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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

sometime in early February. However, a notice of intent has been filed, and the company said all documents would be available on the UniSource Energy Web site (

KKR executives say the deal is predicated on no change to UniSource Energy's current business model or rate structure, and KKR does not intend to make any changes that jeopardize reliability or its relationship with regulators.

"Our business model is not in this context to cut costs. You don't make any money at a utility by cutting some costs around the edges. For us, this is all about putting a large amount of capital to work for a long period of time at a reasonable rate of return. The reasonable rate of return comes from just earning your regulated return and then putting an appropriate financial structure in place," says Marc S. Lipschultz, partner at KKR.

"I think the only risk is that we as investors do not make an acceptable return. There is no downside for the customers of this company because as part of this transaction we are actually infusing equity in TEP for them to pursue their goals in providing good customer service and reliability. And they have a rate freeze, so there is no change to rates. There is only an upside for customers and ratepayers," he says.

Furthermore, Lipschultz adds that KKR will not be a fly-by-night operation, which buys out the company, carves up the pieces, and sells the parts for more than the whole.

"Our average hold period is seven to eight years. We have held some businesses as long as 15 years. We think a portion of our portfolio can be in lower risk and lower return utilities. … If one takes a very long and steady view and really understands the sector, we think there is really good fit between our kind of capital, which is long-term patient capital, with the needs of the energy sector," he says. But while no one may doubt KKR's good intentions, some regulators, who asked to remain anonymous, are concerned over whether the amount of leverage being used is appropriate, even as other regulators say ring-fencing laws make the question irrelevant.

Leveraging Up to the Nose: The Great Debt Debate

Even as KKR presents a very conservative approach in its future ownership of the utility, the company's use of heavy financial leverage still leaves many regulators and financial analysts uneasy. One banker, using public data, forecasts KKR's levered return on total invested capital to be as high as 18 percent (see Box, p. 27). While a private equity specialist familiar with the deal says the base-case return will be 16 percent.

Some argue that the forecast of almost 16 to 18 percent return that KKR will receive could be a "windfall." Others point out that the returns forecasted are not guaranteed, and that KKR will always live with regulatory risk.

Branko Terzic, global regulatory policy leader for Energy & Resources at Deloitte and a former FERC and Wisconsin state commissioner, says that the regulator always has the