[BETA] Fortnightly

A new report from Moody's Investors Service finds that foreign investments often offer U.S. electric utility shareholders the prospect of higher returns, but hold little immediate upside benefits for bondholders.

The report, Some Investments Riskier Than Others in Wave of Overseas Expansion by U.S. Electric Utilities, finds that for bondholders, such investments detract from alternative uses of free cash flow. The bondholder could apply the invested money to debt service or repayment, or growing retained earnings to offset potential write-offs of stranded investment. The bonds also expose the company and its debtholders to the risk of the target company and to the political and economic risk of the countries in which the companies operate.

Companies investing overseas typically either buy an entire company or build a diversified portfolio of investments in which ownership tends to be less than 50 percent. Containing the risk of such investments most easily is achieved through nonrecourse debt or project financing. Moody's generally views such tools as the least risky alternative for financing an acquisition. But in many foreign acquisitions, such financial obligations may be truly nonrecourse in name only.

Moody's believes that in case of a problem overseas, the parent would be unlikely to walk away from a high-profile investment. For example, Virginia Power pledged to its regulators that customers would not suffer ill effects from acquisitions in the U.K. by parent company Dominion Resources. However, Moody's said customers would be hurt if bond ratings deteriorated due to the acquisition. Debt would become more expensive and a rate increase would be needed to pay for it.

Moody's said, "We might agree that the regulatory compact indirectly protects bondholders by protecting customers." But if a debacle occurs overseas, Moody's said that Dominion Resources would have no choice but to involve Virginia Power liquidity.

Moody's pointed out a downgrade of an acquirer or a target is not necessarily a penalty. Some companies have decided that a lower credit rating is an acceptable tradeoff to meet today's competitive pressures.

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