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Corporate Unbundling: Are We Ready Yet? A Bondholder's Primer

Fortnightly Magazine - June 1 1996

need a lot more equity in its capital structure than the traditional, vertically integrated electric utility. He noted last year that the electric industry's debt ratio reached 52 percent in 1994: "Debt leverage in the 52-percent vicinity will prove too high in a completely deregulated environment.7

In January, Central Maine Power Co. endorsed corporate unbundling in its initial comments filed in with the state commission on electric utility restructuring:

"CMP is prepared to pursue a complete, 'legal' separation of the generating assets, contracts, and obligations from transmission and distribution assets and obligations. We believe that the most efficient manner of achieving this separation in our case is to divide the company into two separate entities, distributing shares of the newly formed T&D company to our stockholders."8

David Falck notes: "To my knowledge, it's the only formal proposal so far by a utility." t

Bruce W. Radford is editor of PUBLIC UTILITIES FORTNIGHTLY.

The Obstacle Course

On March 19, Pacific Gas & Electric Co. and Southern California Edison Co. each filed separate comments with the CPUC showing how a voluntary divestiture of generating plants or a corporate breakup into separate subsidiaries might play out at each individual utility.

Here's a brief look at just a few of the hurdles cited by Edison:

. Vertical is Better. "Business units are a better alternative than separate subsidiaries." Staying integrated, says Edison, "requires fewer approvals, and is more flexible and less costly."

. If Breakup Occurs. Holding company would sell generation and transmission assets to two new subsidiaries, a GenCo and a TransCo; Edison would remain as the DisCo-distribution only.

. The Cost. The price tag to break up vertical integration "could exceed" $500 million: $245 million in one-time initial costs, and $150 to $350 million annually.

. Trust indenture. Lien dates from 1923, secures approximately $3.7 billion in outstanding bonds. Does not provide for early defeasance of bonds, unless bonds are callable by their terms. Forbids release of the mortgaged property as "an entirety." Amendments require OK by bondholders (80 percent of outstanding principal).

. Escaping the Lien. Release generation and transmission assets from lien; sell to new GenCo and TransCo subsidiaries; deposit cash with trustee to replace mortgage; withdraw excess cash, but only to extent that property still subject to lien exceeds 150 percent of bonds outstanding (condition implies a 66-percent bonding ratio).

. Capital Structure. Edison claims weighted cost of capital of separate subsidiaries exceeds current cost for integrated company by $100 to $300 million annually, for both debt and equity.

. Bond Retirements. Rebalancing capital structure would force bond retirements, but many bonds were issued with call restrictions-some not callable until after 2004-while callable bonds require redemption premiums above principal amount.

. Bondholder OKs. Would involve "inducements" to obtain 80-percent consent (see "Indenture," above).

. Shareholder OKs. Preferred stockholders ($560 million), according to Edison, "would have little reason to consent" to reorganization without "additional consideration," such as a tender offer tied to a consent solicitation, a special dividend, or an exchange of new, higher-yielding securities for existing stock.

. Agency Approvals. Would