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Business & Money

Experts debate whether KKR's leveraged buyout of UniSource Energy is right for the industry.
Fortnightly Magazine - February 2004

sells power and fuel. Furthermore, you need to evaluate its industrial customers, which could go bankrupt.

Regulators really need to understand commodity exposure because that drives how you want to structure your balance sheet."

The KKR/UniSource Energy LBO: The Fine Points of the Deal

An anonymous Wall Street investment banker breaks down the important points of the deal for Fortnightly readers and analyzes how much KKR stands to gain. A source close to KKR confirms his analysis (see box).

  1. On Nov. 23, 2003 UniSource announced that it had agreed to sell to an investor group (a partnership called Saguaro Acquisition Corp.) including KKR 62 percent, J.P. Morgan Partners 31 percent and Wachovia Capital 7 percent. The General partner is Sage Mountain LLC, owned by Frederick Rentschler, a long time KKR associate formerly associated with Armour-Dial, Beatrice and Northwest Airlines.
  2. The transaction is priced at $25.25 per share, for a total equity value of $880 million and assumed debt of approximately $2.1 billion. Total enterprise value is approximately $3 billion. KKR's motivation for the deal was, among others: (i) the company was a small-cap utility with no research coverage and limited public market support; (ii) Arizona is a good load growth region; (iii) TEP has balanced, low-cost generation; (iv) there was significant noise around the Millennium investment; (v) the markets appear receptive to the transaction.
  3. The sources of capital for the $880 million of equity will be $557 million of equity from the sponsors and the balance new notes ($300 million) and bank debt ($360 million). The balance of the debt will be used to fund a contribution of $260 million of equity capital to TEP, which will be used to repay an intercompany note and bring the equity ratio of TEP to 40 percent, which is the target set by the ACC. This is intended to attract support from the regulators. This also will result in incremental leverage at the holding company while de-leveraging the utility.
  4. The transaction is subject to a number of closing conditions including, among others: (i) ACC approval (apparently the standard is no adverse impact to customers); (ii) no material adverse change, which includes a significant adverse rate case; and (iii) obtaining the incremental holding company financing. The rate case and ACC approval are expected to be taken together in June. There is a $25 million breakup fee.
  5. The acquisition is at a trailing multiple of 8.6x EBITDA. However, the run rate multiple of EBITDA is closer to 6.5x, representing a run rate EBITDA of approximately $400 million to $425 million, versus LTM EBITDA of $313 million as of 9/30/03. The variance is largely a result of the synergies associated with Citizens acquisitions, which continue to come on line. The Springerville plant also represents $0.30 per share of upside, but it will not be on line until 2006. There are some cash and financial assets on the balance sheet which reduce the effective debt by $200 million to get to the 6.5x.
  6. Holding Company Leverage - While there is an additional $660 million of holding company leverage, half