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Dynegy Inc. and Enron Corp. executives spent Monday trying to justify their $24 billion combination, with some success. Shares in Dynegy rose 14.3 percent Monday to close at $44.31. Enron shares jumped 7.7 percent to close at $9.24 — 11 percent shy of the deal’s valuation of $10.41. Analysts generally praised the deal, saying it gave Dynegy a huge leg up on its growth strategy, especially in online energy trading. “We think Dynegy has all the necessary skill sets and as importantly the financial stability, resources and investor confidence and experience to get the job done,” Merrill Lynch & Co. analyst Donato Eassey wrote in a report Monday. But even its proponents recognize the deal faces some big hurdles, both on the regulatory side and the financial side. First and foremost, Enron will have to work through its problems with the U.S. Securities and Exchange Commission, which launched a formal investigation in October into the firm’s relationship with several partnerships that may have been used to hide liabilities and losses and possibly represented conflicts of interest. The investigation has led to more than a dozen lawsuits seeking class action status. Dynegy officials said they accounted for some risk in the merger agreement. But they also confirmed they built an escape hatch into the agreement that if litigation costs amount to $3.5 billion or more, Dynegy can walk away. That was on top of a general material adverse effect clause built into most agreements. “We put some risk into the economics,” Dynegy president and COO Steve Bergstrom said in a conference call with analysts and investors. “Even if there was a significant settlement, it would be difficult to get to $3.5 billion.” Dynegy also tried to downplay the possibility that regulators might quash the combination, putting a six- to nine-month completion date on the deal. “We have several approvals we have to go through, but we don’t see a lot of risk for those,” Bergstrom said. “It’s just a matter of time, and [the Federal Energy Regulatory Commission] will take the most time.” One antitrust lawyer familiar with both companies said the electricity generation side of the business is unlikely to raise major antitrust problems because deregulation is increasing the amount of competition in the market. But the natural gas side could raise alarms at the Federal Trade Commission. The agency has been increasingly tough in its review of natural gas deals, requiring significant divestitures and taking a year or longer to complete its reviews. “The parties had better be ready to make divestitures,” the lawyer said. At issue will be whether the FTC or the Justice Department considers the energy commodity business to have high barriers to entry. If regulators find barriers to entry, the companies will have to divest more assets to win approval. “The key is how much new entry could you get and how quickly,” another lawyer said. There are also financial hurdles. Analysts expressed concerns about lingering problems with Enron and its off-balance-sheet partnerships — what one analyst called “hanging chads.” “Could there be more possibly? Yes,” Enron CFO Jeff McMahon said. “Do we expect more? No. We think we have identified all of [the] transactions as was disclosed [in SEC filings]. But the investigation remains ongoing.” While Dynegy shareholder ChevronTexaco Corp. is kicking $2.5 billion into the deal, $1.5 billion now and $1 billion at closing, analysts are concerned about Dynegy assuming $13 billion in Enron debt, not to mention whatever liabilities might lurking in those partnerships. The $13 billion alone would bump up Dynegy’s debt-to-capital ratio to 45 percent, which would not only increase its debt payments but perhaps put its own credit rating at risk. Indeed, on Monday, Moody’s Investors Service placed Dynegy’s ratings under review for possible downgrade in response to Friday’s acquisition announcement. “Notwithstanding the franchise benefits of the proposed merger, the financial and business risks associated with the transaction could negatively impact Dynegy’s credit fundamentals,” Moody’s said. Dynegy CFO Rob Doty said the company is still comfortable with the capital structure. “We’ve got a lot of work to do with the agencies over the next several months between now and closing,” he said. “But the initial response was very positive.” Enron Chairman Ken Lay mentioned Enron’s asset divestiture program, which could bring in several billion dollars before the deal closes. The proceeds could be used to further bolster the firm’s liquidity and lower its debt load. “We already have $4 billion under contract, including $3 billion for Portland General,” he said. “We have significant others close, in the not too distant future.” Lay claims that Enron had other alternatives, mostly financial, which he didn’t name, but that the Dynegy deal made the most sense. “We became convinced over the last week or so, financially and strategically, that it had to be Dynegy,” he said. “It was necessary to stabilize the ship and strengthen the balance sheet. We thought the stock-for-stock transaction that Dynegy proposed gave our shareholders a better alternative than the financial alternatives.” Dynegy officials said Enron made the initial approach. “We would have probably not gotten into this if we hadn’t been approached by three key executives in Enron,” Dynegy chairman and CEO Chuck Watson said. “That’s hugely important, when you think of integration of assets and executives. It’s important that we got the sense we’d get full cooperation of the management team. That made a lot of difference and accelerated the whole process.” Dynegy officials quickly tried to dispel rumors that it did the transaction because Enron owed it substantial amounts of money. “It’s simply not true. Dynegy currently owes Enron an immaterial amount, less than $50 million,” Doty said. “We’re doing this transaction because of the significant value it brings to our shareholders.” Post-merger, the biggest hurdle will be merging the two merchant businesses, which have separate staffs, customer sets, books and systems. But Dynegy’s Bergstrom said that’s where the bulk of the $400 million to $500 million in cost savings will come from, merging back office systems and procedures. “I don’t want to minimalize the difficulty of doing this,” Bergstrom said. “But it’s workable and the organizations are excited about doing it.” Jaret Seiberg in Washington, D.C., contributed to this report. Copyright (c)2001 TDD, LLC. All rights reserved.

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