Kansas City, MO-based Aquila Inc. struck two deals last week that, if completed, will bring an end to the 90-year-old company whose fortunes rose and then fell as deregulation swept through the energy patch in the late 1990s. At its peak in 2001, Aquila raked in $36 billion in revenues. But following the collapse of Enron Corp. the company, once known as UtiliCorp United (see NGI, Nov. 12, 2001), was forced to retreat to its utility roots as it sold diversified energy assets to repay debt.

Now, it appears, Aquila's last seven utilities will be divided among Great Plains Energy Inc. and Black Hills Corp. in dual transactions that at least one large investor says undervalue considerably what's left of the former energy powerhouse.

Aquila is selling its five heartland utility businesses (four gas and one electric) in Nebraska, Colorado, Iowa and Kansas to Black Hills Corp. for $940 million in cash. And it's selling its Missouri electric utilities -- Missouri Public Service and St. Joseph Light and Power -- to Great Plains Energy Inc., parent of Kansas City Power & Light (KCP&L) for $1.7 billion in cash and stock plus assumption of $1 billion of Aquila debt.

"We have made tremendous progress since 2002 executing our repositioning strategies," said Aquila CEO Richard C. Green in press release announcing the deals. "Having improved our financial condition significantly, we believe this transaction provides the best overall, long-term value for Aquila shareholders by accelerating their return on investment. Following the combination, our utilities will have access to lower-cost capital to fund investments to meet customer growth projections, environmental upgrades and improvements to utility infrastructure. In addition, Aquila investors will receive a significant ownership stake in Great Plains Energy and resulting dividends."

Terms of the deals hold no appeal for Thomas R. Hudson Jr., portfolio manager of Norwalk, CT-based hedge fund Pirate Capital LLC, owner of about 17.6 million shares, or 5%, of Aquila Inc. "As we have previously stated, we are extremely dissatisfied that the deal with Great Plains Energy and Black Hills Corporation was accepted by management, and cannot believe that such despicable terms for ILA [Aquila] shareholders were even entertained," Hudson said to Green in a letter last week. Hudson promised to challenge the deals, and Aquila had no comment on his letter.

If and when completed, the two transactions will significantly increase the size and scope of Kansas City, MO-based Great Plains' and Rapid City, SD-based Black Hills' operations.

Great Plains will be the parent of Aquila and have revenues of more than $3 billion. Aquila will continue to own its Missouri-based utilities and its merchant services operations, primarily consisting of the 340 MW Crossroads power generating facility and residual natural gas contracts. By acquiring Aquila's Missouri-based utilities Great Plains will expand its service territory around the Kansas City metro area. The Aquila transaction will add about 300,000 electric utility customers to the existing base of about 500,000 customers.

Proceeds from the utilities sale to Black Hills will be used to fund the cash portion of the Great Plains acquisition and to reduce existing Aquila debt. Aquila shareholders will own approximately 27% of Great Plains common stock.

There will be no change to Great Plains or Black Hills senior management teams or boards of directors.

Wednesday, the day of the deals' announcement, Aquila shares closed down more than 7% at $4.34 in heavy trading. Great Plains and Black Hills were unchanged at $32.05 and $39.08, respectively. Standard & Poor's Ratings Services placed Aquila's short-term corporate credit on watch, positive; the long-term corporate credit was already on watch, positive. The long-term corporate credits of Great Plains and its subsidiary KCP&L were placed on watch, negative.

"The rating actions reflect our concerns that the transaction, which comes as KCP&L begins to implement its $1.5 billion comprehensive energy plan, will stress the company's cash flows and add to leverage, at least until its capital expenditure plant is complete and the Aquila integration under way," said S&P credit analyst Jeanny Silva.

S&P affirmed its rating on Black Hills, with a continuing negative outlook. "If finalized, the proposed transaction could stabilize the company's ratings at 'BBB-'," said Silva. "The outlook revision would be predicated on lower business risk post-transaction, offset by acquisition-related assimilation risk, higher leverage, and a lack of history in maintaining a business mix at the lower-risk levels contemplated in this transaction."

In September 2005, Aquila agreed to sell four utilities in Michigan, Minnesota, Missouri and Kansas for $896.7 million combined, about $20 million more than their estimated worth in March 2005 when the intent to divest was announced (see NGI, Sept. 26, 2005). WPS acquired gas Aquila's gas utilities in Michigan and Minnesota. Missouri gas operations went to Joplin, MO-based Empire District Co., putting Empire in the gas business for the first time. And Aquila's electric utility in Kansas went to Mid-Kansas Electric Co.

Black Hills

Black Hills currently provides electric utility service 101,500 customers in South Dakota, Wyoming and Montana, and gas utility service to another 32,000 customers in Wyoming through Black Hills Power and Cheyenne Light, Fuel & Power.

The acquisition will add about 616,000 utility customers (93,000 electric and 523,000 gas) to the 133,500 utility customers Black Hills currently serves. Other assets included are a customer service center and centralized natural gas operation in Nebraska. Black Hills will then have approximately 750,000 gas and electric customers in seven contiguous Midwestern and Rocky Mountain states.

The Aquila assets add:

"Our acquisition of these utility properties and related assets has great industrial logic for Black Hills strategically, operationally and financially," said Black Hills CEO David R. Emery. "It will significantly enhance our existing footprint in Colorado, enabling us to serve retail utility customers and communities in that state and to do so on an efficient basis. It will also give us, for the first time, a significant presence in the three neighboring states of Kansas, Nebraska and Iowa...

"We expect the transaction to provide positive cash flow immediately. We also expect that, after some earnings dilution in the first post-completion year related to transition costs, the transaction will be earnings accretive beginning in the second full post-completion year."

Emery touted the deal for giving Black Hills the ability to bolt on the utilities to existing operations without acquiring their related corporate administrative operations. He said Black Hills will scale up its existing administrative operations as needed to service the acquired utilities.

Black Hills has entered into a binding agreement with a group of lenders including ABN Amro Bank as administrative agent for a committed acquisition credit facility to finance the transaction. Black Hills said it expects the permanent financing that will replace this bridge facility to be a combination of new equity, mandatory convertible securities, unsecured debt at the holding company level and internally generated cash resources.

Black Hills also has a wholesale subsidiary, called Black Hills Energy, which produces natural gas and oil, mines coal, markets energy and generates electricity. Acquiring the Aquila utilities tips the company's balance sheet heavily toward regulated assets, which is something management said last week has been contemplated. There are no plans to pursue acquisitions on the wholesale side merely for the sake of rebalancing the company, Emery said. In March Black Hills nearly doubled its Piceance Basin acreage with the acquisition of 40 Bcf of reserves from Koch Exploration (see NGI, March 13, 2006).

The company's purchase of the Aquila assets is subject to regulatory approvals from the Missouri Public Service Commission, the Kansas Corporation Commission, the Colorado Public Utilities Commission, the Nebraska Public Service Commission, the Iowa Utilities Board and the Federal Energy Regulatory Commission; Hart-Scott-Rodino antitrust review; as well as other customary conditions.

Great Plains

Great Plains Energy expects the transaction to deliver financial and operational benefits in several areas. Total pre-tax synergies are estimated to reach about $500 million over a five-year period, with costs to achieve, including transaction costs, of approximately $185 million, the company said.

After closing, Great Plains would have 19 generating units producing about 5,800 MW and selling into the wholesale market as well as about 3,300 of transmission lines.

"Combining Aquila's many strengths with our own will result in superior customer service, enhanced reliability, and an even greater investment in environmental stewardship and energy efficiency," said Great Plains CEO Michael J. Chesser. "Moreover, our complementary service territories and generation portfolios provide the opportunity to realize significant synergies."

Operational synergies over the same five-year period are expected to total about $310 million. These synergies are expected to result from:

Following the transaction, Aquila's credit rating is anticipated to be investment grade. The improved credit rating is expected to lower interest costs on a substantial portion of existing high-interest rate debt through rate step-down provisions while also lowering rates on new debt planned to help fund ongoing capital investments. Aquila interest rate savings are estimated to be about $190 million over five years following the closing of the transactions.

The transaction is expected to be modestly dilutive to Great Plains Energy earnings in 2008 with per-share earnings accretion beginning in 2009. Great Plains said it expects to fully utilize Aquila's substantial net operating loss tax benefits over the next several years following transaction close.

Great Plains' acquisition of Aquila is subject to the approval of both Great Plains Energy and Aquila shareholders; regulatory approvals from the Missouri Public Service Commission, the Kansas Corporation Commission and the Federal Energy Regulatory Commission; Hart-Scott-Rodino antitrust review; as well as other customary conditions.

Each of the two transactions is conditioned on the completion of the other transaction. Both are expected to close in about a year.

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