Experts debate whether KKR's leveraged buyout of UniSource Energy is right for the industry.
Mark T. Williams, executive-in-residence at the Finance & Economics Department at Boston University, identifies the quintessential issue that will no doubt be heatedly debated in boardrooms and commissions as more utility CEOs are tempted to become private utilities through a leveraged buyout transaction.
And tempted they will be.
Morgan Stanley estimates that the top 10 largest private equity groups seeking to invest in the sector have a total buying power of $198 billion (see chart 1, p. 25). While this amount is for total investment in all business sectors, many experts say billions are being earmarked for utility industry investment even as significant amounts of private equity investment already have been spent (see chart 2, p. 25).
Moreover, Williams says, given that interest rates are currently at 40-year lows, and utility sector debt spreads over risk-free treasuries have declined in recent months makes highly leveraged transactions more attractive.
In a typical leveraged buyout (LBO) a small group of investors, usually including current management, acquires a firm in a transaction financed largely by debt. The debt is serviced with funds generated by the acquired company's operations, and in some cases, by the sale of some of its assets. In other instances, the LBO firm plans to sell off divisions to other firms that can gain synergies. The acquiring group expects to make a profit from the LBO, but the inherent risks can be great due to the heavy use of financial leverage, according to a textbook definition. LBO specialists are quick to point out that the amount of financial leverage in recent deals has been much lower than in the past.