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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
Fortnightly Magazine - March 15 2003

term. Nevertheless, progress is occurring. For example, ISO New England announced that its new SMD-based market would go live on March 1, 2003.

Ultimately, the SMD should increase trading volume and liquidity, giving merchant plants access to a more active marketplace, and thus firmer footing in the secondary asset market. Meanwhile, some merchants are finding more fertile trading ground in multilateral energy clearinghouses, such as NYMEX and the IntercontinentalExchange.

"A third-party clearinghouse function allows exposures to be mutualized across the market," says Kevin Howell, head of the trading group at Dominion Energy.

By spreading counterparty risks, clearinghouses reduce credit-clearing costs and facilitate greater liquidity in over-the-counter markets. Both FERC and the Committee of Chief Risk Officers (CCRO) recently have recognized the importance of this role. To the degree companies accept these clearinghouses as a place to hedge their risks, merchant power plants could become more saleable assets.

Securitize Those Assets!

As they weigh their least painful options for extracting cash from assets, companies are considering all manner of spin-off vehicles. One of the more interesting approaches might be the master limited partnership, a structure that petroleum and real estate companies have used to consolidate assets for tax purposes.

"MLPs have been effective for managing diverse oil and gas properties, so this may be a viable approach for managing electric properties," Zimmer says.

An MLP is essentially a subsidiary company that is established to own and manage a given set of assets. Plant owners "drop down" the assets into the MLP, whose securities can then be leveraged, sold, and traded.

This structure holds some promise for companies seeking to spin off power assets. A big attraction is that the general partner can continue controlling the assets with as little as a 1 percent ownership stake in the MLP. This means the asset owner can both liquidate assets and retain their strategic value.

Further, in some circumstances an MLP structure can bring higher prices by combining assets in strategic ways. "You can maximize the value of the asset if the cash flow is good, and if the market is putting more of a premium on net revenues than could otherwise be obtained in an asset sale," says Byron Egan, a partner with Jackson Walker LLP in Dallas. "You need certain operating synergies for it to make sense from a cost standpoint, but the assets don't have to be tied together."

Spin-offs like MLPs also could expand the universe of potential investors-a critical factor in today's tight capital markets.

"A lot of banks are reluctant to lend into this industry, regardless of the economics presented to them," says Kroll's Boken. "An MLP or equity-backed investment fund could be used to put banks in the position where they are not bearing the kinds of risks they have borne in the last few years."

Under New Management

Estimating the deal volume for assets entering the liquidation pipeline is difficult, given that many companies are not advertising the full extent of their sell-off aspirations. Rumors suggest that some major players have put their entire merchant fleets up for