San Jose, CA-based Calpine Corp.’s “bad hair day” turned into an even worse week, and the question now is how badly the high-flying merchant power plant developer will be hurt by a growing wave of skepticism on Wall Street on the soundness of its strategy, financial ability and future earnings.

There was more bad news Friday when Moody’s downgraded the company’s debt to ” status, Ba1 from Baa3. Moody’s lowered Calpine’s ratings after reviewing Calpine’s near-term cash flow, liquidity sources and financial flexibility. The ratings remain under review for further downgrade pending arrangements to obtain additional financing.

Fitch placed its “BBB-” rating of senior unsecured debt on a negative ratings watch on Thursday. Others were downgrading the company’s stock to a “hold” rating with revised lower estimates for the stock price, which plummeted during the week.

What sort of week was it? Friday Calpine’s stock price fell to a two-year low ($13.20), and its bonds fell to 75 cents on the dollar. “I hope Calpine isn’t going to be another Enron, but I wouldn’t touch it will a 10-foot pole,” said Jon Burnham, who manages the $175 million Burnham Fund, in a San Jose Mercury-News article Friday.

Moody’s had boosted Calpine one level from junk to investment grade in October (“Baa3” — its lowest investment-grade rating). That was the same month that Moody’s downgraded Enron. Standard & Poor’s rates Calpine at its highest junk level (BB+). Calpine has been below-investment grade for most of its 17-year history, analysts noted. “It has never been fully investment grade,” one analyst said, other than by one firm.

Calling the action “premature,” a San Jose-based Calpine spokesperson, Katherine Potter, said Friday the company’s management is “very disappointed,” feeling victimized by Enron fallout that has spiraled out of control on Wall Street. “Nothing has dramatically changed since October in our business fundamentals other than what has happened in terms of the volatility” arising from the Enron financial debacle. She said they are working closely with the rating agencies to address their concerns.

“Our fundamentals and solid, though, so we feel we are going to weather the storm and press on,” said Potter, noting that the lower rating will not change any of the firm’s debt structure, which she said would remain about 65% (debt)-35% (equity).

As an assets-based company there is nothing in Calpine’s debt portfolio that would get triggered by a downgrading, Commerzbank Securities’ Andre Mead said Friday.

While noting that Calpine’s operating fundamentals are “sound,” Fitch said the company’s “financial profile is aggressive and not consistent with the current market environment. Questions have arisen regarding Calpine’s ability to refinance $878 million of maturing zero coupon notes and to fund future capital requirements.”

Other energy companies were facing similar declines in their stock prices and ratings (see related story), and growing skepticism that gained momentum less than two weeks after Enron filed the biggest corporate bankruptcy ever. Part of the impetus came from Capitol Hill where several long detailed hearings got underway. New laws and regulations are sure to follow, and some anticipate other financial meltdowns.

For its part, Calpine senior officials in two conference calls during the week stressed its business model was far different than Enron’s, being tied more to hard assets, but the officials did for the first time indicate they may have to reassess earnings estimates for 2002, and maybe even this last quarter of 2001, along with its aggressive goal of having 70,000 MW in its portfolio by the end of 2005. Financial analysts indicated they project total capacity far below that goal.

Meade, U.S. utility analyst for Commerzbank Securities, projected Friday that Calpine’s total portfolio may be only 30,000 MW by that time, and Ronald Barone, a UBS Warburg researcher, while noting comparisons with Enron “have little substance,” projected Calpine’s building program would only net about 45,000 MW of capacity by year-end 2005.

“While Calpine can satisfy its cash needs associated with its plants in construction and its maturing debt without accessing the capital markets, the company will be required to access debt markets to complete a buildout to the 45,000 MW of capacity by year-end 2005 that we forecasted,” Barone said. “Should borrowing costs remain at levels recently implied by the market, we would have to re-evaluate this target over the coming six months. Our expectation for total capacity in operation by year-end 2005 remains well below the company’s official target of 70,000 MW.”

Unless there is a dramatic change in energy markets and a turnaround in the macroeconomics generally in the U.S., Commerzbank Securities’ Meade does not think the capital markets will support Calpine’s lofty goal. “We always questioned whether 70 gigawatts (70,000 MW) of one fuel, one technology made sense, especially when based-loaded gas-fired units don’t make economic sense in most of the U.S. markets. So what the capital markets are telling Calpine now, I think, is we’re worried about over-building so we don’t want you to build as many units, and Calpine itself has acknowledged that it is likely to delay or scrap a lot of projects if it can’t get the capital.”

The additional, eye-popping 40,000 MW of gas-fired generation never was viewed as having a lot of potential value, Meade said, noting that it “certainly would contribute to causing a glut” of plants on the market.

In response to the backlash from negative news and analysts reports, Calpine CEO Peter Cartwright said the company will not pursue any power plants on which it cannot make 18% after-tax returns on equity. Later Calpine’s CFO Ann Curtis revealed that the company has acknowledged that it may reassess its earnings projections for next year in the face of depressed energy prices and the recessionary economy. “We’re taking a very hard look at 2002, and we will let you know if we change anything as a result,” Curtis said

“Our view is that (Calpine) has melted down probably as far as it is going to go,” Andre Meade said. “There are hard physical assets that have value and underpin its debt. So we think it is a good value at about $15-per-share.”

Are there other Enron’s out there in the energy industry?

“No, I don’t think so,” Meade said. “Companies have problems and capital budgets are getting slashed, capital is tight, but no one in my view has a business where the bulk of its value can vanish overnight like Enron, whose trading business was dependent upon credit and when that credit went away so did the value. The other top (energy) traders that I follow are generally more conservatively leveraged and their financials are fairly straightforward. So none of them appear to be subject to a liquidity crisis at this point.

“In addition, most of them have other businesses that are asset-based, so if their trading businesses were in trouble, they would have plenty of assets to sell to firm up their credit situation.”

Meade said he has “never been a big fan” of Calpine’s business strategy, but he said that given the strategy, the company’s “execution has been quite good.” If there were “insatiable demand” for new power plants in the U.S., he thinks the 70,000 MW goal might make sense, but since there isn’t, he considers Calpine’s strategy “riskier than most of its competitors.”

In the immediate wake of its stock being rocked by comparisons with Enron, Calpine went on the offensive the first part of last week, announcing it plan to meet with California officials to begin renegotiating its long-term supply contracts with the state’s power-buying agency, the Department of Water Resources (DWR).

While saying its current contracts are “strong” and going “a long way to stabilize California’s power market,” Calpine’s senior vice president and lead negotiator for the DWR contracts, James Macias, said Calpine is “willing to consider different opportunities to better meet (the state’s) needs. Calpine and the state stand behind their respective contractual obligations, however, we are open to working with DWR to explore options that can add value for both parties.

“We’re going to listen to the state and try to trade values. We’ve done this with other customers from time to time. We do think there are some ways we can mutually improve these contracts.”

Calpine signed two 10-year, fixed-price deal with DWR for 2,000 MW for its new and existing generation plants in the state. In addition, the company has two separate contracts to provide 735 MW of peaking capacity from 15 new peaking units Calpine has committed to build.

Calpine emphasized that it has undertaken what it calls “the largest energy initiative ever undertaken in the state,” bringing on line three new power plants this year that have added 1,600 MW of generation capacity in the state. In total, Calpine said it has 3,000 MW of generation in operation in California, 2,400 MW under construction and another 5,100 in announced development.

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