EDF's offer appears to have a shot

Electricite de France's proposal to invest $4.5 billion in Constellation Energy Group's nuclear-generation business looks like it has a shot.

Since the state-owned French electricity giant pitched the deal last week, investors have bid Constellation stock as high as $29. That's a bet that a rival proposal from Warren Buffett for $26.50 won't go through or that Buffett will take it seriously enough to increase his offer.

Rating agencies have suggested that if Constellation shareholders reject Buffett's deal in favor of EDF, Constellation would have enough cash at hand to avoid bankruptcy court.

Most encouraging for the French, Constellation's board has agreed to speak with them. This is a bigger deal than it seems. Buffett's contract requires Constellation's directors to support his offer and avoid talks with rival bidders in all but a narrow set of circumstances, one of which is the arrival of a "superior proposal."

On Monday, Constellation said it would open talks, signaling that directors believe EDF's offer might indeed be better.

Now Constellation's board will have to macarena its way between its contractual obligation to Buffett and its legal duty to shareholders, who have been hammered by a 75 percent decline in Constellation stock. Whether it continues to recommend Buffett's deal or reverses itself, it could be trumped by Constellation shareholders, who vote on the transaction Dec. 23. (The Buffett buyout also requires state and federal approval.)

Hopes of a Buffett counteroffer helped prop up the stock. Yesterday, MidAmerican Energy Holdings, the Buffett-controlled company bidding for Constellation, repeated its vow to stand pat.

"We have a signed merger agreement with Constellation Energy, and we have no intention to alter that bid," said spokesman Mark Reinders.

Constellation stock popped on Monday's announcement but dropped back below $27 yesterday. It's still trading higher than before EDF announced its bid, however.

Constellation owns Baltimore Gas & Electric and is one of metropolitan Baltimore's biggest companies. Buffett has offered to buy the whole company for $4.7 billion. EDF has offered a nearly equal amount - $4.5 billion - for a half-interest in Constellation's nuclear energy business. Under the French bid, Constellation stock would continue trading.

Key to any decision by shareholders or the board is whether EDF could keep Constellation out of bankruptcy court if Buffett's offer is rejected. The threat of insolvency let Buffett swoop in with a lowball offer in mid-September in exchange for cash to keep Constellation afloat. High debt levels and the market meltdown made Constellation vulnerable to ratings downgrades and a date with a bankruptcy judge.

For EDF to play a similar role, it will need access to billions in cash, which is hard to come by in the worst financial crisis in decades. The company has said it will obtain the money "through corporate funds and credit facilities," but it has added little else.

But with $6 billion in cash on its books and $12 billion in cash flow for the first half of the 2009 fiscal year, you would assume EDF, the biggest nuclear-plant operator in Europe, has the wherewithal to do this deal. At least some analysts do.

"We strongly believe that existing shareholders should reject MidAmerican's offer" so Constellation can accept the French proposal, Macquarie Research wrote last week in a report to clients.

I've talked to other shareholders who feel the same way - despite the enormous consolation prize Buffett gets if they repel his offer. He receives over $500 million in cash plus 10 percent of Constellation's stock. (He was supposed to get 20 percent, but nobody expects regulators to allow such a big portion by Dec. 23. So instead he gets 10 percent in stock and the remainder in cash.)

Moody's has determined that Constellation "would likely maintain an investment-grade rating" if shareholders reject Buffett's offer and the EDF deal goes through.

The larger risk might be whether the Federal Energy Regulatory Commission and other regulators clear the way for a quick EDF transaction. People close to EDF say it won't be a problem. But ratings agency Fitch raised the possibility that a rejection of Buffett by shareholders might be followed by "failure of the EDF transaction due to some legal or regulatory impediment."

That could put Constellation back where it started, only with no lifelines.

These are the issues Constellation's board is presumably investigating.

Meanwhile, if Buffett won't raise his bid, his other option is suing Constellation, alleging that by speaking to the French, Constellation has violated the September buyout deal. Although the agreement allows Constellation's board to investigate a "superior proposal," the contract includes very precise language describing what that is. It's not obvious that EDF's bid meets the definition.

But litigation would probably only anger Constellation shareholders even more, without accomplishing much for MidAmerican.

After all, it's the shareholders who will decide this. Not Constellation's board. And shareholders seem to believe EDF is a player.