Dynegy Inc. and Exelon Corp. have scrapped a $2.25 billion transaction under which Dynegy would have sold its Illinois Power subsidiary to Illinois-based Exelon. The announcement came after Illinois lawmakers failed to approve legislation needed to facilitate Exelon’s purchase of Illinois Power.

Dynegy and Exelon said that the current legislative and regulatory environment “made it impossible to complete the transaction in accordance with the original agreement.”

First announced in late September and put into writing earlier this month, the proposed acquisition came under heavy criticism from state government as well as consumer groups (see NGI, Nov. 24).

Legislation related to the proposed deal recently passed the Illinois State Senate. However, the Illinois House adjourned at the end of the week without state lawmakers taking action on the House’s version of the legislation.

A coalition of consumer groups led by the Illinois Citizens Utility Board (CUB) had argued that the senate version of the legislation would have resulted in unwarranted rate hikes for consumers to pay for inflated power contracts between Exelon and its Commonwealth Edison Co. (ComEd) subsidiary.

Under the legislation, HB 2200, the Illinois Commerce Commission (ICC) would have been required to approve the power purchase contracts next year as part of its expedited review of Exelon’s acquisition of Illinois Power. Once approved, the coalition argued that those contracts would become the basis for a series of rate hikes beginning in 2007.

The coalition backed the house version of the bill, SB 25, which would have protected consumers by allowing the ICC to review whether the costs of the contracts are prudent and reasonable in future rate cases.

“Exelon’s acquisition of Illinois Power would have been good for the state of Illinois,” said Dynegy CEO Bruce A. Williamson. “While we are disappointed that the legislation did not pass, we must now focus on the future with Illinois Power as a part of our organization.”

He said Dynegy’s “first priority will be to improve Illinois Power’s financial condition by creating a sustainable cost structure for this business. We will work closely with the Illinois Commerce Commission and the unions throughout this process.”

“We will ensure safe, reliable and affordable service for our electricity and natural gas customers in Illinois while we restructure Illinois Power to make it a sustainable business and implement changes as soon as possible to cut costs,” Williamson added.

“I really believe that this transaction would have benefited the state of Illinois, our customers, our investors, and certainly the employees of Illinois Power,” said Exelon CEO John Rowe. “Given the outcome of the legislation, the terms of the current acquisition agreement cannot be met. Exelon recognizes that it is not in the interest of the customers, employees or investors of either company to pursue a deal that no longer has a realistic chance of successful completion. We recognize Dynegy’s need to pursue other business plans for Illinois Power.”

As a result of the canceled deal, Standard & Poor’s Ratings Services (S&P) last Monday removed its ‘A-‘ corporate credit and other ratings on Exelon and its affiliates from CreditWatch with negative implications. The outlook for Exelon is negative.

“Exelon’s decision to call off the deal demonstrates the company’s discipline in approaching the potential transaction, which is supportive of credit quality,” noted S&P credit analyst Scott Beicke.

S&P said that Exelon’s negative outlook reflects challenges related to balancing Exelon’s growth initiatives while reducing debt burdens and increasing key credit protection measures. In addition, uncertainty regarding future regulatory treatment for Exelon subsidiary Commonwealth Edison concerns S&P.

Exelon’s ratings may be lowered if its higher-risk generation strategy does not provide sufficient cash flow in step with its associated risk level and/or its adjusted financial metrics do not improve in the near term, S&P added.

As for Dynegy, S&P affirmed its ‘B’ corporate credit rating on the company and its subsidiaries. At the same time, S&P removed its ratings on Illinois Power from CreditWatch with positive implications. All rating outlooks are negative.

“The sale of Dynegy’s Illinois Power unit was a key part of the company’s comprehensive self-restructuring program,” said S&P credit analyst John Kennedy. “Now that the agreement to sell Illinois Power to Exelon has been terminated, Dynegy will need to improve Illinois Power’s financial structure through cost reductions to stem credit deterioration at the consolidated enterprise.”

S&P said that several key credit issues still need to be resolved. Before the sale was canceled, Dynegy expected to eliminate $170 million in annual interest payments associated with the $2.3 billion intercompany note and $1.8 billion in Illinois Power debt, which was to be assumed by Exelon. In addition, the company’s consolidated debt leverage will remain at a “burdensome level” because the anticipated proceeds could have been used to reduce debt retained from the prior failed business strategy, S&P said.

The ratings agency noted that the negative outlook reflects the continued uncertainty around “Dynegy’s ability to effectively manage the Illinois Power operation, difficulty generating sustainable cash flow given the current environment in electric generation, as well as the price volatility in gathering and processing of natural gas liquids.” In addition, the current rating level incorporates maintaining access to capital markets for debt refinancing, preserving an adequate liquidity position and meeting obligations over the next 12 months.

S&P said that lower ratings are “a distinct possibility given Dynegy’s weakened financial profile, regulatory uncertainty in Illinois, stagnant generation prices, volatile gathering and processing natural gas liquids margins and vulnerability to adverse economic conditions.”

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