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After months in the dark,



investors finally know the blinding truth.

The utility's performance remains dim at best. The company, which first shed some light on its operations by issuing restated financials in September, offered another dark picture on Friday. The company weathered steep first-half losses, particularly in the second quarter, as its trading division continued to bleed.

Hit by writedowns and big trading losses, Allegheny ended the first half $290 million in the red. All told, the company lost $2.29 per share, more than tripling its 70-cent loss from a year ago. Generation and marketing losses, which totaled $316 million, more than offset growing profits from the more stable utility division.

Lehman Brothers analyst Daniel Ford called the results "particularly negative." Ford had been expecting ongoing profits of 34 cents a share instead of the $1.81 loss, excluding special items, which Allegheny reported. Even the company's delivery business, which benefited from cold first-quarter weather, managed to generate less than half the pretax profits Ford had been anticipating.

Although utility profits rose, particularly in the second quarter, asset sales elsewhere in the division dragged overall results lower. For the first half of 2003, delivery and services profits came in at $53.7 million -- down 18% from a year earlier -- as some $258 million worth of unregulated revenue disappeared with asset sales.

Still, the company blamed major trading losses for the disappointment. It also reminded investors that, following a renegotiated contract in California last quarter, it has largely exited the Western financial trading business. It also promised brighter days ahead.

"The year 2004 will be a time of transition for our company, as we focus on becoming timely with our

Securities and Exchange Commission filings, refinancing our debt and creating a high-performance culture that will improve both quality and cost," CEO Paul Evanson said on Friday. "I am confident we are taking the right steps for long-term success."

The market barely reacted. Shares of Allegheny slipped 6 cents to $10.79 in light Monday trading.

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'Priced for Perfection'?

Even before Friday's disappointing update, at least one analyst felt that Allegheny shares -- then trading for $10.70 -- were already "priced for perfection."

Granted, J.P. Morgan's Jim von Riesemann was concerned in part by overdue financial statements that have now been filed. He questioned late last month whether Allegheny could update its financial reports -- and clear the way for a crucial equity offering -- before year's end. While the company has in fact issued its first-half results, it acknowledged on Friday that its third-quarter report -- already two months past due -- will not be filed until January.

Meanwhile, von Riesemann is braced for serious challenges in the year ahead.

"The balance sheet remains stretched ...

and the company is in violation of its minimum financial metrics," wrote von Riesemann, who has an underweight rating on the stock. "Fundamentally, our concern is that this company has '$1.7 billion in excess debt' -- by management's own admission -- yet has a market cap of $1.35 billion."

Over the next two years alone, Allegheny faces $2.2 billion in debt maturities. When evaluating that schedule earlier this month, Burnham Securities analyst Ali Agha projected that Allegheny could face a $123 million liquidity deficit by the end of next year. Ford has also predicted a tough road ahead. Although he noted last month that Allegheny has enough cash to meet current obligations, he said "the bigger question is how they address 2004 and 2005."

In the meantime, Allegheny is already struggling with rising interest costs. During the first half, operating expenses jumped by $80.8 million -- most of it from interest hikes -- as the company paid higher rates on a larger overall debt load.

Still, Allegheny has pledged to shave costs going forward. And Ford has indeed pointed to cost cuts as one of several positive developments that could push Allegheny shares higher next year.

But one possibility he didn't list -- a legal victory against Merrill Lynch -- promises even more upside potential. Allegheny has accused Merrill of fraudulently inducing it to pay $490 million for an overvalued trading division in 2001. Last month, a judge issued a ruling in Allegheny's favor that allows the lawsuit to proceed. Then, on Friday, a former Merrill trader pleaded guilty to charges that he had helped inflate the unit's value before its sale to Allegheny. The trader, Dan Gordon, was later fired by Allegheny after the transaction and continues to aid the federal government in a broad investigation of the deal.

Ford, for one, has taken some comfort in the recent developments.

"Mr. Gordon's admission gives the appearance that Allegheny may have a valid claim, in our view," he wrote on Monday.

Ford believes an Allegheny victory in the matter could be worth as much as $3.10 a share. But von Riesemann still sees better opportunities elsewhere.

"The shares appear to be 'priced for perfection' ... for a company that doesn't pay -- nor has any prospects for paying -- a dividend," he wrote.