Raymond/Don:
I would not have wanted to be Calpine management today. I tried calling IR, and they were either on the phone or in meetings all day (there are apparently 3).
Anyway, as it pertains to Calpine, generally speaking I was impressed, but judge for yourselves. The replay call number (until December 21, 1-877-519-4471, code: 3012759). I feel that management is genuinely bewildered as to the comparisons between them and Enron as the only similarity, in their view, is their participation and as beneficiaries of the deregulated energy markets.
As an editorial note, I think that Calpine management was very responsive in organizing this conference call and they were also very professional in addressing the real points, overlooking the inferences made regarding their accountants and investment bankers, also overlooking the red herring inferences of Calpine's head trader who came from Enron.
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Here are my notes:
General & Strategy
Calpine was disappointed with the NYT article and feels any comparison between Calpine's and Enron's business models is "ridiculous." Enron is a trader in electricity and gas, whereas Calpine is an integrated power company -- building and operating a fleet of power plants, controlling gas assets, and distribution to wholesale clients. For instance, this year alone, they will double their generating capacity.
They do not take speculative trading positions. Calpine's traders only trade around their production assets -- but for accounting reasons, the contracts must be accounted for using FAS 133 (hedge accounting).
The goal is to sell 2/3 of capacity through long term contracts.
Exposure to Enron
The article infers that Calpine's recent PR efforts distancing themselves from Enron are a matter of convenience, that they "emulated Enron's business model" when Enron was successful but are now, given their liquidity problems, are distancing themselves from Enron. Calpine's position is not a matter of convenience. It is a matter of fact. Calpine owns all their production facilities and trades on that production, taking no speculative positions.
While the article says that it does not "appear" that Calpine has any of the off-balance sheet partnerships that contributed to the breakdown of confidence from the capital markets, Calpine emphasized unequivocally that it has no such partnership.
Calpine went on to state that they have no exposure to Enron because of their netting agreement as earlier disclosed.
With respect to trading activities, the article claims that Enron accounted for 23% of revenues, and trading accounted for 10% of profits. This is true but only insofar as it relates to the maximization of the assets that they owned. They were selling what they had; maximizing the spot spread, versus profiting from speculation. That Enron has failed will likely have little to no effect as Calpine has long been trying to sell directly to the wholesale distributor -- versus through Enron's trading house.
It's like being a farmer having a bunch of corn to sell on the market, and you sell all your goods to a broker, who then sells to the grocer. If the broker goes bankrupt, it doesn't mean that you have lost your market for your corn as the grocer would find some other way to get to the farmer.
The analogous comparison that Gretchen would have made here, is to say that the farmer is just like a commodities speculator.
Falling Energy Spot Prices
Calpine's management views this to be a red herring. This is what is supposed to happen in energy markets. Deregulation should make prices go down. The point being that Calpine makes money based on the spread and that Calpine is most efficient in that field.
ie - although the prices have gone down, the _cost_ of generation has also gone down -- arguably faster -- which is Calpine's business model.
Accounting issues regarding Hedging Activities
Here I think Gretchen borders on being libelous. She infers that the accounting treatment is being deliberately used to mislead the readers.
The article states that 10% of net profit is from trading activities and that accounting statements are so complex as to be unfathomable, and that hedging activities have only produced losses on the balance sheet (while showing only profits on the income statement).
Calpine energy services only tries to maximize prices on the spot market and through long term contracts with load serving entities (e.g. municipalities, cooperatives, etc.) on a direct basis, ie cutting out middle man.
Majority of transactions with Enron were short term (<1 year), because most of focus was on load serving entities for reducing long term risk. Average price was higher for short term versus long term. This is not specific to Enron -- this is specific to the duration of the contract. Calpine sold to Enron because they were the most active in the market. This is a commodity market, if Enron had not existed, they would have sold to others for the same _market_ price.
With respect to accounting, FAS 133 specifies the type of accounting to use -- this is not "a choice" as was suggested by the article. The criticism was that there were certain items that are considered hedges (flowing through balance sheet using mark-to-market) and certain items that are considered income (flowing through income statement).
All long term power sales are considered normal for accounting purposes. So they flow through on an accrual basis on income statement when power is delivered. When fixed priced power is sold, the fixed price gas is also locked in at the same time (hence the term "locking in spot spreads") -- this is a hedge under FAS 133. Gas hedges are mark to marketed.
Since the majority of gas contracts and fixed price power sales, both commodities have dropped in price -- which is why there is a negative mark to market on the balance sheet. Positive amounts are not included. (If my FAS 133 memory serves, you always mark down, never mark up -- assets are at the lower of cost or market; liabilities should always be shown at the full value.) If the value of the power contracts were allowed to be marked up, there would be billions in additional value.
Liquidity & Captalization Issues:
The article states that the company has $10 billion in debt. What the article does not state is that the company also has $20 billion in assets of the lowest cost operating fleet which is the most diversified across the US. The target debt/capitalization is 65%, and the current ratio is 66% -- on target.
With respect to cash flow coverage -- ie the ability to service that debt, EBITDA/interest is 6.8 times -- ie they had cash flow of 6.8 times their interest charges. Original financial model calls for EBITDA/interest of 3.5 times. The reason why it is so high, is because of the prices that the trading division was able to lock in (ie higher spreads). The bonds are also rated investment grade by Moody's and BB+ by S&P.
They like to have at least 2:1 coverage in predictable contracts coming in (ie 66% in long term contracts which are fully hedged). On existing megawatt base (12,000 MW), this value of the already hedged cash flows is worth $13 billion with a capital base of $5 billion -- ie NPV 13B. The next 17,000 MW will require $3 billion in debt.
Noteworthy is that the existing locked in cash flows, (ie the $13 billion), would cover all the debt of the company -- existing debt _plus_ construction debt.
With respect to the "deep support required" in capital markets, Calpine states that it is a capital intensive business. It costs $550/KW for each power plant. Today there are 17,000 MW in construction ($9.5 billion to complete program, $7 billion which has already been spent). There will need to be another $2.5 billion in capital.
Calpine has a $3.5 billion revolver, of which $2.5 has been used -- ie $1 billion remaining, $750 million in cash, $400 million cash revolver (not currently used) -- in the process of being increased to $1.5 billion dollars (which should close January 4th, and is "right on schedule"). In addition, EBITDA is $1.7 billion and next year is $2.3 billion. There is free cash of over $100 million a month (over $1.2 billion a year).
Ergo -- adding that up, there is $4.45 billion available -- Calpine would not have to go back to the capital markets. Calpine may have to go back to the capital markets for the zero coupon.
Internally, one of the targets, is that they do not want to have more than 10-15% of capitalization maturing in any one year. This is $1 billion against debt of $10 -- which is within the range of policy. Would be refinanced, through Medium term note, or not market, etc. -- whatever is the lowest cost at the time. It is investment grade -- so it is likely refinanceable.
Summary
Calpine is building portfolio of best plants possible to build. Working life is 40+ years. "America needs this power". Reliable source of low cost non polluting power. Any comparison between the two models of Calpine and Enron is ridiculous. |
