October 10, 2002 — Moody’s Investors Service downgraded the ratings of Mirant Corp. and its subsidiaries due to significantly lower operating cashflow relative to its high debt burden coupled with the likelihood that future operating cashflow levels may weaken further due to asset sales and challenging market conditions for the North American merchant power business and the energy marketing and trading business.
Moody’s assigned Mirant a senior implied rating of Ba3 and the issuer rating of Mirant Americas Energy Marketing, L.P. (MAEM) and the senior unsecured ratings of Mirant Americas Generation, Inc. (MAGI) were lowered to Ba3 from Ba1.
Mirant’s senior unsecured ratings were lowered to B1 from Ba1 and are notched down from the senior implied rating due to higher levels of debt at Mirant and reduced operating cashflow expected from MAGI and MAEM, thereby weakening debt protection measures at Mirant to a level Moody’s feels no longer offsets the structurally subordinated position of the senior unsecured bonds.
Moody’s also lowered the rating for Mirant Mid-Atlantic, LLC (MirMA) to Ba3 from Baa3 to reflect the risk associated with comingling funds at the Mirant Corp. and MAEM levels.
Moody’s is maintaining a negative ratings outlook due to; (i) uncertainty as to potential liabilities arising from ongoing government investigations and lawsuits related to California’s power markets and; (ii) uncertainty surrounding the independent auditors current review of the company’s financial statements, which has prevented Mirant from filing its second quarter 10-Q and providing the required CEO or CFO representations in line with SEC requirements.
Clarity around both these issues, with no material negative implications, would likely result in a stable ratings outlook. Moody’s has lowered the following ratings: Mirant Corporation senior unsecured debt to B1 from Ba1; Mirant Americas Energy Marketing, L.P. issuer rating to Ba3 from Ba1; Mirant Americas Generation, Inc. to Ba3 from Ba1; Mirant Mid-Atlantic, LLC to Ba3 from Baa3; and Mirant Trust I preferred stock to B3 from Ba2.
The ratings downgrade reflects concerns surrounding Mirant’s ability to generate sufficient levels of operating cashflow relative to its total debt of approximately $10.8 billion.
Total debt consists of consolidated recourse and non-recourse debt of $8.4 billion, off-balance sheet operating leases and turbine facilities of $1.7 billion, a $218 million gas prepay, a $118 million obligation related to construction projects that have either been cancelled or deferred and $345 million of convertible trust preferred securities.
In addition, the acquisition of PEPCO’s generating assets in December 2000 included the assumption of out-of -market TPA’s and PPA’s, which are not included in the debt amount.
Mirant’s cash payments to PEPCO related to these agreements will vary with PJM market prices, but when the transaction closed the discounted fair market value of these obligations was estimated to be $2.3 billion. PJM market prices have come down since then, thereby reducing that amount, however it continues to represent an additional financial obligation.
Moody’s believes these obligations, which exclude unconsolidated minority interest subsidiary debt of $500 million (Mirant’s share), are high relative to cashflow. The company has been selling assets to reduce debt and has announced plans to sell additional assets. Mirant expects to generate proceeds of $500-$750 million (excluding WPD which has already closed).
The combination of lower operating cashflow and cash needed for reinvestment in the business is likely to result in minimal amounts of free cash flow, leaving Mirant highly dependent upon asset sale proceeds to further reduce debt. Many companies in this sector have announced similar plans, which put downward pressure on prices and will likely result in a longer period of time needed to complete the contemplated sales.
The downgrade further considers Mirant’s reduced operating cashflow. In 2001, consolidated operating cashflow before working capital changes was $1.3 billion (adjusted for cash payments to PEPCO and dividends received from Shajiao C). On a similar basis, unaudited six-month results for 2002 indicate operating cash flow of $235 million, compared to $836 million for the first six-months of 2001.
Operating cashflow after working capital and adjustments related to non-recurring items yields similar results. This clearly indicates a substantial reduction in the level of cashflow Mirant is able to generate.
This reduction is largely due to the company’s reliance on MAEM and North American merchant activity for a substantial portion of its operating cashflow. These businesses have been negatively impacted by weak power markets and a continuing lack of investor and counterparty confidence.
Moody’s believes challenging market conditions are likely to continue in the near term and asset sales will negatively impact cashflow, therefore, operating cashflow in 2003 may not be materially better and could weaken further. The rating also reflects Mirant’s current liquidity profile.
The company has effectively drawn all its available credit and has unrestricted cash balances of approximately $1.8 billion as well as approximately $400 million in cash at subsidiaries that would be available for debt service at these levels.
Debt maturities in 2003 include Mirant Corp.’s $1.125 billion credit facility due in July (the term out provision has already been exercised) and amortization of debt at various subsidiaries totaling $437 million (including the gas prepay). Assuming the company’s operations don’t consume cash over the near term, Mirant appears to have adequate liquidity to meet its obligations through year-end 2003.
However, the company has approximately $2.7 billion of maturities in 2004, a significant portion of which will need to be refinanced. Due to the current lack of investor confidence, access to public debt markets is very limited. Furthermore, the banks have also pulled back from the sector as a whole, resulting in significantly increased refinancing risk.
Mirant is continuing to try and address these concerns through asset sales and by restructuring its business. Trading and marketing activity will decrease going forward as the company scales back its natural gas related business and difficult market conditions continue. Mirant hopes these steps will help reduce debt and significantly reduce the amount of capital needed to run the business.
As Mirant completes various stages of its plan, Moody’s will evaluate the impact on the company’s credit profile. At this point, Moody’s believes Mirant’s most significant challenges will be reducing its debt to a level commensurate with its cashflow and refinancing debt maturities in 2004.
Mirant owns an international portfolio of electric and gas assets. MAEM is Mirant’s US marketing and trading arm. Subsidiary MAGI holds a portfolio of US power assets. MAGI subsidiary MirMA holds power assets near Washington D.C.