PG&E’s Bankruptcy Creates Value by Consolidating Damage Claims in a Single Proceeding and Facilitating the Sale of Its Component Business

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Eric Selmon                              Hugh Wynne

Office: +1-646-843-7200         Office: +1-917-999-8556

Email: eselmon@ssrllc.com    Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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January 14, 2019

PG&E’s Bankruptcy Creates Value by Consolidating Damage Claims in a Single Proceeding and Facilitating the Sale of Its Component Business

PG&E Corp. (PCG) has announced that it will initiate voluntary reorganization proceedings under Chapter 11 of the U.S. Bankruptcy Code on or about January 29th. The bankruptcy, in our view, can preserve and increase shareholder value. Critically, bankruptcy will allow PG&E to consolidate all of the wildfire claims into a single, more efficient and consistent process; to effect the sale of the component parts of PG&E’s operations free and clear of liens and liabilities; and to prepare a comprehensive plan of reorganization that simultaneously addresses existing debts, the damage payments to plaintiffs and the capital needs of the utility. We continue to believe that the fundamental value of PG&E, even after adjusting for the wildfire claims and potential for future wildfires, exceeds the current share price by a large margin.

  • PG&E’s bankruptcy filing, in our view, can preserve and increase shareholder value, allowing PG&E (i) to consolidate all the damage claims arising from the 2017 and 2018 wildfires into a single proceeding to be adjudicated in front of the bankruptcy judge, and (ii) to prepare a comprehensive plan of reorganization that simultaneously addresses PG&E’s existing debts, the damage payments to the plaintiffs and the capital needs of the utility.
  • To the extent PG&E plans to sell assets or the component parts of its business, and apply the proceeds to pay third party damage claims, bankruptcy permits these assets or businesses to be sold free and clear of any liens or wildfire liabilities. Such sales would be virtually impossible outside of bankruptcy due the risk buyers would face from wildfire claims.
  • By making a voluntary filing for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code, PG&E will secure protection from its creditors while maintaining control of its assets as a “debtor in possession.” This will allow the company to apply its internally generated cash exclusively to fund the capital expenditures required to maintain and expand its transmission and distribution network.
  • Finally, bankruptcy likely enhances PG&E’s leverage with legislators and regulators to ensure that its power transmission and distribution system, the portion of its asset portfolio most vulnerable to wildfire risk, enjoys the regulatory and legislative protections required to ensure continued access to debt and equity capital, either as an independent company or as the subsidiary of acquiring utility.
  • In our view, the primary reason for the bankruptcy filing is the ability to consolidate all of the wildfire claims outstanding, whether in state or federal court, to be adjudicated in front of the bankruptcy judge.
    • This consolidation allows uniform standards to be applied to all of the claims, resulting in a more efficient process to determine threshold issues, such as the validity of claims, as well as issues that affect broad groups of claims, for example, whether PG&E is the cause of the fires and the degree of its negligence in causing them.
    • The bankruptcy court is also able to set a date by which all claims pertaining to pre-bankruptcy causes of action, i.e. the wildfires, must be made, defining with finality the universe of potential claims.
      • If there is concern that valid potential claims from the wildfires remain, the court can estimate the value of the remaining exposure and set up a fund of that value from which all remaining claims must be paid, thus eliminating the risk of post-bankruptcy claims against PG&E.
    • Moreover, in such a consolidated proceeding, most claims would be determined by the judge or an arbitrator appointed by the judge, avoiding the risk of excessive or improper damages being assessed by juries.
    • Finally, in assessing damages, the bankruptcy court would have before it all of the facts regarding the financial condition of PG&E, and thus would be able to make equitable decisions that consider the claims of other creditors on PG&E’s assets.
  • A second reason for the bankruptcy filing, in our view, is to facilitate the sale by PG&E of its component businesses and to apply the proceeds to pay third party damage claims. Such sales would be virtually impossible outside of bankruptcy due the risk buyers would face from wildfire claims. In bankruptcy, by contrast, such assets or businesses can be sold free and clear of any liens or wildfire liabilities.
  • We believe that PG&E’s gas and power generation businesses could be effected at attractive valuations and raise significant capital to fund the payment of plaintiffs’ damage claims, at a time when PG&E’s depressed stock price precludes it from raising equity capital to do so.
  • We estimate that the sale of PG&E’s gas and power generation businesses could raise ~$18 billion, net of associated debt, reflecting an estimated equity value of ~$15 billion for PG&E’s gas assets and ~$3 billion for PG&E’s non-nuclear generation assets.
    • We calculate PG&E’s total gas rate base to be ~$9.2 billion, comprising some $6.4 billion in gas distribution assets and $2.8 billion in gas transmission and storage assets. Assuming an equity ratio of 52%, this implies that PG&E’s tangible net worth in these assets is ~$4.8 billion. Applying a comparable company average ratio of market capitalization to tangible net worth of 3.1x,[1] we estimate that PG&E’s gas business could be worth some ~$14.8 billion pre-tax.
    • PG&E’s electric generation rate base totals ~$5.5 billion, comprising $1.7 billion of unrecovered investment in the Diablo Canyon nuclear power plant, which is scheduled to be retired by 2025, and some $3.8 billion in a fleet of primarily hydroelectric power stations.  We assume (i) that Diablo Canyon is excluded from the sale, and (ii) that upon the sale of PG&E’s other power plants these would continue to supply it with power under long term PPAs. Applying a 52% equity ratio, PG&E’s tangible net worth in its non-nuclear generation portfolio can be estimated at ~$2.0 billion.  If we apply the average price to tangible net worth ratio of small to mid-cap utilities in the northwest, 1.8x, the value of these assets can be estimated at $3.6 billion, although the value could be even higher depending on their cash flows.
  • Any capital gain on the sales of these assets will likely be offset by the enormous tax losses that PG&E will incur as a result of its 2017-2018 wildfire liabilities, so the after-tax proceeds from the sale will likely also be ~$18 billion.
  • Given these assumptions, the proceeds from the sale of PG&E’s gas business and power generation assets would be sufficient to offset over 60% of PG&E’s estimated maximum exposure of $29 billion in after-tax, after-insurance wildfire losses. If we assume that PG&E is able to settle the property damage claims against it at the same ratio at which San Diego Gas & Electric settled the property damage claims arising from the 2007 Guejito, Rice and Witch Creek fires (57%), thus reducing PG&E’s estimated 2017-2018 wildfire liabilities to $22 billion net of insurance and taxes, the ratio of sales proceeds to net wildfire losses is equivalent to over 80%.
  • A further advantage of PG&E’s bankruptcy filing is that, by making a voluntary filing under Chapter 11, PG&E will secure protection from its creditors while maintaining control of its assets as a “debtor in possession.” While in Chapter 11, payments on liabilities are suspended unless exceptions are made (such as for salaries and ordinary course of business payments), which can dramatically reduce cash expenditures during the proceedings. This will allow PG&E to conserve internally generated cash sufficient to continue to fund the capital investments required to maintain and expand PG&Es power and gas networks until the plan of reorganization can be put in place.
  • We estimate that, in bankruptcy with a stay on interest payments to creditors, PG&E could fund its planned 2019 capital expenditures of $6.4 billion with internally generated funds.
    • Over the last 12 months, PG&E generated cash from operations of some $5.5 billion; adding $0.9 billion in interest expense, PG&E should be capable during a stay on debt service to fund $6.4 billion in annual capex internally.
    • Any deferral of low priority projects would further improve PG&E’s financial position.
    • Finally, a voluntary Chapter 11 filing will allow PG&E access to debtor in possession financing. Based on highly confident letters the utility has received from banks, PG&E has stated that it expects to have approximately $5.5 billion of committed DIP financing at the time it files.
  • Unfortunately for shareholders, PG&E’s last and critical objective – to ensure that its power transmission and distribution network regains access to the debt and equity markets – will require a fundamental restructuring of the utility’s assets or regulatory framework. This will likely be the most difficult aspect of PG&E’s restructuring and, as we explain below (see “What Does Bankruptcy Not Achieve”) will require significant political and regulatory action.
    • As we have argued in our last two research reports on PG&E,[2] the 12% of PG&E’s power transmission and distribution assets that lie north of San Francisco Bay are responsible for all the company’s 2017-2018 wildfire losses.
    • We estimate PG&E’s maximum exposure for the damage caused by these fires at $29 billion, after-tax and net of insurance. By comparison PG&E’s total power transmission and distribution rate base totals only $17.5 billion, and its annual electric revenues $13 to $14 billion.
    • Even if PG&E’s 2017-2018 wildfire losses are recovered in full from ratepayers, the risk that such losses will continue in future render the system a deeply unattractive investment.
    • To ensure that PG&E can raise the capital required to maintain and expand the northern California power grid, which today serves some 16 million people, the state of California will be required to absorb future wildfire risk, either by taking over PG&E’s power grid in the fire prone regions north of San Francisco Bay or by making taxpayer dollars available to cover PG&E’s wildfire losses.

What Bankruptcy Does Not Achieve?

  • Although bankruptcy can achieve many goals for PG&E, there are a number of things bankruptcy will not do:
    • Policy Changes: Bankruptcy does not force the state to change policy nor can it change state law. The bankruptcy court would adjudicate claims based on state law, by applying the relevant state law and precedents. Thus inverse condemnation is not subject to review by the bankruptcy court, only the validity of the claims and value of any claims to be paid by PG&E. However, a bankruptcy proceeding could increase the sense of urgency among legislators, regulators and the governor, spurring change.
    • Determine how much is recoverable from ratepayers: Although the amount of wildfire claims that is recoverable from ratepayers is an important factor in the financial impact of the wildfire claims, the bankruptcy court has no jurisdiction to change retail rates or force the CPUC to allow recovery from ratepayers. The potential for such recovery would likely be addressed with conditions in the reorganization plan the allocate any such recovery between creditors and shareholders.
    • Reduce the value of PCG’s stock to $0: Most importantly, should PG&E, the utility, and, even, PG&E Corp, the holding company, file for Chapter 11, the stock of PCG has value as long as the value of the ongoing business exceeds the total eventual claims. Chapter 11 is a reorganization process, not a liquidation process.
      • As we have argued in our most recent notes, cited above, unless the state of California wants to operate the utility and bear all of the blame for future liabilities or face exceedingly high costs of capital, the state will have to address the future wildfire risks and limit shareholder exposure. We still see significant value, therefore, in PG&E.
  • In Exhibit 1 below, we replicate the valuation analysis set out in our research report of December 3, Are PCG & EIX Still Hot Stocks? We Assess the Risk of Repeated Catastrophic Wildfires & Its Implications for Valuation; Maintain PCG & EIX on Our List of Preferred Utilities (available at http://www.ssrllc.com/publication/are-pcg-maintain-pcg-eix-on-our-list-of-preferred-utilities/).
    • As explained there, this valuation analysis takes into account both (i) the scale of recovery that regulators permit PG&E with respect to the damage claims arising from the 2017-2018 wildfire (the vertical access of the two charts) and (ii) the scale of recovery allowed PG&E with respect to future wildfire losses (the horizontal axis) over the next decade, during which we assume PG&E will implement grid upgrades and operational changes to significantly mitigate ongoing wildfire risk.

Exhibit 1: Estimated Fair Value of PCG Stock in $ per Share (1)

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Source: SSR research and analysis, California Department of Insurance and company reports.

1. 20% recovery is approximately in line with a cap on equity issuance due to the 2017 fires of $3 billion. 65% recovery is similar to the amount of equity required if the CPUC capped total equity issuance for 2017 and 2018 at ~$9 billion.

©2019, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

  1. The average of CenterPoint, NiSource, Vectren and Southwest Gas. 
  2. Are PCG & EIX Still Hot Stocks? We Assess the Risk of Repeated Catastrophic Wildfires & Its Implications for Valuation; Maintain PCG & EIX on Our List of Preferred Utilities (available at http://www.ssrllc.com/publication/are-pcg-maintain-pcg-eix-on-our-list-of-preferred-utilities/) and Would Splitting PG&E Create Value for Shareholders?

    Why Municipalization Might Make Sense (available at http://www.ssrllc.com/publication/would-splitting-pge-create-value-for-shareholders-why-municipalization-might-make-sense/).

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