Credit analyst says best AEP holders can hope for is stability

By Ronda Fears

Nashville, Tenn., June 19 - American Electric Power Inc. gets merits for raising money in a tough market, said Carol Levenson, director of research at Gimme Credit, but she doesn't see a big improvement in the credit.

Earlier this month, AEP sold $300 million of three-year 9.25% mandatory convertibles.

"We refrained from including AEP in our list of 'safe' utilities because of the large and growing earnings contribution from riskier businesses and we think the best a bondholder can hope for here is stability, not improvement," Levenson said in a report Wednesday.

As wave after wave of "me too" utility acquisition or expansion fads have come and go, she said it's easy to become jaded.

The must-have accessory of the mid-1990s was a regional U.K. distribution company or an Australian utility or both, the analyst noted, and AEP (Baa1/BBB+) owns one of each.

AEP inherited a U.K. distributor, Seeboard plc, through its merger with Central & Southwest.

With the new emphasis among energy merchants on improving their balance sheets, and maintaining their credit ratings, both Seeboard and the company's Australian utility, CitiPower, suddenly became "noncore" assets, put up for sale as soon as pooling accounting rules allowed it, she said.

Although there are reports the bidding for CitiPower may be delayed, yesterday AEP announced the sale of Seeboard to a unit of Electricite de France for $2 billion in cash and assumed debt.

"While $2 billion in consolidated debt reduction is always a welcome event, the fact the company expects to suffer a $440 million loss on the sale takes some of the bloom off the rose," Levenson said.

The sale is expected to have no impact on AEP's earnings, which implies the investment was "dead money," its after-tax financing costs equal to its earnings.

"The cash flow impact is likely to be neutral as well, but we believe business risk could increase somewhat with the loss of geographic diversification and quasi-regulated earnings," Levenson said.

"Furthermore, increased business risk is something AEP does not need right now, as its unregulated businesses already make up a large and unpredictable component of its earnings and cash flow."

AEP is about to embark on a massive corporate restructuring, she said, that is more complex than usual as its service territory covers 11 states in various stages of deregulation.

When the transformation is complete, however, the analyst said AEP's risk profile should be much easier to ascertain and track.

One reporting segment will contain the wholesale energy and other competitive businesses, and the other will comprise the transmission and distribution businesses in the deregulated states Ohio and Texas, as well as the integrated utilities in those states that remain under traditional regulation.

"As long as the company doesn't do a for-real splitup, we would tend to view unsecured credit quality on a consolidated basis," Levenson said.

"Nevertheless, if you asked any current bondholder which segment he or she would rather be a creditor of, we think the unanimous choice would be the regulated businesses."

AEP sells wholesale power from its owned generation, but it also has an active marketing and trading group.

This means it has been drawn into the recent trading controversies.

The company has not yet indicated any desire to pull back from the trading business like some of its peers, the analyst noted, "perhaps because it can still reap the benefits of possessing a huge capital base and relatively strong ratings."

Still, this business has exhibited the usual volatility of cash flow and earnings, offset somewhat by the regulated segment.

"However, we give AEP credit for raising nearly $1 billion in equity in a tough market and for completing a major asset sale," Levenson said.

"We estimate these transactions will lower AEP's leverage from the mid to the low 60s and the CitiPower sale should improve this measure even further. We note AEP has considerable off-balance-sheet obligations and plans to make $1 billion in annual acquisitions."

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