Shares of Tokyo Electric Power Co went into freefall on Tuesday, April 5, dropping to a record low as the company announced that it was dumping radioactive water from its damaged Fukushima nuclear power plant into the sea. While the equity value of the company dwindles, the outlook for creditors is much better. The severity of the disaster – and the company’s role as a public utility – actually make it likely that massive claims against Tepco will be absorbed by the public sector and that creditors will fare relatively well.
The pressure on the equity is intense, however. Shares fell 18 percent, the daily limit, to 362 yen. They have now lost 83 percent of their value since March 10, the day before the Fukushima reactors were damaged by the earthquake and tsunami. Its market cap has dropped from $42 billion to less than $9 billion. The company and the government of Prime Minister Naoto Kan have struggled ever since to bring the partial meltdown, one of the worst nuclear power breakdowns in history, under control.
From the company’s point of view, the crisis has been compounded by questionable disaster control. As power systems at the plant failed, pumps that were used to cool nuclear fuel were out of operation. Critics say managers led by President Masataka Shimizu waited too long to use seawater to cool the fuel, apparently because they were reluctant to permanently damage the site. Seawater has been in use since March 13, and the plant will be decommissioned once the situation is brought under control.
The risk to the environment and public health appears to be considerable. The water being dumped into the ocean has a level of radioactivity that is 100 times the regulatory limit, and fish have been found off the coast between Fukushima and Tokyo with twice the allowable level of radioactive iodine 131. That limit itself has been described as too lenient, because it is based on external exposure to radiation, not ingestion of radioactive materials.
As grave as the overall situation is, investors believe that the company, the fourth largest electric utility in the world, will survive the crisis in one form or another. The Japanese government has the resources to absorb Tepco expenses and claims against it. Considering that it actually was part of a government monopoly until 1951, some form of nationalization wouldn’t be such a huge change.
Bond traders don’t expect the company to default. Some investors view the company’s debt as a buy.
Credit default swaps on the company’s debt are trading at around 375 basis points. The CDSs – a form of insurance – suggest that investors believe there’s a 25 percent probability of default over the next five years, according to Ashish Shah, co-head of credit at AllianceBernstein.
“We believe it should be lower than that. The yield on the company’s 4.5 percent debt maturing in March 2014 was around 7.20 percent on Tuesday,” according to Shah.
Their bonds are eligible for Bank of Japan purchase under the (Japanese central bank’s) quantitative easing program, which is clearly supportive, Shah says. “Clearly, there is risk here, given the severity of the situation, but government support will mitigate that to a certain extent,” he said.
On Friday, March 31, Standard & Poor’s cut its rating on TEPCO’s long-term debt by three notches to BBB+ from A+. However, the company’s debt remains three notches above speculative status. If the company’s debt rating falls to speculative status, some institutional investors would be unable to hold TEPCO debt. That would put selling pressure on the bonds, but it wouldn’t necessarily create a liquidity problem for the company. That would raise its borrowing costs, but with the government as a potential source of funding, the implications aren’t that dire in TEPCO’s case.
Given the seriousness of the situation, the Japanese government is considering a “virtual nationalization” of TEPCO, in which it would take a majority stake in the utility, according to Toshihiro Uomoto, a chief credit strategist at Nomura. He views that outcome “effective and fitting” and recommended in a note that investors “go long” on the credit.
Such a bet isn’t for the weak of heart, though.
Uomoto says the government is likely to pay nearly all of the claims that individuals and local government make against TEPCO, which had about $65 billion in revenue in $1.4 billion in profits over the trailing 12 months. But the process of virtual nationalization could be messy. The credit rating agencies could lower the boom once again, resulting in mark-to-market losses for holders of the debt.
“Accordingly, we hesitate to recommend this name to investors without strong enough stamina,” Uomoto wrote.
What sort of a future could a company in the midst of such a serious crisis possibly have?
Moody’s, which also downgraded the company, says TEPCO faces an extended period of unprofitability characterized high leverage and high liability.
The company will face rising costs as it moves away from nuclear power toward coal and liquefied natural gas, S&P said. “BP faced a similar nightmare after the Gulf of Mexico oil spill debacle, but earns around $20 billion in a good year and had a portfolio of valuable businesses to sell to meet a bill of $30 billion. Not so Tepco, which made a profit last year of £1bn and has few assets to put on the auction block,” according to The Guardian newspaper.
That would be enough pressure to sink most companies. But Tepco is just too big to fail.
