Dynegy Inc.’s bonds were raised to “overweight” from “neutral” in a revised report by J.P. Morgan Chase & Co. on Monday. The revision followed the “company’s strong performance in the fourth quarter, its focus on debt reduction and our belief that Dynegy has a reasonable probability that it will prevail in the lawsuit with Enron over the aborted merger last year.”

The Houston-based energy trader saw its fortunes and stock fall after it pulled out of a proposed merger last year with Enron Corp. However, when Dynegy released its fourth quarter earnings and year-end report last week, the company reported that even though it had lost money in the final quarter — some related to the Enron debacle — it managed to overcome its losses to post 47% profit for the entire year (see Daily GPI, Jan. 24).

J.P. Morgan noted that it believed that “Dynegy will retain its investment grade rating” from both Standard & Poor’s Ratings Service and Moody’s Investors Services “despite heightened scrutiny of the sector by the ratings agencies, particularly Moody’s.” Moody’s downgraded Dynegy’s senior unsecured debt one notch in December to “Baa3,” its lowest investment grade.

Following the downgrade, Dynegy announced it would issue $500 million of equity to generate $750 million by selling some assets and reducing costs. The move by Dynegy will help the company lower its debt-to-capitalization ration, including its off-balance sheet liabilities, to the mid-40% region, said J.P. Morgan. “Since mid-December, Dynegy has made measurable progress in its objectives.”

Potential hurdles still exist with the $10 billion breach of contract lawsuit by Enron, which followed Dynegy’s pull-out from the merger. However, J.P. Morgan wrote, “in our estimation, Dynegy does have a legitimate argument that its decision to terminate the merger was based upon review of Enron’s Sept. 30 [2001] 10-Q, which revealed a dramatic reduction in Enron’s near-term liquidity.” In its year-end conference call Jan. 23, CEO Chuck Watson noted that he expected the Enron litigation to be settled without material financial consequences, said J.P. Morgan.

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