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Enron Mail |
--------------- Authored by: Jeff Dietert ---------------- OUR VIEW: ENE is down huge (-80% for the year, and trading at only 7.5xFY02) and its hard to imagine more confusion associated with the stock. More pressure is likely today on the news of S&P revising its long-term ratings outlook to negative (based on the decline in market capitalization) and ENE's additional draw on its credit facilities (which does not change its net debt, but prevents banks from denying access to its liquidity in the event that the rating agencies do downgrade its credit rating, which could break covenants and restrict liquidity). We believe the major issues are: 1) management's ability to regain the confidence of the street and persuade investors that it can restore balance sheet strength and generate the expected earnings and cash flow, 2) ENE must maintain its investment grade credit rating, 3) ENE must successfully execute its divestiture plans, and 4) ENE must control the timing of the recognition of the write-down in the value of any assets whose market value is less than book. IF ENE management does not step-up to calm investor fears, these fears could become a self fulfilling prophecy. In the potentially vicious cycle, investor fears could drive the stock down, the lower stock prices force the rating agencies to consider downgrades, potentially lower credit ratings force counter-parties to reduce exposure with ENE, limiting ENE's to generate earnings and cash flow. Thus we see a big incentive for ENE to clarify the issues. We expect ENE to put together a more complete explanation of the major issues over the next few days in order to stabilize the stock. If/when ENE schedules a conference call or road show, we would consider this a bullish sign. Absent further clarification, the stock is likely to continue to be weak. Our gut feel is that ENE can pull it off and that long-term investors should hold firm, as eventually the stock gets valued on earnings (with upside potential to $25+/sh over the next 12 to 18 month period), rather than break-up value ($16/sh-see below). We believe new money (with high risk tolerance!) should wait until ENE announces its intentions for communicating a clear path to recovery. ENE's VIEW: ENE has stated that it has reviewed its asset base with Arthur Anderson and that no additional asset impairments are required other than an approximate $200 MM charge expected in 1Q02 due to an accounting change. With no further asset write-downs, and roughly $890 MM in asset divestitures ($390 MM India E&P, $250 MM Puerto Rico power plant, and $250 MM Brazilian power plant) in 4Q01, ENE's D/TC ratio is likely to decline from 50% at the end of 3Q01 to roughly 48% at the end of the year. After the close of the Portland General divestiture, expected by year-end 2002, we expect its D/TC to fall below 45% (we are projecting FCF to be break-even in FY02). We estimate that ENE's interest coverage at the end of 3Q01 is 3.5x. ENE is currently rated BBB+ by S&P and Baa1 by Moodys, and would need to decline 3 ratings to fall below investment grade. For comparison purposes, S&P's BBB median D/TC is 47.4% and EBITDA/Int. Exp. coverage is 6.1x, while BB (non-investment grade) median D/TC is 61.3% and interest coverage is 3.8x. IMPORTANCE OF ENE's INVESTMENT GRADE CREDIT RATING: We believe that ENE's Wholesale segments, which generates 80% of its EBIT, would be noncompetitive if the credit rating falls below investment grade. In addition, a decline in credit rating below investment grade would trigger the issuance of 50 MM shares of common stock and $1 B in convertible preferred stock associated with ENE's off-balance sheet structured financing vehicles. We believe ENE will do what ever it can to maintain an investment grade rating. Moodys has its BBB+ rating under review for a possible downgrade. Last night S&P revised its long-term ratings outlook to negative due to concerns that the significant drop in market capitalization in the past week has adversely affected the company's financial flexibility and could impede its ability to pursue plans to rebuild its balance sheet. BREAK-UP VALUE: We believe ENE 's Wholesale America ($2.7 B in TTM EBITDA), Wholesale Europe ($900 MM) and Retail ($450 MM) segments are conservatively worth a 4x multiple (recent multiples have been higher, but we are discounting due to limited buying interest) or $16.2 B. The Gas Pipeline segment ($820 MM) and Global Assets ($200 MM) valued at a 6x multiple are worth $6.1 B. PGE valued at the divestiture price is $2.9 B. Total asset value is conservatively $25 B, vs. debt of $13 B, leaving $12 B or $16/sh for equity investors in a break-up scenario. The challenge is, if ENE loses its investment grade rating, the value ($16.2 B) of its Wholesale and Retail segments would be materially compromised--leaving little for equity investors. POTENTIAL FOR ADDITIONAL ASSET IMPAIRMENTS: ENE's Global Assets portfolio includes assets with $6 B in book value (ENE's total gross PP&E is $14 B) that has generated an EBIT loss of $18 MM (EBITDA of +$168 MM) over the last 12-month period (4Q00 to 3Q01). The Global Assets portfolio includes Elektro (an electric utility in Brazil), Dabhol (power plant in India), TGS (a natural gas pipeline in Argentina), Azurix and Enron Wind operations. These assets seem ripe for a write-down although the company argues that it has reviewed them with Arthur Anderson recently and that the assets are not impaired. ENE will have to continue to convince Anderson that the value of these assets has not been impaired. The write-down of these assets would reduce shareholder equity and ENE's D/TC, threatening its credit rating. It is not clear that ENE put all its under-performing assets in the Global Assets portfolio. There could be other poor performing assets in other segments that are hidden by strong performance in its Wholesale business. ADDITIONAL DATA POINTS: ENE's counter-parties seem to be supportive and have not indicated any change in business activity. EnronOnline trading volume was slightly above average yesterday. Some energy traders have bought ENE in their personal accounts, convinced that ENE core marketing business is strong and the belief that the equity markets have over-reacted. Lots of ENE corporate finance people are working late nights solidifying ENE's financial strategy (hopefully for a more complete discussion with the street?). THE SEC INQUIRY: We believe ENE has an extensive paper trail from its attorneys and accountants that will clear them of any legal problems with the SEC associated with the LJM partnerships in which CFO Andy Fastow participated. We do not expect the SEC to find any legal wrong-doing--although this doesn't mean that they won't express qualitative concern over the appearance of the transactions. **************************************************************************** ************************* This e-mail is based on information obtained from sources which Simmons & Company International believes to be reliable, but Simmons & Company International does not represent or warrant its accuracy. The opinions and estimates contained in this e-mail represent the views of Simmons & Company as of the date of the e-mail, and may be subject to change without prior notice. Simmons & Company International, its partners and/or employees may have positions in the securities discussed. Simmons & Company International may make a market in the securities discussed and may have served as a financial advisor and/or underwriter to companies discussed. Simmons & Company International will not be responsible for the consequence of reliance upon any opinion or statement contained in this e-mail. This e-mail is confidential, and may not be reproduced, in whole or in part, without the prior written permission of Simmons & Company International.
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