Puget Energy's path to going private

When Puget Energy shareholders met — perhaps for the last time — at the company's Bellevue headquarters in mid-April, they overwhelmingly approved the sale of the company to a group of Australian and Canadian investors for $30 a share.

After counting the votes, top managers beamed, calling the $7.4 billion transaction a necessary step to infuse the parent company of Puget Sound Energy with money to grow. But some stockholders remained reluctant.

"We should not have sold it," said an elderly shareholder after the tally was announced. The room, packed with many longtime owners of the local utility's shares, erupted in applause.

The proposed sale of the state's largest energy company, which provides natural gas to Seattle and electricity as well as gas to much of the Eastside, has some stockholders or customers worrying that new owners will jack up rates and wondering what it will mean to have foreigners control what seemed like a local asset.

Of course, Puget Energy has been a "public company" only in the sense that the public could buy shares. It currently is owned by investors (unlike Seattle City Light), and the proposed deal simply will swap one set of shareholders for another, more private set.

Public meetings beginning May 15 will let customers and other stakeholders voice their opinion as the Washington Utilities and Transportation Commission (WUTC) decides over the coming months whether to approve the takeover.

Other stakeholders who will chime in on the process range from the Attorney General's Public Counsel, which represents ordinary ratepayers, to theIndustrial Customers of Northwest Utilities, which represents large corporate users like Microsoft and Boeing.

The WUTC has the ultimate word: Its mission is to make sure that Puget Energy's passing into new hands does not harm customers. At the same time, the commission will consider the utility's petition for a November rate increase.

Most stakeholders haven't stated their position yet. For Ronald Roseman, of The Energy Project, a local nonprofit group that represents low-income people, the question is whether his constituency on the Eastside "can continue to receive electrical service, at a price they can afford." The group has hired an expert to study the question.

But others have already identified potential red flags. For one, the buyers are borrowing $4.2 billion to help pay for the transaction.

Simon ffitch, who represents consumers as the Public Counsel chief in the state Attorney General's Office, wonders whether this could saddle Puget Energy with debt, sapping its financial standing and creating pressure in the future to raise rates.

"We want to make sure this critical company is not put at risk," he said. His office hasn't yet stated a formal position on the sale, though.

ffitch and other stakeholders also worry that the transaction may draw a veil over Puget Energy's finances.

Those fears are downplayed by the buyers, a group of pension and infrastructure funds led by the Macquarie investment bank, which is Australia's equivalent to Goldman Sachs.

"We don't think the financial structure will impose any additional costs over and above what the company presently has," said Chris Leslie, chief executive of Macquarie Infrastructure Partners.

Puget Energy and Macquarie executives said that the company will continue to publish financial statements after it goes private because it will still have publicly traded debt. The buyers plan to recoup their investment slowly, over decades, rather than seek a quick profit, the executives said. The Federal Energy Regulatory Commission gave its go-ahead to the deal last month. Other federal players — the Department of Justice, the Federal Trade Commission, the Committee on Foreign Investment in the U.S., and the Federal Communications Commission — are also poised to review the deal. Macquarie and Puget Energy executives don't think there will be any roadblocks.

The deal is likely to go forward, said Paul Latta, an analyst at McAdams Wright Ragen, and having the company go private could benefit both Puget Energy and its customers.

To raise money for its growth, Puget Energy now has to cater to two different audiences: the capital markets and the WUTC, which grants rate increases. When it asks for a rate increase, it must pull out its pockets in front of the state authority and plead poverty. Conversely, when the company's managers tap Wall Street for capital or report to shareholders, they must convey an image of success.

"Look poor, look poor, look rich, look rich — it's a horrible existence," Latta said. "It's better to take it off the public market."

By going private, the pleading is done behind closed doors — with owners who say that they understand the industry's capital-intensive, long-term nature.

Capital needs

To keep up with population growth and environmental mandates, Puget Energy says it must add enough power by 2025 to fuel two cities the size of Seattle.

It plans to build natural-gas-fired plants, wind farms and transmission infrastructure at a cost of some $5.7 billion over the next five years — an amount larger than what the entire company was worth last October, before the merger's announcement.

The company's "capital need is exceptionally large relative to its size," said Chief Financial Officer Eric Markell in testimony filed with the WUTC.

Part of the reason is the utility's need for more independent generation capacity. The California energy crisis in 2000 and 2001 made it clear to the company that buying power from others was risky.

"Ever since, Puget has been on a huge spending spree," said Latta.

A takeover by Macquarie will help by allowing the utility to reinvest its earnings without worrying about the short-term capriciousness of the capital markets, said Puget Energy's chief executive, Steve Reynolds.

"We as a management team won't have to be as focused on the next quarter," he said.

The acquirers have committed to fund the company's spending plan over the next five years, Reynolds said.

But some utility watchers fear the loans taken by the acquirers to buy Puget Energy might overstretch the utility's credit.

Credit-ratings firm Standard & Poor's estimates the company's consolidated debt will increase after the acquisition by about $1 billion; its credit rating could suffer if the WUTC, in order to approve the merger, imposes conditions that end up restricting cash flow, S&P analyst Antonio Bettinelli said in a report. That could make it more expensive to borrow money at a time when the lending industry is roiling.

"Does this transaction increase the cost of capital for Puget Sound Energy?" asks Melinda Davidson, a Portland-based attorney representing the Industrial Customers of Northwest Utilities. "There's been some indication that it very well could."

Macquarie's Leslie said that despite the current financial crisis, the credit lines the consortium secured to invest in the utility's capital program remain open, their terms mostly unchanged. "Basically we don't see the change in shareholding and slight changes in financing structure making any difference to the cost," he said.

Public reporting

The proposal to transform Puget Energy, a publicly traded utility, into a privately held firm is a "new kind of animal" for Washington state regulators, said Public Counsel ffitch.

As a public company, Puget Energy has strict reporting requirements with the Securities and Exchange Commission (SEC) and other regulators; as a private firm, its disclosure obligations "would be very limited compared to what is required right now," ffitch said.

Puget's Reynolds said the availability of information will not be any different.

"We're a regulated utility, there's nothing to hide," he said. The company will likely have tradable debt, which requires it to file financial reports with the SEC. "There are no secrets in our business and we don't expect that is going to change," he said.

While many shareholders and customers fret about foreign ownership, most stakeholders say it's more important to know how the company's day-to-day operations will be run. The Macquarie-led consortium has said that the current leaders, including Reynolds, will stay in place.

"We don't propose to meddle in the business," Leslie said.

Recouping the investment

Even though the Macquarie-led consortium is portraying itself as a benevolent, hands-off landlord, some are concerned that new owners might try to quickly recoup their investment by bleeding customers with high rates. After all, the buyers are paying a 25 percent premium above what Puget Energy's market value was.

The concern is heightened by the fact that shortly after the acquisition was announced, the utility requested the commission's OK to raise its rates by an average of 12 percent for electric-residential customers and 6 percent for residential gas users.

Part of the increase is to allow the company a higher profit rate — a return on equity of 10.8 percent, up from the current 10.4 percent.

"Customers are finding it very difficult to separate the two [issues]," said ffitch.

But the state has tight rules on rates. Utilities can only change them after a long and detailed process, making their case to the WUTC on the cost of infrastructure investment and operations.

Reynolds said that even if there were no merger pending, the company would have pushed for higher rates needed to pay for past capital expenses and rising power-supply costs.

The request for higher profit margins is similar to what other utilities are asking, he added. Spokane-based Avista, the state's second-largest investor-owned utility, is also asking for a 10.8 percent return on equity.

The rate case and the merger are "essentially independent items," Reynolds said.

Puget Energy and the Macquarie-led consortium have committed not to seek higher returns than the company would have had without the takeover.

The hopeful buyers said they are confident that even with such restrictions, they will recoup their investment over time.

Said Lincoln Webb, vice president for private placements at British Columbia Investment Corp., which is investing about $500 million in the deal: "We want to hold this company for 10, 20 years."