Enron Mail

Subject:FW: A Happy Landing For PGE
Date:Tue, 9 Oct 2001 13:19:02 -0700 (PDT)

-----Original Message-----
From: firstcall.notes@tfn.com [mailto:firstcall.notes@tfn.com]
Sent: Tuesday, October 09, 2001 1:27 PM
To: Koenig, Mark
Subject: ENE: A Happy Landing For PGE


09:30am EST 09-Oct-01 Sanders Morris Harris (Research Department 800-423-9656)
ENE: A Happy Landing For PGE

Enron Corp (ENE/NYSE): A Happy Landing For PGE.
John E. Olson, CFA (713) 220-5151; john.olson@smhhou.com
October 8, 2001
Industry: Energy Recommendation: Strong Buy
Price: $33.54 Price Target: $42.00 Type: Company Update
Estimates (Dec.) 2000A 2001E 2002E
Curr Prior Curr Prior Curr Prior Investment Profile:
---- ----- ---- ----- ---- ----- --------------------------
EPS (Diluted) 1.47 1.85 2.15 Share Base (MM): 890
P/E: 22.8x 18.2x 15.6x Market Value ($B): $29.9
CFPS (Diluted) 1.34 2.42 3.25 Cash ($B): $1.1
P/CF: 25.0x 13.9x 10.3x Lg Term Debt ($B): $12.8
Div. Rate: 0.50 0.50 0.50 Preferred ($B): $4.4
Div. Yld.: 1.58% 1.58% 1.58% Ent. Value ($B): $44.3
% Leverage: 61.9%
Inst'l Ownership: 67.3%
Dly Trading Vol.: 5.9 mm
Price Range (52-week):

Erngs./Share 2000A Prior 2001E Prior 2002E Prior
----- ----- ----- ----- ----- -----
Q1 0.40 0.47 0.54
Q2 0.34 0.45 0.52
Q3 0.34 0.43 0.53
Q4 0.41 0.49 0.56

KEY POINTS: The Second Time Around Still Looks Good.

* ENE has cut another deal on Portland General Electric (PGE), this time with
Northwest Natural Gas (NWN: $23.04: $1.26 Div-5.46% yield). The deal size is
$2.955 billion. The original deal, in November 1999, was for $3.1 billion
with Sierra Pacific Resources (SRP: $15.12: $0.80 Div: 5.29% yield). This was
$300 mm better than we expected in our September 28 report, which upgraded
ENE to a Strong Buy.

* This deal has very few externalities, and should close twelve months hence.
Both companies are Oregon-based, and should get a better regulatory break
than ENE did when it bought PGE in July 1997.

* The impact on ENE? (1) Very little gain or loss on sale of the assets; (2)
Interest expense reductions should largely offset expected $140 mm (after
tax) annual PGE earnings contribution; (3) A better balance sheet, with total
leverage dropping from 61.9% to 57.3% if done today.

* This is a step in the right direction. PG&E will be in much better hands to
pursue its Oregon agenda, and ENE will look better without PGE's presence. We
continue to rate ENE a Strong Buy up to $36; it becomes a Buy from $36 to
$40. Our 12-month price target is $42-$44.

Current Events:

The deal is straightforward. NWN will raise $1.55 billion in cash, $200 mm in
Feline Prides, and will issue $50 mm in NWN stock to Enron. NWN will assume the
residual $75 mm obligation inflicted on ENE by the Oregon PUC as the price of
regulatory peace (i.e., ransom demands) at the time of the original acquisition.
This brings the total purchase price to $1.87 billion for PGE's $1.118 billion
of common equity. NWN will assume $1.05 billion of total debt and $29 mm of
straight preferreds. The price-to-book is 167%. PGE has been earning in the $125
mm-$140 mm after-tax area, although the numbers may work higher this year ($150
mm) because of FASB 133 (mark-to-market) profits on longer-dated power trading
of $16 mm being realized (so far). The approximate P/E is about 12.5x forecasts.
The electric group is now trading at 11.5x 01Es and 10.9x 02Es.

The regulatory due process should take about 12 months. There are no looming
rate cases, ROE or capital structure issues. The OPUC ranks very low among state
PUCs in terms of providing fair or competitive ROEs for investors. We were
pleased to learn that the OPUC has finally ditched the CAPM (capital asset
pricing model) as a worthless relic for determining costs of capital and has
embraced discounted cash flow methodology. The bad news was that this still
didn't prevent the OPUC from rolling over PGE in its August 1 rate case
settlement, dropping the allowed ROE from 11.6% to 10.5%. The annualized
earnings impact looks like $8-$9 mm after-tax.

Given the very parochial nature of the Oregon retail energy market, there is no
question in our mind that this should be a worthwhile deal for NWN and a win for
ENE, as well. If the deal were closed today, ENE would deleverage to the tune
of the $2.95 billion proceeds, or from 61.9% to 57.3% total leverage. It would
also trade up ENE's unnecessarily low composite ROE from the 12.5% area to
something better. PGE's secular growth rate is 3%-4% annually in rate base
terms, and its EBIT contribution would run only 8%-9% of ENE's totals in
2002-2003. There would be very little book gain or loss on the sale, and the
$1.4 billion of underlying goodwill on the PGE assets will disappear. ENE had to
reincorporate in Oregon at the time of the PGE purchase. Chances are that it
will be a Delaware corporation by this time next year.

On the other hand, NWN has seized a very good, but highly leveraged opportunity.
Both managements are largely in sync, covering much of the same ground already.
The synergies can be meaningful. NWN's asset base would more than triple, from
$1.29 billion to about $5.65 billion. In essence, NWN's $840 mm rate base will
be joined with PGE's rate base of $1.65 billion, and NWN would have tripled its
rate base to $2.49 billion. About $780 mm of goodwill will be created in the
process. NWN is funding the deal 98% with debt and a mandatory convertible
preferred, and 2% with common equity. It will set up a new upstream corporation,
and presumably do a Section 351 acquisition. The two subsidiaries will then be
merged into "NewCo", and that name will be changed back to NWN. NWN's total
capital structure at midyear ran 47.9%-3.6%-48.6% (total debt-preferreds-common
equity). The pro forma structure should run 79.7%-6.9%-13.4%. If short-term debt
is excluded, the structure becomes 77.9%-7.5%-14.6%. Each subsidiary of NewCo
will continue with about 48%-52% leverage, but the parent will look more like an
LBO. Is this bad? We don't think so, because: (1) NWN is buying $140+ mm of
earnings and may pay out about $85 mm-$90 mm in after-tax interest expense, and
thanks to FASB 140-142, there would be no goodwill amortization; (2) Newco will
have almost entirely regulated assets; and (3) the synergies in both G&A and O&M
expenses should be noticeable. The surplus CFFO/ Profitability of (say) $50-$70
mm can be used to pay down the acquisition debt. The good news is that NWN's
earnings should be ramped up significantly as a result of this deal. The
trade-off may be that this is a one-time event, and NewCO will still be subject
to the whims of the OPUC. This should not be underestimated. NWN's realized ROEs
have been about 10.0%-10.5% recently, and PGE's have been in the 12.0%-12.5%
realized range. NWN is expected to grow at 5%-6% annually, and PGE should do
3%-4% annually.

We like the deal fit, the people fit, and the collateral benefits to ENE.

Copyright 2001 Sanders Morris Harris Group. The study herein is not a complete
analysis of every material fact respecting any company, industry, or security.
The opinions expressed here reflect the judgement of the author at this date and
are subject to change. Facts have been obtained from sources considered to be
reliable, but are not guaranteed. Sanders Morris Harris, its officers,
directors, and/or employees may have an interest in the securities of the
issue(s) described herein and may purchase, sell, trade or act as market maker
while this report is in circulation.

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