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Aquila Sells Four Utilities for $897M; WPS Adds Michigan Gas, Minnesota Gas for $558M

Aquila Inc. signed definitive agreements last week to sell four utility businesses in Michigan, Minnesota, Missouri and Kansas for a total of $896.7 million, or about $20 million more than estimated in March when it announced its intention to divest the utility assets. The majority of the assets, including Michigan Gas Utilities and Minnesota Gas, went to WPS Resources Corp. for $558 million.

Aquila said it will retain ownership of the St. Joseph Light & Power electric operations in Missouri as well as its electric operations in Colorado as part of its ongoing business. Those assets were previously expected to be among the utilities sold (see NGI, March 21).

"The execution of these agreements marks a major milestone in our program to reposition Aquila, strengthen the company's financial condition and improve the financial performance of our regulated utility business," said CEO Richard C. Green. "Upon completion of these sales, Aquila should be stronger financially than it has been in recent years. The proceeds are expected to allow us to significantly reduce our debt, improve our credit profile and put Aquila on a path to reaching an annual [earnings before interest and taxes] EBIT growth rate of 3% to 5% on our post-divestiture rate base."

The assets sales include the following utility operations:

Of the utilities identified for sale on March 14, Aquila continues to consider the sale of its three merchant peaking plants and Everest Connections, as well as a settlement of its Elwood toll contracts. Following the sales, Aquila will operate in five states, with gas operations in Kansas, Colorado, Nebraska and Iowa and electric operations in Missouri and Colorado.

Green said the key elements of Aquila's strategy remain to maintain its focus on operating an integrated, multi-state utility business, as well as significantly reducing its debt and strengthening its credit profile. He said Aquila wants to gain access to the capital markets on improved terms, allowing the company to cost-effectively fund investments in its rate base to meet customer needs. It also wants to improve operational efficiency and lower earnings variability.

Green said Aquila intends to work with regulators and legislators to address rate and fuel cost issues.

Completion of the sales is subject to closing conditions and regulatory approvals but is expected in 12 months. "We maintained a disciplined strategic sales approach that resulted in strong interest from a wide range of potential buyers," Green added. "This allowed us to select offers from financially sound buyers with strong utility experience and a commitment to customer service and reliability. We are confident that the quality and commitment of these buyers will set the stage for a timely and orderly regulatory review and approval process."

After studying the Kansas City-based company's finances exhaustively earlier this year, the Kansas Corporation Commission (KCC) said in March that Aquila may have no other choice than to divest some or all of its domestic utilities in order to fix its balance sheet and reduce its debt (see NGI, March 28). The commission said Aquila was facing "extraordinary financial distress," largely as a result of "ill-advised investments" in unregulated lines of business beginning in the 1990s and continuing through early 2002.

"The significant amount of losses from negative earnings, asset impairment charges, asset sales and discontinued operations since the beginning of 2002 that have occurred in Aquila's noncore, nonregulated businesses have resulted in a considerably less healthy financial condition for the company," the KCC said in a report.

"Aquila's divestiture of investments in domestic utilities and unregulated business arrangements is in the best interest of ratepayers and shareholders alike," the commission added. "Aquila's only realistic choice to raise enough cash to payoff excessive nonutility debt is to undertake divestitures of its remaining unregulated investments and contractual arrangements, and to divest most, if not all, of its domestic utility businesses."

Two weeks prior to the KCC's report Aquila had announced an "accelerated repositioning" plan that would involve selling some of its utility assets in order to collect funds for an investment program designed to achieve 3-5%/year earnings growth and eventually return the company's credit to investment grade status (see NGI, March 21). The KCC gave the company until Feb. 9, 2006 to move the company's credit from a "junk" rating to an "investment grade" status.

Standard & Poor's said Thursday that it may raise debt ratings on Aquila. Associated EBITDA loss is estimated at about $100 million in total, which implies Aquila received relatively attractive bids for its assets, S&P said. If the sales are approved by regulators, Aquila potentially could reduce its total adjusted debt by 30%, S&P said. Although Aquila would likely lose as much in cash flows, the expected debt reduction would push back the company's maturity schedule, giving it more time to pay back debt, S&P said. In addition, the sale of three gas utilities will materially reduce the company's working-capital requirements, which would improve liquidity. Aquila has about $2.35 billion in total debt.

S&P may cut WPS Resources Corp.'s "A" corporate credit and senior unsecured rating, which is the sixth-highest investment grade level. However, the company said it expects to maintain its current dividend policy and its investment-grade credit ratings. WPS added regulated assets in complementary jurisdictions to its existing regulated electric and natural gas operations in Wisconsin and Michigan, making it a larger, stronger regional energy company, WPS officials said. WPS CEO Larry Weyers, called it "a great strategic fit with our existing operations given the geographic and operational profile of the combined asset base.

"We will be building the scale and scope of our regulated operations in jurisdictions with similar ratemaking environments. Natural gas distribution is a core business for us. This is an opportunity for our company to deliver on our commitment of providing value to our customers, employees, and shareholders."

Weyers said that WPS Resources does not expect to reduce field staff, but instead will welcome the 182 Michigan and 226 Minnesota employees into its existing ranks of 3,048 employees. WPS will pay a total cash consideration of $558 million for Michigan Gas Utilities and Minnesota Gas. Excluding one-time transaction and integration costs, the transaction is expected to be accretive to WPS Resources' earnings over the first 12 months following the close of the acquisition, the company said. .

The Minnesota assets give WPS another 200,000 customers in 165 cities and communities including Grand Rapids, Pine City, Rochester, and Dakota County with 226 employees. Annual gas throughput is 76.1 Bcf, roughly equal to that of WPS Resources' existing regulated natural gas operations. The assets operate under a cost-of-service environment and are currently allowed an 11.71% authorized return on equity on a 50% equity component of the regulatory capital structure, WPS said.

The Michigan gas assets provide gas distribution service to about 161,000 customers, mainly in southern Michigan in 147 cities and communities including Otsego, Grand Haven, and Monroe with 182 employees. Annual gas throughput is 36 Bcf. Like Minnesota, the assets also operate under a cost-of-service environment and are currently allowed an 11.4% authorized return on equity on a 45% equity component of the regulatory capital structure.

Combined with the acquired Aquila assets, WPS Resources will serve roughly 666,000 natural gas customers through its regulated utilities with annual natural gas throughput of 189 Bcf. WPS Resources already serves more than 473,000 electric customers.

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