In union circles, they call it "burial insurance." That apt phrase denotes the severance, early retirement and re-training packages negotiated for veteran utility workers sideswiped by a changing...
Utility Valuation: Shedding Light on the Black Box
much different than Enron's in terms of assets, organizational structure, and culture. Energy merchants and traders like Aquila and NRG decided they were better off having the considerable balance sheets of their former parents and carved themselves back in due to credit concerns prompted by the Enron misadventure.
This has put the industry back to square one, introducing once again the problem that bankers first unearthed in early 2000: How do you evaluate these diversified structures? The current situation has prompted calls by many in the industry for utilities and analysts to work on a new framework for reporting and analyzing energy companies-to shed light on the black box, as it were. But to date, both the industry and the financial community seem to be struggling for a common evaluation language.
Building the Better Valuation Model: Making Sense of the Noise
Dr. J. Robert Malko, a certified rate of return analyst (CRRA) and professor of finance at Utah State University College of Business, says there has been a shift in recent years in the way energy companies are valued.
"Under traditional rate-based regulation, a lot of emphasis was on historic cost. With [electric] restructuring and more sales, there is a logical shift to looking at an income approach. And in theory, the income approach is the theoretical correct approach to value a property. What are the expected cash flows the company is going to generate?" he asks.
Malko says that relative emphasis, or weighting, must be determined in evaluating companies when using the indicators of cost, income, and markets (known as the comparable sales approach). Certainly, there is still debate over how much emphasis to put on the indicators, but the overall weighting has shifted to analyzing cash flows.
For example, he says, in terms of looking at a company's costs, you have the choice of using historic, replacement costs, or a trend in historic cost. When calculating income in estimating the future cash flows, the challenge is calculating the appropriate discount rate and then looking at comparables.
"Once a parent holding company goes into a wide range of business activities and has a wide-range of subsidiaries, the measurement of risk on the parent is certainly more complex than if you turn the clock back and have a more traditional integrated public utility. The complexity and the type of diversification activities clearly changes the risk profile," Malko says. In terms of measuring of risk, if you look at the beta values (coefficient measuring a stock's relative volatility) on the pure non-regulated generation companies, they have higher beta values than the traditional regulated companies.
Malko believes it is important that a comprehensive assessment of business risk be made in addition to financial risk in the industry.-business risk in term of the variability of earnings before interest, taxes, depreciation, and amortization (EBITDA).
EBITDA can be used to analyze the profitability between companies and industries because it eliminates the effects of financing and accounting decisions. A common misconception is that EBITDA represents cash earnings. EBITDA is a good metric to evaluate profitability, but not cash