A tale of three deals - ADT, Westinghouse, KCPL - at Western Resources.
Sensing changes in the utility industry, Western Resources Inc. in 1994 began to examine what it was and what it needed to be - to customers, to investors and to other constituencies. Through an extended exercise in strategic planning, we produced a rather typical end product: a document outlining a hypothetical future of growth, financial strength and customer satisfaction. What followed often appeared more like a "Chinese fire drill." But the end result, if one can call it an end, was a completely new look, orientation and structure-along with a substantially improved stock price.
The story of how Western Resources set about recreating itself is long and complex. I played a role in that story, as I served as general counsel at Western Resources from 1987 to 1998. This discussion, however, deals with only one element of that process, the coordination of a wide array of legal and regulatory issues among and across several major, simultaneous transactions.
The object, when a transaction was selected, was to get it done, preserving the benefits for the company with minimum difficulty for the other transactions in progress. Given the number of issues and the number of simultaneous transactions, this coordination effort became a discipline in itself.
Planned, but Unforeseen
In 1995, Western Resources, a $5 billion electric and gas utility with a small unregulated subsidiary engaged in various related businesses, began to diversify into other types of business in a small way. Its first decisive step into a new business came near the end of 1995, when it acquired several small home security companies and set up Westar Security (a name it subsequently relinquished).
As the process continued, in came a new development. Kansas City Power & Light Co. (KCPL), a neighboring utility often confused with Kansas Power and Light (the trade name for Western's own utility division), announced in January 1996 that it had reached an agreement to merge with Utilicorp United Inc. This announcement, in light of a long history of discussions between Western and KCPL, appeared illogical to Western's management because of the greater potential benefits we perceived for shareholders and customers from a merger of KCPL and Western. Western immediately shifted focus. In April of that year we announced a $2 billion tender offer for all of KCPL's common stock, thereby launching a proxy contest that set a precedent for the industry.
Not all of management's attention was focused on KCPL, however. In this same period Western acquired approximately 25 percent of the outstanding stock in ADT Ltd., the country's largest home security company. While this acquisition in itself was not particularly complicated, the subsequent relationship with ADT's management posed an increasingly distracting influence.
As 1996 wore on, our tender offer led KCPL shareholders to reject a merger with Utilicorp. The issue of KCPL's control heated up that fall. Concurrently, Western's management had concluded that the company's best interests required the transfer of the natural gas business. After several months of negotiation, OneOK Inc. and Western entered into a strategic alliance in December that gave OneOK control of the gas business and Western a 45 percent equity interest in the resulting company, the eighth-largest natural gas utility in the country.
Two other strategic events took place in December: Western purchased the $370 million home security unit of Westinghouse Electric and announced an unsolicited tender offer worth $3.5 billion for the remaining stock in ADT.
Finally, in February 1997, Western and KCPL reached a merger agreement, beginning a regulatory approval process that normally lasts more than a year. That agreement was renegotiated in March 1998, after months of discussion about the structure of the new company and a substantial change in valuation of the transaction. A revised merger application was submitted to the Federal Energy Regulatory Commission in August, describing formation of a new holding company that would retain the name Western Resources Inc. It will own a single public utility subsidiary, known as Westar Energy. The regulatory process will likely extend well into 1999.
In the meantime, however, Western's offer for ADT had been topped rather dramatically by Tyco International, an industrial conglomerate, raising the value of Western's stake in ADT to well over twice its cost. Finally, Western had agreed to merge its home security business with Protection One Inc., for 84 percent of the outstanding Protection One stock, creating the second-largest home security company in the country. The OneOK and Protection One transactions both closed during Thanksgiving week, 1997.
Throughout this period, Western continued to make smaller acquisitions and investments ranging in value from a few million dollars to well over $100 million. None of these many transactions were laid out in the original planning document, although acquisitions certainly were contemplated as one means of growing the company. The KCPL merger and the ADT transaction, in particular, were products more of unforeseen circumstances than a long-range plan. But management's openness to each transaction was undoubtedly influenced by the strategic planning process it had undergone. Of equal importance, however, was executing the program - getting each project done in the best interests of the company.
Calling in the Outside Counsel
Needless to say, the energy and commitment needed to maintain such a transformation were extraordinary. Staying focused and organized became the most essential part of the job. From a legal point of view in particular, the complexity of this program posed unprecedented problems for Western. An outline of most of the legal issues would look something like this:
Rates & Certification
Kansas Corporation Commission
Missouri Public Service Commission
Federal Energy Regulatory Commission
Nuclear Regulatory Commission
Securities and Exchange Commission
Public Utility Holding Company Act
General disclosure requirements
Federal and state income tax
State property tax
Employee Retirement Income Security Act
The diagram at the end of this article suggests the interrelationships among these projects and the issues they raised.
Many of these issues not only applied to most or all of the transactions, but interacted among them. For example, the transfer of assets in the OneOK strategic alliance created an issue with respect to whether the KCPL merger could be accounted for as a pooling of interests (the restructuring rendered that point moot). In fact, with every transaction we asked whether pooling would be jeopardized. The interaction of these two transactions also posed issues under the Public Utility Holding Company Act, which ultimately dictated the structure of both.
Compliance with the various Securities and Exchange Commission shareholder disclosure rules became particularly complex as transactions multiplied while Western was in registration and in the middle of its proxy battles (essentially from the beginning of 1996 to mid-1998). Since multiple law firms, accounting firms, investment bankers and consultants were involved in the various deals, their activities had to be carefully coordinated to avoid lapses in disclosure compliance.
Three transactions - KCPL, Westinghouse and ADT - also involved litigation. This meant retaining local law firms in California, Texas, Florida, Kansas, Missouri, Bermuda and the United Kingdom to assist firms working on the deals. Litigation can affect the outcome of the transactions themselves, transactions being pursued at the same time, shareholder votes and the regulatory process surrounding some of the transactions. The flow of information connected with securities law disclosures, regulatory review and litigation increased the sensitivity of the process and the diligence required not simply by counsel, but by everyone involved both inside and outside the company.
This coordination came primarily from the top. Western's chairman and CEO, John E. Hayes Jr., demonstrated constant commitment to every project throughout the period, including the hiring of David Wittig. Wittig, an investment banker with expertise in mergers and acquisitions who is now president and CEO, helped spearhead the program of growth and restructuring. Executive management met frequently with outside advisors, sometimes daily when the action was particularly heated.
The advice of outside legal, accounting and other experts was absolutely essential to the process because of the amount of work and variety of disciplines involved. At least six consulting firms, three investment bankers and 19 law firms worked on various issues of one or more of the major projects. Meetings did not include all of these outside advisors, but drew them in as needed to address particular problems. Everyone was urged to provide relevant information and raise pertinent questions as soon as they became known. Few items of importance escaped attention long.
The use of so many advisors, while potentially cumbersome, achieved a critically important result. Every advisor contributed expertise and experience to the process that otherwise would have been unavailable to a hard-pressed management team. That left management free to do the coordination and run the rest of the business.
The 90-hour Weeks
Even with the help of advisors, the process created a hectic pace. Many in the working groups put in 80- and 90-hour weeks, week after week for two years, to reach the point where the company could say it had truly restructured itself. From January 1996 to November 1997 in particular, the pace of transactions and related litigation was virtually non-stop. Anyone going on vacation took a cellular phone, portable computer and fax machine, and spent a good deal of time on the phone.
This is the kind of commitment required to undergo the change Western contemplated. However, even in less complex programs such as a single major transaction, success often depends on commitment, focus and organization. Given these attributes and the willingness of managers to seek the outside advice of those who have been there, it is surprising what can be accomplished.
Commitment must be coupled with the appointment of someone within the working group to serve as the organizer-coordinator - someone who understands, at least generally, the myriad aspects of the transaction and can see the interrelationships among them. The organizer-coordinator must, therefore, know the legal requirements, where they fit into the business, regulatory, accounting and public/ investor relations aspects of the transaction and how to marshal necessary resources.
While there may be different individuals in charge of public relations, investor relations, finance, legal and other functions, each making decisions in his own area in coordination with the others, corporate counsel is in the unique position of reviewing all of these areas to make sure there is no lapse of legal compliance. Such lapses might include the violation of securities laws through public relations strategies.
At the top must be an executive with dedication to the project and the ability to make ultimate decisions for the group. Absent this type of clearly understood arrangement, two serious problems can arise: decisions don't get made or conflicting decisions are made. Both problems can arise within the same project. The larger the working group, the greater the potential problems and the tighter the organization must be. Allowing these problems to persist easily can doom the project.
Working groups should be no larger than necessary, but, as we have seen, the number and diversity of issues and disciplines involved in a highly complex project or set of projects may require a considerable talent pool. Whether the project is complex or ultra-complex, it is best to begin organizing the group and identifying the issues as early as possible. Discovering issues late in a project increases the risk of failure, and causes a great deal of anxiety for chief executives and those who report to them.
Deciding When to "Lose"
The entire working group must, of course, understand the objectives of the project. This is more than simply the completion of a particular transaction. As noted, each transaction affects the existing business and other transactions. Each group member must understand what the company hopes to achieve and what it wants to avoid.
Western Resources might have been able to win the battle for ADT at a price, but it kept in mind the goal of keeping the company financially strong. Thus, the company accepted a "loss," but in so doing created value for the company, allowing it to grow in far more economical ways. A "win" was possible, but it could have left the company without financial flexibility for years.
Every project is unique in some way. Setting up the working group will be a new experience each time. But once it is done and the process begins to get comfortable, it is amazing what the group can accomplish. The more complex and volatile the situation, the more carefully the team must be organized and led - with a commitment from the top down, plus ample resources and good communications. It's a tall order, but I've seen it done.
John K. Rosenberg, president of JR Consulting LLC, Topeka, Kan., is also a senior advisor to the Brattle Group, a national economic and management consulting firm. Previously, he served as executive vice president and general counsel of Western Resources Inc., which is still pursuing a merger with Kansas City Power & Light Co.
A Tortured Timeline Western/KCPL merger case marked by fits and starts.
Aug. 22 First Filing. Western files unilateral application at FERC asking to merge with KCPL.
November Merger Talks. Bilateral negotiations begin.
Feb. 7 First Deal. Agreement reached with KCPL.
Sept. 18 Second Filing. New application, predicting closing date of June 3, 1998. Acknowledges potential for vertical market power due to gas transmission/distribution activities in Kansas and Oklahoma.
Nov. 17 Challenge. Missouri munis intervene, allege market power, transmission rate increase under combined tariff, inadequate protections for transmission customers.
Nov. 27 Divestiture. Western trades gas operations to OneOK Inc., for a 45 percent equity interest.
Dec. 19 Meanwhile. Southwest Power Pool files regional tariff at FERC.
Jan. 9 Stalled? Western asks FERC to hold case "in abeyance," citing problems over fairness opinion from Salomon Smith Barney.
March 13 Meanwhile. SPP regional tariff OK'd for point-to-point service, with flow-based, distance-sensitive pricing.
Tariff to be expanded later to cover long-term and network services.
March 23 Still Alive. Western advises FERC of new revised merger agreement to form single combined utility subsidiary, Westar Energy.
Aug. 7 Third Filing. Parties submit revised merger agreement, say new plan will meet muni concerns over fuel cost differential. Also commit to join an ISO - either within SPP or outside if no SPP ISO within one year of merger close.
Aug. 24 More Data, Please. FERC writes to parties, asks for more supporting data in light of new SPP tariff, announces AEP/CSW merger and Midwest price spikes.
Sept. 8 Still Unhappy. Missouri munis renew protest, claim customer protection provisions not adequate, since combined average Westar fuel costs still will exceed prior KCPL charges.
Sept. 23 Rebuttal. Parties counter muni charges.
Dec. 2 Cost Data. Parties comply with FERC's request for revised analysis on market power, renew claim of no anticompetitive impact. - B.W.R.
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