Concerns about the amount of cash that Dynegy Inc. and its subsidiaries will be able to generate, and the continuing worries about the energy merchant’s ability to refinance debt obligations not due until next year, led Moody’s Investors Service to downgrade the Houston-based company’s credit ratings on Thursday. Those included in the latest cuts were parent corporation Dynegy Inc., Dynegy Holdings Inc., its primary operating subsidiary, and that of Illinois Power, its largest utility.

Dynegy had already suffered one blow last week when its interim chairman, Glenn Tilton, resigned after only four months to accept the top job at another ailing company, United Airlines. Tilton joined the board last January, and assumed the interim chair in May. Tilton had been a vice chairman of ChevronTexaco Inc., Dynegy’s 26.5% shareholder, and appeared to be offering some needed stability to the company. Tilton and Dan Dienstbier, who is CEO, were both tapped to run the company after Chairman and CEO Chuck Watson resigned (see NGI, June 3).

Otis Winters, the lead director of Dynegy’s board, said Tilton had provided leadership “at a critical time for Dynegy and has been instrumental in helping the board guide Dynegy through a particularly tough period.” Winters added that Tilton was one of three Dynegy board members representing ChevronTexaco, and the election of a new CVX board member and new board chairman would be under consideration soon.

“I’ve been privileged these past months to see firsthand the extraordinary efforts of the men and women of Dynegy to pull together and rebuild this company, all in the face of difficult and complex challenges,” said Tilton in a written statement. “Their focus on overcoming these challenges, and on the fundamental work of this company, day in and day out, is what is enabling Dynegy to restore the trust of investors, lenders and business partners.”

Dienstbier added that Tilton has provided “valuable counsel” over the past few months to the energy merchant. “He leaves us at a good time: We have achieved notable milestones in our capital and liquidity plans and are fully focused on the future.”

In its report Thursday, Moody’s noted that four issues are contributing to Dynegy’s “negative” outlook, including the following: 1) execution risk of the restructuring plan, including the “ultimate structure and viability of its marketing and trading business;” 2) the ongoing lack of investor and counterparty confidence, which has limited its access to public debt markets and negatively impacted the company’s marketing and trading business; 3) uncertainty surrounding the Federal Energy Regulatory Commission and Securities and Exchange Commission (SEC) investigations; and 4) uncertainty relating to the re-audits and reviews of the financial statements from 1999 through June 30, 2002. Because of the re-audits, Dynegy has not provided the newly required CEO or CFO certifications under SEC requirements.

With approximately $5 billion of debt securities affected, Dynegy Holdings is carrying “increased amounts of secured debt ” and an “expectation that future renewals of existing bank debt will likely be done on a secured basis, effectively subordinating the senior unsecured bonds.” The ratings downgrade also “reflects concerns surrounding the sufficiency of future cash flow levels from Dynegy’s non-trading and marketing businesses relative to its total debt of $8 billion.”

Except for Illinois Power, which Moody’s noted had “exhibited a relatively stable cash flow profile,” Dynegy’s cash flow from its remaining businesses, even with its working capital changes, “is insufficient to cover debt maturities for 2002 and 2003,” which will leave it “highly dependent upon asset sale proceeds and refinancing of the $1.6 billion of DHI and IP bank debt,” as well as the $1.5 billion of ChevronTexaco preferred securities. Because of its lack of operating cash flow, what Dynegy gets from additional asset sales is not expected to reduce its material debt either, which would lead to debt protection measures “likely to remain very weak.”

The current liquidity profile appears to be enough to deal with 2002 debt maturities, said Moody’s, but “continuously increasing collateral calls make additional drains on liquidity likely and difficult to predict and significant questions remain for 2003.” The company has debt maturities totaling $3.9 billion that will be due in 2003, with the largest, $1.6 billion, due in April and May. The $1.5 billion to ChevronTexaco comes due in November 2003.

The company is currently working on restructuring its trading and marketing business in order to reduce capital requirements and improve returns, but Moody’s has seen little evidence to suggest that a solution is imminent.”

Given the debt maturity profile, Moody’s stated the company needs to find a solution “very soon.” Uncertainty related to the future structure and profitability of the marketing and trading business, coupled with the lack of clarity on the current status of negotiations between Dynegy and ChevronTexaco related to the $1.5 billion in preferred securities due late next year, “may create an environment that makes refinancing the bank credit facilities extremely challenging.”

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