Ratemaking Special Report
Return on Equity:
Fixing an appropriate rate of return on equity (ROE) for electric utility investors marks a fundamental...
Deregulation or Bust?
For better or worse, deregulation is now a factor in the electric utility industry. As a general proposition, deregulation makes for increased competition, which in turn will trim costs for consumers. Deregulation of the electric industry means that utilities face the prospect of freezing or reducing rates to retain market share. Stranded investments and the burdens of above-market supply contracts and construction and development contracts (especially nuclear-related contracts) will place additional pressure on these utilities and further reduce their revenue. Ultimately, these problems could hinder a utility's ability to service its debt, invest for the future, and provide a reasonable rate of return to investors.
Certain companies will be able to adapt to the changes and challenges of deregulation more quickly and adeptly than others. Weaker participants may restructure and emerge as powerful industry players, while others will fail and disappear. Some may succeed through simple expense reduction programs; others may require significant operational and/or balance-sheet restructuring (such as asset, debt, and equity writedowns).
Utility companies that are being smothered by their existing debt-service and dividend obligations are less likely to be able to meet the challenges of deregulation. Short-term solutions to liquidity problems, such as eliminating stock dividends or selling assets, may not solve the problem if revenues remain flat or fall. On the other hand, potential long-term solutions, such as attracting new equity or selling a division or business section, may not be feasible.
For at least some utilities, dramatic financial restructuring will be needed to reduce debt and preferred stock obligations. Traditionally, this has meant out-of-court workouts/exchange offers or Chapter 11. A third option that has emerged in the past few years (em the "prepackaged"
reorganization (em combines the best features of both alternatives.
The first choice for debt and preferred stock reduction, if feasible, is a fully consensual exchange outside of court. This type of restructuring, at first blush, appears particularly applicable to the electric utility industry, where ownership structures customarily involve bonds and preferred-stock capital. In a workout, the parties can achieve anything they can agree upon. This may include forgiving debt, in whole or in part; extending debt maturity dates; reducing interest rates; releasing liens; selling assets; converting debt to equity; and much more. In a bond exchange offer, bondholders may consensually exchange their existing bonds for others with new terms the company can satisfy and new values in conformity with the writedown of stranded investment or whatever else.
Workouts/exchange offers avoid the enormous expense, time, and diversion of management energies that often accompany a traditional Chapter 11 case. Additionally, they generally enable management to stay in place and in control of the restructuring process, an important factor when one considers the value that management continuity brings to a successful franchise in this industry. Finally, they avoid the stigma and related business deterioration that may occur in Chapter 11.
Workouts/exchange offers, however, are difficult to implement because they are binding only on bondholders that voluntarily exchange bonds and creditors that consent. Bondholders that choose not to exchange will retain their existing bonds unchanged and