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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

the Iowa Utilities Board. Nevertheless, the board agreed with consumer advocates that it is the best approach to recognize the true capital structure at the subsidiary level, and to prevent the parent company's stockholders from earning a "windfall," or excessive returns at the expense of ratepayers. "The Board sees no reason on this record to disavow the application of double leverage in all instances. Double leverage is one regulatory tool to help protect the utility from abuse by its parent company," the Iowa Utility Board wrote recently. But the use of double leverage has always been a source of controversy in regulatory circles.

Additionally, many have pointed out that the KKR deal with UniSource Energy has a material adverse change (MAC) clause, which nullifies the deal if there is a change to the business or to rates. This result may not be likely to occur.

Heather Murphy, public information officer at the Arizona Corporation Commission, says as far as TEP's rates are concerned, "the commission's decision on electric competition and subsequent settlement with Tucson Electric Power ushered in a two-step rate decrease-one percent in 1999 and one percent in 2000. Thereafter, TEP's rates are locked in at the current tariff levels until after Dec. 31, 2008. If the company seeks a change in rates or rate structure to take effect after Dec. 31, 2008, TEP would have to file a rate case in late 2006 or early 2007."

Of course, the KKR MAC clause expires when the deal is consummated. "Regulatory risk will be a part of their life," says one. Of course, some regulators say there may be benefits to dealing with one owner.

"A rational, individual regulator might well decide that it is preferable to be negotiating with one rational, economically motivated counterpart, rather than a board and management team working on behalf of 10,000 disparate shareholders. But regulatory bodies are groups of individuals, and these groups have their own historic, institutional biases. It's harder to apply the Rational Man rule. These institutional relationships are difficult to suddenly change in a dramatic way," says McGinnis. As such, he says, LBOs will not be for every utility, and the relationship with regulators may be at the heart of any deal.

"Companies that are weaker candidates for an LBO include some utilities that have relatively uncertain regulatory horizons, and, in particular, utilities that have had a difficult relationship with regulators. On the other hand, under some circumstances, utilities that are in the midst of difficult regulatory relationships can improve their circumstances through the introduction of new senior management that may be able to adopt a fresh perspective and do a better job of interacting with regulators in a constructive way than past management. It's not a forgone conclusion that weaker regulatory relationships would rule out an LBO, but it is certainly the first touch point," McGinnis says.

Can 'Ring-Fencing' Protect Ratepayers From Risk?

Some believe that regulators should not concern themselves with the leverage at the holding company, and instead operate on the assumption that the regulated utility is ring-fenced and thus,