Recent downgrades and investigations into trading activities of El Paso Corp. (Ba2/BB) have created a quandary for holders of the roughly $800 million in bonds issued by El Paso Limited Energy Partners (EPN). Financially troubled El Paso Corp. is a general partner with a 42% stake in EPN (B1/BB+). When El Paso was an investment-grade credit, it was seen as a possible boon to EPN bondholders, but since it has fallen to junk some fear an El Paso bankruptcy could drag EPN down with it. Standard & Poor's recently issued a report saying the two entities are "tethered," and put the partnership on creditwatch for a potential downgrade, and the EPN bonds traded down as a result. However, at least two sell-side analysts and one buy-sider say the entities are entirely separate and the EPN bonds are cheap. If the latter group is correct, they stand to make substantial gains, as spreads have widened some 200 basis points or more on several issues.
One EPN issue, the 10.375% notes of '09 yielded 8.66% on June 17. A similar issue which has now become the benchmark, the 10.625% notes of '12, traded to yield 10.62% last Thursday. Because leverage has been reduced significantly during this period,Christy Parsons, analyst at CIBC World Markets, concludes that the widening is due to investor concerns over El Paso Corp., which she believes are unfounded, adding, "It seems to me to offer good relative value." Parsons does not have an official recommendation on EPN, but another sell-side analyst, who takes a similar view, argues that when investors become convinced that EPN is completely separate from El Paso, the 10.625% notes of '12 will rally from 102 to 110 at the very least. (El Paso trades significantly lower. Its 7.625% notes of '11 were bid at 62 last Wednesday.)
Some have concerns, however. Gary Stromberg, analyst at Bear Stearns, points to the recent Standard & Poor's release putting EPN on creditwatch with negative implications. In particular, he notes that S&P gave as a reason "El Paso Corp.'s credit quality pressures." "They're saying the ratings are tethered. That to me means you're taking El Paso Corp. rating risk," he says. He also argues that that EPN's options for reducing debt may be limited, as an attempt to issue equity in the fall was unsuccessful. He sees five- to 10 points of potential downside in EPN's bonds.
Tom Parker, portfolio manager at Barclays Global Investors, also sees the EPN bonds as being higher priced than they should be, given the risk of litigation or continued negative headlines for El Paso. He says he has not yet determined what to do with the EPN bonds held by Barclays.
The shadow of Enron may also be hurting the EPN bonds. One sell-side analyst points out that Enron Corp. had a similar partnership with an entity called EOTT Energy Partners. EOTT filed for bankruptcy protection earlier this year following Enron. "If it follows the only other situation like this, it'd be a goner," the analyst says.