Constellation Energy

1. Constellation Energy Merger and Arbitrage

2. Summary of Constellation Energy (CEG) The Nation’s largest supplier of competitive electricity to large commercial and industrial customers Transmits and distributes utility for 1.2 million electricity customers and 640,000 gas customers in central Maryland Recent liquidity problems led to risk of bankruptcy, owing to its trading ties to collapsed Lehman Brothers Current market conditions put additional pressure Loss of market confidence, rating downgrades pushed the company to the brink of bankruptcy

3. Overview of MidAmerican’s Offer Purchase all outstanding Constellation Energy common stock for $26.50 per share in cash CEG to become wholly owned subsidiary of MidAmerican Made an immediate $1 billion investment through the purchase of convertible preferred stock yielding 8% Best and only offer of immediate capital infusion necessary to manage liquidity problems and avoid bankruptcy Merger expected to close in 2Q of 2009

4. Update: EDF’s Rival Offer (On Dec 03) Offered $4.5 billion for half of CEG’s nuclear assets (Valued CEG at around $52 per share) Option to buy $2 billion gas, oil, and gas-generation assets $1 billion cash injection as part of proposal The bid would give CEG a solid foothold in the market Constellation up 10 percent upon the release of news A lot better than the Buffet offer Expected to close within six to nine months after signing an agreement with CEG

5. Porter’s Five Forces Rivalry - Electric Utilities Industry Concentration Ratio of 33%, indicating a fragmented market of many rivals with high competition Threat of Substitutes Minimal threat of products from other industries Portfolio includes nuclear, coal, natural gas, oil, and renewable alternative fuels such as solar, geothermal, hydro and biomass. Threat of New Entrants Very nominal threat; barriers to entry such as startup costs and government approval/regulation can be very restricting Supplier Power Weak due to many competitive suppliers & heavy regulation Buyer Power Weak due to fragmented buyers & threat of forward integration

6. SWOT Analysis Strengths Strong customer base (over 36 states and three Canadian provinces, over half of the Fortune 100 companies) Decreasing reliance on fossil fuels, 61% of output is from nuclear energy Over 100 years of experience Provides competitive energy supply as well as energy consulting and services to other businesses Very strong and experienced management Weaknesses Suffered immensely from the financial crisis, stock dropping over 50% in the course of one week Highly subject to government regulation of energy prices

7. SWOT Analysis cont’d. Opportunities Avoiding government regulation of prices by using more alternative renewable energy sources Merging with larger energy corporations, thereby expanding its residential customer base Financial backing by a more financially stable energy corporation Threats Stricter government regulation of prices Uncontrollable foreign oil prices and the increasing dependence on foreign oil Imminence of bankruptcy barring MidAmerican’s $1billion investment back in September

8. Competitor Analysis Constellation is the nation’s largest supplier of electricity to large commercial and industrial customers, and the nations largest wholesale power seller. Few other competitors diversify their energy sources as much as Constellation, which only uses fossil fuels for 30% of its energy output. Constellation more diversified in their products, providing energy on the national level and the local level (Baltimore Gas and Electric Company), and offering energy consulting services. However, compared to its competitors, Constellation suffered the heaviest impact from the financial crisis.

9. Financial Statements Analysis Income Statement Gross profit: grew by 8.4% from 2006 to 2007 Total revenue: grew by almost 10% from 2006 to 2007 Cost of revenue/Total revenue = 0.777 (thin margins) Operating income > 0: making money before taxes Interest expense: 6% of gross profit, not crippling Anomalies: no one-year bumps, no deferred income tax expense to artificially boost income YOY growth of net income: around 15%

10. Financial Statements Analysis Balance Sheet Total current assets (9B) > Total current liabilities (6,9B): solvent-can pay its bills Cash/Total stockholder equity (market cap) = 29%: optimal amount of cash on hand Inventories, goodwill and intangible assets seem reasonable Long-term debt is stable but large

11. Financial Statement Analysis Cash Flow Depreciation is a significant portion of cash flow Changes in accounts receivable are stable: no indication that the company’s customers fail to pay off their credit accounts Changes in inventories are decreasing: the company is spending less cash purchasing raw materials Capital expenditures have an increasing trend and exceed the cash flow from operating activities Net borrowings are increasing

12. Valuation Metrics

13. Valuation Metrics Low P/B: 0.92, with reasonable goodwill and intangible assets Fair P/E: 14.90, no one year bumps, earnings are sustainable Low PEG: investors are placing a lower price on the growth prospects of the company, indicating the stock may be cheap D/E: fair compared to industry and sector, the company can remain solvent Low P/B compared to industry and sector: undervalued, cheap, investors are paying less than $1 for $1 of equity

14. Discounted Cash Flow Assumptions YOY Revenue Growth: 9% (Typically Higher) Expenses: 95% of Revenue Tax Rate: 35% Discount Rate: 9% (highest shown rate was only 7.6%) Capital Expenditures extremely hard to predict both STRONGLY positive and negative in preceding years due to acquisitions and sales of plants with values far surpassing a normal years cash flow Used 5.7% figure (high except 2007) which led to cash flows of approx .4% of revenue, which seems reasonable, but pessimistic given the company is “making money” Even tiny changes in capital expenditure drastically change overall value This makes cash flow a weak predictor of value as just change capital expenditures slightly drastically alters the companies value. VALUE: $31.15 per share, compared to merger @26.50/share YOY growth of net income: around 15%, here we made a conservative assumption of 9% Discount rate: highest was 7.6%, here we were being conservative and used 9% Capital expenditures: hard to predict, vary greatly over the preceding years, here we used 5.7%, perssimistic Resulted value was $31.15 per share, the company is undervaluedYOY growth of net income: around 15%, here we made a conservative assumption of 9% Discount rate: highest was 7.6%, here we were being conservative and used 9% Capital expenditures: hard to predict, vary greatly over the preceding years, here we used 5.7%, perssimistic Resulted value was $31.15 per share, the company is undervalued

15. Risks & Drawbacks Price is currently above the MidAmerican offer price Which offer CEG would accept remains to be seen Worsening market conditions might lead MidAmerican or EDF to drop its bid Securing approval from government agencies could turn out tougher than expected Failure of both deals will likely result in bankruptcy of the company

16. Conclusion Shareholder vote on the merger – Dec 23 Possibility for counter-offer or new deal terms from MidAmerican in the meantime BoD currently reviewing both proposals Great upside potential for share price in either case Should buy now