The Shoeshine Column: EDISON'S TANGLED WEB

Friday 5th May 2000

Down at Edison Mission Energy the clock is ticking. The US energy giant has just nine days to decide what it's going to do about its forthcoming default on the terms of issue of the $400 million of redeemable preference shares it used to finance last year's Contact Energy buy.

If nothing happens by May 14 there will be another interesting test of how staunch New Zealand trustees are prepared to be in protecting investors' interests.

Observers will recall the Skellerup fiasco and the inglorious role played by the bondholders' trustee, Guardian Trust.

In the unwelcome limelight this time is Tower Group unit The Trustees Executors and Agency Company, whose subsidiary TEA Custodians is looking out for the interests of Edison Contact Finance preference shareholders.

The story so far. Edison Mission Energy (EME) paid $1.21 billion, or $5 a share, for its Contact holding in the middle of last year.

To do so it set up local offshoot Edison Mission Energy Taupo Ltd (Edison Taupo). This company shelled out $808 million of equity capital, raised $160 million of preference share capital from "an institutional investor" and borrowed $240 million from Credit Suisse First Boston's Melbourne branch.

CSFB understandably didn't want to hang onto such a big lump of debt so, in keeping with its modus operandi overseas, Edison put into place a hideously complex refinancing structure to repackage the debt to the retail market.

Two new companies, Edison Contact Finance (ECF) and Edison Contact Investments (ECI) were set up. Neither company is a subsidiary or affiliate of any Edison entity or of Contact. The shares in both are held by TEA Custodians as trustee of the respective discretionary trusts.

ECI then issued the preference shares to retail investors.

So who calls the shots here? According to the preference shares investment statement, ECF isn't managed or controlled by EME or any of its group member companies, although Edison Taupo "has the power to appoint and remove the trustees of the discretionary trust holding the ordinary shares in ECF." The same is true of ECI.

In other words, the trustees can do what they please but if Edison doesn't like it they can be fired.

TEA says this arrangement is "not uncommon." It was happy with it because investors could bail out if they didn't like what Edison Taupo was doing.

Details of the "transaction matrix" of the $400 million share issue take up six pages of the investment statement.

The mysterious institutional investor holding $160 million worth of preference shares seems to have concluded, like CSFB, its exposure was too big. So CSFB issued to the investor, on behalf of ECI, a $170 million letter of credit. It syndicated this obligation to three other institutions - Credit Agricole Indosuez Australia, the Development Bank of Singapore, and SG Australia - retaining only part of the exposure itself. These players are the "LC issuers."

This establishes the food chain in the event of a default - such as the default that will occur on May 14 if Edison doesn't pull its finger out.

In that case the LC issuers have to pay the institutional investor the issue price of the "institutional shares" and up to six months' accrued dividend. ECI indemnifies the LCs. Edison Taupo indemnifies ECI. And EME, presumably, indemnifies Edison Taupo.

For the investors holding the other $240 million of shares the position is slightly different.

Edison Taupo and ECI - the preference shareholders' "independent watchdog" - have a "facility agreement" detailing amounts to be paid to ECI by Edison Taupo if there is a breach of financial covenants.

The specific breach Contact's share price looks likely to trigger arises when Edison Taupo's debt-to-valuation ratio, to be assessed daily after May 14, is exceeded. The ratio must not be greater than 0.65 before and on May 14 and 0.6 thereafter.

Interestingly ECI can elect to assess earlier if EME's long-term debt rating falls below its current medium-grade BBB rating from Standard & Poor's. A downgrade would bring it to one notch above "speculative" grade.

For Edison Taupo to comply with this covenant Contact's share price will have to be at least $2.45 on the day. From then it will have to stay above $2.76, a 17% rise from Monday's $2.35 post-result close. Fat chance.

What happens then? Edison Taupo has to "remedy its breach" within an unspecified "cure period" or pay ECI on demand (our italics) "an amount" prescribed under the facility agreement. If it fails to do either, EME - read Edison - will pay ECI on demand the amounts required to ensure Edison Taupo satisfies the ratios.

In the event - somewhat unlikely, Shoeshine admits - that neither Edison Taupo nor EME remedy a breach, ECI may exercise its security over Edison Taupo's Contact shares.

The LC issuers also hold, in their own right, debentures over the Contact shares as security. So while these sophisticated investors have ensured they can enforce their rights themselves, retail shareholders have to rely on the ECI trustees - who can be sacked by Edison.

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