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Business & Money
Experts debate whether KKR's leveraged buyout of UniSource Energy is right for the industry.
"From a public policy standpoint, should a utility that provides a vital public good be owned by a private group that gains ownership by taking on a high degree of debt (risk)?"
Mark T. Williams, executive-in-residence at the Finance & Economics Department at Boston University, identifies the quintessential issue that will no doubt be heatedly debated in boardrooms and commissions as more utility CEOs are tempted to become private utilities through a leveraged buyout transaction.
And tempted they will be.
Morgan Stanley estimates that the top 10 largest private equity groups seeking to invest in the sector have a total buying power of $198 billion (see chart 1, p. 25). While this amount is for total investment in all business sectors, many experts say billions are being earmarked for utility industry investment even as significant amounts of private equity investment already have been spent (see chart 2, p. 25).
Moreover, Williams says, given that interest rates are currently at 40-year lows, and utility sector debt spreads over risk-free treasuries have declined in recent months makes highly leveraged transactions more attractive.
In a typical leveraged buyout (LBO) a small group of investors, usually including current management, acquires a firm in a transaction financed largely by debt. The debt is serviced with funds generated by the acquired company's operations, and in some cases, by the sale of some of its assets. In other instances, the LBO firm plans to sell off divisions to other firms that can gain synergies. The acquiring group expects to make a profit from the LBO, but the inherent risks can be great due to the heavy use of financial leverage, according to a textbook definition. LBO specialists are quick to point out that the amount of financial leverage in recent deals has been much lower than in the past.
Putting it another way, leveraged buyers in the last few years have faced less-favorable terms. For example, in the last three years LBO firms parted with equity worth an average 41 percent of the deal price, according to a Standard & Poor's report. This is a significant change from the 10 percent equity that defined the typical 1980s LBO.
Certainly, many industry insiders disagree over whether the heavy use of financial leverage would pose any risk to utilities, which as a matter of historical record have always been highly leveraged, capital-intensive businesses. Furthermore, they say the capital structure of a utility is but one of many considerations a regulator makes to determine if an acquisition is in the public interest.
But other criticisms come down to trust. Can the so-called "barbarians at the gate" be trusted?
Some utility executives have raised concerns over the possibility of holding-company abuses by private equity groups that haven't been raised since the 1930s, when such abuses were terminated by the passing of the 1935 Public Utility Holding Company Act (PUHCA). Conversely, proponents of LBOs say that private or public ownership has little to do with corporate abuse,