June 30, 2019 4:53PM

This Fragile and Bankrupt Power Company has Much More Downside Risk (I’m Talking About PG&E)

by: Adem Tumerkan
ArticlesThis Fragile and Bankrupt Power Company has Much More Downside Risk (I’m Talking About PG&E)

Recently I’ve come across a positively asymmetric (low risk – high reward) opportunity via buying puts on a utility firm that’s recently entered bankruptcy.

I’m talking about PG&E Corporation (NYSE: $PCG) – which is the holding company that owns the California utility firm Pacific Gas & Electricity (PG&E).

But first – here’s some context. . .

Pacific Gas & Electric was created in the mid-1800’s and is still the largest power provider in California. (And one of the largest in the entire country).

They provide energy to over five million customers – and have many sources of generating power (such as wind, water, solar, nuclear, conventional).

Putting it simply – the firm’s a massive power provider in one of the largest and wealthiest states in the U.S.

But – fast forward to today – and PG&E’s now bankrupt (just filed Chapter 11 in January 2019).

(Keep in mind that this is the second time they’ve entered bankruptcy – last time was in 2001 and later resumed operations in 2004).

So – what led to this?

For starters: years of mis-using shareholder capital. Significant debt accumulation. And deferred maintenance of equipment put PG&E in a very fragile position.

And – like most fragile things – they break once a ‘tipping-point’ is reached.

Well – that ‘tipping-point’ came in 2018. . .

The ‘Camp Fire’  (which was the deadliest and most destructive forest fire in California history) was the event that broke PG&E.

To put things in perspective – this forest fire killed 85 people and destroyed nearly 19,000 homes, businesses, and commercial buildings.

And making matters worse – last month (May) – the California Department of Forestry and Fire Protection (aka Cal Fire) publicly announced that “after a very meticulous and thorough investigation” – it has determined that the ‘Camp Fire’ event was triggered by the “electrical transmission lines owned and operated by PG&E. . .”

(PG&E also stated back in February that their equipment was most likely the cause of the ‘Camp Fire’).

This put PG&E directly liable for significant damages caused by their own “negligence” (estimated at $30-plus billion in wildfire liabilities – which dwarves the firms $1.5 billion in fire insurance coverage).

Therefore – ballooning liabilities from last years ‘Camp Fire’ incident – and further potential criminal and civil liabilities – pushed the already very leveraged and fragile company into Chapter 11 bankruptcy.

(There’s already been new fires this month in California which have been linked to PG&E’s falling power lines. This indicates that their liabilities will soar even higher).

So – what now?

Well – currently – PG&E stock trades for $24.00 per share (a roughly $12 billion market cap).

That’s because shareholders still believe that after paying liabilities and creditors – they will still receive something.

For instance – back during the 2001 bankruptcy – shareholders came out looking very well. (For those that held from the 2001 bankruptcy until September 2017 made over 700%).

PG&E was able to re-pay the $10 billion they owed to creditors via a combination of existing cash and new debt.

But what really saved the firm was the de’facto bailout from the State of California. . .

In short – the state bought PG&E’s spare electrical power (what they didn’t sell to citizens) at artificially high market prices for about five-years.

So – will this scenario happen this time around?

I’m doubtful.

Actually – I believe PG&E shares have much more downside compared to any upside potential (aka negatively asymmetric i.e. huge downside – limited upside).

For starters – PG&E’s assets – in my opinion – aren’t nearly worth as much as the market’s expecting.

True – power companies have the ability to hike utility prices (cost of electricity). And most are forced to pay for it (unless the government steps in).

But still – PG&E has destroyed significant shareholder value and has burned through lots of cash over the last 15 years (since coming out of their previous bankruptcy).

For instance – just over the last decade – the firm’s generated nearly $9 billion in negative free-cash flow. . .

This means that the firm hasn’t grown organically. And has instead depended on both debt ($10.5 billion worth over last 10-years) and selling stock ($6 billion worth over last 10-years). . .

Thus – if PG&E hasn’t been able to generate any cash flow over the last 10 years (and instead binged on debt) – I don’t believe things will change in the future. 

(Keep in mind that the firm has mounting liabilities compared to cash. According to the recent PG&E filing (Mar/2019) – the firm has only $3 billion in cash. But has $5 billion due in short-term liabilities. $14 billion in wildfire claims. And $69 billion in total liabilities – this isn’t even counting the additional wildfire claims they owe in excess of $30 billion).

Another hit to shareholders is the fact that there are creditors sitting on $8 billion worth of unsecured bonds (aka debt that’s not backed by any collateral) that want to take a chance at reorganizing the company.

This means that – if the plan’s accepted – it would raise $30 billion of cash. And $18 billion of that would come from selling new shares. (They also want to rename the company ‘Golden State Power Light & Gas Co.’).

This would significantly dilute current shareholders (meaning their piece of the ‘corporate pie’ would be much smaller).

 

So – in summary – the key takeaway here is that it will take many billions to get PG&E whole again.

Liabilities such as: mounting wildfire claims – repaying creditors – employee pensions – and re-investing in ‘outdated’ infrastructure must be paid.

(Note that all these must be paid first before shareholders can receive anything – i.e. what’s left over).

Don’t forget that it’s already been six months since PG&E filed Chapter 11. And they still haven’t submitted a plan to reorganize.

Now – with the 2019 fire season underway in California – there could be even more wildfire damage. (Which is already happening).

This means even more claims PG&E must pay . . .

So here’s the big question: will PG&E shareholders get anything after they restructure?

Who knows.

But I believe it will be considerably less than the current share price of $24 per share.

Or said another way – I believe PG&E shareholders own more liabilities than assets. 

And because of this – I’m buying long dated, way out of the money, put options on $PCG. Since I expect shareholders will be wiped out over the coming year(s).

As always – do your own diligence.

I’ll write more later on this.

AS A DISCLOSURE: Because of the asymmetry (low risk – huge upside) of buying long dated out of money options. I personally purchased the $PCG Jan17’20 $3 Puts @ 0.08 for my own portfolio.

NOTE: These puts are very out of the money (aka strike price far from spot price) – and are my way of betting on a negative tail-risk event wiping out $PCG shareholders. (The worst case scenario being I lose the time value I pay for the options – nothing more).

Did You Like What You Read?
Enter your email below and you'll receive my top contrarian insights right when I find them. (PS - I 'll never send you any hype or useless material). And make sure to check out Speculators Anonymous: Premium if you want to receive my top macro-plays and asymmetric (low risk – high reward) opportunities right when I find them plus more. . .
We respect your privacy
Join The Speculators Anonymous Free Email List

Speculators Anonymous isn't for the faint of heart. It's for the contrarians, the skeptics, and the rebel speculators.

Every other Friday you will receive:

- Macro-Thoughts
- Contrarian Market Ideas
- And Book Recommendations

I look forward to having you.

“The stock speculator, as a rule, is beaten by himself” - Edwin Lefevre
We use cookies in order to give you the best possible experience on our website. By continuing to use this site, you agree to our use of cookies.
Accept