www.preplounge.

com

MBB - Cutting Carbs -

Divestiture in the
Electrical Power Market
Topic Difficulty Style
Growth strategy, Mergers & Intermediate Candidate-led (usual style)
Acquisition, Operations
strategy, Valuation

Case Prompt

Our client is Energy England, one of northern England’s largest electric utility companies. They
were created over the past decade through an aggressive series of mergers of existing utility
companies each specializing in a single energy generation source.

Recently, the CEO has embarked on an initiative to return to the core of the business. She is
looking to increase free cash flow and cash reserves in order to prepare the business for
evolving future trends.

The following can be verbally provided to interviewee if asked:

Energy England is made up of assets across the energy-generation space. These include
coal, gas, nuclear, and wind

Payment ID: 52775 (paigelinden15@aol.com)

Page 1
We are looking to divest from just one of our previous acquisitions (i.e one target is
sufficient)
There are no specific goals/metrics – the client trusts our judgement

Payment ID: 52775 (paigelinden15@aol.com)

Page 2
Exhibits

Payment ID: 52775 (paigelinden15@aol.com)

Page 3
I. Operation Cost Comparison

Additional Information

Note for Interviewer

When sufficiently prompted, you may share Exhibit 1 with them.

Note for Interviewer

If asked about column 5 Expected Carbon Tax, tell the candidate that our company places a
very high probability on future regulation doubling the carbon tax. If pressed for a specific %
probability, simply state that we are very confident of this.

You may provide the following clarifications when they are asked for:

MwH stands for Megawatt hour, a unit of measurement for energy produced
1 GwH stands for Megawatt hour
1 Gwh = 1,000 MwH
Total Annual production can be calculated by leveraging # hours per year

Payment ID: 52775 (paigelinden15@aol.com)

Page 4
 Note for Interviewer

After calculating the MwH Operating cost per energy type when incorporating carbon, the
candidate may now attempt to calculate benefits from plants. Remind them that electricity is
electricity and that, for the sake of simplicity, we can assume all MwH are sold by our
company at the same price.

If the candidate is stuck, remind them that revenues are essentially constant per unit across
all revenue streams. If they insist, you may clarify that profits are generally 10-15% of
operating costs.

Note for Interviewer

To calculate the total annual free cash flow, inform the candidate they can round to 20 hours
per day and 350 days per year for the sake of simplicity.

Solution

The candidate needs to recognize that we need to evaluate our existing assets. They
should ask for information regarding our current asset performance (operating costs, revenues,
etc.) with the hypothesis that we will need to scale down or improve certain non-performing
assets.

A good candidate will note the following:

Coal and gas make up the majority of our business

Carbon taxes play a notable role in the ultimate cost of coal and gas assets

The candidate should proceed to calculate the MwH Operating cost per energy type when
incorporating carbon. They should note that they are as follows:

Payment ID: 52775 (paigelinden15@aol.com)

Page 5
 MwH Operating cost per energy type when incorporating carbon

1. Coal = 110 GBP/MwH

2. Wind = 100 GBP/MwH
3. Nuclear = 90 GBP/MwH
4. Gas = 85 GBP/MwH
calculation
Hide
While the candidate should clearly indicate now that coal is the most expensive, an excellent
candidate will also note that wind, while 2nd, should continue to decline in price over time due to
current market trends.

The candidate may opt to calculate the total annual free cash flow from Exhibit 1. They may
proceed with this calculation at this time, or later in the case. The calculations are as follows:

Total annual free cash flow

[Column 2 “Energy Production”] X [Column D+F “Cost per Mwh”] X 1,000 Mwh per Gwh X
24 hours per day X 365 days per year

Round to 20 hours per day and 350 days per year for the sake of simplicity

Coal operating costs = $2.695B

Wind operating costs = $1.05B

Nuclear operating costs = $1.575B

Gas operating costs = $1.19B

calculation
Hide
II. Divestiture Target Identification

Additional Information

Payment ID: 52775 (paigelinden15@aol.com)

Page 6
Note for Interviewer

At this stage, the candidate should be locked into coal as the ideal candidate for divestiture.
They should ask if we have any information on sale value, carve-out logistics, etc., essentially
looking to compare savings to value.

At this point you may share Exhibit 2 with them.

Note for Interviewer

If the candidate looks to clarify whether CoalCo represents all the coal assets, GasGuys all the
gas assets, etc. you may confirm that this is the case.

Note for Interviewer

The candidate may be dissuaded from selling CoalCo given the large difference between
column 2 “Initial Deal Valuation” and column 3 “Market Offering”. This is a distraction. The
initial deal valuation is a sunk cost that has already passed. The market is offering less than
the original purchase price precisely because of the high operating costs and expected future
carbon tax hikes.

Payment ID: 52775 (paigelinden15@aol.com)

Page 7
 If the candidate does not move past this thought after a light/gentle nudge, this is a mark
against them.

Note for Interviewer

If the candidate asks if we know how many assets we would like to part with, you may clarify
that one entire energy stream is entirely sufficient.

Solution

At this stage, the candidate should be locked into coal as the ideal candidate for divestiture. They
should ask if we have any information on sale value, carve-out logistics, etc., essentially looking to
compare savings to value.

Upon receiving the exhibit, the candidate needs to realize that total cost savings need to be
compared to our market offering and cost of divestiture execution.

A good candidate will quickly realize the following:

Coal will free up the most cash flow (Exhibit 1) and result in the highest cash pile (tied
for 1st, Exhibit 2)
CoalCo has declined in value in the market’s view
Calculating the total annual free cash flow from Exhibit 1 is important to determine total
benefit (they may realize this now or earlier)

If the candidate opts to calculate the total operating costs for the various energy sources now,
they may do so (see end of Section I. for answers)

III. Total Benefit Calculation And Final Recommendation

Additional Information

Payment ID: 52775 (paigelinden15@aol.com)

Page 8
 Note for Interviewer

A good candidate will recognize that divestitures cost money. A large amount of time and
money goes into separating out two previously intertwined companies.

When prompted, you may inform the candidate that a divestiture of any of the business
units will cost $1.5B (one-off cost).

Solution

It should now be clear the CoalCo is the best target for sale and the candidate needs to clearly
state this. The candidate needs to be clear about the objective of the case, namely “to increase
free cash flow and cash reserves”.

A good candidate will look to calculate the NPV of the divestiture of CoalCo. This can be done
as follows:

NPV of Operating Costs

NPV of Operating Costs ($2.695B / 10%) + $8.5B - $1.5B = $33.95B

calculation
Hide
Recommendation:

A strong candidate will lead with the recommendation that we divest from CoalCo, noting that
this will bring us $33.95B in NPV in the form of $2.695 of free cash flow AND $7B cash
reserves.

Notable risks to consider include the following:

1. Loss of potential profits from continued operation of CoalCo

2. Loss of the largest part of our business (one third)
3. Difficulties in executing divestitures (IT, Staff, Legal, etc.)

Payment ID: 52775 (paigelinden15@aol.com)

Page 9
 4. Selling CoalCo at a markdown

A strong candidate would counter these risks by proposing the correlated next steps:

1. Further investigation into the Revenues earned by CoalCo to understand loss

2. Identification of exactly how the additional cash/cash flows will be used, with ultimate
evidence of higher returns than would have been achieved by keeping CoalCo
1. Investment into gas, wind, nuclear, etc.
2. Investment into additional projects/initiatives
3. Share buybacks/dividends
3. Due diligence into carve-out logistics to confirm $1.5B cost
4. Look for higher bidders

Payment ID: 52775 (paigelinden15@aol.com)

Page 10