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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

pointing out that corporate scandals in the last few years came largely from publicly traded companies such as Enron.

Moreover, other critics heatedly complain that private equity firm support for a utility could dry up after privatization when interest rates increase, causing a liquidity crisis. "While existing company debt will have been refinanced at lower rates in conjunction with the LBO, private equity firms will be harder pressed to raise more money as interest rates rise and thus will constrain the utility's access to capital," says one analyst. Private equity proponents respond, "We always have access to public equity markets and can take the company public again in order to raise capital in the public markets." Furthermore, "The company will continue to have access to public debt markets and can go back to their private equity sponsors for additional equity if needed," argues another LBO expert.

So why a private equity investor in a high-interest-rate environment would continue to leverage its acquisition or provide equity at a higher cost of capital, when such an investment fails to outperform treasuries is anybody's guess, queries one.

Fairly or unfairly, private equity investors using heavy financial leverage to acquire companies have raised debate in almost every industry where such transactions have been introduced. The focus of the concern has always centered on implementation. The utility industry is no different. If anything, experts say, private equity groups will be more heavily scrutinized because of the high degree of regulatory oversight over utilities involved in protecting the public interest.

That is why the LBO by Kohlberg Kravis Roberts & Co. (KKR) and its investor group purchase of Arizona-based UniSource Energy, parent company of regulated utility Tucson Electric Power, is a good test case to debate whether, and in what circumstances, the LBO structure may or may not be appropriate for the utility industry from a business and policy perspective.

The KKR Deal: The Art of Going Private

On Nov. 24, 2003, the board of UniSource Energy accepted an offer to acquire the company from a private investor group that includes KKR, J.P. Morgan Partners LLC, and Wachovia Capital Partners as limited partners, plus general partner Sage Mountain L.L.C, an Arizona company owned and managed by Frederick B. Rentschler, a former corporate CEO. The approximate $3 billion transaction would leave UniSource Energy's senior management team in place, and the company's headquarters would remain in Tucson. This transaction will be financed with approximately $560 million of partner equity and $660 million in new debt. The leverage added to UniSource from the deal causes the company's debt on a consolidated basis to exceed 80 percent, according to analysts.

"Ironically, while other industry players such as Duke Energy and El Paso are shedding debt as quickly as possible, here is an example of a strategy that embraces debt to achieve an objective," says Boston University's Williams. A private equity specialist adds that an appropriate level of debt can impose a discipline on companies to remain more focused on their core business rather than divert capital and management resources into unrelated businesses.