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Financial News

Fortnightly Magazine - January 1 1997

Treatments: Restructuring, Unbundling

To counteract these forces, the company or it regulators may consider restructuring scenarios that involve creation of a holding company and two separate subsidiaries (em a Genco and a "wires" (T&D) company (em or perhaps a third sub that takes the form of an energy service company (ESCO or SuperESCO) to conduct unregulated activities. However, many senior officers of utilities continue to preach the model wherein the same management controls all three basic types of utility assets, whether they are only functionally separated or separated into different corporate entities. If this model is in fact sustainable, the difference in the business climate for utilities going forward is likely to permit or require a different approach to the classic three-layer capital structure (debt, equity, and preferred) that has served the industry well for decades but is now seen going forward as a source of problems.

Nevertheless, the utility managers themselves may pose a major obstacle to disaggregation. In short, many managers prefer not to lose control of any assets.

This desire arises partly from the basic instinct to hold onto what you've got (em be it assets, market power, reliability of supply, or control over sources of supply. It also stems from a lack of comfort level in knowing what will be best in a future deregulated market. When in doubt, hold on to equity. That path always appears easier than to recognize that rates are prices, or equity can be replaced (substituted for) by a more cost-efficient source of capital.

A Proposed Cure: Targeted Debt

Utility stockholders tend to focus on yield, showing only a very secondary interest in capital gains. As such, they are atypical as equity investors. These investors have no other investment vehicle which suits their goals of high income and minimal risk.

Utility managements, protected by the Public Utility Holding Company Act and state laws dating from the same era, remain much more isolated from common stockholders (less likely to feel pressure) than their counterparts at public companies in the deregulated sector.

These two observations suggest a disarmingly simply strategy (em issue more debt. In essence, simply convert stockholders into bond investors with more secure expectations. Increasing debt leverage offers a way of counteracting financial pressures from threats of restructuring, deregulation, and divestiture. It should pay dividends all around.

A targeted debt strategy would involve three basic proposals:

1. The Debt Issue. Offer subordinated secured debt (the "target debt") in exchange for common stock for up to 60-80 percent of outstanding shares. This idea assumes the typical utility structure of senior first mortgage bonds plus a limit in the corporate charter on unsecured debt. This targeted debt would take the form of either a 30-40 year bullet maturity or otherwise be structured as a long-term obligation that would be refunded, or have some rollover or remarketing feature akin to adjustable rate preferred stock. Meaningful equity would still remain, given the size of most utilities, to serve as a buffer with respect to the fraudulent conveyance issues that could be raised by creditors.

As for tax