The rapid late-1990s expansion by CMS Energy of its global power interests has taken its toll on the company's balance sheet, and against the background of a slumping share price CMS has recently announced the details of a major financial restructuring.

During the first half of 2000 there will be an extensive program of asset sales, both in the United States and internationally. In addition the company has announced that it has plans to make an initial public offering of tracking stock, representing 20% of its stake in the electric and gas utility Consumers Energy.

The stock offering and asset sales will together raise well in excess of $1billion, which will be mostly used to pay down debt. In addition CMS Energy will be buying back some of its own shares in a repurchase program, since it believes that its shares are currently undervalued.

Loy Yang sale

One high profile asset on the block is the CMS share in the Australian Loy Yang power project. CMS Energy announced on 14 February that it will be retaining an advisor to sell its 50 % stake in the 2000MW power plant and coal mine complex, which has suffered badly as a result of plummeting power prices in the Australian market.

"The company has determined that Loy Yang is no longer strategic to CMS Energy's portfolio, and it has not met the company's original financial expectation," commented Alan Wright, chief financial officer at CMS Energy in Dearborn, Michigan.

Already in January CMS had signed a letter of intent to sell all of its Michigan oil and gas exploration and production properties to Texas based Quicksilver Resources. Also in January, the CMS Field Services subsidiary agreed to sell a partial interest in its Northern Header gas gathering system to a group of buyers including Enron Corp.

These asset disposals put CMS Energy on target to reach the high end of the range they have set in meetings with analysts, which forecast that between $600 million and $750 million could quickly be raised by selling non-strategic assets. Any proceeds from the Loy Yang sale would be additional to this amount, though analysts suggest that CMS may in fact have to write off some of the value of its original investment.

They believe that CMS Energy is likely to have to sell its stake at below the 1997 acquisition price, which involved a bid of A$4.746 billion plus the assumption of A$109 million of debt. Nor is CMS Energy receiving any help from the exchange rate, since the A$ was trading at around 77 cents in 1997 at the time of the acquisition, versus only 62 cents in February of this year.

CMS is not the only company which has tripped up in the state of Victoria in Australia. The late 1990s saw a large scale privatisation of generation assets by the state government, and there was considerable interest among buyers, driven by expectations of higher wholesale power prices. Instead electricity prices have headed south, squeezing the cashflow of large players such as Loy Yang Power.

In May last year Loy Yang Power missed a payment on its subordinated debt, blaming tough market conditions made worse by the uncommercial behaviour of state owned competitors in neighbouring New South Wales. It subsequently made the November debt service payments, but the event served to underscore the problems in the electricity generating sector in parts of Australia.

Paying down debt 

The cash raised via the various asset sales will be dedicated to improving the consolidated financial profile by paying down long term debt on the parent's balance sheet. CMS Energy currently has a junk bond rating of BB from Standard & Poors. Though the domestic capital markets for companies with similar ratings are highly liquid and readily accessible, access comes with a high price.

Over the past few years there has been a flight to quality by fixed income investors, and below-investment grade borrowing has become relatively expensive, giving companies a strong incentive to achieve investment grade status. Two key domestic units within the group, Consumers Energy and CMS Panhandle Pipe Line, both carry their own investment grade BBB ratings.

In July of last year Standard & Poor's revised its outlook on CMS Energy to stable from positive, further dampening any long term hopes of an upgrade from its junk bond BB rating. This revision "resulted from the expectation that CMS Energy's credit fundamentals will not improve to a level comensurate for a higher rating in the near term," S&P said at that time. "Despite expectations for improved cashflow, CMS will continue its aggressive use of debt to fund a substantial $3.5billion capital budget."

And in a report released last October Moody's Investor Service noted that "CMS management has maintained consistent financial growth and development goals in recent years that, combined with a highly leveraged financing strategy, transfer increasing business risk to fixed income investors."

"Recent increases in demand for share price appreciation on the part of equity investors, combined with depressed stock prices in the electric power industry, have increased management incentive to transfer risk to fixed income investors," Moody's argued. It rates CMS Energy senior unsecured debt at Ba3.

It was against this background of concern about its aggressive use of debt that management at CMS came to their decision to take strategic measures to improve its balance sheet, and put more emphasis upon stable income flows from domestic regulated investments.

"Longer term they would like to reduce leverage, and strengthen their cashflow coverage, so that their credit protection profile would be in line with an investment grade entity," says John Whitlock, analyst at S&P in New York.

"This is a step in the right direction," Whitlock says, with the asset disposals making the company less dependent upon the portfolio of riskier non-regulated investments overseas, and putting more emphasis upon regulated entities which have a stronger business profile.

Similarly, the offering of tracking stock will give investors an opportunity to buy into the solid track record of Consumers Energy, and raise cash to pay down debt. "What they are trying to do is monetise some of that regulated investment, because they do not feel that the intrinsic value of the whole operation is being captured," says Whitlock.

Rating agency Duff & Phelps also welcomed the plan. "Although the company will initially remain highly leveraged with approximately 60% debt/capital, DCR expects that over the next two years, reduced leverage, increased earnings retention and improved cashflow coverages will be supportive of credit quality and offset the somewhat credit dilutive impact of its stock repurchase annoucement and underperformance of key international investments," says John O'Connor, analyst at DCR in Chicago.

"Longer term, additional credit upside will largely hinge on the realisation of the phased in cashflow contribution from large overseas investments," O'Connor continues. "The company's international investments are, and will continue to be, challenged by the sovereign and geopolitical risks inherent in higher risk sovereign nations."

More sales to follow

More assets will be sold in the coming months, and some analysts suggest that Argentina will be one country where there may be some sell-offs. CMS is majority shareholder and operator of Centrales Termicas Mendoza. This 517MW plant is in Mendoza province, and its turbines are powered by natural gas or diesel fuel. It was acquired as part of the Argentine government's privatisation program.

In addition CMS Generation owns and operates the CMS Ensenada natural gas cogeneration facility, which produces 128MW of electricity and 200 tons of steam per hour. Both steam and electricity are sold to two nearby oil refineries, with electricity also being sold into the Argentine wholesale market.

Even with asset sales in countries such as Australia and Argentina, CMS Energy will continue to have a highly diversified portfolio of international projects, including some under construction. Last October the international energy distribution unit CMS Electric and Gas Co closed the acquisition of a 77.13% stake in a group of electric distribution companies in southern Brazil, Grupo Companhia Paulista de Energia Electrica (CPEE) for around $85 million.

It also has power plants in Thailand, Morocco, The Philippines and India. In November of last year, CMS Generation announced that it had closed a $220m project financing for the Neyveli independent power project in the state of Tamil Nadu in India.

The Neyveli project is a 250 megawatt lignite coal fueled power plant, which is being built at a cost of around $320m. Preliminary contruction of the plant began in 1999, and commercial operation is scheduled for 2002. CMS Generation will hold a 50 % equity ownership interest, and operate the plant upon completion.

In August last year construction began on the Transportadora de Gas del Mercosur (TGM) natural gas pipeline, which will transport natural gas from the Argentine town of Parana to the Brazilian border town of Uruguaiana. CMS has a 20 % ownership in the project, which will link up with the existing TGN pipeline in Argentina, which is also 29 % owned by CMS. The new pipeline, which will become operational in June of this year, will allow the export of Argentine natural gas into Brazil for the first time.

CMS also has large investments in a number of projects currently being developed. These include the Al-Taweelah A-2 natural gas fired plant in the United Arab Emirates, the Takoradi natural gas fired plant in Ghana, and the Jorf Lasfar coal fired plant expansion in Morocco. Also under construction is the 740MW GasAtacama plant in northern Chile, which will supply power to regional electric distribution companies and Minera Escondida, which is the world's largest copper mine.

In addition there is a large portfolio of power projects in the United States, in areas such as Connecticut, New York, Michigan, California and Oklahoma. Though less risky than some of the overseas projects, the growth of this domestic IPP portfolio over the past five years has added to the risk profile of CMS Energy.

The move last year to buy the Panhandle gas pipeline assets for $2.2 billion, though adding to CMS Energy's debt burden, was viewed as a positive move by analysts in that it provided an additional source of stable dividends to the group

There is no strategy to exit any geographical regions of the world, but rather a review of its portfolio of assets, and making sales on a case by case basis. CMS clearly hopes that its initiative will show investors that it has a clear strategy which will get the company back on track.

But equity investors have been bailing out. During the past 52 weeks CMS Energy shares have traded as high as $47, and in spite of selling pressure found support at the $30 level towards the end of 1999. They have since slumped, and as of mid-February were trading at only $18.50, partly because of concerns about the February spike in oil prices. Clearly the company has some way to go before convincing the markets.