Disclosures Send Dynegy Shares Down

In a series of disclosures that had echoes of Enron Corp., Dynegy Inc. reduced earnings estimates Thursday and said the Securities and Exchange Commission is examining a gas supply transaction--triggering a 30% decline in its stock.

Dynegy said the gas transaction, known as Project Alpha, will result in a revision of Dynegy’s 2001 cash flow statement. The Houston energy company’s stock fell $8.09 to close at $19.21 on the New York Stock Exchange and brought a warning of a potential credit downgrade by Moody’s Investors Service, the Wall Street debt-rating firm.

Standard & Poor’s Corp. downgraded Dynegy’s debt one notch Wednesday.

Dynegy Chief Executive Chuck Watson said the company remains strong despite the setbacks, which include $313 million in first-quarter charges related to the company’s unprofitable telecommunications operation and to unexpected losses at the Northern Natural Gas pipeline, which Dynegy got from Enron as part of the failed merger between the two firms.

Dynegy said it will meet first-quarter earnings estimates of $173million, or 41 cents a share, for recurring net income before the charges are taken into account. For the year, Dynegy lowered its earnings guidance to $2 to $2.05 a share, down from previous guidance of $2.26 a share.

“Nobody is more disappointed than I am right now about some of these things,” Watson said Thursday in a conference call with analysts and investors.

The controversy over Project Alpha was ignited by a Wall Street Journal article April 3 that likened the transaction to some of the special-purpose entities that hastened Enron’s downfall. Watson said it was a legitimate deal that produced $80 million in tax savings last year, while supplying Dynegy with significant amounts of natural gas.

The story prompted a request for a meeting by the SEC’s accounting staff as well as a separate informal inquiry by the SEC’s Fort Worth office, he said.

During a meeting last week with SEC accounting and enforcement staff in Washington, Dynegy executives agreed to change the way the firm accounted for cash from the transaction in 2001, settling the SEC’s accounting questions, Watson said. He said the inquiry by the Fort Worth office continues.

The $300 million generated by the transaction in 2001 will be accounted for as a financing activity rather than an operating activity, Dynegy said. The restatement will not affect the balance sheet or the income statement for last year, the company said.

Investors probably overreacted to the news, said Chris Ellinghaus, an analyst with Williams Capital Group, who has a “buy” rating on Dynegy.

“This is not the first energy company to find itself the subject of an SEC inquiry and it won’t be the last,” Ellinghaus said. Most of the companies, including Williams Cos. and Calpine Corp., have seen their stock rebound.

Gordon Howald, an analyst with Credit Lyonnais Securities, downgraded Dynegy to “add” from “buy” because of uncertainties facing the company, particularly from the debt rating agencies, which are holding Dynegy barely above “junk” bond territory.

“An energy marketing and trading company needs an investment-grade credit rating to be successful,” Howald said. “It’s a slippery slope that they’re on right now.”