Dynegy Inc.’s restructuring is on schedule, liquidity is improving, and investors are slowly showing a little more faith. Now, management wants to stabilize the once prosperous marketing and trading unit, and will disregard those who believe the energy merchant sector has been wiped out. “It’s awfully easy to get in a doom-and-gloom mood,” interim CEO Dan Dienstbier said Tuesday. “But I’m not pessimistic in our ability to complete our plan and move forward…Sometimes, you have to go home and say, ‘Hey, get a grip…This is a good, solid company, and we intend to be here when it is all sorted out.'”

Dienstbier’s positive tone seemed to set the mood for the company’s shareholders and stockholder wanna-bes on Tuesday, and its share price gained steadily throughout the day, closing up 54 cents, or 45% to $1.74 on volume of more than 39 million shares. Last Thursday, Dynegy’s stock price was 51 cents. Dynegy also was boosted by the show of support Tuesday by shareholder ChevronTexaco, which owns a 26.5% stake (see related story).

For the second quarter, Dynegy reported a loss of $328 million, or 92 cents a share, compared with income of $146 million, or 43 cents a share, for the same period of 2001. Dynegy’s losses were attributed to lower natural gas prices and a sharp fall-off in its once prosperous trading unit, where results declined 93% from a year ago. The 2002 quarterly results include a pre-tax non-recurring charge of $499 million ($324 million after tax), which the company had already disclosed. Without the extra charges, Dynegy would have lost $4 million in the quarter, or only 1 cent a share.

If the company breaks even for the remainder of the year, earnings are estimated to be 41 cents, a steep drop from its previous 2002 guidance of $2.00-2.05. The revised guidance, said Dynegy, reflects “new capital and liquidity initiatives and takes into account lower commodity prices, reduced liquidity levels and weaker energy industry fundamentals.” Reported cash flow from operations for the first six months of 2002 totaled $375 million. The company confirmed its fiscal year 2002 guidance for cash flow from operations of $600 million to $700 million.

Dynegy declined to offer 2003 earnings guidance. Dienstbier said the energy merchant business is “changing too rapidly” to make a realistic assessment so far ahead. He said he thinks there will be a lot of changes within the sector before the end of the year.

“Clearly, times are tough for the entire industry,” said Dienstbier. Going forward, he said, will be the “stabilizing period.” The CEO noted that the quarterly results were “consistent with our previously announced goal to manage for cash as we execute our capital and liquidity plan.” He said results were substantially affected by the decline in realized commodity prices and lower liquidity levels. Now, he said, Dynegy will be “focused on running our businesses efficiently, managing our costs and generating cash.”

Asked to detail the challenges facing the entire energy merchant sector, long-time COO Steve Bergstrom declined, saying it would take too long. “If you look at all of the challenges, it would take a day to go through. We’ve got to get some stability in this industry. Our goal on risk management is to break even for the rest of the year. This is the worst quarter…the third quarter should be better. We can’t extrapolate across the year, but the entire environment should be much different in the third and fourth quarter. It looks like things are bottoming out, and I don’t think things can get materially worse. We can at least cover our costs, and we’ve taken out a bunch of costs with the trading business, and we’ll start seeing the impact of those costs coming down in the third quarter as well.” Dynegy continues to seek a marketing and trading partner with strong credit that will back its trading expertise.

Most of Dynegy’s cash flow at this point is coming from its hard assets, including its power plants and storage facilities. The largest cash flow generation for subsidiary Illinois Power comes in the third quarter, said Bergstrom. “We’ve done quite a few things over the past month to manage the cash. What we’re not worried about is cash.” Bergstrom said that the company continues to have a “modest increase” in its marketing and trading business, but most of it is original business where the collateral has been posted.

Once the sale of Northern Natural Gas Co. (NNG) closes, said Dienstbier, “it will give us liquidity. It will certainly be different at that time…The sale of Northern Natural is a huge step, and it gives us some breathing room.” Dynegy announced Monday that it would sell NNG to MidAmerican Energy Holding Cos. (see Daily GPI, July 30). Other assets are expected to be sold in the near future, including its UK-based natural gas storage units, but no sales were announced on Tuesday.

To improve its financial reports, Dynegy said it will enhance their transparency and clarity. Among other things, additional information will be provided to investors beginning with the second-quarter earnings in its Securities and Exchange Commission filing. Included will be operating cash flow disclosure by segment and segregated financial contribution (a non-GAAP term defined as revenues less costs of sales, plus earnings for unconsolidated investments) among earnings generated from regulated operations, term contracts, fee-based operations, other assets and marketing and trading operations. In addition, Dynegy will provide a single schedule that reconciles the financial effects of risk management activities to the company’s balance sheet, income statement and cash flow statement.

Following the conference call with analysts, the research team at Credit Suisse First Boston recommended Dynegy as a “strong buy,” but it reduced its 2002 earnings estimate to 50 cents a share, down from 95 cents. For 2003, the analysts reduced its estimate on Dynegy to $1 from $1.20. Cash flow estimates are $1.75 for 2002 and $2 for 2003.

“Our valuation thesis for Dynegy looks for a near-term recovery to our ‘distressed asset value’ of $3.50 per share,” said the analysts. “Our longer-term target of $12 per share represents ‘utility multiples’ of 12X earnings per share and 5.5X cash flow.”

For the second quarter, Dynegy’s Wholesale Energy Network reported recurring net income of $11 million, a 93% decrease compared with $150 million for the same period of 2001. The asset businesses, including generation and storage, reported recurring operating income, after the impact of general and administrative expenses, depreciation and amortization, of $57 million in the second quarter 2002, a 16% decrease compared with $68 million in the second quarter 2001. These results reflect lower earnings from the company’s generation assets because of lower power prices. The decline was partially offset, however, by the addition of Dynegy Storage, the company’s natural gas storage and gas processing facilities in the United Kingdom, which contributed $15 million in operating income in the second quarter 2002. Earnings from unconsolidated investments were also impacted by reduced power prices.

Customer and risk management activities, which include controlled assets, marketing and trading, had a recurring operating loss, following the deduction of general and administrative expenses, depreciation and amortization, of $48 million in the quarter, compared with $96 million in recurring operating income in the second quarter 2001. “These results reflect reduced energy trading and wholesale origination activities associated with less market liquidity and Dynegy’s lower credit ratings,” the company said in a statement.

Dynegy Midstream Services, which consists of the North American midstream liquids processing and marketing business and worldwide natural gas liquids marketing and transportation operations, reported a recurring net loss of $4 million in the quarter, compared with recurring net income of $10 million for the same period a year earlier. Lower natural gas liquids prices and liquidity levels in global energy markets impacted this segment.

Dynegy’s regulated transmission and distribution segment net income was up, standing at $15 million for the second quarter, compared with $6 million a year ago. The segment’s performance benefited from the brief addition of NNG, which had recurring operating income of $14 million after expenses. The unit also benefited from the performance of subsidiary Illinois Power (IP), which reported recurring operating income of $50 million after expenses, depreciation and amortization. IP had lower costs because of above-normal weather in its service territory, said Dynegy.

The company’s communications segment, Dynegy Global Communications, which was launched during the fourth quarter 2000, reported a $26 million loss in the quarter. However, the reduced earnings from equity investments were offset by cost containment and improved revenues. Dynegy’s 16,000-route-mile, optically switched mesh network now reaches 44 U.S. cities. Management has already announced that it intends to reduce its financial exposure to this segment, and has written off all of its balance sheet investment with the second quarter charge. Dynegy said it would continue to maintain its operations in order to meet current customer commitments and obligations.

Also previously announced, the company’s total after-tax non-recurring charges for the second quarter 2002 include $212 million for certain communications assets and technology investments; $80 million related to the natural gas marketing business; and $32 million primarily for severance and related exit costs and other write-offs.

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