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Under the Radar: Calpine Could Have Further to Fall

The San Jose, Calif.-based company plunged 17% Monday to a 52-week low, partly because of an article in

The New York Times

on Sunday that shed an unfavorable light on its accounting practices and earnings.

But pressure on the stock price is also coming from escalating fears of a cash crunch. Indications are growing that the debt market, the main source of Calpine's financing, is unwilling to supply the money the company needs to fund its gargantuan power plant buildout.

At the minimum, without this financing, Calpine would have to slam the brakes on its plan to nearly triple its current power-generation capacity to 30,000 megawatts. Doing this would make Wall Street's aggressive earnings projections almost impossible to achieve.

And in a nightmare scenario, banishment from the debt markets could make it extremely hard for Calpine to pay back as much as $1 billion in potential short-term obligations, prompting a liquidity squeeze.

In the past year, Calpine's stock has suffered for reasons largely outside of its control, such as Enron's (ENE) collapse and, before that, the California energy crisis. But the weakness in the Calpine story always has been its utter reliance on a pliant debt market. In the first nine months of this year, the company spent $5.9 billion on plant and acquisitions, while taking on more than $5 billion in debt.

On a conference call held especially to rebut

The Times'

article, Calpine spent time addressing liquidity concerns. Robert Kelly, head of Calpine Finance Co., said the company wouldn't have to return to the capital markets to get to 30,000 MW from the current 13,000 that he implied was in operation. He listed a range of potential cash sources to make his case.

These included $750 million of cash in hand, about $1 billion left undrawn on a revolving loan for construction, a second revolving loan that Calpine aims to increase to $1.5 billion from the current $400 million, and expected "free cash flow" of $1.2 billion in 2002. (Kelly didn't give his free cash flow methodology, except to say that it's based on a cash flow measure called earnings before interest, taxes, depreciation and amortization, or EBITDA.) In total, those sources come to $4.5 billion.

And what might Calpine's cash uses be over the coming months? An extra 17,000 MW of plant would cost about $9.5 billion, at the $550,000-per-MW cost Kelly stated on the call. Kelly says Calpine has $7 billion of plant in construction. Let's subtract that from the $9.5 billion to get a remaining financing need of $2.5 billion, which, on paper, looks easy to cover with the $4.5 billion in potential cash sources.

Now, let's give this scenario the sniff test. First off, the $550,000 per MW seems aggressive; $625,000 might be a closer bet. Second, the remaining undrawn sum on the construction revolver may be lower than stated if Calpine's banks have guaranteed letters of credit. Third, it's by no means a foregone conclusion that Calpine can increase the other revolver by $1.1 billion. Kelly said the company was all set to boost the size of the bank loan in early January.

The results of this financing effort will be key. A month ago, Calpine's bankers wanted the loan to have an interest rate of London InterBank Offered Rate plus 1%, which would currently work at about 3.44%. With Calpine bonds trading at a yield of 11% to 12% Monday, it's almost inconceivable that it could raise money at that rate. It may end up cutting the size of the deal if current conditions persist.

Fourth, EBITDA is a deeply misleading indicator of cash flows, meaning the $1.2 billion forecast is hard to rely on. Why? In the year's first nine months, Calpine's cash flow from operations, a much more rigorous measure on which to base cash-generation estimates, was $488 million. Calpine would have to more than double cash production to get to $1.2 billion -- and that's even before subtracting capital expenditures to get a free cash flow number. What's more, in the nine months to the end of September, cash flow from operations was up only 46% over the year-earlier number.

Finally, there are two other large uses of cash that Calpine may face. The company may need cash to pay back a $1 billion bond that investors have the right to demand early repayment of in April 2002. Calpine's Kelly said the company has a "number of contingency plans" to pay this back "if the capital markets are not there." He didn't list what they are. Finally, there's the distinct possibility that Calpine's trading partners, spooked by the stock price slide and liquidity worries, have started demanding higher collateral to back trades. If that has happened, cash usage could be even higher.

Perhaps tellingly, Calpine didn't take questions on its conference call. If it had, it could've dealt with the sort of skepticism contained in this column. Until the company answers its critics, stay well away from this stock.

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In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.