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The Merchant Asset Fire Sale: Deal of the 21st Century?
Companies that were on a buying spree before 2001 are putting assets worth billions n the block
A casual observer might expect that the industry's economic condition would produce a cornucopia of cheap assets for acquisitive companies . Eventually it might, but so far, it generally has not.
"Many investors enter this market with the impression that because the industry is in trouble, you will be able to buy assets at low prices," says Jeff Bodington, president of Bodington & Co. in San Francisco. "That may be true in some situations, but if you want to get good assets you still have to pay top dollar."
In 2002 and into the first quarter of 2003, prices have remained strong for high-quality assets-those with firm, long-term agreements and solid operational characteristics . The reason? A "classic flight-to-quality market," according to Bodington.
First, investors are eager to acquire high-quality assets, so demand is strong. At the same time, investors are shunning projects that lack long-term contracts, or those with operational problems.
Second, companies (and their creditors) are understandably reluctant to part with their strongest assets, but they are eager to dump those considered, in PR lingo, "non-core" or "non-strategic." Indeed, many companies are banking on their ability to sell those assets. As a result, the number of strong assets on the market has been limited, and the number of weak ones is growing by the day.
This supply/demand combination is keeping prices buoyant for contract-secured assets. Others, however, are not yielding their book value or their original cost.
Merchant plants, as a class, are suffering the worst devaluation in the secondary market, mainly because of exposure to three huge risk factors: anemic power markets, rising fuel prices, and persistent regulatory uncertainty.
In some cases, developers have cut their losses and withdrawn from plants that were under construction. NRG Energy, for example, pulled out of the 1,168-MW Pike project after it was 20 percent built, leaving more than $100 million behind. NRG and other companies have been forced to absorb losses on operating assets as well. But in most cases, where facilities are producing cash flow, their owners have resisted pressure to sell at a steep discount.
"The companies that own these assets don't yet face severe enough liquidity pressures to drop prices," Bodington says.
In some corners of the industry, the hardships of 2002 foretell fire sales in 2003.
"The initial array of bankruptcy filings that we have seen is the first phase," says Michael Zimmer, a partner with Baker & McKenzie in Washington, D.C. "It's possible there will be a phase two of bankruptcies in the next 12 to 18 months. It is the logical outcome of the inability to sell or restructure."
Others echo these sentiments, but positive trends are evident as well.
First, some merchant power plants might be transformed into contract-supported facilities. Utilities that are seeking low-cost, medium- and long-term power supplies see such contracts as a way to get price security in illiquid and volatile wholesale power markets.
Second, liquidity and stability might begin returning to the wholesale electricity