Recent developments at Williams Communications ( WCG) don't bode well for Williams Cos. ( WMB) But even if the former unit does file for bankruptcy, as it has vowed not to do, analysts believe Williams Cos. should be able to meet its financial obligations and avoid a downgrade from one of the major ratings agencies.

Shares of Williams Cos. fell almost 14% to $16.36 Monday after bank lenders told Williams Communications that it might be in default on its credit agreement following the recent spate of bankruptcies and big losses in the telecommunications industry. Williams spun off 95% of the high-speed network operator WCG in April 2000, but is responsible for paying $2.15 billion in debt obligations if the subsidiary can't.

Williams Communications has submitted a restructuring plan to de-leverage its balance sheet but has said it doesn't intend to file for bankruptcy. Still, investors are concerned that it will, and that could prompt ratings agencies to downgrade Williams Cos.' debt.

The Whirlwind

Energy traders rely on maintaining an investment-grade rating, because they are required to put up collateral that's based on the quality of their debt when they make a trade. If the debt is reduced to junk status, companies are required to put up more collateral, and that pushes up the cost of trading. This can prompt a loss of confidence among customers, forcing them into the hands of competitors.

"If WCG goes bankrupt, that could put Williams Cos.' debt rating in jeopardy, which could impact their trading operations and potentially wipe out 35% to 40% of their earnings," said Mark Easterbrook, an analyst at RBC Capital Markets.

Still, he said he does not expect that to happen, because Williams is currently "a few notches" above junk status and may have "some wiggle room." In addition, Williams said Monday that it plans to sell its Midwest petroleum products pipeline and on-system terminals, and is prepared to sell stock to appease ratings agencies.

"The equity issuance and asset sales would be a positive from a balance sheet perspective and should alleviate investor concerns of a ratings downgrade," said Gordon Howald, an analyst at Credit Lyonnais Securities.

On Friday, Standard & Poor's placed Williams Cos. on negative credit watch, but Moody's has confirmed the company's rating, saying it "has the financial resources and liquidity to perform on its obligations to WCG without impairing its own credit quality."

Several analysts agree with Moody's view.

"What we have done was assume a full writedown of Williams' WCG exposure of about $2.15 billion and assume a corresponding equity issuance of $2.15 billion to cover the WCG writedown," said Howald. "In our worst-case scenario, we end up with a balance sheet with 55.7% total debt to equity."

Howald said rating agencies would be content to see a debt-to-equity ratio of about 59.5%. His calculations include about $1 billion of off balance sheet debt.

"This company is getting ripe for a stock upgrade," added John Olsen, an analyst at Sanders Morris Harris. He said the stock "looks like it's heading toward a selling climax."

Williams' stock has fallen 32% since last Tuesday.

Dilution Potential

One concern is that even if the company can pay down debt and avoid a downgrade, it may still have to take measures that would dilute ownership and reduce profits over the short term.

If the company were to issue equity of $2.15 billion to cover the $2.15 billion writedown related to WCG's debt, Howald said, earnings could be diluted by about 15% to 20% this year. He is looking for earnings of about $2.20 a share in 2002, compared with the consensus estimates of $2.52 as measured by Thomson Financial/First Call.

Still, other analysts say the firm may not need to tap the equity market, because asset sales could be sufficient.

"Considering $3 billion of available liquidity and a diversified asset base, we do not believe such action would require the issuance of equity at current highly dilutive prices," noted Merrill Lynch analyst Curt Kirst. "We believe the company has the ability to sell north of $1 billion in assets without significantly impacting its earnings power."

In such a highly skittish market, though, most analysts agree that Williams will remain under pressure for the near term.

"This stock is likely to remain highly volatile and event-driven," Kirst noted.

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