[Response to Jim]
Jim -
It's great to get the views and insights of an oil insider. I am a long and am operating under the assumption that both Fitch and Moodys will downgrade.
That said, I am actually quite happy that they have initiated steps to sell their oil patch assets. It is somewhat unfortunate, but shows that they are thinking a few steps ahead should they be unable to increase the size of their corporate revolver. They said in their mother-of-a-conference call that it would take between 30-45 days to sell these assets to raise $2-2.5 billion based on today's gas prices. If they have already put together data rooms they could a few days into the process already (perhaps you can enlighten us on a typical time period to do this -- while I am in investment banking in a separate industry, the level of difficulty to put together a data room can vary significantly)
I believe they would show a loss on those assets but at the same time, they were bought to basically offset the gas needs in California whose power contracts were sold at the peak of the market. So even though they might have been disadvantageous from the perspective of your friends, since Calpine makes money on the spread, perhaps it was a highly advantageous transaction overall. Secondly, it's critical I think to realize that these losses, should they occur, are only paper losses - and that the cash is what you get out the other end (to stave off more critical short term issues).
Given that you are essentially raising the possibility of bankruptcy, I think it important to recognize what the a downgrade would mean. First off, Moodys only raised their ratings September 28th, 2001 to the lowest investment grade rating. S&P at the time only affirmed their rating (as they have done now with a stable outlook) at the highest junk status. So what would the impact be on Calpine?
Don't forget that these zero coupon bonds with puts in them are already trading at a significant discount (a la 20%+ to put date in April -- which is in the magnitude of basically 40 some odd percent if you annualize it).
There is empirical evidence (traders of bonds) that says Calpine is in the market looking to purchase additional converts. Calpine will in fact recognize an accounting gain which will help to offset the financial loss of selling the gas assets.
So forget about all the accounting for a moment, and let's look at the short term cash flow scenarios. The downgrade will serve to increase the cost on their construction revolver by 25 basis points (per mother-of-a-conference call... I have posted my notes on the call here).
The ratings downgrades killed ENE because they had provisions in their debt agreements that accelerated repayment schedules with cash they did not have. This is not the case for Calpine. The only thing that changes here will be incrementally higher interest costs.
For the next few months, much of the operating cash flows have already been locked in through perfect hedging. They still have capacity on their other revolvers and several hundred million in cash. But looking at the cash commitments of the company -- it is critical to recognize that the cash outlay is not mandatory but optional -- to finance the buildout of new plants. If they wanted to stop or push the buildout further out, the costs would be negligible while reducing short term cash needs.
If the math is done (see notes from the mother-of-a-conference call), Calpine has a significant margin to be able to complete their next phase of growth to 30,000 MW. At that point, they will have significant cash flows to complete the remainder of their build out.
The risk is not solvency, the risk at hand is the pace of growth. Then it becomes a question of valuation. Is Calpine worth this without the growth?
Here's the answer. Calpine has about $1.2 billion in 2002 hedged free cash flows. The market cap is $4.0 billion.
Hope that helps.
Clement |
