On cooperative responses

Aug. 27, 2003 — Kevin Williams, attorney and contributor of EL&P’s monthly “Benefit of Counsel” column beginning in September, dissects the arguments of Glenn English, head of the National Rural Electric Cooperative Association (July EL&P guest commentary — click here for article).

English was replying to Williams’ original article, “Balkanization Powers ‘Win-Win’ Acquisitions of Electric Cooperatives” (May EL&P click here for the article).

Williams begins “While I am flattered that an organization backed by $76 billion worth of assets would find my musings to be so threatening, their well-worn rhetoric does not match reality. Further, I find it ironic that one of the nation’s best-compensated and most powerful lobbyists would accuse me of bias and conflicts of interest (but, then again, the cooperatives have never developed a sense of humor, much less irony)…” He goes on to challenge allegations of flawed data and misuse of the term “balkanization,” and discusses the difference between “non-profit” and “not-for-profit” amongst other topics.

By Kevin Williams

In response to my guest commentary “Balkanization Powers ‘Win-Win’ Acquisitions of Electric Cooperatives” (EL&P, May, 2003), Mr. Glenn English, head of the powerful National Rural Electric Cooperative Association (NRECA), accused me, somewhat shrilly, of a variety of failings via a letter published in last month’s EL&P.

While I am flattered that an organization backed by $76 billion worth of assets would find my musings to be so threatening, their well-worn rhetoric does not match reality. Further, I find it ironic that one of the nation’s best compensated and most powerful lobbyists would accuse me of bias and conflicts of interest (but, then again, the cooperatives have never developed a sense of humor, much less irony).

I do not wish to spar back and forth ad nauseam with NRECA, but I do feel compelled to respond to some of the wilder claims that Mr. English chose to make. Since I’ve already covered this ground, I’m being a bit redundant (but, then again, having worked on both sides of coop acquisitions, I have a well-developed sense of deja vu):

“Flawed data”: All data in the article came from NRECA’s web site, EL&P, or training classes conducted by NRECA (I confess, however, to calculating comparative IOU balkanization myself based on information from IOU web sites, but even lawyers can operate a calculator). Since Mr. English does not specify what data was flawed, I cannot respond more definitively, but I stand by my article, and will be pleased to provide citations if requested to do so. The same offer applies to alleged “factual errors,” most of which are discussed below.

“Balkanization”: I find it odd that NRECA would claim that roughly 1,000 distribution and generation and transmission cooperatives and allied organizations operating in 47 states are a monolithic whole, especially when it cites Touchstone Energy (brilliant though the concept truly is) as demonstrating unity. By my count, more than a quarter of eligible cooperatives do not participate in Touchstone at all.

The irrefutable fact is that coops are balkanized, and coops can lower their costs through consolidation (a point made quite eloquently at the 1996 NRECA annual meeting, as reported in the June, 1996 issue of EL&P). As to use of the term “balkanization,” I learned it when was applied (at some length) to electric cooperatives in an NRECA mergers and acquisitions conference that I attended September 13 – 16, 1993, at the University of Nebraska at Lincoln. Additionally, a Google search performed on the terms “balkanization electric utility” produces over 500 hits, including documents from DOE and FERC web sites. I’m hardly the first person to use “balkanization” to describe the coop’s “fragmentation,” although I must admit that I don’t have the vaguest notion of how to use Mr. English’s term “geopolitical.”

Recovery of “equity payment,” “rate increases,” etc.: Investors receive a return on their investment (which is as American as apple pie), not “recover[y];” in order to earn that return, pay taxes, and so forth, without raising rates (which would, even in the unlikely event of regulatory approval, scuttle virtually any acquisition), acquirors must incorporate the acquired coops into entities that enjoy economies of scale and thereby eliminate the inefficiencies created by the coops’ balkanization. An investor owned utility would be well positioned to do so, but a non-utility acquirer could do so by integrating two or more cooperatives. The former coop consumer/owners, in addition to receiving cash for their equity, will benefit from the stable or lower rates of the larger entity. The “best defense against higher rates” is consolidation and efficiency.

“Profits”: Coops are not “nonprofit” entities, instead characterizing themselves as “not-for-profit,” a subtle but important distinction. Coops do, indeed, earn profits — typically around 5.6% of revenue by my calculations. Those profits, called “margins” in coop parlance, are retained by the cooperative as “patronage capital.”

When the cooperative reaches a certain equity level (usually 35 to 40%), that capital is repaid or “rotated” back to the coop consumer/owners who paid it in and in the order and amounts that they paid it in (“first in, first out”) — a cycle that typically lasts 10 to 15 years; it is also possible for the cooperative to experience financial difficulties and deplete its patronage capital prior to rotation, an admittedly rare occurrence.

Assuming ever increasing bills and steady margin rates, a coop consumer/owner’s capital credit account balance will likewise constantly grow, and the consumer/owner will not get all of its money back until 10 to 15 years after the consumer/owner leaves the cooperative (and if the coop cannot locate a former consumer/owner, its capital credits are retained by the cooperative or paid to the state). Patronage capital does not earn interest or any kind of dividend, thus has negative returns; in other words, there is a true cost to coop consumer/owners. To sum up coop profits, “That which we call a rose, by any other name would smell as sweet.”

“Better [acquisition] model”: Mr. English seems to accuse me of teasing the readers by not discussing the correct acquisition model. Having been involved in coop acquisitions for over a decade, I know that most folks outside the coops (and even many within) don’t have the background knowledge essential to understanding the correct model; imparting that knowledge is cannot be accomplished in a short article — or even a series of them. But, in order to respond to Mr. English, I will contrast the correct model (which is somewhat similar to a political campaign) with the tender offer model.

The correct acquisition model recognizes that the audience for the offer is the coop’s consumer/owners: unintentional investors who often don’t know that they are, indeed, owners of their coop, and who don’t know how to evaluate the offer. The audience for a traditional tender offer, on the other hand, is intentional investors, the financial press, analysts, and so forth. The latter is well informed; the former will require an educational effort in order to make an informed decision. As I said previously, potential acquirors must function outside their comfort zone to accomplish this goal.

“Ultimate control by board directors”: The term “ultimately controlled” was unfortunate, and Mr. English has, quite rightly, corrected me. I should have used the term “penultimately,” as a coop’s consumer/owners have the ultimate say over major changes, such as an acquisition. A representative vote was that of the consumer/owners of Teche Electric Cooperative who approved, by a ratio of 9 to 1, acquisition of their cooperative in 1995, easily besting the super-majority required by some state statutes.

“Conflicts of interest”: As I am one of the only attorneys in the country that maintains an electric cooperative acquisition practice, I believe that I offer valuable expertise to potential acquirors. It is absolutely correct that I am well compensated for this expertise, and that I seek to expand my practice. But I do not advocate the acquisition of cooperatives per se. I have no doubt that, in certain circumstances, the cooperative business model is the best way to provide electric service. I also have no doubt that, in many more circumstances, it is not.

However, I never attempt to determine which is which: I do not make recommendations that my clients acquire specific cooperatives. I do, however, advocate the reasoned evaluation of cooperative acquisitions via a structured process. The process is designed to be relatively inexpensive, simple, and expedient, with a key objective of dispelling the misconceptions and misunderstandings that cause many potential acquirors to wrongly assume that coops are unobtainable.

Since many coop consumer/owners would benefit from an acquisition that would allow their service providers to enjoy economies of scale, and since many potential acquirors would benefit as well, I think failing to consider cooperative acquisitions is a sad mistake — but one that the coops and many potential acquirors will probably make as long as there are coops. I am quite comfortable with the process that I employ and my ethical posture.

“Cousin of Enron”: In the course of protecting their turf, coops often engage in some eye-popping distortions of truth and assaults on character, but I was still shocked at being called an emissary of Enron (although I will resist the temptation to respond in kind to Mr. English). While I carefully maintain client confidentiality, I feel compelled to disclose that Enron has never been my client, nor would I accept an engagement from them.

Space constraints preclude me from adding any additional detail. If you would like more information, I have prepared a series of articles on my web site at www.kevintwilliams.com (including one explaining why cooperatives almost always have a knee-jerk reaction to acquisition offers — or even short commentaries discussing them).

Finally, while I have taken the liberty of poking a little bit of good-natured fun at NRECA, potential acquirors should not thereby assume that NRECA is anything but formidable and tenacious; Glenn English is worth every nickel they pay him.

Attorney/Entrepreneur Kevin Williams practices law and operates businesses in Nashville, Tennessee. He was the anti-takeover “guru” for electric cooperatives in Virginia, Maryland, and Delaware, and has advised IOU’s and investment banks about electric cooperative acquisitions since 1995. Due to ethical considerations, his services may not be available in some areas. Kevin can be reached at (615) 264-8249 or kevintwilliams@att.net. His web site is www.kevintwilliams.com.


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