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January 19, 2001
Heard on the Street

Amid California Power Crisis, Investors Bet on Utilities
Bonds

By GREGORY ZUCKERMAN and JATHON SAPSFORD
Staff Reporters of THE WALL STREET JOURNAL

As lights go out in California, on Wall Street light bulbs
are popping over the heads of investors hoping to profit
from the electricity crisis.

Amid the rolling blackouts, investors with a taste for
risk are betting on the bonds of the two struggling
utilities, units of PG&E Corp. and Edison International,
even as they move precariously close to filing for
bankruptcy-law protection. The investors are gambling that
the companies have enough assets -- and political
importance -- that a solution will be found that will
include gains for intrepid bondholders.

But some experts advise investors to be careful wading
into the energy current, saying it could be a while before
the bonds pay off. And they are emphatic that the
companies' stocks should be avoided like a downed
electrical pole.

Over the past few weeks, the debt of Pacific Gas &
Electric and Southern California Edison has been
downgraded to "junk" status by leading rating agencies,
and both utilities have missed debt payments -- usually a
huge red flag for investors. Meanwhile, holders of the
utilities' commercial paper, which is the shortest-term
debt, are doing everything they can do to dump their
holdings, though it is getting hard to find takers.

But the unsecured, longer-term debt of both companies has
remained in demand, trading at around 50 cents on the
dollar -- at least 10 cents higher than such debt usually
trades at when a company veers so close to a bankruptcy
filing. Prices of bonds that are secured by the utilities'
plants have actually edged higher in recent weeks, moving
from 65 cents on the dollar to about 80 cents -- though
the move has come on limited volume.

Behind such movements are aggressive investors such as
money manager Martin Whitman, of M.J. Whitman. "We're
trying to buy the secured [bonds] like it's going out of
style, and some of our smartest clients are buying the
unsecured debt," says Mr. Whitman, who runs Third Avenue
Value Fund, a mutual fund, as well as hedge funds. Mr.
Whitman, whose firm also acts as a broker-dealer for
distressed debt, hopes to buy as much as $200 million of
the bonds in coming weeks. His only frustration is that
the prices aren't coming down.

The number-crunching by investors works along these lines:
At current prices for unsecured bonds, investors could
score gains of 20% to 25% annually if principal and
interest payments are made within the next two to three
years, the average bankruptcy-court stay. For secured
bonds paid off within that period, the gain would be
almost 15% annually. With quicker payoffs, the return
jumps, of course. The two utilities have more than $20
billion in debt outstanding, of which just a small
fraction is insured.

Why do the bulls -- including distressed-debt specialists
as well as funds such as Mr. Whitman's -- see so much
value in the utility mess? Unlike the run-of-the-mill
troubled company, the utilities are so big, and so
important to the California economy, that some form of
resolution will likely be found to help them get back on
their feet, perhaps by allowing the companies to boost
electric rates. Even if a bankruptcy proceeding results,
the utilities control sufficient assets to give
bondholders a good chance of full recovery of their
principal and even eventual payment of any missed interest
payments, bulls say.

"They're too big and important not to get a solution,"
says Todd Thompson, a portfolio manager at Conseco Capital
Management. "If a theater company or retailer goes away,
no one cares, but here there has to be a resolution."

Bond specialists also point to their past home runs
betting on debt of troubled utility companies -- such as
Public Service of New Hampshire, which was under
bankruptcy-court protection in 1988 to 1991 and never
missed a bond payment.

"If there's a liquidation, or if they figure this out,
you're going to get paid back" principal payments and
accrued interest, Mr. Whitman says. Adds Marc Lasry,
managing director of Amroc Investments, a leading investor
and trader in distressed debt: "There's been quite a lot
of buying [because] at the end of the day you'll get paid.
The question is how long it will take."

But some caution that the bonds could see weakness in
weeks ahead, because some debtholders who want to sell are
waiting on the sidelines, hoping to dump their positions,
once a resolution becomes more evident. Others caution
that the California situation is unlike past utility
fiascos where savvy investors made out quite well. The
problem in California is a newly deregulated pricing
system that has fallen apart, not the overzealous
expansion plans that created various earlier problems.

A bankruptcy-court filing would raise further uncertainty,
perhaps causing more debt to come up for sale. Creditors
fear consumer advocates could lobby against an
electric-rate increase that many say is necessary to solve
the crisis and cover payments to creditors; these
advocates may demand that creditors suffer at least some
loss in the value of their holdings. Moreover, resolution
of the matter could take much longer than the two to three
years that some investors are banking on.

Even as Mr. Whitman and others place their new bets, many
investors who months or even years ago bought the
utilities' debt, figuring it was rock solid, are licking
their wounds. "We stayed away from tobacco. We stayed away
from Japanese banks," says Orange Country Treasurer John
Moorlach, who invested $40 million in Edison's commercial
paper before the credit-ratings agencies downgraded the
utilities' debt. With the two California utilities now
rated below other investments that Mr. Moorlach wouldn't
touch, he says, "It's frustrating."

Mr. Moorlach, as fate would have it, was the man appointed
in 1995 to help lift Orange County out of its own
financial crisis, one brought on by bad investments. He
improved Orange County's finances by prudent
investments -- including securities issued by utilities.
"This is survivable," he says of his current quandary,
"but it's just awkward."

Others say the commercial-paper market is one area where
investors could suffer further losses, at least in the
near term. One reason: There are few potential buyers for
tainted commercial paper, because these short-term
securities issued by corporations generally appeal only to
ultraconservative investors. Both utilities' commercial
paper is being quoted for about 50 cents on the dollar.
With little being traded, "it's very hard to get rid of it
right now," says Sean Egan, managing director at
Egan-Jones Ratings Co., who says those reluctant to bid
include Wall Street securities firms.

Things might get worse. While the commercial-paper holders
might eventually get at least some of their money back,
some fear those payments won't come soon enough to prevent
some money-market mutual funds from seeing the value of
their shares "break the buck," or drop below the
$1-per-share level, causing losses for supposedly sound
investments. Such an event, however, would be rare in the
money-market world.

As for the utilities' stock, if there is a reorganization
of the companies, it could wipe out at least some
shareholder value, while bondholders could gain control of
the remaining equity. "You're taking huge risks" on the
stock, says Mr. Whitman.

PG&E shares have dropped sharply over the past few months,
falling from a high of about $30 in late summer. At 4 p.m.
Thursday in New York Stock Exchange composite trading they
were up 13 cents to $9.75. Edison, meanwhile, was up 13
cents to $9 on the Big Board, down from more than $25 in
the summer. Yet, as steep as the declines have been, the
shares of both utilities still trade higher than is
typical for stocks of companies facing the possibility of
bankruptcy.

"The stock price is irrational," Amroc's Mr. Lasry says.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com
and Jathon Sapsford at jathon.sapsford@wsj.com