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Why Aren't Distressed Assets Selling

'First movers' will be positioned to extract the most value from the acquisition of generation infrastructure.
Fortnightly Magazine - May 15 2003

of the industry as a whole.

When Will a Round of Selling Occur?

The first step to a significant round of asset sales is when lenders transfer asset control to well-seasoned workout specialists. These workout specialists, although not power industry experts, have weathered the demise of the financial, healthcare, dot-com, and technology industries. Extremely capable individuals, aided by energy and bankruptcy experts, are forming steering committees to analyze and extract all current tangible value from the distressed electric generation assets. While this takes time, several companies have been unable to restructure their debt and may soon be forced to sell.

Secondly, a new group of players is forming to acquire assets. Since depressed industry fundamentals, poor short-term liquidity, and the lack of access to equity and capital markets have impacted virtually all of the players connected to the U.S. merchant market, the companies most knowledgeable of the market and, to some extent, most bullish on future prospects are not capable of buying these distressed assets. Consequently, new equity is entering the market. This equity is split among traditional private strategic equity and equity funds, including hedge funds chasing outsized returns. However, each of these participants faces challenges in allocating their capital to the industry.

The problems with these entrants are:

  • Lack of market knowledge that contributes to a conservative approach to asset valuation;
  • Lack of management capability that makes them hesitant to buy single assets without a supporting management structure; and
  • Inability of capital alone to solve or halt the slide in asset values.

Traditional utilities could fill the distressed asset gap and create significant value in the process. They have the market knowledge, the management capability, and the capital to find value in this market if they are willing to consider both acquisition and options that assist lenders and IPPs.

Lender credit committees are waiting to see if market prices recover. Hedge fund managers are waiting to see if prices drop further. Utilities are exercising market power and taking advantage of transmission constraints, e.g., call option prices at the marginal cost of generation. The big question is who will sell or buy first.

Creating Value in the Current Market

The current depressed market for power generation offers unprecedented value creation and risk mitigation opportunities for utilities seeking to acquire capacity or contracted power supply. Utilities have emerged as among the best positioned to take advantage of the current overbuild, financial crisis, and regulatory uncertainty plaguing the merchant power community. Utilities are in a position to acquire assets at relatively low prices and to potentially embed them in their rate base or, at a minimum, to leverage their load resources and credit rating to obtain preferred financing terms.

At one extreme are utilities that find themselves short on economic generation, with both outstanding load obligations and a regulatory framework intended to maintain or extend their service obligations. Utilities in this class will be best positioned to enhance their generation supply portfolio by taking action to purchase or contract for term generation capacity from among the pool of distressed assets. This is particularly