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I am forwarding some Wall Street comments from Kathryn Corbally related to
the Transmission buyout. Looks like they view it as very favorable - not a major hit against EPS tied to full recovery of remaining undercollection. Not sure yet if they incorporate the going forward - maybe SCE doesn't want any merchant obligations? Jim ----- Forwarded by James D Steffes/NA/Enron on 02/27/2001 08:18 AM ----- Kathryn Corbally 02/26/2001 04:47 PM To: James D Steffes/NA/Enron@Enron cc: Subject: CaliforniA Jim, Have sent you three notes that show some level of support to activity in California - its probably a little bias since there are a few reports out there that say quote the 'devil is in the details' and quote 'the odds of bankruptcty remain in the 50% range.' Note1 09:42am EST 26-Feb-01 ABN AMRO Inc. (Ford,Daniel F. 212/258-1548) CPN DYN EIX One Down Two to Go One Down Two to Go ABN AMRO -- Research Notes Subject: Power Companies Mentioned: CPN, DYN#, EIX, PCG, SRE Analyst: Daniel F. Ford, CFA 212/258-1548 Po Cheng, CFA 212/258-1709 ============================================================================== = Date: February 26, 2001 ------------------------------------------------------------------------------ - Highlights: - On Friday (2/23), Governor Davis triumphantly announced that the State of California and Edison International had reached an agreement in principle for the sale of its electric transmission system as part of a financial recovery package. He also commented that "good progress" was made with Sempra Energy and "some progress" with PG&E Corp. - The preliminary terms of the agreement call for the State to buy Edison's transmission system for approximately $2.76 billion (2.3x estimated book value) and allow for the securitization of "a substantial portion of its undercollection". - In exchange, Edison would: 1) make payments of approximately $420 million to its utility subsidiary, Southern California Edison; 2) commit the entire output of an Edison Mission project at cost-based rates for 10 years; 3) provide cost-based rates from native generation for another 10 years; 4) give conservation easements on 20,000 acreas of watershed lands for 99 years; and 5) drop a pending lawsuit against the California Public Utilities Commission. - We view this agreement as a positive development. Based on the 2.3x purchase price, the EPS hit from the loss of the transmission lines would be approximately $0.10 lower than our worst case estimate (at 1.5x) of $1.90 . The agreement, however, is not final and additional details need to be worked out before being submitted to the legislature. - Events to watch over the next couple of weeks include: 1) a definitive agreement with Edison; 2) deals with PG&E Corp. and Sempra Energy; 3) a package that the legislature can accept (which could include concessions from generators); and 4) terms that are acceptable by the FERC. - In our opinion, the proposed deal is reasonable for EIX shareholders and renews the hope for a resolution to the crisis. While our optimism is tempered by the shortening timeframe, we are encouraged by the governor's recent statements, which have been more positive than negative. As such, we maintain our Buy ratings on Edison International and PG&E Corp as well as on the generation companies: Calpine and Dynegy. Other News: In other related news, on Friday (2/23) Edison announced that all of its banks have agreed to extend their forbearance until March 14. Note 2 05:16pm EST 26-Feb-01 Goldman Sachs (NEWYORK) EIX PCG ACTION EIX agrees to deal in principle with Gov Davis.PCG still negotiating.Buy EIX... Goldman, Sachs & Co. Investment Research EIX agrees to deal in principle with Gov Davis.PCG still negotiating.Buy EI * On February 23, EIX and Governor Davis reached an agreement in principal in which the state would agree to buy the transmission grid and allow for recovery of a 'substantial portion' of unrecovered cost in return for EIX refunding money from its parent to the utility and dropping pending litigation. This settlement appears to be a reasonable 'shared pain' scenario and is consistent with the 'buyout vs. bailout' structure we have been anticipating. To be enacted the deal needs to be finalized and approved by the EIX board and the California Legislature. FERC also must approve the asset sale. * EIX agreed to sell a portion of its electric transmission system to the state of California for $2.76 billion and transfer $420 million cash to its utility subsidiary from the parent. In return, the state would allow EIX to recover a substantial portion of its under-collected power costs and drop pending litigation in which the company is pursuing rate hikes. If approved by the EIX board and California legislature this agreement, in concert with passage of ABX1-1, would eliminate the overhang that has depressed EIX shares. * Although dependent on several factors, we believe the net impact on earnings from the settlement will not be as high as the current EIX stock price implies. We believe post-settlement EPS in 2002 will likely total at least $2.00/share, which supports a conservative valuation of $20 share (10X '02 EPS, a 20% valuation discount to the peer group). * Also late last week, PCG issued a press release indicating they had met with the Governor, had submitted proposals, and discussions were ongoing. With the framework already established for EIX, we expect a PCG settlement could be announced in the near future. PCG's negotiating flexibility is limited relative to EIX because their generation rates are lower, their under-recovered balance is higher, and the potential cash 'refund' from parent to subsidiary being requested by the government is probably larger. * PCG's transmission system has a book value of roughly $1.5 billion. At 2.3X book value, these assets could potentially be worth $3.5 billion. Assuming a parent company to utility cash transfer proportional to the one proposed for EIX, we estimate PCG would refund $780 million. PCG's stock price also reflects an earnings impact more punitive than implied by a settlement of this nature. We believe a deal like this would support post-settlement EPS of at least $2.50/share which supports a conservative valuation of $25/share (10X '02 eps, a 20% valuation discount to the peer group). * Because EIX has a 'deal in principle' the stock is trading at a premium to PCG despite having lower potential 2002 earnings power. Those investors who believe PCG will strike a deal that is similar in structure and proportional to EIX's settlement should purchase PCG over EIX at this juncture. NOTE 3 09:17am EST 26-Feb-01 Merrill Lynch (S.Fleishman (1) 212 449-0926) EIX PCG UTILITIES-ELECTRIC:California: One Goes Forward, But Need All Three ML++ML++ML Merrill Lynch Global Securities Research ML++ML++ML UTILITIES - ELECTRIC California: One Goes Forward, But Need All Three Steven I. Fleishman (1) 212 449-0926 Reason for Report: Governor reaches preliminary agreement with Edison; PG&E up in the air; Need all 3 utilities to move forward Investment Highlights: o On Friday, Governor Davis announced a preliminary agreement with Edison International (EIX; D-2-2-9; $14.69) on a financial resuscitation plan. The plan follows the basic framework previously outlined by the Governor. o The state will purchase Edison's transmission assets for $2.76B, or 2.3x book value. This would help pay off some of Edison's net $4.1B of undercollections (a number agreed upon with the Gov.) The remainder will be recovered through a bond financing tied to a dedicated rate component to be carved-out of Edison's rates. o In exchange, Edison will agree to: 1) Drop the lawsuit against the PUC, 2) Invest $420M back into the utility from the parent, representing tax overcollections , and 3) Sell power from its hydro and nuclear assets at cost- based rates for the next 10 years. Edison also agreed to sell power from its unregulated Sunrise plant, currently under construction, at cost-based rates for 10 years. o A number of uncertainties remain in Edison's deal, and it is still preliminary. The exact terms and language will be very important, particularly given the need to issue securitization bonds. It is impossible to provide exact earnings guidance based on this deal, but the only loss of earnings power would appear to come from lost transmission earnings (-$0.20-$0.25/share) and potentially lower generation earnings depending on the terms of cost-based rates. o This is a significant step forward for Edison and the resolution of the CA power credit crisis. However, it could be for naught if the other utilities cannot work out deals. We believe Sempra Energy (SRE; B-2-1-7; $22.10) is relatively close, but PG&E's (PCG; D-2-2-9, $13.70) talks were flailing last week. We continue to see little chance that this plan can move forward and pass through the legislature unless all the utilities are on board. o We believe PG&E is willing to work a deal within this framework. However, the simple problem is that PCG's undercollection numbers are much bigger. At YE 2000, PCG's net undercollection was more than $5B and we believe this may have reached $7B by the end of January. Selling the transmission for 2.3x book would provide only $3.5B, leaving the other half to be recovered though the dedicated rate component/securitization. It may be that the only way the numbers can work is with a rate increase. Despite the significant hurdles that remain, we believe the momentum toward a constructive outcome is improving. To that end, we maintain our Accumulate ratings on EIX and PCG for high rate accounts.
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