Dynegy Sacrifices Bondholders

Utility's plan to avoid default involves new layer of debt senior to existing bonds.

Dynegy Inc. is refinancing debt and altering its corporate structure to avoid a default, putting bondholders at a disadvantage by reducing their claims on the assets of the third-largest independent U.S. power producer.

Dynegy is seeking $1.7 billion in new loans to replace an existing facility on which it expects to default later this year.

The utility has posted four straight quarterly losses as low power prices and tougher capital requirements led it to consider bankruptcy earlier this year. Robert C. Flexon, named chief executive officer on June 22, needs a new credit agreement because Dynegy expects to be out of compliance with an earnings-to-interest ratio requirement in its current loan package by the end of the year, according to a May 9 regulatory filing.

“The new management team’s first requirement is to get liquidity, get the new bank facilities and then once that’s done to go after some of these long-dated maturities,” said Andy DeVries, an analyst at CreditSights Inc. in New York.

The proposed financing package includes term loans of $1.3 billion and $400 million, the company said in a regulatory filing yesterday. Credit Suisse Group AG and Goldman Sachs Group Inc. are arranging the six-year facilities, which Dynegy expects to be completed at the end of July.


‘Asset Stripping’
Dynegy’s plan adds a layer of debt senior to its bonds, whose holders are also at risk of having company holdings sold.

“The bondholders have no covenants protecting them against asset stripping,” said CreditSights’ DeVries. “They caught the market off guard, and senior unsecured bondholders are saying that management is no longer looking at the whole company as one big portfolio and that is telling bondholders they may try to strip some assets out from under them.”

Neither Flexon, 52, nor Chief Financial Officer Clint Freeland, 42, would comment on yesterday’s filing, Millie Brinkley, a company spokeswoman said in a telephone interview. Flexon was hired by a new board backed by the company’s two largest owners, Carl Icahn and Seneca Capital, after shareholders rejected two takeover bids.


Gas, Coal
Dynegy said it will restructure itself with one unit owning eight primarily natural gas-fired power generation facilities and another owning a group of six primarily coal-fired baseload facilities, according to the filing. The $1.3 billion debt will be available to the natural-gas unit, while the coal subsidiary would get the $400 million loan, Dynegy said.

Separating debt at its natural-gas fueled plants, which have been running more, from its coal-burning plants, which have been running less based on fuel costs, will make it easier for Dynegy to sell either unit, Brandon Blossman, a Houston-based analyst for Tudor Pickering Holt & Co., said in a telephone interview.

Dynegy must increase the ratio of its earnings before interest, taxes, depreciation and amortization to interest expense to 1.6 times or more by Sept. 30 to remain in compliance with its covenant and avoid default, according to the SEC filing.

It is “virtually certain that we will not be in compliance with this covenant at some point over the next twelve months unless we reach agreement on an amendment to or replacement of the credit facility, or obtain a waiver of its terms,” according to the company’s 10-Q filing received May 9.


Bond Ratings
Moody’s Investors Service assigned Dynegy a rating of Ca, 10 steps below investment grade, on March 28. Standard & Poor’s cut its level to an equivalent CC on March 18 and said it could downgrade the company further, citing the “near-term possibility of a bankruptcy filing” if lenders don’t agree to modify the terms of the loans.

The company’s 8.375 percent bonds have fallen 12.75 cents since touching 87.75 cents, the highest in a year, on May 3, Trace data show.

The extra yield investors demand to own Dynegy’s $4.31 billion of bonds instead of similar-maturity Treasuries widened to 13.24 percentage points on average yesterday from 11.75 on June 22, even as spreads on high-yield debt narrowed 6 basis points over the same span, according to Bank of America Merrill Lynch index data. A basis point is 0.01 percentage point.


New Loans
Dynegy had $68 million outstanding under its term loan B due April 2013, as of March 31, according to the regulatory filing. The utility also has $850 million outstanding under a term facility also due April 2013 that is fully collateralized by $850 million of restricted cash, which means current bondholders are behind $68 million in the capital structure. After the refinancing, they will be subordinated to the new $1.7 billion facility.

“This structure gets them down the road a year or two, and you just don’t know how much more new debt will be ahead of you,” Peter Thornton of KDP Investment Advisors in Montpelier, Vermont. said in a telephone interview. “You’re going to be facing increasing structural subordination, and in that case the recovery value just goes down as more and more debt is layered on to those new subsidiaries.”

Dynegy has risen 66 cents, or 11.6 percent, to $6.36 in New York Stock Exchange composite trading since the Houston-based utility announced April 13 it had hired Lazard Ltd. to refinance its debt. The company reported its fourth consecutive quarterly loss on May 9 as electricity prices fell from a year earlier.


Energy Prices
Falling gas prices have hurt Dynegy’s earnings. Gas costs set energy prices in most market because plants powered by it usually provide the marginal power needed to meet demand. Coal is easy to store, and plants powered by it are usually slow to be turned on and off.

The first-quarter net loss was $77 million, or 64 cents a share, compared with net income of $145 million, or $1.20, a year earlier, the Houston-based company said in the May 9 statement. Sales fell 41 percent to $505 million.

NRG Energy Inc. and Calpine Corp. are the two largest U.S. independent power producers.

Natural gas for May delivery rose 3 cents to $4.31 per million British thermal units yesterday on the New York Mercantile Exchange. Natural gas futures traded at $4.405 per million Btu on Dec. 31 and as high as $13.577 on July 3, 2008. Dynegy failed to hedge at that time, and it sold eight natural-gas powered plants to LS Power Group in 2009.

The spot price of Illinois coal rose 16 percent from a year earlier to $47.80 a ton in the past quarter, trailing a 31 percent increase in power prices in PJM Interconnection LLC, the largest U.S. power market over the same period, Bloomberg data show. Natural gas prices fell 5.2 percent, to $4.37 a million Btu, in the same period.


‘More Time’
Dynegy’s loss excluding some items such as adjustments to the value of fuel and power sales contracts probably doubled to 55 cents a share in the past quarter, the average of four estimates by analysts compiled by Bloomberg.

“If this works, they’ve bought themselves a little more time,” said Tudor Pickering Holt’s Blossman. “Presumably, the covenant language in the new facilities will allow them essentially the six years to right the ship.”


Bloomberg News


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