MOODY'S REVIEWS DEBT RATINGS OF POWERGEN UK PLC, POWERGEN ENERGY PLC, LOUISVILLE GAS & ELECTRIC, KENTUCKY UTILITIES, LG&E ENERGY CORP. AND LG&E CAPITAL CORP FOR POSSIBLE DOWNGRADE
Moody's Investors Service has placed the A2 long-term and Prime-1 short-term ratings of PowerGen UK plc and the guaranteed A2 rating of PowerGen (East Midlands) Investments on review for possible downgrade as well as Louisville Gas & Electric, Kentucky Utilities, LG&E Energy Corp. and LG&E Capital Corp. The ratings action follows today's announcement that PowerGen intends to acquire the US utility LG&E Energy Corp, for approximately $3.2 billion (GBP 2.0 billion) in a debt-funded transaction. Moody's review will focus on the weakened debt protection that bondholders of PowerGen UK plc now face in light of the higher leverage and reduced interest coverage of the Group on completion. Bondholders of PowerGen (East Midlands) Investments (formerly DR Investments) are guaranteed by PowerGen UK plc. For the LG&E system, the review will focus primarily on the pressure to pay dividends out of the system in order to service acquisition related debt and the amount of such debt. Moody's will also examine to what extent regulatory "ring fencing" may come into play and how much comfort bondholders of the various issuers in the LG&E system may derive from said regulatory protection.
Moody's has also placed the A1/Prime-1 ratings of PowerGen Energy plc ("PowerGen Energy", formerly East Midlands Electricity plc) under review for possible downgrade. Although PowerGen Energy's credit profile is not directly affected by the acquisition of LG&E Energy Corp, Moody's will review the extent to which PowerGen Energy may be expected to pay increased dividends to help service the additional debt. Moody's will also consider whether there are additional protections offered by the regulatory ring-fence mechanism surrounding the regulated distribution business.
At the same time as announcing the acquisition of LG&E Energy, PowerGen has also announced the intention to pursue selected asset disposals both in the UK and overseas. Moody's believes that the sale of international assets will significantly improve PowerGen's business risk and quality of cashflow, and to some extent mitigates the effect of the increased debt.
PowerGen plc, the ultimate 100% shareholder of PowerGen UK plc, intends to raise approximately $4 billion through a syndicated bank loan to fund this proposed acquisition. The debt will be held at a new UK subsidiary - PowerGen US Holdings Limited, a fully owned and guaranteed by PowerGen plc - which will become the parent of the LG&E Energy group of companies. PowerGen plc is currently unrated, but it is likely that Moody's will assign a rating as part of our credit assessment of the group. It is likely that PowerGen plc would be rated one notch lower than the rating for PowerGen UK plc. It is expected that a sizeable portion of the term bank debt will be refinanced through disposals or in the bond markets. The dividends LG&E would have paid its shareholders will now be used to service the acquisition debt, whereby Moody's does not expect to see substantial calls on the cashflow of the existing PowerGen business to service the acquisition. The acquisition of LG&E is subject to US regulatory approvals and shareholder approvals and is expected to complete by early 2001.
For some time PowerGen has made clear the strategic aim of a significant acquisition in the United States. While smaller than PowerGen's existing UK operations, Moody's believes that the operations of LG&E Energy are in many ways complementary to PowerGen's assets. LG&E Energy is based in Kentucky and has approximately 8 GW of mainly coal-fired plant with 840,000 electricity customers and 290,000 gas customers. By way of comparison, PowerGen's UK operations have generating capacity of 10.5 GW with 2.6 million electricity and gas customers. Moody's believes the strengths of LG&E Energy lie in its traditional well-managed low-cost electricity production as well as its distribution system - which is held in high regard for its customer satisfaction oriented focus. The company has recently completed a regulatory review which has diminished regulatory price risk for the next three years, and LG&E Energy has neither nuclear production nor stranded assets.
On 11th February 2000, Moody's downgraded the long-term credit ratings of LG&E Energy by two notches from A1 to A3. This downgrade was as a result of the revenue cuts which LG&E Energy faces following the regulatory review. Moody's other concerns with LG&E Energy have centred on trading activities and a contract dispute with Oglethorpe Power Corp ("Oglethorpe"). The dispute with Oglethorpe related to a 15-year $4.5 billion largely fixed-price agreement between Oglethorpe and LG&E Energy Marketing. Under the agreement, LG&E Energy is obligated to supply around half of Oglethorpe's power needs, and due to higher than expected power prices and load factors, the contract is now unprofitable for LG&E Energy. The contract with Oglethorpe is voidable in 2004. In December 1999, LG&E Energy made an after-tax provision of $175 million to cover potential losses on the Oglethorpe contract. Furthermore, in the summer of 1998, the company made a $225 million provision to exit its electricity-trading book, the majority of which was attributed to the Oglethorpe contract. Moody's understands that PowerGen has carried out extensive due diligence in relation to both LG&E Energy's trading activities and the Oglethorpe contract before making its offer for LG&E Energy.
PowerGen has announced the intention to pursue selected asset disposals both in the UK and overseas. PowerGen believes that the sale proceeds of these assets could meet a substantial part of the cost of acquiring LG&E Energy. Although PowerGen has an attractive portfolio of international power assets, the exposure to developing markets inevitably increased the business risk of the group. Moody's believes that the disposal of assets, together with the acquisition of LG&E Energy, will enhance the business risk and cashflow stability of the PowerGen Group and this mitigates some of the effect of increased debt and reduced interest cover. For this reason, Moody's believes that the effect of any potential downgrade of PowerGen's ratings should be no more than one notch.
The following ratings are subject to review:
PowerGen UK plc
Senior unsecured long-term A2
Commercial Paper and other short-term P-1
PowerGen (East Midlands) Investments
Senior unsecured long-term A2
PowerGen Energy plc
Senior unsecured long-term A1
Commercial Paper P-1
Louisville Gas & Electric
Senior secured First Mortgage Bonds A1
Issuer rating and senior unsecured debt A2
Preferred stock "a2"
Commercial paper and other short term P-1
Senior secured First Mortgage Bonds A1
Issuer rating A2
Preferred stock "a2"
Commercial paper and other short term P-1
LG&E Energy Corp.
Issuer rating A3
LG&E Capital Corp.
Senior unsecured debt A3
Commercial paper and other short term P-2
PowerGen plc is the holding company for an international power generation business headquartered in London, which reported turnover of approximately œ2.3 billion for the nine months ended 31 December 1998. Its principal operating subsidiary is PowerGen UK plc.
LG&E Energy Corp. is the holding company for Louisville Gas & Electric Company, Kentucky Utilities Company and LG&E Capital Corp. LG&E Energy Corp., along with its subsidiaries, is headquartered in Louisville, KY.
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