The energy sector shakeout targeted



Monday, after drubbing



last week and finishing off



earlier in the month.

Houston-based Dynegy announced a restructuring Monday morning designed to shore up its balance sheet, protect its credit rating and conserve liquidity. But its comments did little to dissuade investors from thinking Dynegy's projected trading profits remain at risk, a worry that if true would have severe consequences for the stock.

Dynegy has been under severe pressure since it pulled out of its merger with collapsed rival Enron. Its shares plunged 13% Monday, dropping $3.24 to $21.70. The stock has now lost half of its value since Nov. 9, when it agreed to buy Enron. Dynegy did not comment.

Hard Candy

Dynegy said it intends to issue up to $500 million in equity by the third quarter of next year, and it has plans to sell assets and cut capital expenses to raise $750 million in cash. Meanwhile, Dynegy took its 2002 earnings guidance down by about 9% to $2.30 to $2.35, and it set a $125 million after-tax charge, including $75 million to cover Enron exposure.

The moves were announced after Moody's Investors Service downgraded Dynegy on Friday to Baa3, one notch above junk status. Standard & Poor's and Fitch have the company in investment-grade territory.

Investors weren't impressed by Dynegy's barrage of initiatives. Of course, this could've been a natural adjustment to the expected equity dilution resulting from the planned stock issue. The bond market's reaction was better, but not overwhelmingly positive. Dynegy bonds due in 2011 rose a penny to trade at 83 cents on the dollar, up from 82 cents Friday, according to


. They yield 9.7%, in line with some junk-rated issuers.

Dynegy since Enron started unraveling

On the surface, Dynegy stock is cheap, trading at about nine times its fresh earnings guidance. But a low price-to-earnings ratio often means the market doesn't believe that the expected earnings will happen. Why might investors think that about Dynegy? Two main reasons: questions about liquidity and the reliability of trading profits in the post-Enron environment.

Have a Drink

On a conference call Monday, Dynegy execs made many efforts to explain the company's liquidity. Repeating what it said earlier this month, the company said it has $900 million in available liquidity. Dynegy said Dec. 6 that this comprised $200 million of cash and $700 million of available credit lines. It acknowledged that it couldn't access the commercial paper market to roll over the $750 million of commercial paper that it has outstanding. But execs said that existing credit lines would provide it with sufficient liquidity, and it was noted that a revolver that comes due in May could be extended.

So, does Dynegy have enough cash? Probably, if counterparties don't run from the company, which seems unlikely as long as it remains an investment-grade credit. Notably, Chief Operating Officer Steve Bergstrom said that "it would only take $350 million to fully collateralize our entire risk management book." Translation: Dynegy could provide trading counterparties with cash to back the total amount they are currently owed by Dynegy on outstanding trades.

Fine, but that has to be compared with the amount of cash that the company is currently consuming to fund current operations. Dynegy has said that its working-capital needs totaled as much as $200 million in October and November. That would appear to be more than in past months. In the second and third


of this year, working capital consumed $166 million and $188 million, respectively. In an interview conducted before Monday, Dynegy's Bergstrom said that the higher use was not due to counterparties demanding significantly higher collateral, but seasonal needs. However, in 2000, far more working capital was consumed in the third quarter than the fourth.

Trading Places?

Trading profits are another source of worry. It's feared that, after the Enron debacle, auditors could become a lot stricter and disallow noncash trading profits that were booked using long-term deals and internal pricing models. Recognizing this sort of chatter, Dynegy honchos moved Monday to convince the market that it wasn't doing speculative trading, but selling power based on the assets it owns. Finance chief Robert Doty said that 70% of its cash flows and earnings "are related to hard assets that we physically own." Chief executive Chuck Watson added that "around half" of the remaining 30% of earnings comes from "trading per se."

It's not clear what these statements mean exactly. Clearly, they're supposed to give the impression that Dynegy makes its trading profits mainly from selling what its power assets produce, unlike Enron, which pursued the now-discredited asset-light strategy that aimed to make big trading gains without owning too many of the assets.

Problem is, Dynegy's most recent filing of quarterly results with the

Securities and Exchange Commission

shows that, in the third quarter, its total power sold, 90.1 million megawatt hours, was

nine times

the net amount generated by the company's assets, 10.1 million megawatt hours. Moreover, the total amount sold doubled from the year-ago period, while the amount generated rose a much lesser 12%. Of course, these numbers don't prove that Dynegy has been trading aggressively, but they do appear to make it harder to subscribe to management's view that Dynegy has kept its trading firmly grounded in what its assets produce.

Finally, Dynegy's managers once again stressed strong cash flows from its businesses. But cash flows can be misleading in trading companies, where unprofitable trades can be liquidated to raise cash. Investors ought to note that, in the nine months through September, $214 million, or 26%, of Dynegy's pretax income came from earnings from "unconsolidated investments." Yet $184 million of earnings from this source were noncash, according to Dynegy's cash-flow statement.

It's going to be a long, unfestive week for Dynegy.

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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.