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TECO's fragile balance

Its stock price hammered by skeptics on Wall Street, the Tampa company has to show investors it can prosper as both a hometown utility and a wholesale power producer.

By LOUIS HAU, Times Staff Writer
© St. Petersburg Times
published September 29, 2002


TAMPA -- TECO Energy Inc. was long the perfect example of a "widows and orphans" stock, an electric utility that generated reliable if unspectacular earnings, stable stock prices and a nice dividend check that had increased every year since 1959.

"They were just kind of a sleepy utility in Tampa with good fundamental growth," said Paul Ridzon, an analyst with McDonald & Co. in Cleveland.

Not anymore. Today, TECO has billions of dollars riding on power plants from Gila Bend, Ariz., to Union County, Ark., to serve increasingly uncertain wholesale power markets. Its stock plummeted after Wall Street analysts turned against a company they once praised. The company's shares are now trading near their lowest levels in a decade and are down about 45 percent from their 52-week high set just five months ago.

And widows and orphans with TECO stock are doubtless asking: How did our shelter from the market's risks became a victim of its wild gyrations?

The answers lie largely in major events that TECO didn't, and probably couldn't, see coming -- from the still-sluggish economy to the collapse of energy giant Enron and even Wall Street scandals that may have shamed stock analysts into a new feistiness.

TECO's stock price improved some last week, after the company offered an emergency plan to delay expenses and buttress its bottom line. It closed Friday at $15.82, down 49 cents, or 3 percent, but up from its week-earlier closing price of $15.08.

But the company's problems are far from resolved, and its standing on Wall Street is still shaky.

"There's certainly a good bit of caution," analyst Ridzon said. "We'll see how they work through the next couple of years."

Branching out from Tampa

TECO's forays beyond its base in Hillsborough County didn't happen overnight. For many years, the company complemented its two regulated utilities, Tampa Electric Co. and Peoples Gas, with diverse small businesses including coal mining, ocean shipping and river barge services.

TECO Power Services, founded in 1989 to develop wholesale power, became the center of the parent company's ambitions and the source of its recent troubles.

Within four years, it had a 295-megawatt plant running in Hardee County. The company went international in 1995 when TECO Power Services opened a 78-megawatt plant in Guatemala in partnership with investors there. In 1998, the company acquired an interest in a power plant in the Czech Republic.

Another key year was 1999, when Robert Fagan became TECO's chairman and chief executive. Months later, the bigger utility across Tampa Bay, Florida Progress of St. Petersburg, parent of Florida Power, gave up on its efforts to remain independent and announced it was being acquired by Carolina Power & Light of Raleigh, N.C.

The Florida Progress deal underscored doubts about whether TECO could survive on its own in an era of giant energy conglomerates. Fagan's answer was to pick up the pace in developing wholesale power far outside its home market, energy that would be sold to other utilities.

It looked like a smart bet. A strong economy was pushing electricity demand far beyond previous forecasts. Speculative for-profit trading of energy was booming, thanks in part to a hot trading outfit from Houston, Enron Corp. And markets in California and the Northeast were opening up to retail competition.

"Even though (deregulation) didn't impact the entire country, what it did do is put new players in the market," said Michael Valocchi, a partner in the energy strategy practice of PwC Consulting in Radnor, Pa. "It really started to define the markets and provide some of these players with bigger sandboxes to play in."

Eaves of trouble

Then things began to go awry. The California power crisis and revelations of deceitful accounting and trading practices at Enron killed enthusiasm for electricity deregulation. The U.S. economy took a turn for the worse, exacerbated by the Sept. 11 terrorist attacks.

With a boom in power-plant construction and delays in the anticipated shutdowns of older, inefficient power plants, it became apparent last year to market watchers that many electricity markets were heading for a glut of generating capacity. Too much supply pushed power prices into a tailspin. Projects with promising profit profiles suddenly began to look like potential white elephants, at least over the short term.

Although the stock prices of Enron and some other giant players were decimated, Wall Street analysts were slow in picking up the implications for others, such as TECO, said Larry Makovich, senior director of research for Cambridge Energy Resource Associates in Cambridge, Mass.

"There's been a fascinating recognition drag, if you look at Wall Street and you look at the equity research done just a year ago," he said. "People wanted to believe in the story about the Internet economy and strong electricity growth and that all existing plants were old and obsolete. . . . The reality just didn't support the expectations, and it just crashed."

TECO's Fagan argues his company doesn't belong lumped with high-flying energy traders like Enron or wholesale power producers that lack a strong base in regulated utilities. After all, TECO projects that 70 percent of its 2003 net income will be generated by its regulated subsidiaries, with 95 percent of its cash flow coming from nonwholesale power businesses.

"What we need to do is differentiate ourselves from the others," Fagan said. "Everybody's been thrown into the same bucket and clearly we should be viewed more as an integrated utility with a very strong utility operation. . . . Why should we be viewed as an independent power company?"

Still, for TECO, the drop in electricity prices couldn't have come at a worse time. The company has an ownership interest of 50 percent or more in 10 power plants or construction projects with total generating capacity of about 7,100 megawatts, considerably more than the combined 4,000 megawatts of Tampa Electric's local power plants.

Of the 7,100 megawatts, about 5,700 megawatts were due to come online next year. That dramatic ramp-up in generating capacity and the added risks that the unregulated wholesale market held for TECO began to draw the attention of credit-ratings agencies such as Moody's Investors Service and Standard & Poor's.

Despite comments from some analysts about the growing exposure, TECO's stock wasn't severely affected until August, when three brokerage firms -- A.G. Edwards & Sons Inc., Credit Suisse First Boston and Jefferies & Co. -- alarmed investors with rare "sell" ratings on TECO. All three warned that the company's earnings outlook for 2003 was at risk.

Credit Suisse's downgrade stood out from the pack given that the firm downgraded TECO from a "buy" rating, bypassing the usual "hold" recommendation in between. Moreover, the firm had just served as joint lead manager, with UBS Warburg, in TECO's offering in June of 15.5-million common shares. Sell ratings are rare enough among stock analysts but have been virtually unheard of from firms with close investment-banking relationships with publicly traded companies. Credit Suisse analyst Neil Stein declined to be interviewed about his downgrade.

As with Enron's collapse, TECO may have been blindsided by changes beyond its control. Investigations on Wall Street have revealed conflicts of interest among some analysts at investment banks, who tailored stock-buying advice to their employers' attempts to court new clients. Analysts were ridiculed for their reluctance to put a "sell" recommendation on all but the most hopeless of stocks.

So the spate of TECO downgrades came just as all analysts were under pressure to demonstrate a new spirit of independence and skepticism.

The downgrades hammered TECO's stock price. After reaching a 52-week intraday high of $29.05 on April 23, TECO's shares entered a freefall, most recently bottoming out Tuesday to close at $14.44, their lowest finish in nearly 12 years. Jefferies has since upgraded TECO to "hold," due to the stock's now-cheaper price. Credit Suisse has relabeled its sell recommendation as "underperform," following the firm's recent simplification of its ratings system. Underperform remains Credit Suisse's lowest rating.

Fighting back

TECO fired back Monday with a plan detailing measures it intends to take to prevent further damage to its earnings from its struggling wholesale power business.

In a cost-saving move, the company is halting construction on two 599-megawatt wholesale plants, its Dell Power Station in Dell, Ark., and its McAdams Power Station in Kosciusko, Miss. The company also said it plans to raise more than $400-million from the sale of assets, including synthetic fuel tax credits, as well as an additional $250-million from bringing home cash from its plants in Guatemala and delaying the completion of the Dell and McAdams plants. These steps would make up for bank financing that TECO no longer expects to get for the two 599-megawatt plants and another plant in McAllen, Texas.

The company also plans a 5 percent workforce reduction at Tampa Electric. And it has filed with the state Public Service Commission for a rate increase at its Peoples Gas unit that is expected to help boost the subsidiary's net income by as much as 35 percent in 2003.

Wall Street's initial reaction was mostly skeptical. The stock continued to drift downward, and some analysts questioned whether the company was being too optimistic about its planned measures. The plan also failed to stave off cuts in its debt ratings by Moody's, S&P and Fitch Ratings.

But Fagan and other top TECO executives were able to arrest the slide, at least temporarily, with a measured and detailed presentation in a conference call with analysts Wednesday morning. Fagan's emphatic commitment Wednesday to maintaining the company's dividend also was well-received by Wall Street, helping lift the company's shares off their earlier lows.

Can TECO save the dividend its conservative investors count on? UBS Warburg analyst Ronald Barone said in a research note that he doubts the company will extend its streak of 43 consecutive years of dividend increases in 2003, but he expects it will manage to maintain the current dividend rate of $1.42 a share.

Merrill Lynch & Co. analyst Steven Fleishman said that while the company is "more likely to keep the dividend than not, we maintain some caution until financial stability is restored."

Unanswered questions

Some big questions remain about TECO's plans. Among them:

-- Will the plants it has halted in mid construction be finished? TECO estimates it will save $90-million to $100-million in 2003 by stopping work on the plants in Arkansas and Mississippi. But if the wholesale market doesn't come back, as TECO predicts, Moody's thinks there's still a risk that the company may have to write off the $690-million to $700-million it will have already invested in the projects.

-- Will it succeed in selling assets and synthetic-fuel tax credits as a way to cover the approximately $400-million that the company no longer expects to obtain in bank financing for several plants?

-- What will be the future of TECO's relationship with Dallas power plant developer Panda Energy International Inc.? TECO and Panda are 50-50 partners in two giant plants, the 2,300-megawatt Gila River Power Station in Gila Bend, Ariz., and the 2,220-megawatt Union Power Station in El Dorado, Ark., both of which will begin operating next year.

In 2007, Panda will have the option of selling its interest in the plants to TECO for $60-million, but TECO would have to buy the interest sooner if Panda defaults on a bank loan that is backed by TECO's purchase obligation.

TECO also has a $137-million loan outstanding to Panda for two other power plant projects in Texas. If Panda can't repay the loan, it will be converted into an equity interest in the plants. Stein of Credit Suisse said he thinks that unless the loan can be restructured, the plants could be a drag on 2003 earnings.

After reporting net income last year of $2.26 per share, TECO expects earnings this year to come in "within a few cents" of its 5 percent growth target. But the company projects a drop in 2003 to about $1.75 to $2 a share.

Barone of UBS Warburg has cautioned that with continued excess power capacity in most U.S. markets and modest prospects for an economic recovery, "The company's margin of error remains quite thin."

Whether TECO succeeds will depend heavily on whether conditions in the wholesale power market improve, as the company predicts.

In the September-October issue of the trade magazine Electric Perspectives, utility analyst Will Dailey argues that even the cancellation of many projects isn't likely to provide significant relief from an oversupply of generating capacity.

"The sheer number of plants that have already begun operating, plus those plants that are now under construction, are enough to ensure significant oversupply in most markets," he says.

One large investor who exited TECO's stock ahead of the recent plunge was Nate Partain, chief executive of DNP Select Income Fund. Partain's fund sold 1-million shares of TECO stock during the second quarter out of concern about the outlook for wholesale electricity prices over the next couple of years.

"The market, it's terrible," he said. TECO's big bet on wholesale power "may not be bad decision ultimately," he added, "but during the next year or two, it's a tough situation."

-- Louis Hau can be reached at hau@sptimes.com or (813) 226-3404.

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