With three hour-plus conference calls over four business days, TXU Corp.’s management team offered assurances that the corporation was liquid and strong. The losses, they kept reminding analysts and investors, were only within its European affiliates. By the end of the week, the Dallas-based corporation appeared to have calmed jittery investors, as management made clear that TXU Europe Ltd. and its entities will always be secondary to the success of the U.S. business.

Late Friday, TXU said it had elected to draw upon its unsecured bank facilities at TXU US Holdings and TXU Energy to increase its available cash by $2.6 billion by early this week, a sure indication that the corporation wants its North American operations to remain unscathed by its European operations.

Before McNally’s announcement on Friday, TXU’s downward spiral publicly had begun Oct. 4, when the first of the four conference calls shocked analysts and investors with the news that it would have to adjust its earnings guidance down for this year and into 2003 (see NGI, Oct. 7). By Monday, with investors trading the stock in record numbers, TXU management regrouped, with McNally offering financial evidence that the company was not in trouble. With a clear repetition that TXU Corp.’s focus in on North American business, McNally reminded analysts that the utility’s major earnings are still to come from the third quarter from strong operations in Texas as well as Australia. Materially, he said, there should be a “substantial” gain in earnings.( TXU will formally announce quarterly earnings at the end of October.)

“I’m confident we will have written confirmation in the next few days to remove the cross-default,” McNally said of the bonds. TXU Corp. also is providing TXU Europe with $700 million in equity to restructure UK power purchase agreements, many signed before UK electricity prices dropped about 40%. There are five long-term contracts TXU wants to renegotiate, but there is no guarantee it will be able to do so. Most of the current contract problems are apparently tied to an agreement with AES Corp., which owns a 4,000 MW coal-fired plant in England. It accounts for about 60% of the problem contracts, according to TXU.

In addition, TXU plans to sell at least $400 million of its European assets to cut $4.54 billion in debt, as well as making other reductions. TXU Europe’s UK retail energy business, its largest overseas operation, currently serves about 5.5 million customers.

Within TXU’s financial contingency planning, McNally said three plans “hold a lot of certainty” for the company. TXU can use the capital market for additional financing of its regulated facilities; it could use its funded capital to pay off commercial paper; or it can use its current bank facilities — all which offer the corporation strong liquidity options, he said.

CEO Erle Nye, 65, who has worked for TXU or its predecessors for 42 years, apologized during conference calls several times for the “unfortunate” and what he has called “unacceptable” developments at TXU. Long considered a conservative utility, the price of TXU shares have rarely veered off of a slow but steady rise in price. It was trading for more than $56 a share in April; at one point last week, it had dropped below $15 a share. Nye called the current environment “in effect sort of a panic situation.” But Nye added that the problems in the United Kingdom are a “setback,” not a calamity.

However, Nye also has come under fire for his stock sale in early September, when he sold 45,000 shares of TXU through an incentive compensation plan. He realized about $2.2 million in the sale, but he said this week that the timing was not based on UK problems, but rather a plan to buy a home in California. Nye added that he still holds around half a million shares of TXU stock, “so the idea that I took undue advantage just doesn’t square with the facts.” Nye said it was “hurtful” because “you can’t stop everybody and give them this whole story.”

Meanwhile, TXU Europe and its European subsidiaries were downgraded to one level above “junk” status Thursday by Standard & Poor’s Ratings Services (S&P), which said it could cut the subsidiary below investment grade “in the very near future.” S&P’s action followed that by Moody’s Ratings Service on Wednesday and Fitch Ratings on Oct. 4.

S&P said the European unit’s weak financial performance this year resulted from a combination of issues, including the following:

“UK market conditions have significantly weakened the company’s financial performance and prospects,” said S&P’s Infrastructure Finance credit analyst Anthony Flintoff. “Standard & Poor’s does not foresee a sustained recovery in wholesale electricity prices for some years and, although TXU Europe’s retail customer base provides a partial hedge to weak wholesale prices, it has not prevented serious dents in the company’s debt protection measures.”

The S&P analyst noted that the financial performance of TXU Europe this year had been “very poor, and, based on the electricity market outlook, is unlikely to improve over the medium term without tangible support from TXU Corp.” The negative CreditWatch placement reflects “immediate liquidity concerns,” he said. “TXU Europe does not face any debt maturities within the next three years. However, the company faces immediate liquidity pressures stemming from rating triggers in borrowing and energy trading contracts.”

TXU Europe “faces collateral calls from trading counterparties of about GBP110 million ($172 million), and the probable put of the company’s GBP275 million bond due 2030. A non-investment-grade rating has other potential trigger implications, although these are unclear at the moment. Some or all of the $700 million support from TXU Corp. will likely be necessary to shore up liquidity at TXU Europe.”

Meanwhile on Wednesday, Moody’s downgraded TXU’s Euro entities to “Baa3” from “Baa1”; preferred stock issued by TXU Europe Capital 1 to “Ba2” from “Baa3,” and left all of the Euro ratings on review for another downgrade, after noting that it had first placed the European subsidiary on review in late July because of the weak UK operational performance.

“The company’s business model, involving the hedging of its generation output and power purchase contracts through its retail customer base, is a logical one,” said Moody’s senior analyst Chetan Modi. “However, the company is currently encumbered with a number of long-term electricity purchase contracts that are out of the money.” Also, said Modi, “with the collapse in wholesale generation prices and the high margins in the competitive supply business, the company has suffered higher than expected erosion of its retail customer base. These events have led to a significantly reduced operating cash flow this year and a weakened credit profile, which the company is looking to stabilize via the equity injection.”

Previously, Moody’s had assumed that TXU Corp. would provide “considerable support to the company should this prove necessary. This support has been evidenced in the [Great Britain Pound] GBP390 million equity already injected this year to help TXU Europe fund acquisitions, as well as the additional US$700 million that it is expected to provide. Going forward, Moody’s expects the parent to continue to remain supportive of TXU Europe’s strategy, as well as showing support through not requiring dividends.”

However, said Modi, Moody’s “believes that the parent is unlikely to provide additional equity, for example for further contract restructurings or debt buy backs.” The primary liquidity issues “concern contingent calls, in particular through the activation of its various rating triggers. Should the company’s senior unsecured ratings fall below investment grade from either Moody’s or another rating agency, a number of triggers may be invoked which could cause significant liquidity problems for the company and result in significantly lower ratings.

“Moody’s believes that the company is fully aware of the commercial and liquidity issues that it faces. It has announced a significant change in focus, cutting back on virtually all development expenditure in Europe, reducing other costs and focusing on initiatives to reduce the rate of customer attrition. The company has also indicated its intent to remove all rating triggers as soon as possible.”

TXU Corp.’s senior unsecured rating was kept at “Baa3″ with a negative outlook, and Moody’s assumes that TXU Europe won’t impact U.S. operations.”This assumption is premised upon two factors: 1) that additional equity will not be sent from TXU Corp. to TXU Europe; and 2) that no further cross default or cross collateral language exists beyond that in the $500 million working capital facility available to TXU Corp.,” which it plans to remove as soon as possible.

On Friday, TXU Europe apparently laid off about half of its 135 employees in Geneva, Switzerland. Other job reductions are expected from TXU’s 2,000-member overseas roster, and some also are expected in the United States. TXU Europe and its affiliates have offices in Germany, the Nordic region and Switzerland, with its largest operations in the United Kingdom, where two-thirds of its business is located. A TXU Europe spokesman affirmed that the company was undergoing cost-cutting measures across the board, which included “reducing numbers in Geneva.”

Reacting to the drop in investor confidence by TXU and other companies that until now had escaped the backlash from Enron Corp.’s bankruptcy, many analysts also are scratching their heads. “Most damaging to investor confidence was the fact that utilities, such as Dominion, Duke Energy and TXU, that up until recently were considered fairly immune to the more extreme pressures on earnings or a liquidity crisis, have come under intense pressure in the last several weeks,” said Christopher R. Ellinghaus an analyst with The Williams Capital Group LP. “While credit and earnings concerns have long been pressuring the energy merchants, earnings and liquidity concerns have now more generically spread to the ‘safer’ utilities.

“The list of stocks we would consider absolutely immune to significant financial strain is growing precariously short,” Ellinghaus continued. “Therefore, the increasing financial risk in the sector further narrows the investable universe for many investors and should lead to continuing pressure on industry valuations.”

Ellinghaus said Williams Capital expects “available credit to tighten further as once perceived stronger companies are financially stress-tested. The access to capital throughout the sector is likely to diminish. Further credit rating downgrades also are likely as financial flexibility is further reduced for many utilities and energy merchants, particularly as stock prices continue their step-change lower. Unfortunately, this is likely to create a continuation of the seemingly unending perpetual circuit of credit rating downgrades and liquidity concerns that have yielded ever lower stock prices.”

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