Dynegy Inc. finally sparked the investor confidence it sorely needed last week following a teleconference ostensibly to report first quarter earnings. Instead, news that it had renewed its much-needed revolving credit line for $900 million 24 hours before the deadline — thus guaranteeing the company’s liquidity in even the worst case scenario — pulled the stock ahead nearly 30% in one day. Chairman Chuck Watson also appeared to soothe Wall Street nerves with his corporate-wide commitment to retain an investment credit rating, making it Dynegy’s top priority going forward.

Since terminating its merger agreement with Enron Corp. last November, Dynegy’s stock has lost about half of its value, and has suffered along with the rest of the energy sector in the past few months. However, the stock went into free fall April 25 after Moody’s Investor Servicesput the company’s credit ratings under review for a possible downgrade — a move that would reduce the company’s rating to junk status and trigger a call for collateral from its trading partners (see NGI, April 29).

However, the conference call and positive news restored investors’ nerves. By market’s close, the stock had recovered $4.15 from April 29, to stand at $18.00. (On May 7, 2001, the stock was $53.09, pummeled by year’s end after pulling out of a merger with Enron and the sagging reports in the energy sector.)

Investors appeared to like the news that subsidiary Dynegy Holdings had been able to renew its credit line, which was to expire May 1, for $900 million. The renewal was $300 million less than the original agreement, but combined with another $500 million in liquidity, provides Dynegy with $1.4 billion available cash or credit. Several analysts upgraded Dynegy, including Wachovia Securities, from “market perform” to “buy.”

In the call, Watson clarified Dynegy’s $300 million loss in the first quarter in its waning telecommunications subsidiary Dynegy Global Communications. He set a one-year deadline to make the losing asset a winner — or else. “Losses will not be tolerated past 2002,” he said.

Watson, also CEO of the 17-year-old company, said he expects no further action on the company’s credit rating “until Moody’s reviews our plans over the next few weeks.” During that time, Watson emphasized, “Our highest priority is to do a much better job of explaining our business and expected cash flow,” from operations, which he said will be growing, to ratings agencies and investors.

Even under a worst case downgrade to junk status — which currently would only be the Moody’s rating — Watson said the new credit facility that closed Tuesday allows Dynegy to be able to put up all the required collateral across all of its businesses, a total of $700 million, and still have $700 million left to operate. Dynegy President Steve Bergstrom said the company had put up $150 million in collateral in the last week. Some companies in the industry have dropped below investment grade and have maintained operations (including Mirant), and Bergstrom is confident the industry has “pretty well worked through” its major credit issues, which are evolving toward stronger credit standards and better explanations.

Explaining the significance of the credit facility, CFO Rob Doty explained that even before April 25, companies were operating in a “tighter credit environment” versus last year. The approved credit facility is less than the original amount Dynegy had sought, but it is a “significant success,” Doty said, and ensures the company’s stability. The deal, which was revised before closing, added an additional financial covenant requiring Dynegy to renew it before its original May 2003 deadline. The transaction’s price also increased, with the facility costing Dynegy $2.5 million to $3 million more in interest costs over the course of 2002 and 2003.

Of the recent news that led to Moody’s review and negative outlook — which in turn led to huge stock market losses over the course of two days — Watson said the blame rested with Dynegy’s management. “We put ourselves in this position, and clearly, the impact of Project Alpha damaged our relationship with them and with you,” referring to the natural gas contract controversy that appeared at one point to nearly spin out of control.

“It is clearly management’s responsibility” to ensure investor confidence, said Watson. “I accept that responsibility and take it seriously,” and said the company was committed to “resolve this disconnect as quickly as possible…I will stay personally involved as we proceed.”

Major shareholder ChevronTexaco, which owns 26% of Dynegy’s stock, also “continues to lend Dynegy its full support ” Watson said. However, he will not ask the oil giant to make a public statement of its support for Dynegy, which he said was not required. “ChevronTexaco is Dynegy’s largest customer,” said Watson. “It is a good partner and a good customer, and I expect them to be around for a long time…to grow for many years to come.”

Clarifying again what he termed “mischaracterizations” about the recent Securities and Exchange Commission (SEC) inquiries regarding Project Alpha, Watson reiterated that the one still ongoing through the Fort Worth office “is an inquiry, it is not an investigation. We clearly understand any dealings with the SEC are unsettling…and we clearly understand and acknowledge the SEC’s job, and pledge our full cooperation with them.”

More than 70% of Dynegy’s recurring contributions come from assets, explained Watson. “The marketing and trading business is a portfolio business. We manage a portfolio of transactions at Dynegy and do some thousands of transactions quarterly.” He said, “it is tough to take one transaction on its own,” comparing the Project Alpha transaction with taking someone’s comments out of context. “It’s equally unrealistic to take one transaction out of context.”

The company actually had a strong first quarter, especially in light of a mild winter and investor jitters. Dynegy reported recurring first quarter net income of $173 million, up 26% from the $137 million reported in first quarter 2001. Recurring earnings per diluted share for both periods were 41 cents. Including all items, Dynegy reported a net loss of $140 million or 41 cents per share for 1Q 2002, which included after-tax non-recurring charges of $313 million, with non-cash charges for Dynegy Global Communications ($300 million) and Northern Natural Gas Co. ($13 million).

Net income available to shareholders was reduced by approximately $8 million for the amortization of a special dividend associated with issuing a discount on a $1.5 billion convertible preferred security by ChevronTexaco last year related to the Enron merger and Northern Natural Gas, which was 2 cents a diluted share. Also beginning Jan. 1, 2002, Dynegy adopted FAS No. 142, which discontinued the amortization of goodwill. Dynegy’s first quarter ’02 recurring earnings per diluted share would have been 37 cents a share if goodwill had been amortized in the period.

Dynegy’s Wholesale Energy Network segment recurring net income was up 33% to $133 million, representing 77% of the company’s consolidated net income. It had $100 million for the first quarter ’01.Customer and Risk Management activities (controlled assets, marketing and trading) financial contribution increased 13% to $169 million, compared with $149 million a year earlier.

Global gas volumes increased 33% to 15.2 Bcf/d in the quarter, up from 11.4 Bcf/d in the first quarter of ’01. In its generation segment, total power produced and sold increased 128% to 118.7 million MWh in the quarter, up from 52 million MWh a year earlier. Bergstrom said the increase came from more domestic origination and merchant sales opportunities captured throughout Dynegy’s energy delivery network, as well as the conversion of UK volumes to physical volumes. Recurring net income from this segment was $17 million, compared to recurring net income of $23 million a year ago.

“Gas and power were positively impacted partly because the largest volume player (Enron) was not there for the entire first quarter for the first time,” Bergstrom said.

Processing volumes increased 18% to 92.1 thousand bbl/d over a year ago. Natural gas liquids sold decreased 5% to 609.5 thousand bbl/d, down from 640.7 thousand bbl/d in ’01. Dynegy’s regulated transmission and distribution segment, which includes Illinois Power (IP) and, as of Feb. 1, Northern Natural Gas Pipeline, reported net income in the quarter of $49 million, compared to $26 million a year ago.

Dynegy Global Communications, which was launched in the fourth quarter of 2000, had issued news about its expected losses last week, with the after-tax charge. The segment overall reported a $26 million recurring quarterly loss from “start-up network difficulties,” related to vendor problems, as well as “continued weakness” in the telecommunications markets.

Bergstrom noted the entire energy industry had been working to evolve to more efficient credit standards, and said as the “Enron hangover” dissipates, he believes companies will be able to overcome credit concerns much easier. “Notwithstanding January and February, which were difficult months, the sector recovered…in the first two months. We still have a very strong franchise, the same franchise, and the same focus that’s been working” for many years. “We will not waiver off our strategy,” which he said includes maintaining its wholesale energy forecast through the rest of the year.

“We are looking forward to the summertime to get our generation running,” said Bergstrom. “We’re seeing good volatility and liquidity coming back to the market after January and February and the summer is setting up very well for industry.”

Dynegy is now working on its earnings expectations for 2003. With a “normalized 2002,” which takes out Northern Natural Gas and telecom losses, Dynegy should grow about 15% this year, said Doty.

Following the conference call and first earnings report, Fitch Ratings on Tuesday downgraded Dynegy Holdings’ senior unsecured debt to BBB and Dynegy Inc.’s implied senior unsecured debt to BBB-, and lowered both companies’ short-term ratings to F3 from F2. “The ratings…remain on Rating Watch Negative where they were originally placed on Nov. 9, 2001,” the day after it announced its merger with Enron. Fitch also lowered one notch the long-term ratings for affiliates Illinois Power Co. and Illinova Corp. and placed them on Rating Watch Negative. Fitch expects to meet with Dynegy management “over the next several weeks to review the company’s updated plans.”

The downgrades, which Fitch said reflected its concerns about financial flexibility in a “difficult business and capital market environment,” noted, however, that “on balance, views the renewal of the facility as favorable news and would have considered lowering Dynegy Inc. and affiliated company ratings by more than one notch if Dynegy Holdings [had] secured the loan or utilized the one-year term-out provision.”

Fitch revealed that Dynegy plans to raise additional cash by mid-year with the sale of approximately $250 million of gas midstream assets to Dynegy Energy Partners LP, a master limited partnership it is forming. “Prospective cash uses include the funding of $200 million of Dynegy Holdings’ debt maturing in July 2002. Also, Dynegy Inc.’s $300 million multi-year facility renews in November 2002.” Dynegy spokesman Steve Stengel said Tuesday the partnership’s approval is in the “quiet stages with the SEC” at this point, but is expected to be in place by the third quarter.

The partnership was formed by Dynegy to own and operate a portion of its natural gas liquids business. Once approved by the SEC, the partnership will be engaged in fractionation, storage, terminalling, transportation, distribution and marketing natural gas liquids to consumers throughout North America. Dynegy and some of its affiliates will be the general partners.

Although not discussed during the earnings call, Dynegy filed Form 8-K filing with the SEC on April 29, noting that it “has recently become aware of the public announcement of several class action lawsuits that have been commenced on behalf of purchasers of publicly traded securities of Dynegy generally during the period between April 2001 and April 2002.” The company said it has not yet been served with complaints relating to any lawsuits, which numbered well over 20 by week’s end.

“However, based on press reports relating to these complaints, Dynegy understands that they principally assert that Dynegy and certain of its officers and directors violated the federal securities laws in connection with Dynegy’s accounting treatment and disclosure of the natural gas supply transaction that was entered into by Dynegy in April 2001 and the subject of Dynegy’s Current Report on Form 8-K filed on April 25, 2002. Dynegy anticipates that additional suits of this nature may be commenced and that all such suits will eventually be consolidated in a single court. Dynegy will fully analyze these allegations once the complaints are received and, based on its current understanding, believes these allegations are without merit and intends to vigorously defend against them.”

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