Activist investor Elliott is back at NRG Energy. Here’s how the company plans to create value

Business: NRG Energy is an integrated power company involved in the generation and sale of electricity and related products and services to residential, commercial, industrial and wholesale customers. It generates electricity using natural gas, coal, oil, solar, nuclear, and battery storage.

Market value: $7.6 billion ($33.30 per share)

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Percentage of ownership: > 13.0%

Average cost: n / A

Activist Comment: Elliott is a very successful and shrewd activist investor, especially in the technology sector. Its team includes analysts from leading technology private equity firms, engineers, and operational partners – former technology CEOs and COOs. When evaluating an investment, the company also hires specialist and general management consultants, expert cost analysts and industry specialists. The firm often monitors companies for many years before investing and has an extensive stable of impressive board candidates.

On May 15, Elliott sent a letter to NRG. The company asked the company to implement a plan that includes appointing five new independent board members it has identified and making operational and strategic improvements, including a review of Vivint Smart Home.

This isn’t Elliott’s first foray with NRG. In January 2017, the company filed a 13D on NRG with a plan centered on operational improvements and portfolio actions. Elliott saw a company with an attractive collection of generation and retail assets that had lost its focus as it expanded beyond its core merchant power and retail power businesses, which which led to an uncompetitive cost structure, an overleveraged balance sheet and a complex asset portfolio. As part of its plan, Elliott suggested that NRG focus on its core business by cutting costs, monetizing non-core assets to simplify its portfolio and paying down debt. NRG conducted a four-month business review that targeted initiatives including $1.065 billion in total cost and margin improvements, $2.5-4.0 billion in asset disposals and $13 billion debt reduction. In February 2017, Elliott reached an agreement with the company to replace two directors, including the chairman, with a long-serving director (since 2003) assuming the role of chairman. Elliott left its 13D six months later with a return of 103.5% compared to 7.5% for the S&P 500. A year later, one of their directors resigned from the board. Two years after Elliott’s engagement ended, the other manager quit.

Since the company’s engagement ended, NRG has reversed much of its progress and has underperformed the S&P Utilities Index by 44% and its integrated power peers by 53%, which may be largely attributed to various operational failures and a loss of strategic focus. NRG missed two years of financial guidance in 2021 and 2022 after battling repeated plant outages and demonstrating an inability to handle extreme weather events. Perhaps more of an impact on its dismal performance is the company’s acquisition of Vivint (a home security company), completed on March 10. This acquisition caused NRG’s market capitalization to drop 20% in the first week and raises the question of why the company would bet so heavily on a strategy that many other companies have already failed to successfully execute. .

Missteps aside, Elliott believes the company’s retail franchise is a crown jewel that has been a market leader in Texas for more than 20 years and there are still several opportunities to get back on track. rails. Now Elliott is back with a plan remarkably similar to its 2017 plan: improve operations, refresh the board, and fix strategy and capital allocation. Elliott calls on the company to adopt an operations-focused strategy of improving reliability, reducing costs and meeting financial commitments. The company believes this could lead to at least $500 million in recurring, EBITDA-accelerating cost reductions by 2025. The company should also establish a new capital allocation framework to return at least 80% of free cash flow to shareholders, with any growth investment focused on production and retail activities. Elliott says this plan would see the company return $6.5 billion in excess capital (~85% of current market capitalization) to shareholders over the next three years. Elliott estimates that this plan could create more than $5 billion in value, driving the stock price to $55 per share.

To effectively oversee this plan, Elliott believes the board needs new independent directors with expertise in the power and energy industry. Elliott has identified five candidates that it believes will help implement the aforementioned operational and strategic changes. The board and management currently consist of the same chairman that Elliott accepted in 2017, five (out of 10) of the same directors before Elliott’s engagement in 2017, and the same CEO as before the engagement. of the company. Elliott doesn’t say the company needs a new CEO, but the company certainly dances around him in the May 15 letter: She notes that the company “needs to restore the credibility of the management team” . “The board should also assess the ability of the management team to drive successful operations in a sustainable manner.” “Strong management will be key to the success of the Repower NRG plan,” and “significant changes are needed.”

One of the most important, yet under-recognized, benefits of shareholder activism is that activists often not only create value during their engagement, but also set the company on the right path to maintain shareholder value over the long term. The latter didn’t happen here, and now Elliott realizes the difference between giving someone a fish and teaching them how to fish. Or, to use a more business analogy, the difference between “building clocks” and “telling time” as author Jim Collins explains in the book “Built to Last.” “Looking for a single great idea on which to build success is time-consuming; building an organization that can generate many great ideas over a long period of time is building a clock. Lasting greatness requires clock building,” said writes Collins. In 2017, Elliott’s campaign was pretty much telling of the times. To achieve the kind of long-term value the company seems to be aiming for this time around, it will have to build a clock.

They will have time to do so. Elliott has only recommended directors rather than appointing them, which signals an out-of-court engagement, but he cannot formally appoint directors until December 29 and has until January 28, 2024 to make appointments. . The amount of change needed to maintain long-term value, as Elliott alludes to in its letter, will require more than just replacing two directors this time around, so a quick settlement may not be in the cards. .

It should be noted that the militants have never been so successful the second time when they return to the well. A 2019 study conducted by 13D Monitor found that when activists file a second campaign at the same company, they have an average return of 16.78% compared to 28.56% for the S&P 500 the second time around. This compares to an average return of 46.54% versus 6.25% the first time they committed.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist investments.