Westar Industries Inc. said Thursday it will sell outright or sell an option to purchase its 45% stake in Tulsa-based Oneok, which declined an offer last week to buy back its stock (see Daily GPI, Aug. 23). The uncertainty over Oneok’s future ownership profile, prompted Moody’s Investors Service to downgraded the company’s credit rating Thursday.

Under a shareholder agreement, Oneok had until Aug. 28 to buy back Westar’s stake — about 4.7 million shares of common stock and 19.9 million shares of series A convertible preferred stock for $21.77 a share, or about $971.1 million, adjusted for a 2-for-1 split. Westar has until Sept. 30, 2003 to complete the sale. Westar Industries is a subsidiary of Topeka-based Westar Energy Inc., a consumer services company and the largest electric utility in Kansas.

Moody’s, which rated Oneok’s outlook as “negative,” dropped its senior unsecured rating to “Baa1” from “A2”, lowered a shelf registration to “(P)Baa1(P)Baa2” from “(P)A2/(P)A3,” cut commercial paper to “Prime-2” from “Prime-1” and dropped Oneok Capital Trust I – preferred shelf and Oneok Capital Trust II – preferred shelf to “(P)Baa2” from “(P)A3.”

In the near term, Moody’s analysts plan to closely monitor Oneok’s “sustainability of the strong cash flow generation and continuing efforts to reduce debt as seen in recent quarters; the upcoming renewal of its $850 million 364-day credit facility which expires on September 30, 2002; the continuing growth of its marketing and trading business accompanied by the continued development in its risk management infrastructure; 4) the ongoing uncertainties related to Westar Energy’s plans to divest its stake; and event risk from acquisitions, which could potentially be large and significantly alter the business mix of the company.”

Resolving or clarifying Moody’s concerns could result in a “stable” outlook, while a “negative outcome” may lead to another downgrade, Moody’s warned. The decision not to purchase Westar’s stake, said Moody’s does support Oneok’s “current credit profile,” since the purchase would have only added to the company’s already burgeoning debt load.

The high debt level has resulted from its “heavy capital expenditures,” Moody’s noted, including major acquisitions and “substantial” natural gas costs during the winter of 2000-2001, left unrecovered for a year because of regulatory reasons. “Furthermore, this debt is increasingly being supported by earnings and cash flows that could be more variable than those of its core regulated gas distribution business. For the 12 months ended June 30, 2002, distribution accounted for 30% of total earnings before interest and taxes (EBIT), down from 46% in fiscal 1999.”

And, Moody’s noted, Oneok’s marketing and trading segment has been the second-largest earnings contributor in recent periods, accounting for 28% of EBIT for the 12 months ended June 30, up from 12% in 1999. The rest of Oneok’s EBIT “comes from the partially regulated transportation and storage business (13%) and other unregulated energy businesses that provide some vertical integration with its distribution business: gas and oil production (16%) and gathering and processing (12%).”

Commodity price exposure has grown from increased investments in marketing and trading, processing, and production, although this is mitigated by hedging and vertical integration. For example, a rise in gas prices relative to liquids prices decreases processing margins, but the decline in earnings is partially offset by higher production results. However, the relatively small size of its production business prevents the company from more fully realizing a positive portfolio effect. Returns on many of these investments have been uneven and modest. The company’s growing marketing and trading operations will likely increase its working capital needs.”

Distinguishing Oneok’s marketing business, said analysts, is its focus on gas storage, with a capacity of 80 Bcf. “Its signature contract is a peaking contract, which provides gas on short notice in case of extreme weather or other shortfall in supply. Customers subscribe to this service for a base fee that generates certain base level of earnings for Oneok; an actual call on this service requires an additional fee that provides earnings upside. The risks related to this business are mitigated by the backing of sales by the physical gas in storage. Also, Oneok’s marketing contracts are short-term in nature, mostly lasting one heating season. Marketing is a growth segment for Oneok. Consequently, the company is likely to keep adding to its gas storage and transportation capacity, requiring more working capital to purchase gas for inventory.” Moody’s noted that Oneok’s working capital requirements for marketing signify the need for “ample alternate liquidity and the importance of the upcoming renewal of its credit facility.” Oneok, fortunately, does not have any long-term debt maturities over the next three years.

Besides lowering its debt levels, Moody’s said, the future free cash flow will be dependent on the company’s “continued discipline in financing its capital expenditures with internal cash flow as it has in recent quarters and requiring no additional debt financing. Although there is now clarity to Oneok’s decision regarding its largest shareholding, uncertainty remains as to Oneok’s ownership profile over the medium term, given Westar’s stated intentions to divest of its stake and regulatory pressures for it to do so.”

Moody’s said it would monitor Westar’s actions related to the Oneok shares, in particular, how Westar plans to “dispose of its stake, how it may be disposed of, and to whom the stake will be sold.” In the meantime, said analysts, “a significant shareholding by a single third party, such as Westar, could potentially pose delays or some other impediment” to Oneok’s growth and financial initiatives.

©Copyright 2002 Intelligence Press Inc. All rights reserved. The preceding news report may not be republished or redistributed, in whole or in part, in any form, without prior written consent of Intelligence Press, Inc.