Dynegy also posted a wider second-quarter loss as lower power prices offset higher production.
Dynegy will receive just over $1 billion in cash in return for the power plants, allowing the independent power producer to pay some of its debt.
LS Power also will return 245 million of Dynegy's Class B shares received when the companies formed their venture. The firm's remaining 95 million Class B shares will become common shares, leaving LS Power with a 15 percent stake in Dynegy.
In addition, the private equity firm will receive Dynegy's remaining interest in a power plant under construction in Texas as part of the deal.
"It's not a huge win for Dynegy, but incrementally it helps near-term earnings on a per-share basis. It makes them pretty much immune from any default issues between now and 2013," said Tudor Pickering Holt analyst Brandon Blossman. "In exchange for that, they give up some upside potential post-2013."
In 2007, Dynegy gave LS Power a 40 percent stake in the company in return for Power's portfolio of 10 power plants. They also launched a development company together.
But independent power producers, which sell at competitive rates into the wholesale market, have struggled as the economic downturn saps demand for electricity. Dynegy shares lost about 80 percent of their value since the Power deal closed in 2007.
LS Power also gave up its opportunity to buy the rest of Dynegy, entering into a new agreement that restricts it from increasing its future ownership in Dynegy for a specified period. It also dropped its three seats on Dynegy's board.
The private equity firm is paying between 35 to 40 percent of what it would cost to build the plants it is buying, according to Tudor Pickering's Blossman.
"If you had a view that you were going to reach new-build economics four or five years down the road, then that's a nice return," Blossman said.
LS Power will also receive $235 million of Dynegy notes that are due in 2015.
Dynegy is selling five peaking power plants generally less efficient plants that only run at peak energy demand levels to LS Power, as well as three combined-cycle plants, which tend to be more efficient.
Dynegy Chief Executive Bruce Williamson said the company had improved itself through both LS Power deals by increasing its combined-cycle plants and limiting its exposure to so-called peakers.
"There's a vast world of difference in the earnings power of a combined cycle asset and a simple cycle peaking asset," Williamson said in an interview. "So we added seven combined cycle from LS and we're keeping five of them.... We are still very much keeping the higher earnings quality assets."
Dynegy posted a loss of $345 million, or 41 cents a share, for the second quarter, compared with a loss of $272 million, or 32 cents a share, in the year-earlier quarter.
Dynegy said it plans to cut costs by about $400 million to $450 million over the next four years.
It expects to take a restructuring charge of less than $5 million in the third quarter related to job cuts associated with the cost savings program.