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Reign of the Bond Kings

S&P, Moody's, and Fitch tell why credit issues now rule the energy sector.
Fortnightly Magazine - October 15 2002

new value emphasis carries its own unique risk.

"It is a bit of a worry," McGinnis notes, "because they will embed in their own forward model a fair value notion which may not be as attractive as what a yield-based investor might expect, or what an income-plus growth investor might expect."

The Next Merger Deal?

Investment bankers live and breathe mergers and acquisitions. So Schreiber says merchant energy firms should consider buying a regulated cash cow, as Dynegy did when it bought Illinova.

Utilities, too, might look for safety in a merger partner.

"You'll see companies like Conectiv and PEPCO merging delivery companies. But they might be interested in somebody like ConEd, which has sold off all of its generation," explains Schreiber. "Then you could match up two basically urban utilities where management is comfortable managing the delivery of power into an urban area, and there are economies of scale to be achieved there."

Schreiber adds that international companies like E.ON, who wants to get into the market, may want to build off its LG&E acquisition.

With the strength of their capital structure, a foreign acquirer could bring instant credibility in the market, and the industry would be comfortable trading and doing business with them.

"There is a wide range of activity swirling around the market. Successfully completing transactions will depend on the values of the assets, the regulatory construct and, in the case of international players, the value of the dollar," he says.

Conversely, Lazard's Bilicic believes that energy merchants should, if they can, tough out the down cycle and wait for at least some recovery before thinking about a merger, so they don't have to deal from a position of weakness.

"If you look at generation assets, they have a historically low value now because of power price expectations. While it doesn't look particularly good right now, the value of many of these assets should recover as power price expectations improve, and so should their liquidity problems," he says.

McGinnis says Morgan is thinking about merger deals that focus on financial stability and investor confidence.

"We are looking" he explains, "at mergers of company-to-company or the purchase of the assets of other companies." All are driven by the desire to get bigger and gain competitive attributes, such as size, financial strength, and the trust of investors. "If you have those things," McGinnis says, "you are going to be in a good position in the next five years."


True Believer

Reliant Resources sticks to its guns.

The plan to take the unregulated merchant energy trading business from Reliant Energy and tie it with 1.7 million formerly regulated retail customers of the old Houston Lighting & Power under the new nameplate of Reliant Resources seemed like a good idea.

Especially two years ago, when merchant energy was hot.

That would give Reliant's merchant arm a built-in customer base-a different model from other merchant firms, whose fortunes are solely tied to wholesale markets. It would position Reliant both upstream and downstream-like ExxonMobil, which counts on retail gasoline outlets to weather those sharp