(Bloomberg Opinion) -- PG&E Corp.’s bleak first quarter drew to a close on a bleak note. California Governor Gavin Newsom isn’t a fan of the bankrupt utility’s new board picks and went to the trouble of sending it a letter saying so. Hedge funds proposing alternatives promptly piled on. Getting out of chapter 11 vaguely intact looks like a distant dream.
Or does it? My colleagues Mark Chediak and Scott Deveau at Bloomberg News recently delivered the scoop that Pacific Investment Management Co., Elliott Management Corp. and Davidson Kempner Capital Management have outlined a plan for PG&E to re-emerge by this time next year, at least a year faster than expected.
They lead with a proposed solution to one of the biggest problems hanging over not just PG&E but the entire state: how to deal with future wildfire liabilities. Climate change amps up the scale and frequency of California’s wildfires; and the current situation – with utilities effectively acting as insurers of last resort if the grid is involved – is unsustainable (exhibit A: PG&E’s bankruptcy).
But changing the law around this situation – known as “inverse condemnation” – isn’t exactly a popular platform in Sacramento. So the creditor group instead proposes seeding a wildfire fund with $13 billion to pay out for future damages across the state (provided any wildfire’s origin doesn’t involve negligence). PG&E would kick in $4.5 billion of that, with the rest coming from California’s other utilities, securitization bonds and the state’s own coffers. For previous wildfires – the reason for the bankruptcy in the first place – a trust of $14 billion to pay claims is proposed, with PG&E providing $13 billion and the state chipping in a billion.
PG&E’s funding for all this would come via about $2 billion of insurance proceeds and $18.5 billion of new capital from the creditors. This would fund $12.5 billion of contributions to the wildfire pools, leaving $8 billion to pay off the company’s debtor-in-possession loan and refinance upcoming debt maturities.
Neat. Neat and ... ambitious.
The $14 billion figure for claims to existing victims is bound to meet resistance. PG&E’s earlier estimate of $30 billion or more looks too high in light of the California Department of Forestry and Fire Protection (CalFire) finding the company wasn’t to blame for 2017’s deadly Tubbs Fire. Moreover, other claims may end up being settled at deep discounts if reports of so-called subrogation transactions – where insurers sell the right to sue for reimbursement to a third party – prove meaningful. Even so, $14 billion is much lower than current estimates of where payouts will shake out; analysts at CreditSights put the consensus at about $23 billion. And one lawyer representing several thousand claimants has voiced her concerns already.
Similarly, the fund to cover future wildfires could face opposition from the insurance lobby. Along with seeing utilities get out from under the burden of wildfire risk, insurers would effectively have to sign on for deep subrogation discounts on future fires. And that’s before getting into the issue of creating the statewide fund and signing up other utilities for their contributions.
The creditor group aims to overcome its opponents with a basket of carrots and sticks. Don’t like the $14 billion compensation trust and the prospect of victims getting much less than expected? At least it’s all cash upfront, rather than a mix of cash and securities paid out after years of litigation. Not wild about the wildfire insurance pool? At least it offers a way of dealing with inverse condemnation that doesn’t require really dealing with inverse condemnation, recognizes this is a statewide issue and doesn’t demand any upfront payment from insurers. What’s more, PG&E ratepayers would only have to contend with a $5 billion securitization bond under this plan, equating to only a 4 percent increase in residential bills.(1)
In the background, a clock ticks relentlessly. Teasing a quick resolution is the creditors’ strongest card. This appeals both to PG&E and California’s politicians, not least the new governor, seeking to get this resolved as fast as possible. But it also speaks to a real threat: the upcoming wildfire season.
Recent heavy rains in the state might seem like a blessing, but the growth they spur can result in a new stack of kindling when dry weather follows. And if a large wildfire strikes while PG&E is still in chapter 11, post-petition claims from new victims would come in on top of existing claimants, including victims of previous fires. That would make the current process seem straightforward by comparison.
If enough stakeholders were persuaded, then, by my math, the creditor group’s roughly $9 billion equity check could leave it effectively in control of a newly recapitalized PG&E, with a roughly 50 percent stake. This depends on a host of assumptions, including valuing the company at a discounted level of 1.3 times its regulatory asset base of about $40 billion (peers trade at more like 1.5 times).(3)
For existing shareholders, that would smother any upside from today’s level. But, lest we forget, they own shares of a bankrupt company. Plus, the restructuring could mean potential gains further out, as PG&E, insulated somewhat from the risk of future fires and hopefully under effective management, was re-rated. The balance of risks look skewed downward, though. In gaining favor for their proposal, the creditors’ most useful lever would be to increase the size of the claims pool for existing victims at the expense of existing shareholders (how it’s supposed to work). Every extra $1 billion put in by PG&E drops the residual equity value by almost $2 a share, by my (crude) math.
And, of course, the proposal may not get anywhere, in which case shareholders remain tied to a long, complex, and fractious restructuring process. If nothing else, the latest proposal illustrates that perfectly.
(1) Assuming a 15-year amortizing bond at 4.5 percent.
(2) Other assumptions include $15.5 billion of wildfire-pool contributions (adjusted for insurance proceeds),almost $26 billion of new and existing debt, $3 billion of DIP financing and $2 billion of fees to CalFire and restructuring advisers.
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Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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