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Calpine Imploding

Its stunning court loss leaves it struggling under massive debt with limited options.

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News flash: You can't rewrite the terms of existing debt indentures in order to remain solvent.



, which I have been vehemently bearish on since

early August, learned that lesson the hard way Tuesday, when a Delaware court judge ordered the nearly illiquid power producer to repay $313 million to a trustee account.

The company had created the trustee account to hold the $709 million left over after it tendered for first lien debt from the sale of its natural gas assets back in July. Also, under this ruling, Calpine is now forbidden from spending the remaining $400 million in the account to buy contracted natural gas to fire its plants.

For those dreaming of an appeal, I would point you to this excerpt from Judge Leo Strine's decision:

In this opinion, I conclude that Calpine's proffered interpretation of the relevantexclusion from the term Designated Assets is erroneous. By any measure, Calpine isusing Rosetta Proceeds to buy "natural gas supplied under ... a contract for the saleor purchase of natural gas..."

There is no ambiguity in this ruling.

Ironically, Calpine, which needs natural gas to fire its plants and make a profit on its power sales, has been on the wrong end of one of the worst natural gas trades in history. It sold its natural gas assets in July when natural gas prices were in the $7's.

Calpine now has to go out and buy natural gas assets with prices in the $11 range. This type of commodity miscalculation can have a devastating impact on the liquidity of any company, and Calpine's weak financial footing only exacerbated the case here.

This ruling has dramatic implications for Calpine.

I believed that Calpine was waiting for a positive ruling in this case before it would sell off its California generating assets for more than $2 billion.

The ruling, however, would seem to make such a sale fruitless, because the company will be severely restricted on how it can use the proceeds. Under the terms of the indenture, it will have to use the money to either buy long-lived assets in an effort to resecure bondholders, or it will have to buy back bonds at par. With all of Calpine's debt trading at 20% or more of a discount to par, it is uneconomical to buy back bonds, and buying natural gas reserves to burn in its plants in the next year does very little for liquidity.

This provides a classic example of the debt market, which has been pricing bad news into the company's borrowings for about two months -- light years ahead of the equity market. What equity analysts overlooked throughout this process was that the company was always in the hands of the debt holders.

With a market capitalization of under $1 billion, and more than $17 billion in debt, the equity side of the equation was essentially worthless, regardless of the outcome of this trial. Recently trading at $1.46, the stock is down some 55% since August.

Signs of Stress

There were obvious warnings signs that something was not right at Calpine:

  • CEO Peter Cartwright has been a big seller of the stock.
  • Two members of the board have defected, including Jeffrey Garten, a member of the audit committee.
  • The company misstated its EBITDA results in its third-quarter earnings release.
  • Capacity utilization has been well below historical standards.
  • The company has been selling off EBITDA-generating assets in order to meet required debt repurchases.
  • The indenture trustee, Wilmington Trust, was named on the lawsuits against Calpine.
  • The company backed away from its targeted $3 billion debt-reduction plan.

Despite all of that, a handful of equity and debt analysts have remained upbeat on Calpine's prospects to turn itself around.

It is also interesting to note that at its current quote, CEO Peter Cartwright saved himself about $1.7 million by selling stock at $3.22 a share, delivering highly positive chatter within days of two board members defecting, and the company received a letter from the Bank of New York saying it wouldn't release money from the trust account for natural gas proceeds due to bondholder complaints about the use of proceeds.

Despite regulator attempts to level the playing field, it's hard to make a case that anything has changed since Enron, when you've seen something like this go unchecked for so long.

Calpine has not yet commented publicly on how it plans to proceed following this ruling. But I don't believe any investors will really care what the company has to say.

In my past conversations with company spokeswoman Katherine Potter, among others, I was often directed to better understand what they were trying to tell me. But I never got the sense the company had a handle on its own reality when I tried to get my arms around their defense.

Where does Calpine go from here?

Unfortunately, I don't believe even Calpine knows yet. As it tries to digest this morning's ruling, Calpine is in court today in New York in a case related to a suit filed by convertible note holders. Harbert Management and Wilmington Trust are suing Calpine for violating a term of its debt indenture that requires Calpine to tender for its convertible notes if they trade below 95% of parity for a five-day period.

Parity is the price of the stock multiplied by the number of shares into which a bond converts. Harbert claims the bonds fell below 95% of parity earlier this summer, and Calpine failed to take appropriate action per the terms of the debt indenture. As I wrote

here, a negative ruling in this case could require Calpine to spend $400 million to buy back the bonds.

I've been negative on the stock for three months now, and even after today's steep selloff, I see no reason to speculate on Calpine's stock here.

William Gabrielski is a research associate at In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gabrielski welcomes your feedback;

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