CenterPoint

(CNP) - Get Report

is getting slapped around in "business-friendly" Texas.

The company, accused by some of

poor corporate governance, is poised to take a massive hit from utility regulators in its home state. It could lose billions -- and its investment-grade rating -- if regulators choose to severely punish the utility for suspected lapses that occurred during the deregulation process.

The ruling, which could come as early as today, will help decide how much CenterPoint can recover for its past investment in a generation business that it has been forced to shed under the state's deregulation law. The so-called "true-up" hearing is the first major one in Texas, where other big utilities -- including

American Electric Power

(AEP) - Get Report

-- will soon be asking for refunds of their own. Since Texas embraced deregulation ahead of most, the ruling is considered by some to be of national importance.

William Kucewics, editor and publisher of

GeoInvestor.com

, recently warned of serious consequences if Texas regulators follow recommendations to slash CenterPoint's recovery by more than $2 billion. A sharply reduced recovery could sap the company's ability to pay down debt to the degree that bond rating agencies expect.

"The impact would be felt far beyond CenterPoint Energy," he wrote. "All Texas electric company borrowers would likewise see their costs of capital rise and their credit ratings degraded. The effect would ripple across the country, affecting any and perhaps all states that are part of the electric power deregulation movement."

But CenterPoint's stock has already weakened in anticipation of a painful hit. Since the hearing took a negative turn this month, shares of CenterPoint have fallen 6% to $10.61.

Spin Control

The real spiral actually began earlier.

The company's stock was fetching more than $12 a share until CenterPoint announced the sale of its generation business in late July. CenterPoint's immediate selloff confounded some. After all, CenterPoint was set to clear $2.5 billion -- far more than most expected -- on the sale of

Texas Genco

( TGN). The market had valued Genco at considerably less just a few months earlier.

But that discrepancy is costing CenterPoint now. CenterPoint critics have long argued that the company, exercising poor corporate governance, intentionally followed a path that would suppress Genco's value so that it could recover more from ratepayers for its losses on the generation business. The market officially valued Genco at $36.26 ahead of the true-up hearing. But as

TheStreet.com

predicted in May, when it

singled Genco out as an undervalued stock, the shares were poised to rise. They will ultimately fetch more than $45 apiece in the planned buyout.

But CenterPoint probably won't pocket the difference. Most observers expect Texas regulators to adopt a high value for Genco -- well above the $36.26 share price established by the market early this year -- when determining CenterPoint's refund.

"CenterPoint learned just how unhappy the Texas

Public Utility Commission is that Texas Genco ended up selling for more than anyone thought it would," wrote CreditSights analyst Dot Matthews, who is bullish on both CenterPoint's equity and debt and owns 200 shares herself. "Our takeaway ... is that the TPUC is going to look for any way to justify cutting back on that premium."

Merrill Lynch analyst Steve Fleishman predicts that CenterPoint -- seeking to recover $4.4 billion through the true-up process -- could walk away with as little as $1.5 billion plus interest. That amount, coupled with the $2.5 billion in proceeds from the Genco sale, could leave the company nearly $1 billion short of the sum needed to keep its investment-grade rating from Standard & Poor's in place.

Still, Matthews remains optimistic.

"We continue to believe that CNP, whether by settlement or in court, will get enough total TGN proceeds and stranded cost recovery to maintain its investment-grade rating ... which is in everyone's interest going forward," Matthews wrote on Friday.

Blame Game

That said, Matthews doesn't necessarily blame Texas regulators for scaling back CenterPoint's recovery in light of Genco's sale price. She believes the commission would face a "publicity nightmare" if it allowed CenterPoint to recover money from ratepayers that the company already stands to collect from its sale of Genco. Still, she insists that CenterPoint technically did nothing wrong.

"As one

critic said, CNP 'blindly implemented' the law," Matthews noted.

Harry Chernoff, an analyst at Pathfinder Capital Advisors who has followed the CenterPoint/Genco saga more closely than most, takes a similar stand. He says that Texas regulators have chosen to dwell on "technical violations" -- which Matthews questions -- when seeking to reduce CenterPoint's refund. And he believes that the resulting penalties could make little sense.

For example, he says, CenterPoint has fielded criticism for failing to auction some of its power in the past. But the company itself has argued that it tried to sell the power -- for as little as a penny -- but attracted no buyers. The company would have apparently suffered an immaterial loss if it had simply given the power away. But it now faces a much higher penalty -- possibly topping $400 million -- for its failure to sell the power in the end.

Matthews, for one, is bewildered.

"If you offer your products for auction basically for free and no one buys them, we would expect impartial people to conclude you had done what the law stipulated," she wrote. "After all, the whole point of the ... auction was to spur competition. If no one wants your product, you certainly haven't harmed competition, nor have you withheld anything you should have offered."

Both Chernoff and Matthews remain puzzled by another regulatory argument as well. CenterPoint chose a partial stock offering of Genco to determine the value of the company. But regulators now complain that CenterPoint simply dividended the stock to its existing shareholders instead of selling it to the public. Moreover, they say, some CenterPoint insiders held on to their Genco stock and, as a result, kept less than 19% of the company -- the minimum required by law -- from being sold.

"There are technical ways of reading compliance and technical ways of reading noncompliance," Chernoff explained. The commission "found that CenterPoint had not met the letter of the law."

Chernoff wonders how regulators can even quantify the penalty for such a violation. But he is already braced for the worst.

So far, he says, regulators have been willing to listen to CenterPoint critics -- who are seeking billions of dollars in so-called "disallowances" -- after deciding that a violation took place. And he says that the true-up method established by law is being ignored in the process.

"They take these technical violations and say, in total, CenterPoint did not mitigate Texas Genco's losses the way it should have," Chernoff said. "Then they go back and change the

true-up method. And they do it in the heart of the case."

Both Matthew and Chernoff believe that CenterPoint could easily reverse any negative ruling on appeal. By now, the Texas Supreme Court has repeatedly upheld the state's deregulation law and, in recent months, even reversed a regulatory decision that went against CenterPoint itself. But Matthews believes that CenterPoint is willing to settle the case and move on -- as long as it can walk away with its investment-grade rating intact.

Chernoff, who owns some preferred CenterPoint stock, fully expects the required funds to come through.

"They'll come out with more than $5 billion" from the Genco proceeds and true-up recovery combined, he assured. "I don't think there's any doubt about that."

Shortchanged

Still, the company could fall short.

Prudential analyst Vikas Dwivedi predicted on Friday that CenterPoint would recover just $1.8 billion of its stranded costs. Coupled with the Genco proceeds -- and even helped by interest due -- the sum might leave CenterPoint well shy of the cash needed to reduce debt to levels that would keep S&P happy. And Dwivedi concedes that CenterPoint could wind up collecting even less than he expects.

"We believe CNP stock will react positively if the commission recommends a true-up value above $2.25 billion and negatively if the recommendation is below $1.5 billion," wrote Dwivedi, who has a neutral rating on the shares. "Our outlook

for the company would change dramatically if CNP receives an adverse outcome."

Kucewicz, for one, hopes to see no major disallowances at all.

"Because these investments were legally mandated, and the law made provision for recouping these costs, to disallow them would be to abrogate the social contract government has with the people -- namely, to deal honestly with the public," Kucewicz wrote. "Texas Public Utility Commissioners should therefore beat back any attempt to rewrite the law and instead provide CenterPoint Energy and other similarly situated electric companies with the relief to which they are entitled."

For her part, Matthews has never been a big fan of stranded cost recovery in the first place. But she notes that every deregulation law across the country includes such provisions. And she is convinced that CenterPoint complied with its own state law even though it now faces some backlash from its regulators.

"The unfortunate thing from the PUC's perspective is not that CNP did anything wrong but that, through a combination of luck and market forces, it got a much higher price

for Genco than anyone would have dared hope ... Doing so has brought

CenterPoint an embarrassment or riches and a real political problem," Matthews concluded.

As originally published, this story contained an error. Please see

Corrections and Clarifications.