by Tanya Bodell, FTI Consulting
“Please take a moment to identify the exit nearest to you.”
The advice given on every airplane before takeoff is as important for business.
An operating enterprise regularly should assess its business assets and determine whether they should be expanded, maintained, securitized or sold, with a decision to exit an existing business being as important as whether to invest in a new business.
It also is important to actively monitor your competitors’ exit strategies, in whatever form they occur, because those decisions could impact your assets and earnings.
As we exit this decade, it seems fitting to examine other exits looming in the power industry.
The industry might see an increase in retirements, mothballing and physical exits of production from wholesale markets.
In classical microeconomics, market prices equilibrate in the short run when production assets with high variable costs choose not to produce.
Over the long run, assets or businesses with total costs that exceed expected prices cannot afford to stay in production.
Generating units with total costs that exceed those of a new entrant will retire, or, as is often the case for long-lived, capital-intensive assets, be sold at a market price that reduces the fixed cost. If depressed prices and compressed spark spreads continue, it might be more economic to shut down or sell certain generating facilities vs. continuing to operate.
In response to major market shifts, companies reposition their portfolios of business investments and exit those that no longer offer required returns.
In the electricity industry, portfolio repositioning events usually are indicated by announcements that a company is going back to basics or selling noncore businesses.
Extreme portfolio rebalancing might occur during bankruptcy, where the insolvent company exits the business completely and assets are sold to pay creditors.
As balance sheets tighten because of falling asset values, expect certain companies to exit nonstrategic markets.
Investors with strong balance sheets might find valuable investment opportunities.
Companies that securitize their assets effectively sell rights to future cash flow in exchange for up-front payment today.
This is financially similar to a sale of a portion of those assets and usually occurs as tranches of debt instruments and differentially preferred equity.
Joint ventures, partnerships and creation of new affiliates to manage existing assets also indicate that otherwise established market participants are engaged in a more subtle exit strategy often called recapitalization. Those with capital are welcome to enter.
Public Policy Reversals
Renewable generation is supported by tax credits, subsidies and renewable portfolio standards, effectively turning government and taxpayers into clean-energy investors.
Such investments are implemented through the votes of elected officials, and the recent election might provide insight into the public appetite for ongoing clean-energy investment.
Declining support for continuing energy investments could indicate that the public is exercising its own exit strategy.
Companies deploy exit strategies that might not be as obvious as a traditional microeconomic physical production plant closure.
Although aging coal plant retirements and mothballing uneconomic generation appear to be coming, asset sales below book value also reflect exit strategies.
Modifying a company’s business portfolio can entail exit decisions and expansion into existing or new areas funded by asset sales or securitization.
Last, a shift in public policy that decreases expected taxpayer investment in renewable resources could reflect a political departure from existing policy and an exit by a publicly funded investor.
Such exits affect the parties involved, impact their customers and can shift the entire market.
Examine your exit strategy. Understand others’ exit strategies. Quantify the impact on your financials and develop a proactive and reactive strategy to increase your chances to survive and thrive.
One company’s exit strategy might provide another with an important entry opportunity.
Tanya Bodell is a managing director at FTI Consulting and co-founder of the Electricity Consulting Group. Reach her at firstname.lastname@example.org.
“While Downie entitles this chapter (VIII) ‘On entry and exit,’ exit is not mentioned.”
J. Nightingale, “History of Economics Review,” Summer 1993
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