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Basic Instinct

If private equity makes a killing, Congress should require full disclosure.

Fortnightly Magazine - April 2007

and uncertainty over potential abuse. They worry that unbridled greed could lead to higher power prices and less reliability. That’s why, these anonymous utility experts say, if the industry is to move to private ownership, Congress must allow for greater regulation of private-equity firms.

The Sins of the Past

Of the many speeches and articles that were written in the last 70 years calling for the repeal of the Public Utility Holding Company Act of 1935 (PUHCA), very few of them talked about private ownership of the kind that private-equity firms now propose. PUHCA repeal would bring needed consolidation among utilities and would allow “passive” financial ownership, they said, perhaps muttering something about Berkshire Hathaway and GE Capital, which are quite different from mainstream private equity.

In fact, hardly anyone in their speeches for PUHCA repeal talked about placing high levels of financial debt leverage on utilities. And rightly so, because the private utility owners of the past used significant amounts of leverage (debt), which caused a significant number of utility systems to collapse during the 1930s.

When this was pointed out to Marc S. Lipschultz, partner at KKR, he explained that the company’s expertise in financial engineering and in running successful competitive businesses works against any possibility of bankruptcy of a utility like TXU.

But even while private-equity firms of today are distinct from the private financial firms of the 1920s and 1930s (known as power trusts), they share several financial techniques that have led to abuse.

Many regulators object to the practice today—as they did in the 1930s—of using excessive leverage (debt), and consequently, the possibility that private firms may not invest in infrastructure as a result of the debt burden (causing reliability to suffer), or even that a private-equity firm’s high financial targets will be achieved through excessive price increases.

In fact, the power trusts of the 1930s were convicted of all of these things. They were not regulated, but again, some experts believe that even today’s private-equity firms are too opaque for modern regulatory techniques.

In fact, in KKR’s failed buyout of UniSource Energy, the ring-fencing protections and benefits offered by the private-equity firm were insufficient to offset concerns. Arizona regulators were uncomfortable with the increased leverage, the partnership structure, how the deal would maintain adequate investment to preserve service quality and adequate PUC oversight, according to a presentation by Markian Melnyk of LeBoeuf, Lamb, Greene & MacRae LLP. Furthermore, Melnyk said the lesson for KKR and others (such as Texas Pacific Group, which tried a few years back to acquire Portland General Electric), is that financial acquirers remain at a disadvantage. That’s because they are not trusted, do not have management expertise, are perceived as short-term owners (contributing to financial instability), and may not have enough operating synergy savings to offer.

Making Private Equity More Public

Private-equity firm representatives from the Blackstone Group (Stephen Schwarzman), Carlyle Group (David Rubenstein) and Permira Advisers (Damon Buffini) recently stated that the buyout business has to embrace openness. An editorial in The Wall Street Journal that seized on these statements said