Credit analysts: El Paso bondholder recovery could be 12% in worst case

By Ronda Fears

Nashville, Jan. 16 - With legal liabilities looming for El Paso Corp. that could put even more pressure on the company to the point of bankruptcy, CreditSights analysts Dot Matthews and Andy DeVries said potential recovery levels could be as low as 12% for senior bondholders.

Settlement talks with California are key, but even if El Paso favorably settles with California as well as the Federal Energy Regulatory Commission, the credit analysts noted there are serious concerns about El Paso's ongoing cash flow.

"We expect El Paso to try to reach a viable settlement with California before FERC rules, but one should even be possible after that date. This exercise involves looking at what could happen if El Paso has a bad California outcome or if El Paso has to file [bankruptcy], but is not predicting that it will file," the analysts said in a report.

"With a settlement, El Paso could be viable, but we do have some ongoing cash flow concerns. Absent a settlement, if FERC finds against it, El Paso could be headed to Ch. 11, with a recovery for senior unsecured holders potentially well below where the bonds are currently trading."

California Attorney General Bill Lockyer said Monday that a settlement with El Paso is close regarding allegations the company restricted natural gas flow into California to boost profits during the 2000-2001 energy crisis. Talks focus on a range of $1.5 billion to $6 billion, he said.

"El Paso can make it through, but worst case outcomes could result in a major haircut for parent-level bondholders," the analysts said.

"Our best case study indicates an eventual par value for the bonds, while the absolute worst case (multiple of cash flow discounted at 35%) implies a recovery of 12 cents on the dollar."

If you are comfortable with the likely California outcome, the analysts said holders might wait to consider selling on the news.

"The bonds would likely have a pop on good news, although they clearly won't rise to par, and you could take advantage of that to get out or to lighten up on position," the analysts said.

That's because even under the rosiest scenario, there are ongoing concerns.

In the best-case scenario, the analysts assumed El Paso settles with California for $1 billion, with a further $1 billion in similar liabilities to copycats. At the high end of asset valuations [$23.3 billion], El Paso covers its debt and has value for stockholders.

"In this high end evaluation, all debt would eventually get par and there would be considerable value for stockholders," the analysts said.

"One could say that no filing would be necessary under this scenario, and that is entirely possible...but that still could happen even in a high end case if there are looming suits or a temporary cash flow crisis."

In the worst case scenario, FERC finds for California, California presses its $3 billion suit and other Western states and large users pile on, adding to the liability.

"If we assume another $2 billion in claims from other parties, that $5 billion total could be enough to sink the El Paso ship near term," the analysts said.

"Even if the suits aren't heard soon, it is possible that the overhang of so much potential liability might be enough to make El Paso seek shelter in a Ch. 11 filing, much like Texaco did many years ago."

In the worst case, with assets valued at $14.65 billion, the analysts said recover on El Paso senior bonds would be about 81 cents on the dollar. Discounted 20% to take into account a two-year bankruptcy, it would be 56 cents on the dollar. At a 35% discount, recovery would be 44 cents on the dollar.

In the event that El Paso's worth was calculated using on a multiple of expected operating cash flow, the worst of worst case scenarios emerge. But the analysts said they think the asset valuation method, which they used in the best and worst cases, would probably be used.

Using the multiple of cash flow method El Paso would have an enterprise value of only $8.496 billion, the analysts said. Under that scenario, recovery would be 22 cents on the dollar, 15 cents on the dollar at a 20% discount to allow for a two-year bankruptcy, or 12 cents on the dollar at a 35% discount.

In any event, the analysts said there are serious cash flow concerns.

The analysts estimate 2002 year-end total liquidity of $2.5 billion. That includes $700 million in cash and $2.5 billion in available credit, outlined by the company in its Nov. 26 conference call.

For 2003, operating cash flow was estimated at $1.4 billion, using the actual amount for the first three quarters of 2002 and the average of those for a fourth quarter estimate.

After debt maturities, capital expenditures, common dividends and an estimated $1 billion settlement with California, the analysts estimate El Paso will end 2003 with negative total liquidity of $2.24 billion. That estimate includes $1.3 billion of asset sales announced by the company.

"If our assumptions turn out to be accurate, El Paso would have to sell over $2.2 billion in assets to meet its 2003 cash flow needs, without paying down any debt," the analysts said.

"When we estimated 2003 operating cash flow using our 2002 numbers, we got $1.4 billion in operating cash flow for next year, not an encouraging number for an enterprise as big as El Paso."

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