Private buyouts, public peril?

Michael T. Burr,

Managing Editor

When Warren Buffett`s Berkshire Hathaway investment firm bought into Iowa utility MidAmerican Energy, Wall Street treated it like just another capital investment-a fairly conservative one, at that. More recently, when New York`s Kohlberg Kravis Roberts (KKR) agreed to buy a chunk of Dayton Power & Light, the news attracted even less fanfare. After all, from a Wall Street perspective, these were fairly ho-hum deals.

From a utility employee`s perspective, however, these private buyouts of IOUs signal something big is happening. The smell of change is in the air, and to some utility employees, the odor is not necessarily pleasant.

“If you believe the best thing that can happen is for a utility to become more nimble and flexible, and to lower costs, this will get you there in a hurry,” said Gerald Keenan, a partner with PricewaterhouseCoopers` energy strategic change consulting practice in Chicago.

This much is clear: acquisitions by private equity firms will accelerate change. These companies are thoroughly accustomed to operating in competitive markets. While they love the steady cash flow and firm customer base that regulated operations provide, they abhor stodgy, institutional thinking.

For investment houses, utilities represent an opportunity to buy low and sell high. Utility stocks are presently undervalued, in general, in a market that is dot-com crazy. After the shine wears off Internet stocks, growth investments with more stable cash flows will likely become more attractive. Few industries have more stable cash flows than regulated utilities, … plus, companies positioned to prosper in unregulated markets-like telecom, global developments, and midstream energy-are expected to increase in value after competition is implemented. TXU, for instance, sees its regulated wires and gas distribution businesses as an end-use foundation to support its unregulated power and natural gas portfolio strategy (See “Utility of the Month,” page 22).

These characteristics add up to an attractive investment for private equity firms. But that`s not the end of the story. While they`re waiting for the stock market`s winds to shift, these firms will seek to maximize the value of their investments. That means restructuring, cost-cutting and efficiency improvements in every possible area.

Hear that groan? That`s the sound of 50,000 utility employees realizing that the belt-tightening of the 1980s and `90s is not over.

The likes of Berkshire Hathaway, KKR and the CIBC World Markets/Laurel Hill partnership that is acquiring TNP Enterprises, will do everything possible to maximize their investment return.

The upside of IOUs going private is that the changes necessary to be competitive in the coming retail energy services free-for-all will likely happen sooner, rather than later. This is a good thing for most people working at these utilities. So are the opportunities that can arise when working for a larger, more diverse corporation.

Obviously there are also downsides. Some people will lose their jobs. That`s inevitable in almost any acquisition, and arguably will happen sooner or later as companies strive to become ever more efficient and competitive. Of greater concern is that not all of the changes these investment houses make will serve utilities` commitment to reliability, customer service and high operating standards.

If their hunger for a quick kill leads private equity firms to adopt a slash-and-burn approach, they are in for an unpleasant surprise. Investment houses beware: utilities are complicated business, with literally the entire economy depending on reliable service. Nothing will damage a utility`s competitive position-not to mention its market valuation-more than a plague of outages. n

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