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December 19, 2001=20



Reliant Energy Proceeds with Corporate Restructuring, Bucking Turnaround of=
 Industry Trend=20



By Will McNamara
Director, Electric Industry Analysis



[News item from PRNewswire] Reliant Energy (NYSE: REI) shareholders approve=
d on Dec. 17 a major step in a corporate restructuring that will ultimately=
 divide the company into a regulated energy-delivery company named CenterPo=
int Energy and a competitive energy services provider called Reliant Resour=
ces.=20

Analysis: It is somewhat surprising that Reliant Energy is proceeding with =
its massive restructuring, which it acknowledges is being done to maximize =
shareholder value, considering how dramatically the market has changed sinc=
e the company first announced its plans about 17 months ago. In July 2000, =
Reliant's plans to bifurcate its operations were just the latest in a strin=
g of similar restructuring initiatives from companies such as Southern Co. =
and Xcel Energy, both of which spun off high-growth, unregulated subsidiari=
es into stand-alone companies in very successful IPOs. Fast forward a year =
later and the splitting of regulated operations from unregulated operations=
 into two stand-alone companies no longer appears to be a sure-fire busines=
s decision. For example, companies such as Constellation Energy and Alleghe=
ny Energy, which announced plans to engage in this kind of restructuring ac=
tivity after Reliant's announcements, now have backpedaled and put such pla=
ns on hold. The details among the companies may be different, but the end r=
esult is pretty much the same: splintering an integrated company into two o=
perations to attract two sets of investors. At the onset of the plans, the =
real appeal was to put unregulated power generation into a separately trade=
d company and sell lots of stock. That sounded like a great idea last year =
when the independent power producer (IPP) market was going gangbusters. Now=
, demand and prices have dropped, and the merchant energy industry is shrou=
ded in uncertainty. Into these rocky waters, Reliant Energy is about the on=
ly company that still believes a major restructuring is presently a wise mo=
ve.=20

As noted, Reliant's restructuring plans have been in motion for over a year=
, so in fairness to the company, it may be making the decision to proceed w=
ith the risky initiative in hopes that investors will still be receptive. T=
he IPO of subsidiary Reliant Resources, held in May 2001, raised about $1.5=
6 billion and was considered one of the most successful offerings this year=
. Reliant Energy presently owns a little more than 80 percent of Reliant Re=
sources, whose business model is focused primarily on wholesale power marke=
ting, maintaining generating and trading assets, and selling retail energy.=
 Quite naturally, Reliant is hoping for a repeat of that success when the s=
pin-off is completed in the first quarter of 2002.

Let's be clear about what Reliant is doing with this restructuring plan. Wh=
at shareholders approved this week was the formation of a new holding compa=
ny called CenterPoint Energy, which will include both the company's regulat=
ed energy-delivery business and Reliant Resources. The creation of a new ho=
lding company and accompanying name change are being characterized as inter=
im steps that Reliant is taking toward the ultimate separation of the unreg=
ulated and regulated businesses. After receiving regulatory approvals from =
the IRS and SEC, shares of Reliant Energy will be automatically converted i=
nto shares of CenterPoint Energy, which will trade under the symbol CEP on =
the New York and Chicago Stock Exchanges. Trading for Reliant Energy, under=
 the symbol REI, will be discontinued at that point.=20

As the next step in the restructuring, pending an additional round of regul=
atory approvals, CenterPoint Energy will spin off the regulated company by =
distributing its shares of Reliant Resources to its shareholders, creating =
two separately owned public companies. Ultimately, CenterPoint Energy will =
own only the regulated side of the business, including electricity transmis=
sion and distribution, natural-gas distribution, pipelines, and any power g=
eneration facilities that remain regulated.=20

Reliant's motivations to divide itself into two companies are pretty straig=
htforward. On one hand, the company is simply complying with the regulatory=
 mandates of Texas, which require that state utilities establish firewalls =
between their operating companies and create separate businesses for genera=
tion, energy services, distribution, etc. Yet, more importantly, Reliant is=
 turning the mandate into a potential financial opportunity by establishing=
 two public companies with dramatically different risk / reward profiles. T=
he unregulated side will include such businesses as power generation, marke=
ting and trading, and the European operations. The regulated side will incl=
ude the businesses related to electricity and natural-gas distribution as w=
ell as the company's U.S. interstate pipelines. Note that the company previ=
ously indicated plans to sell its communications unit, which has struggled =
amid a larger market downturn in this sector. Thus, once the restructuring =
is completed, CenterPoint will be aimed at the traditional type of utility =
investor, which expects steady returns and reliable dividend income, while =
Reliant Resources will be more geared toward investors with a high toleranc=
e for risk that want to take advantage of competitive opportunities in the =
deregulating wholesale market.=20

Reliant Energy's CEO Steve Letbetter recently said he expects CenterPoint's=
 dividend payout to be comparable to other regulated utilities, suggesting =
a payout greater than 50 percent of earnings per share. The company had alr=
eady projected that CenterPoint's earnings per share for 2002 will fall in =
the range of $1.17 to $1.22.=20

As I mentioned, however, economic conditions in the energy industry have ch=
anged considerably since Reliant announced its restructuring plans over a y=
ear ago, and the new industry climate may make the company's decisions to p=
roceed with its plans a risky move. Again, I will point to the examples of =
Constellation and Allegheny, which really seemed to be caught in the crossf=
ire of the restructuring trend and are still sorting through residual fallo=
ut. At the time of their original restructuring announcements, both Constel=
lation and Allegheny had grounds to be fairly confident of their plans, con=
sidering how high the valuations for independent generating companies were =
running at that time.=20

Yet, in a fast-changing market, those valuations have dropped considerably =
and the shares of both companies received some major hits related to this d=
ecline. Constellation shares were trading at about $50 in May 2001, but pre=
sently are priced at half that figure. Allegheny is down about 39 percent f=
rom its high of $55 a share to $33. While the drop in share price that thes=
e two companies have faced cannot be totally attributed to their restructur=
ing plans, the important point is that companies that planned to restructur=
e have done so to put more emphasis on their unregulated trading operations=
, a sector that has been undervalued. This point can be supported by lookin=
g at companies that have completed their restructuring processes (such as N=
RG Energy and Mirant), which are trading at 40 to 50 percent below their 52=
-week highs. Clearly, investor confidence in such companies has been eroded=
. By the same token, shares of Reliant Energy are trading at about $24, dow=
n from a 52-week high of $50, while shares of Reliant Resources are trading=
 at about $15, down from a high of $37.50. This could be related to investo=
rs' concerns about the company's plans to proceed with restructuring in the=
 current market climate.=20

Moreover, a year ago the concept of utility restructuring to separate regul=
ated operations from unregulated businesses seemed like a quick way for com=
panies to cash in on the opportunities created by deregulated energy market=
s. In fact, it was the expectation of companies involved in the restructuri=
ng to gain a 20-plus P/E ratio for the unregulated company once it had been=
 split off from the regulated business. However, the actual process of rest=
ructuring, which can take a year or more, is taking place under less-than-c=
onducive market conditions, including a drop in energy prices, reduced dema=
nd and warnings of an energy glut. The original purpose of the restructurin=
g plans (that is, to give shareholders increased value) is no longer a guar=
anteed result for companies that proceed with the separation plan, as Const=
ellation and Allegheny clearly found. Only time will tell if Reliant's comp=
leted restructuring plan will prove to be another success or another failur=
e in the energy industry, but it is a fairly safe bet that Reliant is one o=
f the last companies that will be riding the restructuring trend any time s=
oon.=20

Ironically, one company that routinely has been praised for its strategy th=
is year is Duke Energy (NYSE: DUK), which made a pointed decision to ignore=
 the restructuring trend and remain an integrated company. In addition to r=
ecently being named Energy Company of the Year at the 2001 Financial Times =
Global Energy Awards, Duke's financials remain quite strong. For the third =
quarter 2001, Duke reported a 46-percent increase in ongoing earnings per s=
hare, or $1.02 per share. Year-to-date earnings per share from ongoing oper=
ations as of Sept. 30 were $2.30 compared to $1.63 for the same period last=
 year. For year-end 2001, Duke remains committed to delivering earnings gro=
wth within a stated guidance of 10- to 15-percent compound annual growth in=
 earnings per share from a base of $2.10 in 2000. Looking ahead to 2002, Du=
ke expects to earn toward the high end of the 10- to 15-percent range. When=
 asked to establish reasons for the company's success, Duke Energy CEO Rich=
ard Priory mentioned the decision to remain an integrated company against a=
 trend of other companies splintering apart.=20


Other Reliant Resources News:
Shareholders of Orion Power Holdings (NYSE: ORN) overwhelmingly approved th=
e merger agreement between Orion and Reliant Resources, which was announced=
 last September. Under the agreement, Reliant is buying Orion for $26.80 pe=
r share in a cash transaction valued at approximately $2.9 billion. Reliant=
 Resources will also assume approximately $1.8 billion of Orion Power's net=
 debt. The companies anticipate that the transaction will be completed in e=
arly 2002, at which time Orion Power's business will be combined with Relia=
nt Resources' domestic wholesale group.=20

When previously discussing this acquisition (please see the 9/28/01 IssueAl=
ert available at www.scientech.com <http://secure.scientech.com/rci>), I es=
tablished five reasons why Reliant is buying Orion, which also support the =
assessment that it is a strategic purchase. These reasons are as follows: 1=
) Reliant Resources gains Orion's generating assets, which support its own =
expanding wholesale business; 2) Orion's assets are primarily located in th=
e Northeast, particularly in New York, which (unlike Reliant's core territo=
ry) offers a fully functional deregulated wholesale market; 3) Facing econo=
mic downturns and the possible softening of demand, Reliant Resources' acqu=
isition of Orion is expected to immediately keep earnings solid, while othe=
r competitors are lowering their own earnings expectations; 4) The purchase=
 illustrates the spate of consolidation efforts that are taking place in th=
e independent power producing market; and 5) The purchase supports Reliant =
Resources' intentions to focus exclusively on North America and divest its =
European assets.=20
  _____ =20


Testimonials:


"Thanks for your material. It is good and I enjoy reading it."


Patrick McCormick
Balch & Bingham, LLP


"Christmas greetings, Will, from one of your readers in Australia.

I must commend you on your articles. I find them not only useful in the det=
ail but also thoughtful in the presentation.

It has indeed been an exciting year. If anything, it proves that 'design' a=
nd 'market' do not belong together - but bureaucrats and academic economist=
s will never learn.

Best regards,

Margaret Beardow
Benchmark Economics

  _____ =20



An archive list of previous IssueAlert articles is available at
www.scientech.com <http://secure.scientech.com/issuealert/>=20


  _____ =20

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