Honig International in the News

Feb 26, 2003
Energy Merchants Edge Toward the Void
The Street.com
By Melissa Davis

With the party over, energy merchants are looking for the one thing known to cure hangovers.

They need time. So they're asking lenders to spare them a little -- that, and a lot more dough.

"This is the energy credit bubble," said Mark Williams, an energy risk-management expert at Boston University. "Too much capital went to these companies, [whose] business model is flawed. The banks are pretty much onto this now."

The banks certainly have had plenty of clues. By now the merchant energy sector is full of disaster stories so similar at times they almost bleed together.

Take Reliant Resources, a $5.9 billion poster child for excess.

"The Reliant story is about one big blunder after another," said one industry expert. "And the company can't blame its problems on Enron, either."

Right now, Reliant is battling the clock to refinance nearly $6 billion worth of junk-rated bank debt. The company needs 100% approval from a huge bank group that includes more than 30 players, many of whom are no strangers to flailing energy merchants. The sector, by itself, is responsible for half the nation's $27 billion in junk-rated debt maturing by year-end.

Binary Stars

Most experts believe the majority of the energy merchants will manage to buy themselves at least another year. After all, the banks are in a pickle themselves. They've already swallowed so much bad debt from the technology and telecom sectors that massive energy charges, at least right now, may be more than they can chew.

"I call it the big, hot burrito," Williams said. "The banks have already taken a lot of bites. What's the upside of taking more now?"

Instead, the banks have been using their strong negotiating arm to hammer out tough deals on their own terms. They're giving energy merchants less money at higher interest for a shorter time -- and they're demanding valuable assets as collateral so they don't wind up empty-handed another year down the road.

They're even calling recruiters, seeking out laid-off energy professionals who understand the assets and could run them, if necessary, until the market turns around.  Barry Honig, the president of an executive search company, said banker interest in energy executives has been picking up for months.

"It's below the radar screen, but it's definitely happening," Honig said. "When there's a loss in the market, there's usually someone else who's trying to make a gain out of it."

Skill Sets

But John McCormack, who leads the energy division of a New York-based financial consulting firm, believes there's "zero actual chance" that big investment banks will end up operating energy assets themselves. He says the banks may, however, attempt to line up experienced professionals in the financial arena -- such as Berkshire Hathaway or Blackstone -- to take the assets off their hands when, and if, they get them.

One big utility investor who's leery of owning any merchant energy stocks said the banks are in the process of gaining access to those assets right now.

"They're more likely to take the security this year and then bankrupt the companies next," he said.

Williams, for one, doubts that energy trading is even a valid business. And that leads him to question whether banks should continue to throw money at an industry that may deliver no real service in return.

"Does this just delay the inevitable?" he asked. "The business model is flawed. So should they just fold up the house now?"

The banks have at least grown hesitant to renew big loans in the sector. They're postponing some renewals for months, then using the extra time to fashion deals that weigh heavily in their favor.

Last week, Reliant became the latest energy merchant to secure an extension -- rather than a commitment -- from its lenders. The deadline came and went for the company to refinance a $2.9 billion loan it took out in 2001. Reliant originally used the money to purchase Orion Energy in a deal that's now legendary in energy finance.

Reliant paid top dollar for Orion, a merchant energy peer, after the market had already soured. And it made some people at Goldman Sachs -- the party on the other side of that transaction -- look brilliant in the process.

"Goldman Sachs made a fortune," one energy expert said. "It was like a home run times two -- easily one of the most profitable deals Goldman has ever done."




It was so good, the expert continued, that some people now view it as more of a fleecing than a sale. Goldman declined to comment on the transaction, involving an energy company it built and sold with perfect timing. Reliant, which is now sweating through refinancing talks on the deal, says it doesn't regret the purchase.

In fact, the company defended its entire acquisition strategy when contacted last week.

"We paid a fair price for the assets at the time we purchased them," Reliant said on Thursday. "We believe we have an attractive portfolio of assets and are well positioned to benefit from a recovery in market conditions."

But critics insist that Reliant has recklessly overpaid for many of its assets -- and has missed plenty of opportunities to learn from its mistakes. They point, in particular, to Reliant's failed expansion overseas.

Just days before agreeing to buy Orion in September 2001, Reliant announced the proposed sale of its only generation assets in Europe. The company was looking to unload the Dutch power plants it had purchased for $2.4 billion just two years earlier.

But that price was considered a rich one even in the heady days when Reliant paid it. And nobody came up with an offer that was even close. On July 5, 2002 -- the day before dropping a $7.9 billion accounting bombshell on the market -- Reliant officially abandoned its search for a buyer of its Dutch power plants.

Reliant had long pulled the plug on most European trading, once its vehicle for growth overseas, by the time it finally found a buyer for its Dutch assets last week. Nuon, a Dutch utility that shook its head at Reliant's high asking price in 2001, came back with a modest offer of $1.3 billion on Thursday.

Reliant, fighting for the financing to keep it afloat, accepted. The company will take a $900 million charge on the deal.

In the meantime, critics blame Reliant's management for the company's current fix. One utility fund manager, who asked to remain unnamed, has grown disgusted with leadership throughout the entire merchant energy sector. He said management teams are filled with old utility executives who have proven themselves horribly inept in the new, deregulated world.

And he said the companies need new leadership -- not just new financing -- if they hope to stay alive.

"The CFO should not be some old utility engineer who's managed to stay with the same company 55,000 years," he said. "People like that just don't understand the energy industry."