Credit analyst sees more downside for Aquila

By Ronda Fears

Nashville, Tenn., August 16 - Carol Levenson, director of research at Gimme Credit, said she sees more downside potential in merchant energy company Aquila Inc.

"With substantial negative free cash flow forecast for the second half and only $92 million in unrestricted cash on hand, this [ratings triggers in debt covenants] could leave Aquila completely reliant on its bank lines in the event of a downgrade to junk," Levenson said in a report Friday.

"And even if it maxed out on its bank lines, the company might not be able to come up with enough cash to satisfy all its collateral calls as well as meet its cash flow shortfall.

"So unless the rating agencies can be placated, it's either back to the capital markets or hold a fire sale of assets. We see additional downside in this name."

On Friday, Aquila said in a statement that it had enough cash flow to meet short-term demands if its credit rating is downgraded.

The Kansas City, Missouri-based energy company reiterated its current liquidity position of $754 million and said total cash flow for the year has not changed.

"You can take all the sworn oaths and financial statement certifications, the investor conference calls and the slick road shows, and give us an ordinary old 10-Q report or, even better, a 10-K report any day of the week, and sooner would be preferable to later," Levenson said.

Aquila (Baa3/BBB) filed its June quarter 10-Q late Wednesday, along with an amended 2001 10-K.

"Once certification-obsessed investors got around to perusing these documents and reports began to circulate the company had drawn down its bank lines, which had just been paid off last month, Aquila's stock fell a sickening 55%, although its bonds traded off only modestly," Levenson said.

Levenson said her firm turned sour on Aquila when it cancelled its acquisition of independent power producer Cogentrix, which would have added another $1.5 billion in debt to its balance sheet.

"As Aquila force-fed the capital markets $500 million in double-digit coupon debt and nearly $300 million in equity in July in anticipation of this purchase, we wondered what it would do with the money instead," the analyst said.

"The 10-Q seems to have provided the answer, and it's not a confidence builder.

"The $500 million bond offering refinanced short-term debt, although the substantially higher borrowing costs should be offset by the less risky maturity structure. But the $300 million in equity proceeds seem to have disappeared, implying the familiar 'failing energy trader cash burn' consumed it."

Aquila's liquidity at the end of June was roughly $900 million in cash and available bank lines. But liquidity had fallen to $750 million six weeks later, at the time of the 10-Q filing, despite $300 million in net new financing in the interim.

Some of the shrinkage can be explained by demands by a customer that Aquila segregate its margin deposits after the end of the quarter, reducing unrestricted cash by $126 million, Levenson said.

On the other hand, she said, the August liquidity number includes not only cash and available credit but also $80 million in "highly liquid commodity inventory, with which it's very difficult to pay one's bills."

Excluding gas and the reclassification of customer deposits, she estimates Aquila consumed $100 million of cash in the past six weeks, and possibly another $300 million from the equity offering proceeds, unless debt has also been reduced during the same period.

"Which brings us inevitably to the ratings trigger issue," Levenson said.

"Any energy investor can tell you this is one of the slipperiest factors to quantify. At least, after Enron, investors know the right questions to ask on this topic."

And Aquila assured investors in its second quarter earnings conference call the maximum amount of cash the company would have to come up with if its ratings were downgraded to junk by both Moody's and S&P was $335 million, she said.

Yet if you add up all the potential cash calls triggered by such downgrades listed in the 10-Q, it comes to over $200 million more than this, or $546 million, she added.

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