By Avi Salzman

Nuclear power is the hottest area in energy investing today. So when news broke Wednesday that Constellation Energy, the country's largest operator of nuclear plants, might buy natural-gas power plant owner Calpine, Constellation's stock fell. Why buy hamburger when you've got prime rib at home?

Investors needn't worry.

Nuclear power is a great business to be in. The reactors don't generate carbon emissions, and they can run 24/7, unlike most renewable generation. That makes them very appealing to tech companies that want clean power to run their big new artificial-intelligence data centers. The big problem, though, is it's going to take at least a decade for a significant amount of new nuclear generation to start up. Natural gas, which accounts for about 43% of U.S. power -- more than any other source -- will have to fill much of the gap until then.

Constellation is said to be willing to pay $30 billion for Calpine, which is privately held. The stock reacted to the news by dropping about 5%, because the company would probably have to issue new stock to pay for the deal, diluting existing shareholders.

But Constellation stock looks more like a buy than a sell here. A deal for Calpine, which owns more than 50 natural-gas power plants and the nation's largest geothermal energy fleet, would vastly expand its asset base to growing markets like Texas and California, and help it tap into surging demand for all sorts of power sources, including natural gas. More consolidation in power markets would invariably benefit big players like Constellation, because they own a scarce asset that's in ever-higher demand: electricity.

This deal is notable because Constellation is a savvy operator, says Andy DeVries, an analyst at CreditSights covering power and utilities. "This isn't some 32-year-old Wharton M.B.A." pitching an acquisition that looks good on paper, he said. "This is the polar opposite. Constellation has been talking to every Big Tech company. These people have such deep insight."

Constellation also looks like it's paying a reasonable price, assuming the deal closes around $30 billion. That amount, which includes debt, values Calpine at about nine times its earnings before interest, taxes, depreciation, and amortization, or Ebitda -- below competitor Vistra at 10 times, according to DeVries. Both Constellation and Calpine are independent power producers, not regulated utilities. They own power plants and sell the power to utilities and corporations at market prices. That allows them to profit when power prices rise because of new demand or other factors.

Being independent also allows them to sign unique deals with electricity buyers that are willing to pay above-market rates. Constellation made one such deal with Microsoft last year to buy all the power from a recommissioned Three Mile Island nuclear plant in Pennsylvania for its data centers, and another this year to supply government buildings.

Constellation stock has doubled over the past year as power prices have risen and tech companies have paid up for electricity. There's reason to believe the trend is just getting started. Data centers could account for as much as 12% of total U.S. electricity demand by 2028, up from 4.4% in 2023, according to one recent study supported by the Department of Energy.

At a recent $243 per share, Constellation trades at about 15 times its enterprise value to Ebitda, because of the premium value placed on nuclear generation. Morgan Stanley has a price target of $321 on the stock, with more than 40% of the value coming from special deals with Big Tech players and other electricity users.

Constellation's 21 nuclear reactors will still be its most valuable assets even if it buys Calpine. But the company is betting that data-center owners will be hungry for all sorts of power -- and their first call when they need it will be to Constellation. Investors should line up too.

Write to Avi Salzman at avi.salzman@barrons.com

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January 10, 2025 02:00 ET (07:00 GMT)

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