The New Year seems to have heralded a new start for British Energy (BE). Nearly two-and-a-half years after its initiation, what has been labelled the ?most complicated restructuring in UK history? has successfully closed ? a massive £1 billion ($1.9 billion) debt-to-equity restructuring to turn around the fortunes of the once-beleaguered energy giant.

On 17 January, amidst rapt attention from the City, BE re-listed on the London Stock Exchange. BE shares opened at 286p, only to drop to 263p by close of trading that day. Investors were reminded of the company's high fixed cost base and exposure to power prices and advised to remain cautious.

Prior to the re-listing, trading in BE bonds began to slow as liquidity moved to the when-issued market. Both Fitch and Moody's gave non-investment grade ratings ? BB- and Ba3 respectively ? to the £550 million new bonds, which become due in 2022. A coupon of 7% is paid on the new issue.

Duquesne Capital Management took some 14% of the shares, after having tapped the distressed bond market for the last few years. Deutsche Bank and Eureka Fund took 10.2% and 7.9% respectively, while Stark Investments came in at 7.8%. Other buyers included LGC Holdings.

Even given this lukewarm response, the restructuring remains impressive: rescuing the UK's largest generator from near financial meltdown in 2002, due to a 40% drop in wholesale prices. The deal will make BE a merchant generator with nuclear generating facilities and the Eggborough coal-fired power station with a combined capacity of 11.6 GW.

A troubled rebirth

But the successful close of this marathon transaction belies another story: a deal fraught with factionalism as well as uncertainly, which, at times, nearly faltered.

Even as late as November last year, both units at each of the Heysham 1 and Hartlepool power stations were shutdown, which meant a reduction in BE's target for nuclear output for the financial year 2004/2005 to 59.5 TWh. In light of this, the nuclear energy giant was forced to seek an extension to its Restructuring Long Stop Date of 31 January 2005.

Fortunately, the requisite majorities for shareholders and creditors approved the Creditors' Scheme, Members' Scheme and Disposal at meetings held in late November. The extension required the agreement of holders of a simple majority of the bond and a two-thirds majority of the Eggborough bank debt and swap claims, and a simple majority of the Enron, Teesside and Total claims (held by Deutsche Bank), and BNFL and the Secretary of State for Trade and Industry.

With the UK government steadfast in its policy of securing security of supply as well as nuclear safety, it was unlikely that these requisite majorities would fail to be reached. Nevertheless, failure to extend the Restructuring Long Stop Date may well have resulted in a number of financial obligations not being met, which, in turn, may have led to insolvency proceedings. In that case, distributions to unsecured creditors would have represented a small fraction of their unsecured liabilities, and it is highly unlikely there would have been any return to shareholders.

The curse of NETA

In 2002, though price falls were anticipated following the deregulation in energy markets, such as Australia and Norway, they were not expected to such an extent over the medium term. However, shorter tenors and the insertion of faster repayment schedules into the loan documentation were unlikely to have made any difference to the impact of NETA.

Certain industry experts believed that prices would fall between £18 MW/hour by 2004, whilst others said this would not be the case. In actual fact, these low levels were hit in 2001, though many were astonished be the sheer speed of the decline.

With the introduction of NETA, offtake agreements between the distributors and generators had to be renegotiated, which produced a number of issues. Under the previous pool system, generators would hedge against price volatility through contracts for differences referencing the universal pool price. However, under NETA, an agreement had to be reached between the parties themselves. But with wholesale prices in free-fall, long-term power purchase and tolling agreements no longer looked very clever.

In early 2002, BE's debt included a £508 million loan to finance the Eggborough acquisition, three sterling bonds totalling £408 million, and approximately £110 million in deferred payments by US-subsidiary Bruce Power. Arranged by Barclays Capital in late 2000, the Eggborough acquisition financing was structured as a 90% leveraged £508 million loan with a 15-year tenor. This deal allowed BE to take the plant off its balance sheet.

By May 2002, BE announced a pre minorities and exceptionals profit of £42 million, whereas a £41 million loss was shown for its UK business. Irrespective of these figures, BE chose to issue a dividend of £48 million to its shareholders.

On 12 August, BE's financial status worsened further when Torness Reactor 1 was taken out of service to investigate vibrations on one of the gas circulators. This shutdown followed a similar shutdown of Torness Reactor 2 in mid May, due to the failure of a gas circulator. Although these shutdowns reduced the company's income by some £52 million, BE issued a statement stating, ?The cost of the lost generation will be partially offset by business interruption insurance. Our future generation plans are unchanged by these events.?

UK government bail out

Although BE spent the summer attempting to renegotiate its contracts with British Nuclear Fuels (BNFL), it did not confront the full extent of its financial problems. However, in early September 2002, BE informed the Secretary of State for Trade and Industry, Patricia Hewitt, of its liquidity issues and in effect asked the government for support.

According to one industry source, ?At the time there was a lot of talk of liquidity problems. The fact is the company was running out of money and had a bad balance sheet. The government came in essentially as a lender of last resort.?

Therefore, in order to uphold BE's trading operations, the government offered a £410 million loan facility, which was later increased to £650 million. Security was taken over the company's assets so as to safeguard the taxpayer's money, and was given by British Energy plc, British Energy Generation (UK) Limited, British Energy Power and Energy Trading Limited, British Energy Investment Limited, District Energy Limited, British Energy International Holdings Limited, British Energy (Canada) Limited, British Energy Generation Limited and British Energy US Holdings Inc.

By February 2003, BE had firmed up the refinancing agreement with its creditors and extended the government's credit facility. EU approval was secured for the second time, and by March the company had paid the outstanding amount on the credit facility.

The principles of the refinancing stated: that BE entering into no-binding Head of Terms with BNFL for two new contracts to replace those agreements where BNFL provided front and back-end fuel related services; that nuclear liabilities, decommissioning liabilities and the historic liabilities relating to spent fuel will be met through a Nuclear Liability Fund (NLF); that BE make ongoing contributions to the fund; that BE issue new bonds to significant creditors, together with new ordinary shares, in exchange for the extinguishment of existing obligations; and that BE issue new bonds to the NLF.

Other terms included limiting the issue of new bonds to £700 million, of which £275 million would be contributed to the NLF; a contractual entitlement for NLF to receive 65% of the net cash flow of the BE Group; and payment of trade creditors and employees in full.

Polygon sparks a row

Given the size of the restructuring and the number of parties that needed to be satisfied, it was unlikely that the deal would appeal to all. In September, Polygon Investment Partners LLP, together with US fund manager Brandes Investment Partners, made a last ditch attempt to change the restructuring process.

Polygon and Brandes, with 5.6% and 6% of the stakeholding respectively, called for an EGM to restructure the existing deal. Proposals for the EGM included the renegotiation of the terms of the rescue, shareholder input into any asset disposal and a restriction on de-listing the company without shareholder consent. Polygon hoped to rescue BE with shareholder capital, citing a surge in power prices as evidence that BE was far from financial meltdown.

The response from BE was expectedly firm. According to Adrian Montague, chairman of BE, ?We have taken the decision to seek de-listing with great reluctance but is necessary to safeguard the interests of British Energy. The requisitionists are asking shareholders to gamble their interests and the company's future.?

He added, ?Major creditors have made it clear that they will take all steps to protect their interests. Passing these resolutions puts the company in real danger of administration. The Board cannot support this and we will take what actions we can to protect the company.?

Although Polygon was well within its rights to use this tactic to try and strong-arm the board as well as the government into making certain concessions, it was unlikely to succeed. The board was bound by the restructuring agreement that had been agreed in 2003, and was unlikely to breach the creditor agreement. Failure to adhere to the restructuring agreement would certainly have led to claims for breach of contract or a demand for payment of £1.5 billion. BE would certainly be forced into liquidation.

By 30 September, Polygon yielded in its fight to have the restructuring terminated. In a public statement, the hedge fund stated that it believed ?there [was] no commercial logic in proceeding with the EGM or supporting the proposed resolutions?. This entailed a humiliating U-turn in having to vote against its own resolutions in the 22 October EGM.

In light of the U-turn, BE dropped its legal action against Polygon that was pending in the US; while the bondholders dropped litigation against the US fund in the UK.

Strong arm tactics

Nevertheless, the bondholders had threatened approximately 230,000 private shareholders with litigation if they did not vote against Polygon's proposals. Shareholders were warned in a letter that they ?could face significant claims against them...in tort? for encouraging a breach of contract. For those small shareholders, who had bought in to the privatisation in 1996, seeing their investments wiped out only to be taken on by banks and bondholders was hard to swallow.

Although Polygon may have been portrayed as de-railers of an otherwise perfect deal, it seems to have been justified in trying to secure better terms for shareholders. It would be narrow sighted indeed if the only viable deal was one where the government and bondholders were in control, and shareholders were not.

However, the UK government, throughout the whole process, has had the most to lose. It played a role in devising the restructuring and has taken on a role as the largest creditor ? thereby taking on BE's liabilities. Had the deal faltered and BE gone into liquidation, this would have had the effect of re-nationalising the company. Therefore, an eleventh-hour hiccup was unlikely.

According to a City banker, ?The government could not have played it better.?

While industry experts seem unclear as to the effects the restructuring will have on the energy sector, there seems to be a consensus as to the benefits of this type of deal. ?You have to remember that British Energy was not always well-managed: it had a sleepy civil service-type culture,? says a City-based expert. ?Now the numbers are in US GAAP, there's a good finance director and it's owned by those with commercial and aggressive interests.?

When the dust settles it seems that British Energy's odyssey will be remembered far more for changing the way companies are restructured, than for its effect on the UK power sector.