Activist investor Elliott returns to NRG Energy. Here is how the firm plans to create value

Company: NRG Energy (NRG)

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

Stock Value: $7.6B ($33.30 per share)

Activist: Elliott Management

Ownership percentage: > 13.0%

Average price: no

Comment from the activist: Elliott is a very successful and smart activist investor, especially in the technology sector. His team includes analysts, engineers and operating partners – former technology CEOs and COOs – from leading technology private equity firms. When evaluating an investment, the firm also employs specialty and general management consultants, expert cost analysts, and industry experts. The firm often follows companies for years before investing and has an extensive stable of impressive board candidates.

What is happening?

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

This isn’t Elliott’s first run-in with NRG. In January 2017, the firm filed a 13D with a plan centered around operational improvements and portfolio activities at NRG. Elliott saw a company with an attractive collection of generation and retail assets that had lost focus as it moved away from its core merchant power and retail electricity businesses, leading to an uncompetitive cost structure, an overburdened balance sheet and a complex asset portfolio. As part of his plan, Elliott proposed that NRG focus on its core businesses by cutting costs, simplifying its portfolio and monetizing non-core assets to pay down debt. NRG conducted a four-month business review targeting initiatives including $1.065 billion in total cost and margin improvements, $2.5 billion to $4.0 billion in asset divestitures and $13 billion in debt reduction. In February 2017, Elliott agreed with the company to replace two directors, including the chairman, with a long-time director (since 2003) assuming the role of chairman. Elliott exited 13D six months later with a return of 103.5% versus 7.5% for the S&P 500. A year later, one of their directors resigned from the board. Two years after Elliott finished the engagement, the other director resigned.

After the firm’s commitment ended, NRG retraced much of its progress and underperformed the S&P Utilities Index by 44% and its integrated power peers by 53%, largely attributable to various operational failures and a loss of strategic direction. NRG missed two years of financial guidance after struggling with repeated plant outages in 2021 and 2022 and showing an inability to manage extreme weather events. Perhaps more contributing to its disappointing performance was the company’s acquisition of Vivint (a home security business), which was completed on March 10. The acquisition resulted in a 20% drop in NRG’s market cap in the first week, raising questions about why the company would do such a thing. betting so big on a strategy that many other firms can no longer execute successfully.

Missteps aside, Elliott believes the company’s retail franchise has been the market-leading crown jewel in Texas for more than 20 years, with some room left to get back on track. Now, Elliott is back with a plan very similar to its 2017 plan: improve operations, revamp the board, adjust strategy and capital allocation. Elliott urges the company to adopt an operationally focused strategy to improve reliability, reduce costs and meet financial obligations. The firm estimates this could lead to at least $500 million in recurring, EBITDA-accretive cost reductions through 2025. Additionally, Elliott believes NRG should strategically review its home services strategy, including Vivint, and focus on core integrated power. Business. The company must also create a new capital allocation framework to return at least 80% of free cash flow to shareholders with any growth investments focused on generation and retail businesses. Elliott says the plan will allow the company to return $6.5 billion in excess capital (~85% of current market cap) to shareholders over the next three years. Elliott estimates that the plan could create more than $5 billion in value, which could push the stock price up to $55 a share.

To effectively oversee this plan, Elliott believes the board needs new independent directors with experience in the power and energy industry. Elliott has identified five candidates it believes will help implement the above operational and strategic changes. The board and management currently consists of the same chairman Elliott hired in 2017, five of the same directors (out of 10) before Elliott’s 2017 engagement, and the same CEO from before the firm’s engagement. Elliott isn’t coming out and saying the company needs a new CEO, but the firm is certainly dancing around it in its May 15 letter: The company needs to “restore the trust of the management team,” it notes. “The board must also assess the management team’s ability to manage high-performing operations on an ongoing basis.” “Strong governance will be key to the success of the Repower NRG Plan” and “significant changes are needed.”

One of the greatest but lesser-known benefits of shareholder activism is that activists often not only create value during their activities, but also steer the company in the right direction to preserve shareholder value over the long term. The latter didn’t happen here, and now Elliot understands the difference between giving someone a fish and teaching them to fish. Or, to use a more business analogy, the difference between “setting a clock” and “telling time,” as explained in Built to Last by author Jim Collins. “Looking for a single big idea to succeed tells time; building an organization that can produce many big ideas over a long period of time is setting the clock. Sustaining greatness requires setting the clock,” Collins wrote. In 2017, Elliott’s campaign was telling of the times. The firm will need to build a clock to achieve the long-term value it aims for this time.

They will have time to do so. Elliott has only recommended rather than nominated directors, indicating a friendly relationship, but it cannot formally appoint directors until December 29 and must nominate them until January 28, 2024. As Elliott noted in his letter, the amount of change needed to maintain long-term value would take longer than replacing two directors this time around, so an early settlement may not be in the cards.

It should be noted that activists historically have not been very successful the second time they return to the well. A 2019 study by 13D Monitor concluded that when activists pitch a second campaign at the same company, they earn an average return of 16.78% the second time around, versus 28.56% for the S&P 500. This compares to an average return of 46.54% compared to 6.25% for first-timers.

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

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