Bad Math at Calpine Adds Up to Sell
William Gabrielski
11/04/05 - 10:03 AM EST
Calpine(CPN Quote) just keeps giving investors more reasons to sell.
The latest drama for the stock came Thursday, when shares of Calpine were halted at 3:15 p.m. EST. Investors were kept on the edges of their chairs until nearly 8 p.m., when Calpine put out a press release explaining the reason for the halt: Turns out the company didn't calculate its third-quarter EBITDA number correctly in its Thursday morning earnings release. Also, Calpine miscalculated its second-quarter EBITDA results as well, leading to a reduction of $106.2 million in reported EBITDA results.
But the overstatement in EBITDA (earnings before interest, taxes, depreciation and amortization) due to the inclusion of one-time gains from asset sales was rather obvious in the original press release, as I pointed out
Thursday morning. Calpine now reports the number is actually closer to $380 million, a far cry from the $516 million it first reported. And at $379.6 million, the company is about $1 million shy of its quarterly interest expense of $381 million.
Perhaps these errors shouldn't come as a surprise. Half of Calpine's audit committee
left the company in September. And at the end of 2004, Calpine made this statement in its 10-K filing with the
SEC:
As of December 31, 2004, the Company did not maintain effective controls over the accounting for income taxes and the determination of current income taxes payable, deferred income tax assets and liabilities and the related income tax provision (benefit) for continuing and discontinued operations.
Wall Street is taking a much more cautious approach to this quarterly report than in the past. Notably, research firm Buckingham lowered its rating Thursday, just three months after calling my
original column warning investors off Calpine "erroneous." Some large hedge funds I follow that had been long Calpine's stock at one point are now questioning the company's reporting tactics and its ability to continue as a going concern.
I always find the debate about the equity side of Calpine's structure interesting because most investors seem to ignore the fact that the bond market is saying there will hardly be any value left for unsecured debt in the event of a bankruptcy. For instance, Calpine's unsecured bonds with an 8.5% coupon due in 2008 are currently yielding 40% vs. the 10-year Treasury's sub 4.60% yield.
Given that the equity holders have less of a claim on assets than the unsecured debt holders, the bond market is signaling that even with the best of all outcomes for Calpine in its upcoming legal proceedings with debt holders, the equity still would be worthless in the event of a Chapter 11 filing.
Back on the numbers, Calpine once again disappointed investors on many fronts. First, its EBITDA excluding one-time and non-cash items failed to cover its interest expense. Second, the company ran a cash deficit from operations that was substantially below its EBTIDA, a sign of glaring earnings quality issues. Last, the company has backed away from its long-held plan to retire $3 billion in debt by the end of 2005, which should tell investors just how tight liquidity is at Calpine.
The company has a very meaningful date in court on Nov. 11, when a judge will listen to Calpine's second lien holders about the way Calpine spent more than $300 million in cash from the sale of its natural gas assets in July. The bondholders believe Calpine's use of the cash -- to buy natural gas to fire its plants -- is a violation of the debt indentures that limit the uses of cash from the sale of designated assets that act as collateral for bond holders.
The company is fighting to get its hands on the remaining $395 million sitting in the account so it can continue buying natural gas in the open market to fire its plants. Second lien holders claim the company is essentially burning through their collateral.
The outcome of this case will be a key factor in what Calpine does next. It is widely believed by analysts and investors that if Calpine wins the case, it will sell its California assets -- also designated assets -- for $2 billion to $3 billion and use the cash to fund operations. If Calpine loses, it will be hard pressed to fund its liabilities in 2006 and 2007.
At this point, I see no reason to hold a position in Calpine.
