A Nasty Short-Circuit at AES


By Heesun Wee Way back in March -- a lifetime ago now -- Dennis Bakke, chief executive of AES Corp. (AES), was confident about his global energy company's future. In fact, the Arlington (Va.) power producer projected higher yearly earnings this year, next year, and all the way through 2005. "We're in 32 countries, but I wouldn't be surprised if we're in 50 [within] the next three years," he said.

Now, AES's aggressive growth strategy -- which hinged on developing new projects around the world -- looks like a pipe dream. Amid expectations for a deepening economic slowdown, a drop-off in new business deals seemed likely for the utility, which has been expanding rapidly for 19 years by buying power plants and setting up shop in countries like Kazakhstan.

In 2000, AES's revenues of $6.7 billion, more than double the previous year's $3.3 billion, reflected new businesses in Bolivia, Chile, Nigeria, Oman, and Venezuela. The company told analysts to expect a five-year compounded annual earnings-per-share growth in the range of 25% to 30%.

MAKING EXCUSES? All that optimism faded at the close of trading on Sept. 25. In a statement and a conference call with analysts, the company indicated that its 2001 earnings would fall short by a hefty 50 cents a share, dropping to a range of $1.25 to $1.45. The previous range was $1.75 to $1.90 per share. AES's stock swiftly tanked. Shares fell 49%, to $12.25, on Sept. 26. That's down 83% from the 52-week high of $72.81 on Oct. 3, 2000.

Shares of other brand-name power producers, such as Calpine Corp. (CPN), also fell on Sept. 26. But analysts contend AES's collapse is more a reflection of its own miscues, not a broader problem in the power industry. "We don't believe anybody should be selling any other [power producer] stock based on what AES said," noted Kit Konolige, an electric-utilities analyst at Morgan Stanley, during a recent conference call with investors.

AES executives cited several reasons for the reduction. The slowdown in business in the wake of the terrorist attacks was the biggest factor, accounting for 20 cents to 25 cents of the 50-cent-per-share earnings shortfall. Lower power prices in Britain accounted for 16 cents to 18 cents of the drop, with poor currency exchange rates between the Brazilian real and U.S. dollar accounting for 10 cents to 15 cents. Also painful for the company was the cancellation of plans to acquire a Mohave power plant in Nevada.

Some analysts wonder whether the tragic events of September present a timely excuse for the earnings shortfall. They figure the company's missteps in the British power market actually may have done more damage than AES executives have acknowledged. The company paid $3 billion in 1999 for a 4,000-megawatt, coal-fired power station -- far too much, some analysts say -- and AES hasn't been getting the return it anticipated on the investment. "That was a miscalculation on their part," says Hugh Holman, an analyst at CIBC World Markets. AES appears to have expected British power prices to rise, while analysts expect them to remain stable at best.

HANGING ON. No doubt the global economic slowdown will take a toll on AES. But despite this year's problems, the growth story at AES isn't over, analysts say. While many U.S. power producers have sold off foreign assets and scaled back international exposure, AES has stuck to its strategy.

"There are a lot of examples of companies that have got it wrong, that fundamentally haven't done well in the international market. AES has done fine. There are a couple of projects that we would have hoped would have been more successful," acknowledges Holman. "But internationally and domestically, you have to say that AES has the most experience, and probably the best track record in terms of making successes of projects of any of the U.S. companies that have taken on the global market."

While AES clearly has fewer business opportunities for now, observers don't believe it's a long-term problem. "To say that the global economy will preclude them from doing any additional business deals this year, counting for some accretion, that sounds partially like a scapegoat and partially a rationale," says Chris Ellinghaus, a power and natural-gas analyst at Williams Capital Group. Analysts laud the company as far more effective than most of its rivals at navigating tricky global markets, allowing AES to capitalize on deregulated power markets around the world.

THE WRONG TACK? The risk is that the formula that worked so well in boom times may not be as effective during a slump. AES has a highly decentralized management structure. Only a few dozen people work at headquarters, while managers at its diverse locales around the world have a great deal of latitude to make decisions. That made the company very quick to adapt and jump on opportunities in local markets. But cost-cutting is generally something best implemented in a centralized management structure.

So far in this slump, top execs appear to have been slow to respond -- or slow to share information with investors about the impact on the company and what management is doing in response, Holman contends. "This is a top management failure," he charges. Ken Woodcock, AES's head of investor relations, didn't return repeated calls seeking comment.

Holman and other investors say the company must do a much better job of collecting information from its far-flung business units and creating reliable earnings estimates. "AES management has lost a significant amount of credibility in the market," says Ronald Barone, power analyst at UBS Warburg. "This will weigh heavily on the company's shares in the future."

AES's strategy may still be a good one over the long-term, but in this brutal earnings environment, it may need to spend some time rebuilding confidence among analysts and investors before the stock can rebound. Wee covers the financial markets for BusinessWeek Online in New York


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