Allegheny Energy ( AYE) has some serious unfinished business to address before it can close the books on its worst-ever year.

The Maryland-based utility faces a year-end deadline to negotiate a critical refinancing package with its lenders. If successful, Allegheny should have enough money to carry it through a possible turnaround year. If not, the company could very well become the first major energy trader since Enron to seek Chapter 11 bankruptcy protection.

Allegheny, which has bought time with two bank waivers already, remains cautiously optimistic.

"Allegheny Energy and its subsidiaries are continuing discussions with their bank lenders -- and are optimistic that they will reach an agreement that provides the necessary liquidity and funding for both near- and long-term financial flexibility," the company told investors after being granted a second extension by its banks.

Analysts tend to believe Allegheny's lenders will come through. But some bondholders, pointing to strict borrowing limits in an Allegheny bond indenture, are already crying foul.

Shares of Allegheny rose 22 cents, or 3.1%, to $7.25 on Friday. The stock has lost roughly half its value over the past three months, and is down 80% for the year.

Take or Pay Dearly

Since October, when it defaulted on some key credit agreements, Allegheny has pinned its future on successful negotiations with its lenders. Allegheny's stock, pounded below $3 when the defaults were still fresh, has more than doubled in recent weeks as the company obtained bank waivers and rumors swirled that a permanent financing package was about to be inked.

That optimism faded last week when Allegheny said it had uncovered accounting errors that would require financial restatements for the first two quarters of 2002 and delay reported results for the third. In the meantime, the company calculated its nine-month loss -- swollen by a huge writedown of its energy trading portfolio -- at $334 million, or $2.67 a share.

More ominously, Allegheny also admitted that only its lenders could save it from likely bankruptcy. Even so, Standard & Poor's said Allegheny was just as likely to secure the financing as it was seven weeks earlier, when bank defaults, credit downgrades and dividend cuts hammered the company's stock. And most observers believe Allegheny can renegotiate its financing if lenders are willing to interpret its balance sheet sympathetically.

"We think this will occur as the SEC has authorized $2 billion of asset coverage -- and lenders are unlikely to bankrupt an otherwise ongoing business," Lehman Brothers analyst Dan Ford wrote late last month.

Some critics nevertheless question whether Allegheny's existing bond indenture entitles the company to $2 billion worth of new secured financing, even if the bankers are willing to extend it.

"We're not sure that financing is even allowable," said a utility fund analyst who asked to remain unnamed. "We've calculated a borrowing capacity of about $1.2 billion."

Behind the Numbers

At first blush, Allegheny looks well positioned to land most of the secured financing it needs. And Allegheny's financial advisers at Lazard Freres have predicted a turnaround for the company -- if Allegheny Energy Supply can pledge enough collateral to secure the required loans.

"It is Lazard's view that, in the absence of flexibility to grant collateral to secure borrowings, Allegheny's current bank group and other lenders will not extend additional credit," Allegheny warned in an October filing with the SEC.

The SEC, which must approve new securities issued by public utility holding companies, has already granted Allegheny permission to seek up to $2 billion in secured financing. But some Allegheny bondholders worry that their own interests, protected under a 2001 bond indenture, will be jeopardized in the process.

That indenture specifically prohibits Allegheny Energy Supply -- the subsidiary seeking funds -- from obtaining additional secured financing in any amount exceeding 30% of the subsidiary's reported assets.

In its latest quarterly report, Allegheny Energy Supply listed $6.3 billion worth of assets on its balance sheet. Simple math would therefore indicate that the division is entitled to pursue at least $1.89 billion of the $2 billion in secured financing it's currently seeking. But Allegheny critics are calling the reported value of those assets, which have remained static throughout serious industry changes, seriously overblown.

Contacted this week, Allegheny pointed to its second-quarter report -- filed nearly five months ago -- for the most comprehensive, up-to-date asset valuations the company has available. But the company said it didn't even consider the value of its assets when deciding to pursue $2 billion in fresh funds.

"That's how much we think we need to address our liquidity issues," Allegheny spokeswoman Debbie Beck said.

Three Strikes

Still, some bondholders insist that Allegheny is stretching its borrowing power by inflating the value of certain assets listed on Allegheny Energy Supply's balance sheet. Allegheny itself last week wrote down the value of the company's energy trading portfolio by $300 million. And critics see the remaining $700 million of that trading book -- dominated by vulnerable, long-term contracts in California -- as potentially worthless.

They're also challenging the value of two other major assets currently on Allegheny Energy Supply's books.

Allegheny appears to be valuing a commodity and power trading business, acquired from Merrill Lynch last year, at its original $600 million purchase price. But Allegheny has since sued Merrill Lynch, alleging it was overcharged for the business, which it could shut down in a return to its utility-based roots. Allegheny critics insist that this trading business, like Allegheny's trading portfolio, is worthless and should be stricken from the company's list of assets.

They also question the value of three Midwestern peaking plants Allegheny acquired from Enron last year. Allegheny paid $1 billion for the plants prior to the power industry meltdown, and concluded last week that the assets aren't impaired. But in today's market, critics argue, those plants are generating no cash flow for Allegheny -- they in fact lost $34 million through the first half of 2002 -- and should therefore be written down.

"I don't even know if they're sellable," one critic said. "But I definitely know they're not worth $1 billion."

These three assets -- the trading portfolio, trading business and peaking plants -- account for 27% of Allegheny Energy Supply's reported assets, critics argue. If their values were written off entirely, critics say, the company would see its secured borrowing power drop from $1.89 billion to $1.2 billion.

Even with $1.6 billion in secured financing -- the midpoint between the most bearish and bullish targets -- Allegheny still would face challenges, analysts say.

"Liquidity remains tight for next year, and we expect sources of cash to equal uses," Deutche Bank analyst Jay Dobson wrote in early December. "Even with the refinancings, Allegheny remains a high-risk company with little room for operating error."

Both Dobson and Ford have neutral ratings on the stock.

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