Calpine's Sales Mask Debt Woes

William Gabrielski

In a recent Morningstar report on power producer Calpine (CPN), the research firm said it would consider buying shares if the stock fell to 10 cents a share. As far-fetched as this may seem, given the stock's current quote of $3.35, Morningstar may be more perceptive than the nine Street analysts who currently rate the stock a hold or buy.

Calpine is in the business of providing natural gas-fired power to utilities. These utilities, such as PG&E (PCG), demand more power during peak periods, such as in California right now where high temperatures have led to a surge in air conditioner usage. So the second quarter should have been a decent period for Calpine.

Yet the company lost 51 cents a share in its second quarter, missing Wall Street estimates by 22 cents a share. Calpine, with all of its mass and scale and perfect geographical positioning in the warmest portion of the country at the right time of the year, only managed to operate at 40% of its capacity in the quarter. This yielded $215.1 million in EBITDA, which is not enough to cover its $333.7 million in interest expense for the quarter, let alone the $50 million to $100 million it usually spends just to keep its plants up and running. (Note that the company, which has a history of issuing guidance that it subsequently misses, said it expected to deliver $1.6 billion to $1.7 billion in EBITDA in 2005. At this pace, it will not come close to this forecast.)

In addition, Calpine stated that July utilization had only risen to 51%. Industry watchers, however, would prefer, or even expect, a company of Calpine's stature to have closer to a minimum 60% of its capacity right now. Part of the problem with Calpine's business results is that plant breakdowns held back power generation in the quarter. This raises the interesting question of why the company did not fix its plants. Perhaps it is because Calpine doesn't have the cash to spend on repairs.

In the company's press release that accompanies its second- quarter earnings report, Calpine reported having $636 million in cash and $993.9 million in restricted cash. Of this reported restricted cash, some $400 million has already been spent by the company to repurchase some preferred securities.

This, in and of itself, is quite paltry relative to the company's $17.4 billion debt load and more than $1.5 billion in annual interest payments. But what's more concerning is that the $636 million cash figure may not be representative of the amount of cash Calpine can actually spend. And when the company's 10-Q is issued Tuesday, some of these concerns may come to light.

First, about $315 million of this cash is inaccessible because it is sitting on the balance sheet of its subsidiaries, as required by certain debt indentures that require a certain amount of collateral. In addition, the company has about $186 million in debt due on Aug. 15.

So of the $636 million in cash on hand, roughly $200 million may be free to fund operations, capital expenditures and further debt and interest payments in the third quarter. This type of liquidity is unsustainable for a public company with large capital expenditures. Calpine will struggle to shell out cash to make plant repairs or buy natural gas to generate power.

To be fair, the company has closed two large asset sales since the end of the June quarter that it said significantly improved its cash position. During the first week of July, the company closed the sales of its natural gas reserves in Canada, the Gulf Coast and California for net proceeds of $835 million. And on July 28, Calpine sold its Saltend facility for $848 million.

If you add this $1.7 billion to the $100 million to $200 million or so in cash the company had to fund its operations at the end of the second quarter, plus Street estimates for about $350 million in EBITDA this quarter and $122 million in proceeds from two other asset sales, you could argue the company is in a decent financial position to get through the end of the year, at least.

Unfortunately, when a company in Calpine's financial situation sells assets that have served as collateral for already existing debt obligations, new debt obligations are triggered because the bonds are no longer secured by the asset, as required in the debt indentures.

Take the sale of its natural gas plant. Of the $835 million raised with the natural gas sale, about $696 million is in escrow and needs to be used to buy back the debt that was secured by the asset. That's because only $139 million of the debt being used to secure the asset has been tendered, meaning the company is still on the hook for the $696 million that is sitting in escrow. In other words, this asset sale had a negligible impact on the company's ability to pay its bills.

And Calpine's other cash obligations -- capital expenditures on maintenance; interest expense; money owed to buy back $620 million in outstanding preferred stock already spent this quarter; the $400 million the company has used to buy back the preferred debt mentioned above; working capital required to secure natural gas to fire its plants -- leave the company with just about nothing at the end of the quarter.

Additionally, there is unconfirmed speculation among a number of hedge funds and analysts that Calpine's sales of its natural gas business back in early July has limited the company's ability to secure natural gas, its main feedstock for power generation. Calpine has a junk debt rating with credit agencies, so securing the financing to buy natural gas can prove quite costly. Without this feedstock for power, the company's total output may be held back during the peak months when demand, and profits, should be soaring.

The bottom line is that Calpine, at some point, is likely to run out of cash and assets to sell. Unlike Williams Companies(WMB) or El Paso(EP), which both climbed out from under massive piles of debt over the past few years and are now operating sustainable business models, Calpine's asset sales are going to pay the interest expense on the financial obligations created by the asset sales themselves, despite the immediate appearance that the company is paying down debt.

When we called the company to ask the CFO for help understanding the financials, we were told he was on vacation and unavailable for comment. Its public relations department was able to confirm the majority of our numbers without dispute, but would not comment on our analysis.

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