. Initially they used project finance to construct new plants
and then were looking to change their financial strategy. Its shares are trading at
$36.44 by the end of 1999. Credit Suisse First Boston has proposed an alternate
hybrid option to source Calpine's capital needs by which Calpine would create a
subsidiary Calpine Construction Finance Company, by investing $430 million of
equity and borrowing $1 billion from several banks.
 Exhibit 5) Representative Economics for a Combined-Cycle Gas Fired Power Plant

Output (megawatts) 1,000

Capacity Factor (availability) 90%
Electricity Price ($ per MWh)
assuming a market
In 1999 $31.00 heat rate of 11,000
assuming a market
In 2009 $24.00 heat rate of 7,500
1MMBtu=1,000,000
Fuel cost $2.20 Btu
note: 1000 kWh = 1
Plant Heat Rate (BTU per kWh) 7,500 MWh
O&M Expense ($ per MWh) $3.50

note: construction
Capital Costs (millions) $500 period = 2 years
Depreciable Life (years) 30
Debt-to-Capitalization Ratio 65%
Debt Interest Rate 7.75%
Inflation Rate 2.00%
Tax Rate 38%
No. Of Days 365
No of hours 24
Price per Mwh of Electricity $31.0

Problem Identified:

Which is the best way to finance?

Project Finance
Corporate Finance
Revolving Construction
Alternate Solution:

Project Finance:

Calpine can go for project finance option but in these loan agreements, banks would
have a lien on the plant and control over cash flows. The good thing is it would not have
to worry about downgrading of ratings.

Corporate Finance:

This would not require collateral and it could operate freely. The problem is that Calpine
could not issue secured debt and even unsecured debt could not be issued if the
EBITDA to interest expense fell below 2:1. Another problem is the negative arbitrage
since construction takes a long time and during this time it would have to pay long term
interest rate which could increase the spread by 250-300 bp.

Best Solution:

Revolving Construction Facility

This seems to be the best solution. Under this a new subsidiary Calpine Construction
Finance Company is being created(CCFC). This will borrow $ 1 bn loan from banks and
push in $430mn equity from self as mentioned in Exhibit 10 and 11. Like project finance
money is borrowed using non-recourse method with no liability on parent company.
Also, amounts borrowed and repaid could be re-borrowed for additional plants with no
required repayment for 4 years.

Conclusion:

Calpine CEO should consider using mixed financing strategy. It would give Calpine
flexibility to build plants using in-house resources and manage them as a whole.
Calpine is able to finance multiple plants instead of one through the same project
finance strategy and without any risk to the parent company.

__________________________