March 19, 2004
DJ POWER POINTS: A $100 Million Here, $100 Million There…
By Mark Golden
A Dow Jones Newswires Column
NEW YORK (Dow Jones) – On the road back to monopoly electric utilities, the U.S. keeps tripping on reminders of why it tried competition in the first place. The latest: On Thursday, PG&E Corp. (PCG) utility Pacific Gas & Electric Co. issued $6.7 billion in bonds, the yields of which immediately tightened in the secondary market, indicating that the utility’s customers will pay about $140 million more in interest costs than the market says they should. Divided among PG&E’s nearly 5 million electricity customers over the life of the bonds, $140 million may not seem like a lot of money. But if it were taken out of the pockets of PG&E’s stockholders or financial advisers, the squealing would split your eardrums. “To me, $140 million is real money, especially in California, where electric bills are so high already,” said Mike Noel, senior adviser with Saber Partners financial consulting firm and former chief financial officer of Edison International (EIX), parent of utility Southern California Edison. Because the utility industry is so capital intensive, one of the most important things a utility can do to protect its customers is pay a lot of attention to its capital costs, Noel said. In fact, lead banks UBS AG (UBS) and Lehman Brothers (LEH) were paid $20 million each in up-front advisory fees in addition to the normal commissions for placing the bonds. Yet when the banks freed the bonds to trade, their yields fell 12 to 16 basis points, or 0.12% to 0.16% from the coupon interest rate. “It sure looks like money was left on the table,” he said. “I wouldn’t want to go to my CEO and say that my deal tightened by double digits the same day.” Results like this are no surprise. In the settlement agreement that Pacific Gas & Electric and the California Public Utilities Commission reached in bankruptcy court, PG&E got regulators to agree that financing costs aren’t subject to further review after the transaction.
Well, They’re All Happy
The bankers defended the deal. “It’s very typical for a new issue in the fixed-income market to perform in the manner that the PG&E issue performed,” said UBS’ co-head of debt capital markets, Kimberly Blue, pointing to the $13 billion debt sale last July by General Motors (GM). “A successful transaction in the corporate bond market is characterized by a tightening of the spread.” Bankers at both Lehman and UBS said the clearing price had to be a bit richer than where smaller chunks of the debt might trade in the secondary market because of the large size of the deal. “The secondary market is not indicative of where a $6.7 billion deal is done,” Jim Merli, Lehman’s global head of debt syndicate, said in an interview. But if size was a problem, why did the yield on the largest tranche of debt tighten less than the yield on a smaller tranche? According to other bond market sources, tightening of a couple points is one thing; double digits means you missed the price. PG&E, along with the banks, pointed to the overall low interest rates on the bonds. “This is a great deal for the company and its customers,” PG&E spokesman Ron Low said. “The settlement agreement that we reached with the CPUC staff last summer, which was reviewed and debated all last fall, assumed we would be paying 6.5 percent. Instead, the all-in interest rate of the bond offering was 4.8 percent.” Of course, that’s taking credit for the low interest rates of U.S. Treasury bonds underlying investment-grade debt. If Lehman Brothers, UBS and PG&E are responsible for Treasurys being so low, then buried in this column is the biggest financial story of the year. The banks did improve the pricing before the offering. Initial price talk on the $1 billion, 10-year bond, for example, was ratcheted down from 115 to 120 basis points over Treasurys to an eventual 109, Merli said. But why did they stop there? Before the bonds were placed, lenders had indicated they wanted $20 billion of the debt. The “gray market” before the placement had the bonds trading at 0.1% lower yields than the interest rates on the coupon. “There is risk in pushing the price too far,” Merli said. “You’d be operating from a position of weakness rather than strength.” Anyway, California utility regulators are pleased with the result. “There was a lot of commission oversight of this offering,” spokeswoman Terrie Prosper said. “We established a financing committee to work with PG&E and the investment firms to help set up financing.”
Mistakes Add Up
A company wants to sell bonds, not oversell them. In January, Southern California Edison sold $1 billion in 10-year bonds at Treasurys plus 78 basis points – compared with PG&E’s 109 basis points – and Edison’s debt has hardly narrowed in the secondary market. It’s surprising that PG&E achieved a worse result, because it is subject to less regulatory review, meaning less regulatory risk. For the next eight years, it can appeal disagreements with the utilities commission at the bankruptcy court. This is part of the whole return to the culture of regulated monopolies, where ratepayers bear the risk and all the supposedly little mistakes add up to electricity costs that are much higher than what competitive generators charge. And, in the current retreat from deregulation, utilities have been able to regain monopoly status with less oversight than before deregulation. Before deregulation, utilities sold their bonds in auctions, Saber’s Noel said. Negotiated deals like the one seen Thursday were the exception, used only if a utility could convince regulators it could get lower interest rates than in an auction. There is a better way, Noel said. Texas is moving ahead with competition, and Saber is the advisor to the Public Utilities Commission of Texas. Under the state’s deregulation law, the commission is charged with achieving the lowest cost of capital. The commission had the utilities and its adviser, Saber, certify that they would do so, and the companies can be held accountable after the fact, Noel said. “Texas did a wonderful job of setting up a system that protects ratepayers,” Noel said. As Texas and the Northeast continue to get electric competition right, and as $100 million mistakes pile up in other states, the road back to monopolies should be questioned.
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