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PG&E's Reorganization: More Debt, More Backstop Investors, and an Equity Offering

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California utility PG&E has been given permission to clear the decks to emerge from a bankruptcy bookended by two disasters. Federal Judge Dennis Montali signed the order approving the company’s disaster reorganization plan on Wednesday. The formal signing of the reorganization plan will occur next week after the “remaining issues” are resolved, according to the Wall Street Journal

The San Francisco-based company was on the hook for as much as $30 billion in claims after a series of fires, notably the one in 2018, one of which burned down an entire town. The company’s reorganization plan has been approved during another disaster, when a pandemic has derailed much of the American economy and threatens to slash PG&E’s main source of revenues: electricity demand. The EIA expects electricity demand to fall by 5.7% this year as compared to 2019.  

Much of this tumult and chaos is reflected in PG&E’s $59 billion bankruptcy reorganization plan, which has undergone multiple iterations to accommodate demands from stakeholders jockeying for a bigger share of the $13.5 billion wildfire fund pie. The latest version calls for the company to raise $38 billion from equity and debt markets through the sale of shares and bonds. That figure has jumped from the $22 billion proposed by PG&E in the initial version in January 2019. The utility plans to sell bonds worth $6 billion and is raising new debt from its holding and operating ventures in addition to making a $9 billion offering to investors. Post-bankruptcy, wildfire victims will own approximately 22% of the company because part of their compensation from the wildfire fund will be disbursed in the form of equity. 

PG&E’s stock price has cratered by 77% since October 2018.  Considering the company’s unending saga of troubles since then, it might be understandable if investors hesitate to risk their cash on it. To that end, PG&E has lined up approximately $3.25 billion in backstop financing from hedge funds and financial firms. A backstop agreement is essentially a commitment from financial firms to buy up shares of the company, if the issue is undersubscribed. In return, the company offers equity to the firms at a discount. In PG&E’s case, backstop investors may pay up to $10.50 per share, when the equity offering takes place. At the time this piece was written, PG&E was trading at $10.95. Backstop investors will own approximately 10 percent of the company post bankruptcy approval. 

Most backstop investors in the utility have already had prior holdings in it. The current agreement, therefore, increases their share of the utility. Some have profited from both ends of the bargain. For example, Baupost Group LLC., a Boston-based hedge fund, raked in “hundreds of millions of dollars” by buying up cheap insurance claims for 30 to 35 cents to the dollar and worth, at least $2.5 billion, immediately after the wildfire and settling them with PG&E for roughly 59 cents to the dollar. Baupost is also one of PG&E’s backstop investors and is poised to profit, if the company’s stock price rises in the coming months. 

The chances of that happening in the near future hinge mostly on the company’s stock offering. Most analysts have expressed satisfaction with the imminent resolution of PG&E’s problems but have retained their price targets owing to the uncertainty associated with the offering. Analysts at Bank of America and Morningstar have cut and retained their stock valuations for the utility respectively. “We are reaffirming our no-moat, stable moat trend, and high uncertainty ratings,” wrote Morningstar analyst Travis Miller. 

While BoA analyst Julien Dumoulin-Smith cut his price target from $14 to $12.20, he stated that the deal eliminated another uncertainty from PG&E’s story. “While selling pressure from victims remains a consideration post lock-up, the group will have $6.75 billion in cash and will likely be incentivised to wait for valuation to recover in order to maximize the value of their share ownership,” he wrote, referring to the lock-up period for investors and wildfire victims before they can cash in their stock. 

Some analysts are outright bullish. For example, analysts at Barclays have upgraded their target price for the stock to $15 from the current $11. If the company’s equity offering is successful, then the company’s stock could rally to $21, analysts at the bank wrote.   

But PG&E is not out of the woods yet. Miller from Morningstar opines that the current arrangement may “depress returns on capital for many years.” The current pandemic is also expected to make a significant impact on its finances in the near-term. PG&E is part of the utility horde that has tapped bond markets for funds during the pandemic. Added to that is the fact that California’s Inverse Condemnation rule still persists: another fire or natural disaster may spell an end to the utility as we know it.

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