PG&E (NYSE:PCG) has announced plans to reinstate its common stock dividend starting as early as April 2005 at $1.20 per share annually. This payment would be the first after a four-year dividend suspension while its wholly owned utility, Pacific Gas & Electric went through bankruptcy. This would be part of a planned return to investors of up to $1.75 billion next year, including share buybacks.
At current prices, that puts the dividend at about 3.7% -- just a little below the 4.2% industry average. But my ears perked up when I heard about the bonds that were apparently going to be used to pay for this. Issue bonds and go into debt just to pay a dividend?
When I first started researching this article, I had jumped to that conclusion. For most businesses, issuing debt to pay dividends is obviously not the best of plans and indicates that the business is in trouble. But I had failed to take into account how a utility company makes money and I had not clearly understood the reason for and nature of these particular bonds.
The nature of the business
Everyone needs to buy electricity; you cannot avoid it. Because it's not a discretionary expenditure, governments oversee the process to make sure that the captive audience is not unfairly charged. Normally this means that the seller of electricity, the utility, presents its case to a regulatory board on how much it will cost to produce the electricity. The board reviews it and eventually an amount is agreed upon. This is called the "rate base" and it determines how much the customers pay for their electricity. To make it worthwhile for the utility to sell the electricity, there is also an agreed-upon return or profit level. In the case of Pacific Gas & Electric, that return is set to be a minimum of 11.22% of the rate base.
In the late 1990s, everything seemed to be going fine for Pacific Gas & Electric. Then the California energy crisis hit. The cost for electricity went up and up and the utility could not raise prices fast enough. The result was bankruptcy. It was not until early this year that Pacific Gas & Electric Company emerged from bankruptcy, but with a special condition. Nothing is easy for a utility company, is it?
The Regulatory Asset
That condition was an asset of $2.2 billion after taxes, called a Settlement Regulatory Asset. This was an asset put onto the balance sheet as part of the plan of reorganization to come out of bankruptcy and was authorized by the California Public Utility Commission.
The reorganization plan states, in part, that the public's interest is best served if Pacific Gas & Electric is restored to financial health and its financial condition is maintained. With the Regulatory Asset on the books, these goals can be met, as it allows the utility to obtain an investment grade rating from Moody's and Standard & Poor's. This would be a higher rating than that attainable without the Asset. The utility could then borrow money at a decent interest rate and pay off the last of its bankruptcy creditors. But there are two odd things about this odd Regulatory Asset. First, it would be amortized to nothing over nine years. Second, because of an agreement with various consumer groups and the California Public Utility Commission, it had to be refinanced as quickly as was feasible.
The bonds
So, last summer California authorized Energy Recovery Bonds, to be guaranteed with a component of the rates collected from customers. Pacific Gas & Electric will issue these bonds, most likely to institutional investors, to retire the Regulatory Asset. By doing this, the utility will raise about $3 billion. What will they do with that money? Among other things, the utility will pay its holding company, PG&E, a dividend. PG&E will then use that dividend along with its own operating cash flow to pay the promised dividends to the shareholders and buy back shares, as announced.
There's a bonus for the customers. By issuing the bonds, the utility will save its customers about $1 billion over the next eight years. Sounds odd, huh? Bear with me for just another moment. You see, as long as the Regulatory Asset exists, it is part of the rate base, that agreement which determines how much customers pay for their energy. When the Energy Recovery Bonds are issued, the obligation to refinance the Regulatory Asset is met and the Asset is removed from the books. Without the Asset, the rate base goes down, which means lower charges to the customers.
So if you are a customer of Pacific Gas & Electric, you win. If you own shares in PG&E, you win. And if you own shares in the institutional investors who will buy most of the Energy Recovery Bonds, you win. Kudos to those fortunate enough to be all three at once.
As Milo learned in The Phantom Tollbooth, and I did after performing some due diligence, don't jump to conclusions. It is an easy place to get to, but a difficult place to leave.
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Fool contributor Jim Mueller welcomes your feedback. He does not own shares in any company mentioned in this article. The Motley Fool wants you to know all about its disclosure policy .
