Description

El Paso is a large and diversified energy company.

The company is highly levered with 25 bn in obligations including debt, gurantees some minority interest and other. EBITDA LTM was 3.8 bn but annualizing last quarter would result in EBITDA of slightly above 2 bn.

The company has significant problems having been downgraded five notches Ba2 to Caa1 on February 11; quite likely one of the largest single one day downgrades in history. Furthermore, the company has large trading book exposure which is not measurable; however, it has had to collateralize its trading book with 2 bn dollars! To add to its troubles, the company is being investigated by the FERC regarding its pricing policies. A ruling that indicates that the company acted improperly would probably result in a suit by the state of California which has claimed that EP overcharged the state by 3 bn. All of this adds up to "going concern" questions regarding this company.


Against these problems. I am proposing the purchase of Limestone 8 5/8% 3/15/03 Holdco bonds trading at 90. The bonds mature in a month and if you were to buy them at 94 they would have a yield to maturity of 94%, they are currently trading at 90 which makes the yield uncalculable.

The recomendation comes from doing an analysis of the Cos liquidity which is as follows.

Cash 600 mln
Recently drawn revolver 1000 mln
Additional availability under facility 1500 mln
Imminent asset sales 500 mln
TOTAL LIQUIDITY 3600 mln (3.6 billion)


With this liquidity, the company needs to make the proposed maturity of 1000 mln indicating that liquidity exceeds maturity of by a factor of 3.6 to 1. Potential additional uses of this liquidity are further collateralization of the trading book, but cash uses from operations should be negligible.

The long term bonds of EP (Holdco) trade at 45 or with a yield of 17%. The dollar price here is what is interesting because it indicates that if the company were to file the entire capital structure (HOLDCO) would fall to the same dollar price indicating that the potential loss for the march 03 holders would be 45 points. So we are looking at the potential to make 10 and the potential to lose 45 on the trade if the CO. files. The implicit probability that the 03 bonds pay is 81%: 10P - 45 (1-P) = 0 solve for P.

Based on the company's liquidity profile, I estimate that the probability that the company makes the payment in one month is substantially higher than 81%.

Finally, El PASO is no Enron. Please look at the previous report on EP on value investorsclub page for a better review of their operations.

Catalyst