As long as TXU Corp. can deleverage itself and lower its debt-to-capital ratio in a “fairly rapid fashion,” Standard & Poor’s Ratings Services (S&P) analyst Judith Waite believes the company shows strong support for an investment-grade rating.

And for now, TXU Corp. continues to have an “adequate safety net,” she said, because of its strength in Texas’ deregulated marketplace, which could support the parent despite its failing European subsidiary, which is apparently close to insolvency. S&P’s Utilities, Energy and Project Finance Ratings Team held a teleconference on the Dallas-based utility giant last week. Analysts focused on the unsure future of TXU Europe Ltd., but Waite, who covers TXU Corp. in the United States, spent considerable time explaining why S&P considers the parent corporation to be sound.

“Fundamentally, what supports TXU [Corp.] is its position in Texas in the retail market, the fact that the retail market there is becoming deregulated in a reasonable and rational fashion,” Waite said. “There has not been a radical change. It is expected that the rate of change will pick up, but TXU will continue to maintain its dominant position in the market, much like Centrica does in the UK.”

Waite continued, “With that strong business position in Texas, there is strong support for an investment-grade rating as long as the deleveraging occurs in fairly rapid fashion.” She was, of course, referring to the corporation’s plan to sell off all of its Euro assets, which would include its retail customer base, numbering around 5.5 million customers mostly in the United Kingdom, as well as assets in Germany and the Nordic region. TXU Corp. has invested about $10 billion overseas in the past four years; the European subsidiary and its affiliates are now considered to be worth perhaps a third of that amount.

Asked to define “fairly rapid,” Waite said that S&P would be tracking the company “over the next six months, nine months, next 10 months. That’s what will support a rating and a move toward an investment-grade,” but she did not believe the parent could complete its plan until late in 2003 or 2004. S&P wants to ensure that TXU Corp.’s debt-to-capital ratio is consistently declining, and that it will make good on its plan to boost liquidity. TXU Corp. wants to move its debt to 50% or less; Waite said its debt ratio currently is “around 56%, even without the European debt.”

Waite said TXU Corp. was “very committed to using whatever additional cash they had to begin to improve” its coverages. “It’s a very turbulent period of time facing them over the next year.” She said TXU Corp. had indicated it would do “whatever it takes” including an equity offering, if that proved necessary.

Anthony Flintoff, who covers TXU Europe for S&P in the London office, told financial analysts that the main focus now for the ratings agency is now directed toward TXU Europe’s default rating and the probability of defaulting. Since the rating has been put at “B+” with CreditWatch negative, Flintoff said analysts “have turned our attention to the recovery, the ranking and the subordination.” The “B+” rating is S&Ps fourth-highest “junk” rating.

Asked what would happen if TXU Europe could become insolvent, Flintoff responded that insolvency proceedings could be considered, depending on the circumstances. “It would come down to either one of the power purchase agreement counterparties, for instance in the case of Drax where capacity payments weren’t made, or any of the others (that have not been paid), to decide at that point whether…they would be better off having the company in administration.” The United Kingdom does not have bankruptcy laws on its books, but rather provides for a illiquid company to sell off assets.

Said Flintoff, “The first point for those counterparties is to understand their incentives right now as to how their interests would best be served and whether in administration they would have a better chance of recovery than through some other work-out or sale option.”

Other financial analysts, including CreditSights, also are weighing in on the U.S. parent, noting, “unless TXU stanches the bleeding soon, investment-grade ratings could be a distant memory. TXU Europe continued to founder, as it became clear that TXU wasn’t going to be infusing $700 million into the sinking subsidiary.

“We wondered where the promised $700 million was to come from…; Now we know it wasn’t coming from anywhere. TXU has removed the cross-default in $500 million of debt (the cost of which was not disclosed) to TXU Europe, setting the stage, we believe, for a TXU Europe default,” said CreditSights.

Analysts noted that “another sign of likely impending default is that TXU Europe is taking plants out of mothballing to serve its UK supply customers, implying to us that it plans to abrogate its contracts with generators like AES Drax.”

Because there is no provision in the United Kingdom comparable to the U.S. Bankruptcy Code allowing Chapter 11, CreditSights analysts said they expect “the worthwhile parts of the business to be sold either by TXU or, eventually, by the creditors. That likely includes the supply business and, possibly, some plants to support it. With these new measures, TXU should be able to hold an investment grade rating, but we aren’t ready to jump back in just yet. Recent history tells us there might still be some surprises.”

According to the London Times on Tuesday, TXU Europe is meeting with bankers, bondholders and trading counterparties, as well as an insolvency adviser. Under arrangements with the UK National Grid, TXU Europe said it was “business as usual,” said the Times. “However, at the same time, it threatened to bring 522 MW of its own power plants out of mothballs in an effort to calm price volatility,” which has risen in the United Kingdom in recent days because of TXU Europe’s liquidity problems.

The London newspaper claimed that the plant re-activation by TXU was part of negotiations with fellow generators from which it contracts power, including Scottish & Southern and U.S.-based AES. Some unidentified generators told the Times that TXU Europe officials had told them, “if you won’t help us, we will try to keep power prices low for as long as possible.” A “rival” generator also said, “TXU [Europe] wants some of its suppliers to take a haircut on these very onerous contracts and, in return, the company will not go into administration.”

The UK Department of Trade and Industry said it was monitoring the situation and was following the discussions between TXU Europe and the UK industry regulator, Ofgem. Ofgem has the right to make other generators the suppliers of last resort to TXU’s 5.5 million customers if the company goes into default.

Before the problems with TXU Europe grew last week, the corporate board of directors already made moves of its own, deciding last weekend to reduce the quarterly dividend 80%, ,to 12.5 cents from an expected 60 cents per share, that is to be paid on Jan. 2. “The indicated annual dividend is now 50 cents per share of common stock,” said the company.

CEO Erle Nye said the board’s actions were “the direct result of rating agencies’ concerns as to the company’s liquidity and credit situation. Today’s financial markets and concerns of the rating agencies have forced us to take this dramatic action.” Nye noted that the board’s decision to reduce the dividend “was not taken lightly. The events of the past few days persuaded the board that the dividend reduction was prudent.

“We recognize the importance of the dividend to our shareholders and sincerely regret having to take this action. However, our primary responsibility to the shareholder is to maintain the financial strength and flexibility of the company. The common stock dividend policy will be reviewed on an ongoing basis. The dividend will be increased when there is unquestioned confidence in the company’s liquidity and credit, combined with access to the capital markets on reasonable terms,” Nye added.

Developmental capital expenditures throughout all regions will be significantly reduced, despite CFO Mike McNally’s statement that the corporation’s cash flow and earnings are “strong and stable in our Texas and Australia operations, which are performing very well.” However, “in light of limited attractive investment opportunities, developmental capital expenditures will be reduced significantly. Cash retained from expenditure reductions and the reduced dividend, which totals approximately $850-to-$950 million per year, will be available for debt reduction.”

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