Dynegy Inc. last week began climbing out of its deep debt-filled hole, launching a major junk bond refinancing project as well as a stock restructuring deal to pay off a credit line with ChevronTexaco Inc., its largest shareholder. If the transactions are completed as envisioned, Dynegy’s debt maturities would be “significantly” reduced over the next few years, including a portion of its recently restructured $1.66 billion credit facility and the secured financing of its Midwest generation assets.

However, expenses to complete those transactions, as well as the cost of pending litigation, will result in a net loss for the second quarter, the company said Friday.

In a preview of its quarterly earnings report, Dynegy announced that while its core businesses’ results have met management’s expectations, the results will be offset by higher-than-expected corporate-level expenses, including pending litigation. The company intends to announce second quarter results next Friday (July 25) and then will hold a conference call in mid-August, after its announced refinancing plan is completed.

What hurt the bottom line during the quarter were several things, the company explained in a written statement, including the expected loss in the Customer Risk Management segment, its energy merchant unit, which Dynegy is in the process of exiting. Also hitting earnings are the following:

“The higher than expected second quarter corporate-level expenses will negatively impact 2003 results,” the company said. “In addition, it is anticipated that the proposed refinancing plan…if consummated on the terms currently expected, will increase interest expense due to higher cash interest expense and the acceleration of the amortization of previously capitalized financing costs. The company intends to update its 2003 guidance estimate as soon as practicable following the expected completion of the proposed refinancing plan.”

Dynegy’s revised guidance estimate, expected to be released with quarterly earnings, will include the operating results of its generation, natural gas liquids and regulated energy delivery segments, as well as corporate-level expenses. Additionally, the revised guidance estimate will continue to exclude the results associated with the company’s Customer Risk Management segment, which includes tolling contracts, and its discontinued operations, which include the company’s former communications business, as well as costs to exit these businesses.

As part of the refinancing plan announced last week, Dynegy intends to exchange ChevronTexaco’s $1.5 billion Series B convertible preferred stock into a $850 million combination of cash, notes and Series C preferred stock. ChevronTexaco, which is a 26.5% shareholder, invested $1.5 billion with its long-time business partner to finance an equity infusion into ailing Enron Corp., when Dynegy and Enron attempted to merge in November 2001 (see NGI, Nov. 12, 2001). The obligation would have come due in November 2003, and has been considered a lynch pin of Dynegy’s recovery.

Dynegy and ChevronTexaco agreed in principle to restructure 150,000 shares of Series B Mandatorily Convertible Redeemable Preferred Stock (liquidation value $10,000 per share) currently held by a subsidiary of ChevronTexaco. As the transaction is currently set up, ChevronTexaco would exchange the outstanding shares of Series B preferred stock with Dynegy for the following: a cash payment equal to $225 million; $225 million principal amount of newly issued Dynegy Junior Unsecured Subordinated Notes due in 2016; and $400 million in newly issued shares of Dynegy Series C Convertible Preferred Stock. The transaction requires bank approval, as well as consent by Dynegy’s board of directors and ChevronTexaco’s internal management.

The Houston-based company also launched a cash tender offer on Tuesday for all of its 2005 and 2006 public senior notes. Dynegy plans to issue $1.2 billion in new senior notes and $300 million in convertible debentures under the offer, which would be subject to an amendment in its credit line. All of the proceeds from these transactions would pay off Dynegy’s existing credit line and the outstanding amounts under its secured financing that are tied to its generation assets. It also would cover the related expenses and transaction fees.

Dynegy Generation has interests in 40 power projects in operation or under development, mostly in the Midwest, which have a total net capacity of 13,200 MW. Sixty percent of its fleet are gas-fired plants, with the remaining facilities fueled by coal, heavy fuel oil or a combination of coal, fuel oil and natural gas. Independent from Dynegy Generation is the company’s utility, Illinois Power, which is excluded from the financing arrangements.

The tender offer and consent solicitation, which expires on August 8, are for a series of notes, including $300 million of outstanding 8.125% Senior Notes due in 2005; $150 million of 6.75% Senior Notes due in 2005; and $200 million of 7.450% Senior Notes due in 2006.

Dynegy also announced two private placement offers last week. The largest would be for approximately $1.2 billion of senior notes that would be secured by substantially the same collateral that secures the obligations under Dynegy’s current credit facility. The current credit facility consists of a substantial portion of Dynegy’s direct and indirect subsidiaries, excluding Illinois Power. Dynegy also will launch a private placement of approximately $300 million principal amount of convertible debentures, which would be convertible into Class A Common Stock.

In conjunction with the refinancing and restructuring transactions, Dynegy wants to amend its current credit facility, obtained last spring (see NGI, June 9). Among other things, the amended facility would allow the proposed restructuring and tender offers. Dynegy would use all of the net proceeds from the proposed capital markets transactions, together with its existing cash on hand, to repay outstanding indebtedness. As of June 30, Dynegy’s liquidity stood at $1.6 billion, which consisted of cash on hand and availability under its revolving bank credit facility. Total collateral posted was $829 million, including $279 million in letters of credit.

In response to the news, Moody’s Investors Service analyst John Cassidy said that the ChevronTexaco stock redemption was one of the major reasons for the negative outlook and Dynegy’s “Caa2” senior unsecured rating.

“Our more immediate concern was what happens with the ChevronTexaco preferreds,” said Cassidy. And the next priorities would be the debt maturing in 2005 and 2006. “If they can get those behind them, they’ve really stretched the maturities way out, and they can focus a lot more on liquidity and the fundamental operations.”

Moody’s raised its credit rating outlook on Dynegy last week to “developing” from “negative.” John Diaz, managing director of Moody’s Corporate Finance Group, wrote that the developing outlook reflected Dynegy’s announced transactions — still not completed — uncertainty on the size of its debt offerings and the ongoing need to reduce its total debt. “If Dynegy is successful,” and there is a “fairly high” probability, “Moody’s will likely consider changing the outlook to positive or possibly reviewing the ratings for a one-notch upgrade.”

Diaz said successful execution of its plan would improve Dynegy’s debt maturity profile for several years. However, he added that the transactions fail to address the “significant amount of debt remaining in Dynegy’s capital structure” adding that incremental debt reduction is still needed. “Moody’s estimates Dynegy will have approximately $8.2 billion of debt once the refinancings are completed. Furthermore, maintenance levels of capital spending and cash interest costs are likely to consume the bulk of the cash flow generated from operations, resulting in limited amounts of free cash flow available for material amounts of debt reduction.”

Total leverage, said Diaz, will continue to be a “key” ratings consideration that will likely limit the upside in Dynegy’s ratings over the near- to medium-term.

Fitch Ratings analyst Ralph Pellecchia added that Dynegy’s refinancing success would be a positive for the company, in part because it would indicate a renewed access to the capital markets. However, he noted that concerns remain on Dynegy’s ability to refinance its new credit facilities in 2005; its ability to generate sustainable cash flows; cash drain related to wholesale tolling agreements; and the company’s overall debt load. “They have too much debt, so debt reduction will be an important consideration in any future rating actions,” said Pellecchia.

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