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Viability of Debt-Laden Utility Buyouts Scrutinized After Adverse State Rulings

March 21, 2005
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Could the recent decision by the Oregon Public Utilities Commission (PUC) to reject a $2.35 billion proposal under which a group of private investors headed by Texas Pacific Group (TPG) planned to buy Portland General Electric (PGE) put the kibosh on similar debt-laden offers for utilities by private investors in the future?

That's a question no doubt on the minds of a lot of power industry players these days, especially when coupled with the fact that the Arizona Corporation Commission (ACC) last year turned aside a similar bid by a private investors group headed by three major Wall Street buyout firms to purchase UniSource Energy Corp. (see NGI, Dec. 27, 2004).

"It's definitely the deathknell," said Mark Williams of Boston University's School of Management. Williams, an energy expert, teaches at both the graduate and undergraduate levels at Boston University. "I was convinced that the UniSource deal was going to be pooh-pooed and with that being done," he foresaw a similar outcome for the PGE-TPG deal at the Oregon PUC.

"Leveraged buyouts create uncertainty. Debt increases uncertainty. The only certainty with debt is that you have to make greater payments. If you have revenue fluctuations, then you have less cushion to make those debt obligations and ultimately the stability and financial health of a utility impacts its ability to deliver dependable, affordable electricity in a safe way."

"There's a couple of broad trends here," Williams told NGI. "One of them, clearly, is this is a big win for consumers," he said.

"Put yourself in the shoes of your typical state regulatory body. We've gone and had sort of this experiment of deregulation, and it's clearly failed to a greater or lesser extent, starting in California, working its way across the country." State utility regulators are now saying "Hey, wait a second, you have to demonstrate the benefits not only to the communities which they serve, but also to the customers."

Williams said that state regulators are focused on three measurements in the context of electricity service -- namely, that such service is safe, dependable and affordable.

He said that overall a leveraged buyout isn't necessarily a bad strategy. "But when it comes to the utility sector, when you're increasing debt, then what you're doing is to pay that debt off -- if you have a predictable revenue stream and not a revenue stream that increases dramatically -- then what you do is you've got to decrease your costs to meet that debt. And I think that's where the regulators get concerned -- they're saying, hey wait, how are you going to meet this debt servicing? You're going to meet it by decreasing costs, which also affects the three measurements, that's the safety or dependability of delivery and ultimately then the costs."

While he sees the industry consolidating, "I think that the industry needs to have participants that are looking longer term" and look at "a utility investment as really actually also being connected with a community in which they serve and they have that responsibility to the community."

Mark Kubow, a managing director in Navigant Consulting's energy practice, said that "we're certainly seeing a definitive position from the regulators about what they like and don't like, and they don't like leverage and they like transparency."

In rejecting TPG's proposal to acquire PGE, the Oregon PUC cited the relative stability and autonomy of PGE, despite being owned by bankrupt Enron Corp.

Oregon's regulators concluded that PGE most likely would not operate any differently after having its stock distributed to the Enron creditors. In contrast, the PUC found "harms or risks to customers" outweighing potential benefits from the TPG purchase, which included too large an amount of debt ($1.7 billion) to suit the state officials, making the potential credit rating of the new holding company, Oregon Electric Utility Co., below investment grade, the regulators concluded. TPG is studying its options in the wake of the adverse decision by the Oregon regulators.

Kubow found the Oregon decision particularly puzzling. "The Portland [General Electric] one is very strange when you think about it because you're basically saying we don't like this financial deal, but now it's still going to go back in the hands of a bunch of other financial players" -- the entities that hold the current debt of Enron.

But PGE's continuing its ongoing operations under ownership divided among the 9,000 creditors in Enron's Chapter 11 bankruptcy is only one of several options that remain possible for the utility at this point. For example, there has already been a renewed push in certain quarters in the state to have PGE become publicly owned.

"You could argue that the Portland deal had some externalities, with the Neil Goldschmidt issues, that got TPG really off on the wrong foot and that was something that they were never able to recover from," Kubow said. Goldschmidt, a former governor of Oregon, had been tapped by TPG to head Oregon Electric Utility Co. until a separate personal scandal from his past forced him to resign all his public board positions last year.

The ACC in December turned aside a proposal made by a private investor group headed by the Wall Street leveraged-buyout firm Kohlberg Kravis Roberts & Co. under which the group would have purchased UniSource Energy. The investors group ultimately decided to walk away from the deal.

Prior to the ACC's decision, an ACC administrative law judge (ALJ) issued a proposed decision to reject the sale of UniSource, although the ACC was not bound by the ALJ's ruling. In the proposed decision, the ALJ identified such risks as increased debt and what she described as "inadequate" bankruptcy protections.

The ACC decision "is even harder for me to understand," Kubow said, noting that Navigant was involved in that transaction. He said that UniSource "pretty much did everything right and still got turned down."

The question that begs to be answered is whether, in the wake of the PGE and UniSource rulings, financial heavy hitters will be more circumspect about pursuing similar deals in the future.

While it's unclear what the answer to that question is at this point in time, Kubow believes that if such deals are pursued "more care will be given to appealing to the regulators and their needs." At the same time, "you'll probably see some of the larger private equity players...I think not only think twice, but think three times before they'd actually go put themselves through it again."

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