Asset Sales Seen Hurting Energy Cos' Long-Term Cash Flow
By David Bogoslaw, Of DOW JONES NEWSWIRES
NEW YORK -(Dow Jones)- A year ago before the bottom fell out of the energy trading market, Enron Corp.'s "asset-light" business
strategy got a lot of hype as an alternative to holding a portfolio of owned and operated plants and pipelines. Now the model is
catching on with other major merchant energy firms, but for an entirely different reason: a desperate need of cash.
For overleveraged energy companies like Dynegy Inc. (NYSE:DYN - News)
and Williams Cos. (NYSE:WMB - News) , cash on hand may take priority
over growth, but the sacrifice of steady cash flow from high-quality assets is
likely to come back to bite them in the not-too-distant future.
The closing of two major natural gas pipeline sales over the weekend by Dynegy and Aquila Inc. (NYSE:ILA -
News) are two cases in point, distinguished only by degree of desperation. Dynegy, said last week in a 10-Q
filing that the only thing standing between it and bankruptcy was the success of its Northern Natural Gas
pipeline sale to MidAmerican Energy Holdings, a unit of Warren Buffett's Berkshire Hathaway (NYSE:BRKa -
News) . Downgraded to junk by Moody's Investors Service and Fitch Ratings earlier this summer, the Houston
company said goodbye to its investment grade rating from Standard & Poor's at the end of July.
Aquila, clinging by a thread to its investment grade, unloaded a major pipeline and natural gas processing
system in Texas and Oklahoma for $265 million in cash in preparation for meetings Tuesday with all three
leading ratings agencies.
But agencies are training their gazes on the more distant future, trying to imagine what ongoing cash flow from
operations for these companies will look like.
"We don't know how much income is going to be left as these assets are monetized," said Ellen Lapson, an analyst at Fitch Ratings.
Unfazed by the pipeline sale, Lapson reduced her ratings outlook on Aquila Monday to "negative" from "stable," though she left the rating itself at investment grade.
One-time plus or minus cash flow events such as asset sales are less important than a company's recurring earnings capability, she explained.
But according to Aquila spokesman Al Butkus, the natural gas assets netted next to nothing to cash flow from operations after maintenance costs of capital were
covered. Shedding those assets also removes the volatility associated with the price risk of natural gas liquids from Aquila's financial statements going forward, he
added.
And for all the $928 million in cash plus the unloading of $950 million in debt that the NNG sale garnered for Dynegy, the deal still translates into a loss of shareholder
equity, given the $1.5 billion Dynegy paid Enron for the pipeline in February, as well as the debt it assumed in the purchase.
Analyst Chris Ellinghaus at Williams Capital Equity Group estimated NNG's contribution to annual earnings at 10 to 15 cents per share, or about $90 million. Lower
earnings estimates make that a bigger percentage of Dynegy's total earnings than it would have been even a few weeks ago, he said.
Williams Seen In More Precarious Position Than Dynegy
To reduce its debt, CMS Energy Corp. (NYSE:CMS - News) is planning to sell the lucrative Panhandle and Trunkline businesses - pipelines and field services
purchased three years ago from Duke Energy (NYSE:DUK - News) - by the end of this year. Those operations are expected to contribute $250 million to $300 million
to the Dearborn, Mich., company's earnings in 2002.
Some analysts view the decision as prudent while others question CMS' earning power after divestiture.
Williams Cos. is another firm whose debt load necessitated a shift in thinking about how much of an asset-based business it could afford to be.
Three weeks ago, Williams was able to replenish its liquidity and skirt bankruptcy with somewhat smaller sacrifices than Dynegy. Rather than selling additional assets,
the Tulsa, Okla., company only had to post them as security for $2 billion in credit lines from Lehman Brothers (NYSE:LEH - News) and the same Berkshire
Hathaway that bailed Dynegy out.
But Williams has recently scattered other strategic gas assets to the wind. It sold businesses that owned the Mid-America and Seminole pipelines to Enterprise
Products Partners (NYSE:EPD - News) LLC, for $1.2 billion. It also gave up a Wyoming gas field to Encana Oil & Gas (USA) Inc. and other natural gas production
properties to Chesapeake Exploration Limited Partnership for $308 million in net proceeds.
However costly to future cash flow, the sale of valuable pipelines is unavoidable, said J. Michael Walker, president of ETRM Consulting. With no one interested in
buying power plants as long as electricity margins remain too low to both cover fuel costs and service debt on the plants, he said he saw no alternative but for
Williams to sell more of its pipelines.
A big chunk of Williams' business was basis swaps, where it made money on the price differential between the floating price of natural gas trading at the New York
Mercantile Exchange and fixed prices at particular transfer-point locations. But once its credit was called into question, many former trading partners stopped trading
with Williams, Walker said.
"The credit issue is adversely affecting Williams more than Dynegy, because Dynegy can go get physicals no matter what," he explained.
Dynegy's access to a virtually unlimited physical supply derives from its role as marketer of ChevronTexaco (NYSE:CVX - News) Corp.'s natural gas in the U.S.
ChevronTexaco owns a 26.5% stake in Dynegy.
"As long as Chevron stays with them, Dynegy will be fine," Walker said. "I don't think Chevron wants to make a new investment in a new gas marketing group and try
to bring that all back in-house, because that would be extremely difficult to do."
With revenues from its Illinois Power Co. utility and its gas-trading operations, Walker said Dynegy should be able to meet its debt obligations going forward.
Trading Model Led To Overvalued Assets
For Stuart Wagner, an analyst at Petrie Parkman & Co., the issue is less what companies are giving up by selling cash-generating assets than the extent to which
assets were overvalued when they were acquired over the last couple years.
Before Enron's implosion, the wholesale energy trading model promised great returns to companies that were able to enhance the value of power plants and pipelines
through creative trading strategies. Consequently, companies were willing to borrow extensively to acquire such assets.
"It allowed them pay a premium for the assets that wasn't supported by the intrinsic earning power of the assets," Wagner explained, adding that servicing debt caused
initial returns to drop below 10%.
But, as the merchant energy business came unwound, companies were stuck with only the intrinsic earning power of those assets.
Aquila's plan to exit the speculative trading business by the end of the third quarter makes it less important to hold onto natural gas assets once seen as integral to its
trading operations, said Craig Shere, an equities analyst at S& P.
As a result, he said he didn't believe Aquila's continuing cash flow would be much affected by the recent sale of a gas storage asset to Scottish Power (NYSE:SPI -
News) or Monday's sale of the Texas and Oklahoma pipeline and processing system.
El Paso Corp. (NYSE:EP - News) , which recently cut its trading staff in half, has a virtual insurance policy in its Transcon pipeline, a steady cash-producer that
services the Northeast U.S., the best market, according to Walker at ETRM Consulting.
"El Paso tended to focus on the end-use market more than anybody did," Walker said. "They have a lot of traditional local distribution companies (as customers) and
those people have tended to stay with them because they're shipping gas on the pipeline anyway."
Difficult as it may be to predict which energy traders will fold, most analysts agree that some degree of consolidation must take place in this shrunken market. And
while asset sales may stanch the cash bleeding for the time being, it's cash flow potential over the longer term that will determine the ultimate survivors. |
