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Financial News

Fortnightly Magazine - January 1 1997

the deductibility of the interest payment and the lack of need for an income tax component for return on common equity has a multiplier effect that very few other elements of the corporate equation offer, so this exchange would provide meaningful savings for very little trouble.

In short, management serves common stockholders by giving them 1) more assured cash flow and 2) priority against independent power producers and other potential or existing creditors who might have been living off of utility balance sheets. The transaction also preserves seniority and cushion for existing debt holders; it simply converts the form

of the junior investment and makes it more tax-efficient, which in turn helps rates get lowered to enhance the company's competitive position.

Some portion of preferred stock and common would remain as a cushion for debt holders. Bondholders are unaffected, however, and management's duty to preferred holders is defined by contract and generally does not reach the fiduciary level, except in cases of fraud of violation of law or express terms of contract. Nevertheless, some preferred consents may need to be obtained where dividend restrictions include repurchase of common shares as well as dividends on common, or where state law does not differentiate, as to the nature of distributions, between dividends and other payments. Healthier companies (em as long as they are still not under Financial Accounting Standard 101 or 121 (em should find no difficulty in this area. It may also be possible to obtain preferred consents by offering them a pro rata exchange of subordinated debt at the next level senior to the debt for which common shares are to be exchanged.

Presumably, the offer would be made on a first-come, first- served basis. Many utility shareholders are simply non-responsive; some will believe that they are better off holding on to their common (em which will, after all, constitute a bigger stake in the recapitalized entity. The impact on deferred taxes under this scenario will also need to be examined, but preliminary analysis does not suggest problems here. t

J. Michael Parish, Richard S. Green and Stephen H. Kinney are partners with the law firm of Reid & Priest.



Disaggregation?

Bond Indentures No Problem:

Bond indentures appear to present no serious obstacle to a breakup of vertically integrated utilities. The combination of unfunded property and retired bond credits, together with the ability to set up purchase money obligations on released property, appear to give many companies substantial flexibility.

The key (em whether trustees will resist releasing large segments of property, based on bondholder pressure, by finding implied covenants or invoking hyper-cautious or result-oriented interpretations, rather than objective contract interpretation.

The law appears to lie strongly on the side of the rights of companies to disaggregate; most indentures easily provide the means to reach a disaggregated state if management is willing.

T&D Spinoff Most Doable:

In this regard, a T&D spinoff of a heavily leveraged company may prove to be the most doable transaction, given the heavy concentration of the industry's investment in high-priced generation. The T&D business, as the regulated element