Fitch Upgrades Eletropaulo to `B-' and `BB/bra' After Restructuring.

CHICAGO -- Fitch Ratings has upgraded the international local and foreign currency ratings of Eletropaulo Metropolitana Eletricidade de Sao Paulo S.A. (Eletropaulo) to 'B-' from 'DDD'. The long-term national scale corporate rating and the rating of the seventh issue of debentures were also upgraded to 'BB(bra)' from 'DDD(bra)' and 'BB(bra)' from 'CCC(bra)', respectively.

These rating actions reflect Eletropaulo's completion of its debt restructuring that included approximately BRL2.3 billion (USD$790 million) of syndicated loans, bi-lateral bank loans, and working capital facilities. Eletropaulo has also just completed a final exchange offer for defaulted commercial paper, leaving an immaterial amount of unpaid commercial paper outstanding with unknown holders. Eletropaulo had previously restructured its local debentures and other commercial paper debt. The rating also reflects Eletropaulo's improving credit-protection measures, which should strengthen over the next year supported by projected growth in operating income and cash flow and reflecting a much-improved capital structure and increased financial flexibility. The new debt structure includes an amortization schedule that reduces refinancing risk until 2007 and improves the average life from less than one year to approximately three years. The rating also reflects that Eletropaulo operates in an environment with a material amount of regulatory risk.

As part of the debt reprofiling process, Eletropaulo consolidated all related debt into one agreement that unified rates, terms, and covenants. Importantly, 47% of the USD debt that was restructured was converted to BRL, resulting in a total debt composition that better protects Eletropaulo from exchange rate fluctuations. Under the terms of the agreement, the debt is also now partially guaranteed by a pledge on consumers' receivables up to BRL200 million.

Separately, but also positive for Eletropaulo, in December 2003, The AES Corp. (AES; senior unsecured debt rated 'B' by Fitch) completed its agreement with Banco Nacional de Desenvolvimento Economico e Social (BNDES) for the restructuring of USD$1.2 billion of debt owed to BNDES by Eletropaulo's holding company. The agreement created a new holding company, Brasiliana Energia, jointly owned by AES (50.01%) and BNDES (49.99%), which now holds AES' previous stakes in Eletropaulo (73% of total capital), Uruguaiana (100%), and AES Tiete (53%). AES equity interests, combined with USD$90 million from AES and its Brazilian subsidiaries has reduced the debt owed to BNDES to USD$510 million to be amortized over eleven years. The agreement was approved by the industry regulator, Aneel, on Jan. 19, 2004. With this agreement, Eletropaulo became eligible to receive additional funds relating to compensation of variation amounts (CVA) advance payment (BRL525 million, already received) and the third tranche of the rationing loan (BRL243 million, expected within the coming weeks). These funds have and will be used to prepay the restructured bank facilities.

Eletropaulo operates in an environment with a material amount of regulatory risk. Based on the concession contract, annual distribution tariff readjustments are designed to maintain the value of tariffs in real terms (adjusted for inflation), plus or minus an efficiency factor (X-factor), which is reset every four years. The annual adjustment reflects non-manageable costs (Parcel A) and manageable costs (Parcel B). The last tariff revision was in July 2003 when Eletropaulo received an 11.35% tariff increase. Variations in Parcel A costs are tracked during the year and then included in the July tariff adjustment. The lag effect of annual readjustments could result in short-term margin erosion and remains a risk on an annual basis. Positively, power purchase agreements with generators other than Itaipu (USD denominated) are also adjusted each July, mitigating the lag effect with respect to those purchases.

Eletropaulo is supported by its large, stable customer base but continues to be pressured due to lower demand following the electricity rationing of 2001 and the beginning of 2002, as consumption growth has been slow to materialize. Eletropaulo expects stable demand levels through 2005 with modest growth beginning in 2006. Future improvement in operating cash flow should also benefit from improving operating efficiencies and a more favorable economic environment.

Eletropaulo has reported credit protection measures that are strong for the rating category. Through the first quarter of 2004, Eletropaulo reported net revenues and un-adjusted EBITDA of BRL1.6 billion and BRL253 million. Adjusted EBITDA includes the positive adjustment for regulatory asset amortization (RTE) of BRL93 million and interest on Fundacao CESP debt of BRL19 million, which is also added to interest expense, and a negative adjustment of BRL82 million of CVA (cash costs paid but not reported) resulting in an adjusted EBITDA figure of BRL289 million. Adjusted EBITDA covered interest expense of BRL112 million by 2.6 times (x). Coverage ratios are expected to improve in the near term as Eletropaulo realizes its annual tariff adjustment in July, which is expected to include 50% of the deferred CVA adjustment from 2003, and longer term as debt amortizes and consumption growth begins to materialize.

Eletropaulo expects to repay approximately BRL1.8 billion of debt during 2004, including prepayment to the banks totaling BRL210 million, related to proceeds from the CVA funds, a significant portion of the third tranche of rationing loan and possibly additional amounts related to a BNDES electric sector capitalization loan. The amortization schedule thereafter is BRL1.3 billion, BRL1.5 billion, and BRL1.0 billion for 2005, 2006, and 2007, respectively. The largest components of annual debt maturities are the restructured bank debt, the CVA loan, existing BNDES financing, and Fundacao CESP obligations. Projected operating cash flow is expected to be sufficient to meet scheduled quarterly interest and principal payments as well as projected capital expenditures over the next few years. The current debt amortization schedule should result in a material deleveraging of Eletropaulo over the next few years. Fitch expects that Eletropaulo will likely issue additional debt depending on market conditions to maintain a balanced capital structure consistent with a debt-to-EBITDA ratio of 2.5x-3.0x.

Eletropaulo is the largest electricity distributor in Latin America in terms of revenues, with a sales volume of 32,774 GWh in 2003 and 7,899 GWh through March 2004, representing a 1% increase and 3.8% decline, respectively, over the comparable periods of the previous year. Eletropaulo essentially operates as a natural monopoly for the distribution of electricity in its concession area. Eletropaulo has a 30-year exclusive concession (beginning in 1998) to distribute electricity to a service territory that includes 5.1 million customers in 24 municipalities in the greater Sao Paulo metropolitan area.