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November 19, 2001 



Montana Power: 
Problems Continue to Overshadow Transformation Into Touch America



By Will McNamara
Director, Electric Industry Analysis


[News item from CBS MarketWatch] Montana Power shares fell on Nov. 16, a day after the utility posted a loss for its third quarter, citing the slowdown in the economy and the company's transition from a diversified energy company to a stand-alone telecommunications firm. The stock fell to a 52-week low of $4.05 earlier in the session. It closed Nov. 16 at $4.18, down 52 cents. As of early morning trading on Nov. 19, Montana Power shares remained at $4.18. 

Analysis: There is little doubt that Montana Power currently finds itself at a challenging crossroads. The company remains in the midst of becoming solely a telecommunications operation, having sold off much of its utility holdings. However, the process has hit several snags, including an incomplete transfer of its transmission and distribution unit to Northwestern Corp. Compounding Montana Power's current problems is a weakened financial performance, which continues to worsen and also leaves little capital to build the telecom business. In addition, the company faces a host of related challenges, including uncertainty about the final regulatory approval needed for the asset sale to Northwestern, requests for rate increases to fund the purchase of power that Montana Power must buy on the wholesale market, and inspection of the long-term power-purchase contracts that the company has formed with various suppliers. The question that investors should be asking with regard to Montana Power's current plight is whether or not the financial losses and resulting drop in stock price represent a temporary setback or some larger indication of doubt about the company's viability as a telecom operation. 

For its third quarter 2001, Montana Power posted a loss of $27.5 million, or 26 cents a share, representing a $57.3-million swing from its 3Q 2000 profit of $30.4 million, or 29 cents a share. During the third quarter of 2000, Montana Power had reported a net income of $31.3 million. Montana Power has noted that the losses in the current quarter were not solely related to Touch America, but also included a $14.8-million pre-tax write-down of investments in two other telecommunications companies. One had filed for bankruptcy and the other defaulted on loans that Montana Power had helped guarantee. In addition, company officials have attributed the loss to price decreases and the slowing economy. However, note that the current third-quarter losses followed losses in the second quarter as well. Specifically, the company reported a net loss of $10.9 million, or 11 cents a share, in the 2Q 2001, compared with net income of $35.5 million, or 34 cents a share, in the second quarter of 2000. The company also previously reduced its expectations of revenue growth in 2001 to 10 percent from 25 percent. According to Montana Power's CEO Bob Gannon, the company is merely experiencing a "short-term liquidity problem." 

Nevertheless, to say that Montana Power is having some growing pains is an understatement. Since March 2000, it has been Montana Power's goal to totally divest all of its energy assets and re-emerge as a debt-free communications company, operating under the name of Touch America (presently the company's telecom subsidiary), with zero debt, $350 million in cash and 26,000 miles of fiber communications lines. CEO Gannon originally envisioned, and continues to see, Touch America as one of the largest broadband companies in the country and a more lucrative business model than the formerly integrated Montana Power. Much of the transition has already taken place, considering that Montana Power has successfully divested its oil and gas, coal and independent power production businesses. As noted, the last piece of the puzzle is the sale of its electric and natural-gas utility operations to Northwestern Corp., a provider of electricity, natural-gas and communications services to Midwestern customers. This is a big piece of the puzzle, however, as Touch America is counting on proceeds from the distribution sale to support continued growth. 

Therein lies one of the main challenges for Montana Power. The Montana Public Service Commission is the last regulatory agency that needs to approve the sale of these assets. Some analysts have suggested that Montana Power's financial problems can be resolved only if the Montana Public Service Commission approves the sale of the electric and natural-gas distribution systems, which could inject some $460 million in Touch America's operations. Yet, state regulators are ensuring that the state consumer counsel's office, which represents ratepayers in utility cases, and a group of large industrial electricity users also have an opportunity to raise any concerns about the proposed sale of the assets. The less time provided for equal-opportunity review and comment could increase the likelihood that the sale could be challenged down the line. 

After some early deliberation, the Montana Public Service Commission has now agreed to review the $1.1-billion proposed sale of the assets to Northwestern Corp. by Jan. 31, 2002, although lawyers for Montana Power are still lobbying to have this review moved up to December. Part of the pressure for the review, the company's attorneys have argued, is that if the sale is not approved by the end of the year, investors and lenders may lose patience regarding the uncertainty of the deal and refuse to provide any further capital support into the growing Touch America. Furthermore, the viability of the entire business plan for Touch America could be brought into question if this asset sale is not approved by state regulators, considering that Montana Power is counting on proceeds from the sale to support growth of the new telecom company. The sales agreement between Montana Power and Northwestern Corp. expires March 31, 2002, so time is also a factor. 

Another issue that has yet to be resolved is Montana Power's intent to raise rates to support purchases of wholesale power. In other words, as a tangential issue related to the sale of its assets, state regulators also question how Montana Power will recover certain power-supply costs as it continues to morph into a telecom business. The company has established that it expects to pay nearly $2 billion over the next 30 years for wholesale power purchases that have been necessitated by its transition to a telecom company from a utility holding company, and hopes to increase electric rates by 20 percent to support these expenses. Montana Power is still considered the default provider to about 288,000 customers, and needs an average of 670 MW for its customers. However, the company also needs to keep a total of 1,050 MW as a peak load during the winter months and aims to keep 100 MW of reserve power. 

Since the company voluntarily divested its own generation facilities to PPL Corp., it must procure its entire load on the open market at rates set by the Montana Public Service Commission. The 20-percent rate increase reportedly would increase residential electricity rates by about $2.00 a month starting in July 2002, making the average bill about $64 per month. In addition to the projected 20-percent increase for residential customers, Montana Power estimated that small businesses could see their rates increase by 21 percent and medium industrial customers could see a 36-percent increase. It is important to note that a recent survey by the Great Falls Tribune concluded that, the increase in Montana Power's rates would produce some of the highest residential electric rates in the Northwest. 

Montana Power is attempting to establish long-term power contracts with suppliers to meet its entire load requirements. For instance, Montana Power formed a buy-back agreement with PPL as a condition of the generation sale two years ago. This contract expires July 1, 2002. Beyond that date, Montana Power announced that it signed a one-year contract to buy 111 MW from Duke Energy at an undisclosed price. PPL also has formed a new contract to provide 450 MW to Montana Power over a five-year period after its current contract expires. Northwestern Power, the purchaser of Montana Power's distribution system, has said that it wants Montana Power to assemble a diverse package of power-purchase deals (instead of buying all its load from one source) to encourage the development of new generation sources in the region. Montana Power has reportedly submitted a portfolio of power-purchase deals to the Montana Public Service Commission to determine the inclusion of those deals within the rate structure, and the portfolio contains about three-fourths of the 1,129 MW that Montana Power will need to cover its peak demand of customers and maintain an adequate reserve. The company will probably purchase the balance of its requirements on the short-term market. 

Also, on the legal front, Montana Power continues to navigate through at least two litigious proceedings. First, in August, a group of Montana Power shareholders initiated a lawsuit against the utility, claiming the company's effort to get out of the electricity business was illegal and cost them $3 billion in lost stock value. The complaint, filed in the District Court at Butte, said the sale of Montana Power generation plants to PPL Montana in December 1999 was done without the required shareholder approval and should be overturned. The suit also asks for a court order putting the plants and an estimated $100 million in profits realized by PPL from operating the plants into a trust until the case is resolved. What this means is that the sale of Montana Power's generation assets are in a state of litigation, even though the sale of the generation assets was completed two years ago. Another lawsuit is related to Montana Power's $200-million purchase last year of Qwest Communications' long-distance and other telephone businesses within a 14-state service area. Essentially, Montana Power has launched a suit against Qwest, alleging that Qwest has violated anti-trust laws and constrained competition in the long-distance and voice and data market. 

Consequently, as Montana Power closes out the year and hits the two-year mark in its transformation into Touch America, the future for the company looks rather questionable. Although there are market doubts about the future of the telecom sector, Montana Power remains confident that its long-term prospects as a telecom company remain very strong. Nevertheless, the current question for investors is how quickly and how successfully Montana can complete its transformation into Touch America. In other words, what Montana Power sees on the horizon may not be so easily reached. The path to the company's final destination is obviously marked by several financial and legal obstacles. 


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