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Ax Continues to Fall on TransCanada Assets, Jobs

Ax Continues to Fall on TransCanada Assets, Jobs

TransCanada Pipelines put down the scalpel last week and took up the ax. Having determined the path toward improved financial health must involve some painful surgery, the company decided to lop off 15% of its asset base in exchange for expected proceeds of about $3.6 billion (net $3 billion), which will be used to pay down debt. It also decided to trim its dividend by a hefty 30% to $0.80/share.

The continued gutting of the company includes its international and Canadian midstream operations, as well as the Express Pipeline crude oil transmission system and Cancarb, its carbon thermal black manufacturing business. Those assets will be accounted for as discontinued operations in the fourth quarter, and TransCanada will take a $700 million charge against earnings as a result. It expects to sell off the assets in large blocks and complete the divestitures in about 12 months. This latest surgery will mean the departure of one-third of its workforce by the end of next year. The move follows the sale of $1 billion in assets earlier this year and the loss of about 600 jobs.

Investors certainly didn't like this latest restructuring move. After losing 40% of its value over the past year, TransCanada's stock price last week reached its lowest level in more than two years, tumbling nearly 20% following the announcement to end the day on the New York Stock Exchange on Friday at $8.12/share.

Despite the clear unpopularity of the downsizing, CEO Doug Baldwin characterized the move as necessary to strengthen the company's financial position. Since becoming CEO last summer, Baldwin has put the brakes on multiple unregulated initiatives. The company now believes its best bet is to refocus on core operations of gas transmission, power generation and marketing --- "the businesses... in which we have a distinct competitive advantage.

"In the future, there will be opportunities to grow these businesses. To capture these opportunities, a significant amount of financial flexibility will be required, which is something we clearly do not have today," Baldwin said during a conference call. "The reality is that we cannot access the incremental capital market required to successfully build and sustain all of our business units. Recognizing this, we have very difficult decisions to make. ...[W]e've decided to pursue a narrower, more focused set of growth opportunities around our core businesses, opportunities we believe will ultimately maximize shareholder value."

The company has been in continuous flux over the past two years. It completed its $11 billion stock-for-stock merger with Nova Corp. last year, and with its added scale from Nova was branching out into many unregulated, presumably higher-growth, businesses to offset losses from competition in its core markets. Many of the changes, including the merger, were viewed as a response to strong competition from its new opponent, the 1.3 Bcf Alliance Pipeline, which is slated for transportation service next November from northern Alberta and British Columbia to Chicago. However, earlier this year there was a sudden shift in strategy.

"They have done a complete turn-around, and in part it's because of a change in management," said Randy Ollenberger, an energy analyst with Merrill Lynch Canada. "If you went back a couple years ago, the target of TransCanada was to have 50% of its earnings coming from non-regulated businesses, and that's why they branched into all these other ventures, like gas processing, international, etc. And now, I think, after two years of experience with very poor earnings performance from those businesses combined with a change in management and what that management believes TransCanada ought to be focused on, they have decided to refocus on their core business, which is pipelines."

Baldwin took over as CEO in July after George Watson announced plans to retire. Baldwin had been a board member but had retired a year earlier. He is a former senior vice president of exploration and production with Imperial Oil, an Exxon subsidiary. "Doug Baldwin was clearly the key change there." Since Baldwin's arrival, the company has sold Angus Chemicals to Dow, pawned off its U.S. midstream facilities and gas liquids marketing and trading business to Coastal Corp., completed a public offering of units of the new TC PipeLines LP (which now owns and operates TransCanada's former U.S. pipelines, including Northern Border), and now is orchestrating this latest divestiture.

"I think they are making the right move. I think the earnings performance that they have demonstrated over the last couple of years has shown that they shouldn't be in these types of businesses," said Ollenberger. "They had negative earnings out of the gas processing businesses. The marketing business has not been performing well, and International hasn't had that great of a performance either... These guys are pipeliners. They are not managers of these other types of businesses."

However, the prospects for growth in TransCanada's core business aren't that great either, he admitted. TransCanada already has experienced decontracting on about 600 MMcf/d (7%) of its firm capacity as a result of Alliance and another batch of long-term contracts is due for renewal in five months. "It's just a question of how much more comes off the system. The maximum that you would expect would be the capacity of Alliance, which is 1.3 Bcf/d, but my expectation is you won't see that much," said Ollenberger. "You'll see something more or less equal to what they've already experienced.

"I think their growth prospects are pretty dim," he added. "What I'm looking for them to do is just refocus on the pipeline business and just have a stable earnings stream and try to return to bit of an income play, which may be tough now that they cut their dividend."

Other observers also said the dividend cut was unexpected and potentially devastating. But several things could help the company turn things around.

One area for pipeline growth is the Northwest Territories. Part of the reason behind the divestitures is recognition that currently TransCanada doesn't have the balance sheet to spend C$3 billion building a new 800-mile pipe to tap the Mackenzie Delta.

Baldwin also believes that a lot more revenue can be milked from the existing mainline and provincial transportation systems. "TransCanada's competitive advantage is in our low cost gas transmission assets across the northern tier of North America," he noted. "We have advantages at both ends of our pipeline system. At one end, we are attached to the most attractive natural gas basin in North America, the Western Canada Sedimentary Basin and are strategically positioned to transport northern gas supply. At the other end, we are linked to the largest energy markets in North America which continue to demonstrate significant growth opportunities."

He said the company first needs to "get our financial house in order." In the meantime, it also will look at increasing its flexibility in setting transportation rates. Already on file with the National Energy Board is a plan to establish a regulated floor on rates for available capacity in order to discourage shipper migration away from long-term firm contracts to plentiful interruptible space (see NGI, Dec. 6). But Baldwin said the pipeline also plans to request more flexibility in negotiating terms and conditions of services as well as offering term-differentiated rates.

"We believe shippers and customers are looking for additional opportunities which can enhance our earnings... We believe that we have the opportunity to see significantly above what I call 'base tolls' in certain applications for certain shippers who want the flexibility to have short-term service. I'd expect to see a 25-30% premium. That's typical of what we see with the pipes that currently operate in that type of environment in the United States today. And in reality, those pipes generate significant returns above their regulated rates." Baldwin said a move toward a more flexible tariff would take place over the next couple of years.

He also said TransCanada would focus on building its energy marketing position and its power generation operations. It currently has 10 power plants with about 1,000 MW of capacity in three Canadian provinces and two Northeastern U.S. states.

Rocco Canonica

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