Calpine HISTORY (fall of 2001): Moody's upgrade
I particularly liked, "Calpine has reduced its exposure to merchant risk to the extent that the company could not sell any of its merchant power for the next five years****Winkman note:(apparently referring to the unhedged 35%)**** and still maintain debt coverage ratios in the range of 1.3- to 1.7-times."
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Moody's rates Calpine investment grade
Calpine Corp., San Jose, Calif., has moved firmly into the ranks of investment grade companies with an upgrade from Moody's Investors Service. The action could be seen as a shift for Calpine, from a fast-growing, high-flying stock company to a mature company more concerned with its debt profile.
Officially, Calpine says that such a shift is not under way. "We have maintained a 65:35 debt-to-equity ratio for quite some time," says Rick Barraza, Calpine's vice president of investor relations. But company officials also concede that Calpine does not intend to go back to the equity market for at least another year.
As Susan Abbott, managing director of corporate finance for Moody's, points out, "There is a fundamental tension between equity and debt." The crux of the matter is that Calpine will have to maintain a balanced debt structure "even if that means that the pace of growth that they have promised to the equity market may have to be stretched out," says Abbott, who adds that Moody's believes that maintaining an investment grade rating is "important enough to them to do those things."
Calpine had been ranked investment grade by Fitch, but the other two major debt ratings services--Standard & Poor's and Moody's--had held out in granting Calpine investment-grade status. But in early October Moody's upgraded Calpine's senior unsecured debt to Baa3 from Ba1. On the same day, S&P affirmed its rating on Calpine at BB+, one tick below investment grade. The Moody's upgrade was precipitated by Calpine's plans to issue debt securities amounting to $2-billion denominated in U.S. dollars, Canadian dollars, British pounds.
Analysts say that by issuing bonds denominated in Canadian dollars, Calpine will benefit from a double tax benefit by being able to deduct interest expense in Canada and in the U.S. They add that by simultaneously issuing in three currencies the firm would be able to force down prices by fostering competition. Calpine says that the timing of the bond issues was precipitated by the fact that several short-term debt instruments were coming due in the fourth quarter. All but about $300-million of the proceeds from the planned issues will be used to repay debt or pay for recent acquisitions.
The debt issue also represents another step away from project financing and toward corporate financing. Barraza says that Calpine began that evolution six or seven years ago. "It gives us maximum flexibility to create value, not just to cover interest payments the way banks want us to."
"The company clearly wants to finance on a corporate basis," adds Moody's Abbott, who notes that, with a couple of exceptions, the company has gotten rid of all its project financings and replaced them with corporate financings. Some of Calpine's recent projects were financed using a lease-back structure, but "we believe they will continue to do leasing," comments Abbott, "but will do corporate leasings from now on."
"Calpine is trying to finance itself as an old fashioned company," says Andy Jacobyansky, vice president and senior credit officer with Moody's. "You don't find a lot of smoke and mirrors. Over the years, they have moved to become a blunt company, from a financing point of view."
However, Jacobyansky's view is not shared by Peter Rigby, one of the S&P analysts who affirmed Calpine's below-investment-grade rating. The main points of contention between the analysts seem to be Calpine's aggressive expansion plans and its resulting exposure to merchant plant offtake risk in volatile markets.
At the heart of the issue are Calpine's stated plans to grow its portfolio to 70,000 MW by 2005. The company has about 10,000 MW in operation and 16,000 MW under construction, and 15,500 MW in development. "We have no doubt they can build 30 power plants, but if markets collapse they are going to keep building. In the past, when markets went bad, utilities stopped building. These guys don't plan to."
The rationale, according to Rigby is that Calpine believes "they are building the cheapest power plants. But anyone who has 75% leverage does not necessarily have the cheapest power plants. They may have the cheapest operating costs, but they may not have the cheapest company in terms of fixed costs. You've got to cover those costs too." One of S&P's concerns is that, to finance its plants in construction, Calpine will have to add an additional $2.8-billion in debt in 2002 and may have to refinance $850-million in convertible, zero coupon debt. In April, Calpine sold $800-million of zero coupon convertible debentures due 2021 in a private placement. That was followed by a second issue of zero coupon convertible debentures due 2021.
Rigby is also concerned about Calpine's exposure to some risky markets, particularly California. About 25% of their cash flow is exposed to the California market, in particular the California Dept. of Water Resources, says Rigby, who notes that the California Public Utilities Commission recently told the DWR that they are not going to get a tariff increase. "Those contacts are hedged, including DWR," counters Moody's Jacobyansky. Nevertheless, he ceded that "over time, they may have to do something about those contracts."
Moody's is not blind to Calpine's exposure to other potentially risky markets, such as Texas, which could be facing an excess of generation capacity in the coming years. Abbott admits that there will very likely be a boom-bust cycle in power project development, "but we factor that into our analysis."
"Calpine has the liquidity to get through the cycle," adds Jacobyansky, who estimates that the company will have a before-tax cash flow of $1.6 billion a year on average for the next five years. In addition, he says, "the more their portfolio grows, the better the coverage ratios look. We based the rating on stuff you can knock your knuckles on, about 25,000 MW, but to the extent the portfolio grows out to 70,000 MW, ratios look better."
In some instances, the analysts appear to be seeing the reverse or mirror image of the same issues. S&P believes that one-third of Calpine's portfolio will be exposed to merchant risk as power-offtake contracts come up for renegotiation. Jacobyansky says that Calpine has reduced its exposure to merchant risk to the extent that the company could not sell any of its merchant power for the next five years and still maintain debt coverage ratios in the range of 1.3- to 1.7-times.
S&P believes that Calpine's preference of taking full responsibility for construction of its own projects exposes it to delays and cost overruns and denies it the benefits of liquidated damages that would be available if it used a third-party EPC firm. But Jacobyansky claims that Calpine's permanent construction team "gives them a lot of advantages their competitors do not have." Among those advantages, as Jacobyansky sees them, are the ability to "commoditize" construction by using the same or similar technology over and over again and the fact that Calpine staff is able to "cost out a plant on a detailed basis."
S&P and Moody's do see some points in common. Both agree that Calpine has been able to build a strong trading and marketing organization over the last year. And both ratings agencies credit Calpine with a strong, broad, and deep management team.
The main risk, from Moody's point of view, is "whether or not the equity market will hold sway over the company," says Abbott. Calpine will need to balance its need to grow against a need to maintain a "certain financial profile," she explains. Among the factors that could keep Calpine on the straight and narrow, according to Abbott, is the fact that an investment-grade rating allows Calpine access to cheaper financing. In addition, investment-grade companies also enjoy an advantage when signing power marketing and gas supply contracts with third-party providers. "Many marketers will trade with non-investment grade firms, but they require guarantees," says Abbott. "Investment grade companies have a lot freer access to the market and less onerous requirements to do business, usually at multiples of what they will do with non-investment grade company."
The other longer-term risk is how Calpine will maintain its growth record. The company has grown rapidly since it was founded in 1984, especially over the past three or four years. It only had a little over 8,000 MW in operation and under construction in 1999. The biggest risk for Calpine could be where to find future growth. Unlike most other private power companies, Calpine has concentrated the U.S. and did not, until its recent Saltend plant purchase, pursue overseas projects. To maintain its growth record, Calpine has said that it will look for new opportunities in deregulated markets in Europe, specifically, the U.K., Italy, and Spain. Calpine officials have said that they hope to achieve market penetration of 10% in those countries.
"If they were at 70,000 MW by 2005, they would be using up those countries at a quick pace," says Jacobyansky, who adds a final cautionary note: "I am not sure how much they can grow internationally and maintain their standards."
--Peter Maloney, Chief Editor, Platts Global Power Report |
