Pennsylvania-based Duquesne Light Holdings has agreed to be acquired by a consortium led by Macquarie Infrastructure Partners (MIP) and Diversified Utility and Energy Trusts (DUET). The transaction has a total equity market value of approximately $1.59 billion, based upon the approximately 79.6 million Duquesne Light Holdings common shares currently outstanding. Duquesne Light Holdings’ headquarters will remain in Pittsburgh.

In a meeting with investors following the deal’s announcement on Wednesday, Morgan O’Brien, CEO at Duquesne Light Holdings, disclosed that top brass from the utility and Macquarie were scheduled to meet with commissioners from the Pennsylvania Public Utility Commission (PAPUC) last Thursday.

“Keeping the company’s headquarters and all those jobs in Pennsylvania is huge,” O’Brien said, noting that the Keystone state, “like a lot of states, has significant challenges on economic development.”

O’Brien thinks that the PAPUC is “going to be focused on understanding Macquarie’s intention…clarifying that Macquarie’s a long-term investor with a lot of expertise in infrastructure and so that will be, I think, our challenge — to really tell the Macquarie story in Harrisburg [PA].”

The Duquesne Light Holdings’ executive said that the PAPUC has been “a supportive commission for lots of utility transactions. I don’t believe they’ve ever disallowed a merger application. I expect them to be supportive. I think they’ll challenge us to be able to tell the right story, which we’re convinced we have a good story to tell them. And I think once they get comfortable with that, they’ll be supportive of keeping the company in Pennsylvania, keeping our headquarters in Pittsburgh.”

If recent history is any guide, how state regulators react to the deal could be the key hurdle that Duquesne Light Holdings and the other parties need to clear in order to get the transaction across the finish line.

Roadkill along the mergers and acquisitions highway includes more than one deal in which a non-traditional entity tried to purchase a U.S. electric utility, only to be met with a thumbs down from state regulators.

In late 2004, the Arizona Corporation Commission (ACC) rejected the proposed sale of Tucson Electric Power’s parent company, UniSource Energy Corp., to a private investor group headed by Wall Street leveraged-buyout firm Kohlberg Kravis Roberts & Co. Among the concerns voiced by ACC staff prior to that decision was the possibility of Unisource Energy facing higher levels of debt.

Last year, Oregon utility regulators rejected a proposal that would have allowed Portland General Electric (PGE) to be sold to private investors headed by Texas Pacific Group. In rejecting the deal, the Oregon Public Utilities Commission cited, among other things, the relative stability and autonomy of PGE, despite being owned by bankrupt Enron Corp. PGE has since severed its ties to Enron.

During Wednesday’s management presentation to the financial community, O’Brien noted that he’s been at the helm of Duquesne Holdings “for a little over five years and part of our initial strategy that we’ve been implementing is cleaning up some of the businesses that we inherited. And as part of that, as we went through that process and also looking for additional opportunities around the core electric business, which has been our focus, we’ve had discussions with Macquarie over the years.”

Those talks have involved the possibility of partnering on potential asset opportunities, “as well as looking at disposing of pieces of the business,” he said.

Under terms of the agreement, the consortium will acquire all of the outstanding shares of Duquesne Light Holdings for $20 per share in cash, representing a 21.7% premium based upon Duquesne Light Holdings’ closing share price on July 3. The consortium also will assume $148 million of Duquesne Light Co.’s preferred and preference shares on issue, as well as assuming approximately $1.26 billion of Duquesne Light Holdings’ long-term debt (estimated at completion).

Prior to the closing of the acquisition, members of the consortium will also invest approximately $141 million in newly issued Duquesne Light Holdings equity under a private placement, priced at $16 per share. Duquesne Light Holdings intends to use the proceeds to assist the financing of the planned acquisition of a minority interest in the Keystone and Conemaugh generation stations, as well as in its ongoing utility infrastructure investment program.

Reacting to the news, Moody’s Investors Service on Wednesday placed the ratings of Duquesne Light Holdings and its primary operating subsidiary, Duquesne Light, under review for possible downgrade. Ratings placed under review include the “Baa3” senior unsecured debt of Duquesne Light Holdings and the “Baa1” senior secured debt and “Prime-2” commercial paper rating of Duquesne Light.

“The significant increase in additional leverage has the potential to result in a multi-notch downgrade for the holding company,” Moody’s said. “Since the transaction is not expected to result in additional leverage at the operating company level, there is potential for a widening of the notching between” Duquesne Light Holdings and Duquesne Light.

Moody’s said its review “reflects the expectation that a significant amount of incremental debt will be incurred at the holding company level, resulting in a materially weaker financial profile, and considers that dividends from Duquesne Light are a primary source of cash for meeting the needs of the parent company.”

The review “will also consider that the company has significant capital needs to support announced asset acquisitions and capital improvement spending for utility operations. In addition, the company is currently in various stages of filing requests with the Pennsylvania Public Utility Commission and FERC for distribution and transmission rate base increases.”

The consortium plans to retain O’Brien in his current role as CEO at the utility. Macquarie will honor the current collective bargaining agreement in place for Duquesne Light’s represented employees, as well as existing wage and benefit packages for non-represented employees.

The transaction has been approved by the board of directors of Duquesne Light Holdings and the members of the consortium.

The transaction is subject to customary closing conditions, including the approval of Duquesne Light’s shareholders and various regulatory agencies, including the PAPUC and the Federal Energy Regulatory Commission (FERC). The companies anticipate completing the transaction in the first quarter of 2007.

Lehman Brothers has provided a fairness opinion regarding the transaction to Duquesne Light’s board of directors. Macquarie Securities (USA) Inc. acted as financial advisor to the Macquarie consortium in connection with the transaction.

Upon completion of the transaction, Duquesne Light Holdings’ common stock will cease to be publicly traded and the company will be a wholly owned subsidiary of Castor Holdings LLC, operating as Duquesne Light Holdings. The company will continue to be subject to regulations of the PAPUC and FERC.

Along with Macquarie Infrastructure Partners and DUET, the consortium also includes Industry Funds Management Pty Ltd, an Australian infrastructure investment fund, and other institutional investors.

MIP, headquartered in New York, is managed by a member of the Macquarie group, which is one of the world’s largest owners and managers of infrastructure assets, managing over $25 billion in infrastructure equity around the world.

MIP is a diversified unlisted fund focusing on infrastructure investments in the U.S. and Canada. The fund’s seed investment includes a committed majority equity stake in Aquarion Co., a regulated New England water utility operating in Connecticut, Massachusetts, New Hampshire and New York state.

In the U.S., Macquarie’s energy and utility investments to date include: Aquarion (pending financial close and regulatory approval); The Gas Company, a Hawaiian full-service gas company; Thermal Chicago, district energy assets located in Chicago and Las Vegas; Path 15, an upgrade of Southern California’s electricity transmission grid; and Michigan Electric Transmission Co., an electricity transmission company in Michigan, among others.

DUET, listed on the Australian Stock Exchange, is managed under a 50/50 joint venture between Macquarie Bank Limited and AMP Limited. DUET has majority ownership in some of Australia’s key, regulated energy utility businesses. These include regional electricity and gas distribution businesses in the state of Victoria as well as Western Australia’s Dampier to Bunbury gas transmission pipeline, that state’s key gas infrastructure asset. DUET also has a minority stake in Western Australia’s largest gas distributor, AlintaGas Networks.

Duquesne Light Holdings is comprised of an electric utility company and several affiliate companies that complement the core business. Duquesne Light “is a leader in the transmission and distribution of electric energy, offering superior customer service and reliability to more than half a million customers in southwestern Pennsylvania,” Duquesne Light Holdings states.

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