TransCanada Pipelines put down the scalpel last week and took upthe ax. Having determined the path toward improved financial healthmust involve some painful surgery, the company decided to lop off15% 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 internationaland Canadian midstream operations, as well as the Express Pipelinecrude oil transmission system and Cancarb, its carbon thermal blackmanufacturing business. Those assets will be accounted for asdiscontinued operations in the fourth quarter, and TransCanada willtake a $700 million charge against earnings as a result. It expectsto sell off the assets in large blocks and complete thedivestitures in about 12 months. This latest surgery will mean thedeparture of one-third of its workforce by the end of next year.The move follows the sale of $1 billion in assets earlier this yearand 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’sstock price last week reached its lowest level in more than twoyears, tumbling nearly 20% following the announcement to end theday on the New York Stock Exchange on Friday at $8.12/share.
Despite the clear unpopularity of the downsizing, CEO DougBaldwin characterized the move as necessary to strengthen thecompany’s financial position. Since becoming CEO last summer,Baldwin has put the brakes on multiple unregulated initiatives. Thecompany now believes its best bet is to refocus on core operationsof gas transmission, power generation and marketing — “thebusinesses… in which we have a distinct competitive advantage.
“In the future, there will be opportunities to grow thesebusinesses. To capture these opportunities, a significant amount offinancial flexibility will be required, which is something weclearly do not have today,” Baldwin said during a conference call.”The reality is that we cannot access the incremental capitalmarket required to successfully build and sustain all of ourbusiness units. Recognizing this, we have very difficult decisionsto make. …[W]e’ve decided to pursue a narrower, more focused setof growth opportunities around our core businesses, opportunitieswe 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 outinto many unregulated, presumably higher-growth, businesses tooffset losses from competition in its core markets. Many of thechanges, including the merger, were viewed as a response to strongcompetition from its new opponent, the 1.3 Bcf Alliance Pipeline,which is slated for transportation service next November fromnorthern Alberta and British Columbia to Chicago. However, earlierthis year there was a sudden shift in strategy.
“They have done a complete turn-around, and in part it’s becauseof a change in management,” said Randy Ollenberger, an energyanalyst with Merrill Lynch Canada. “If you went back a couple yearsago, the target of TransCanada was to have 50% of its earningscoming from non-regulated businesses, and that’s why they branchedinto all these other ventures, like gas processing, international,etc. And now, I think, after two years of experience with very poorearnings performance from those businesses combined with a changein management and what that management believes TransCanada oughtto be focused on, they have decided to refocus on their corebusiness, which is pipelines.”
Baldwin took over as CEO in July after George Watson announcedplans to retire. Baldwin had been a board member but had retired ayear earlier. He is a former senior vice president of explorationand production with Imperial Oil, an Exxon subsidiary. “DougBaldwin 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 businessto Coastal Corp., completed a public offering of units of the newTC PipeLines LP (which now owns and operates TransCanada’s formerU.S. pipelines, including Northern Border), and now isorchestrating this latest divestiture.
“I think they are making the right move. I think the earningsperformance that they have demonstrated over the last couple ofyears has shown that they shouldn’t be in these types ofbusinesses,” said Ollenberger. “They had negative earnings out ofthe gas processing businesses. The marketing business has not beenperforming well, and International hasn’t had that great of aperformance either… These guys are pipeliners. They are notmanagers of these other types of businesses.”
However, the prospects for growth in TransCanada’s core businessaren’t that great either, he admitted. TransCanada already hasexperienced decontracting on about 600 MMcf/d (7%) of its firmcapacity as a result of Alliance and another batch of long-termcontracts is due for renewal in five months. “It’s just a questionof how much more comes off the system. The maximum that you wouldexpect would be the capacity of Alliance, which is 1.3 Bcf/d, butmy expectation is you won’t see that much,” said Ollenberger.”You’ll see something more or less equal to what they’ve alreadyexperienced.
“I think their growth prospects are pretty dim,” he added. “WhatI’m looking for them to do is just refocus on the pipeline businessand just have a stable earnings stream and try to return to bit ofan income play, which may be tough now that they cut theirdividend.”
Other observers also said the dividend cut was unexpected andpotentially devastating. But several things could help the companyturn things around.
One area for pipeline growth is the Northwest Territories. Partof the reason behind the divestitures is recognition that currentlyTransCanada doesn’t have the balance sheet to spend C$3 billionbuilding a new 800-mile pipe to tap the Mackenzie Delta.
Baldwin also believes that a lot more revenue can be milked fromthe existing mainline and provincial transportation systems.”TransCanada’s competitive advantage is in our low cost gastransmission assets across the northern tier of North America,” henoted. “We have advantages at both ends of our pipeline system. Atone end, we are attached to the most attractive natural gas basinin North America, the Western Canada Sedimentary Basin and arestrategically positioned to transport northern gas supply. At theother end, we are linked to the largest energy markets in NorthAmerica which continue to demonstrate significant growthopportunities.”
He said the company first needs to “get our financial house inorder.” In the meantime, it also will look at increasing itsflexibility in setting transportation rates. Already on file withthe National Energy Board is a plan to establish a regulated flooron rates for available capacity in order to discourage shippermigration away from long-term firm contracts to plentifulinterruptible space (see NGI, Dec. 6). But Baldwin said thepipeline also plans to request more flexibility in negotiatingterms and conditions of services as well as offeringterm-differentiated rates.
“We believe shippers and customers are looking for additionalopportunities which can enhance our earnings… We believe that wehave the opportunity to see significantly above what I call ‘basetolls’ in certain applications for certain shippers who want theflexibility to have short-term service. I’d expect to see a 25-30%premium. That’s typical of what we see with the pipes thatcurrently operate in that type of environment in the United Statestoday. And in reality, those pipes generate significant returnsabove their regulated rates.” Baldwin said a move toward a moreflexible tariff would take place over the next couple of years.
He also said TransCanada would focus on building its energymarketing position and its power generation operations. Itcurrently has 10 power plants with about 1,000 MW of capacity inthree Canadian provinces and two Northeastern U.S. states.
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