UniSource Deal Flips a Switch in Energy Sector

Just Flip It

For its part, KKR has expressed a clear commitment to the endeavor.

"As long-term investors," Stuart announced, "our goal is to invest in the highest quality businesses and back the strongest management teams we can find, providing them with the financial resources to implement their strategic initiatives."

But Williams is skeptical. Typically, he said, leveraged buyouts are targeted at high-risk investments that promise similarly high rewards. He views the UniSource buyout -- financed with considerable debt -- as risky enough. But he questions just how KKR plans to achieve acceptable returns.

"The real test will be how this company will be able to become profitable given that it is taking on additional debt to the tune of $970 million," he said. "To meet these debt payments, any additional income generated will have to come from the cost side, not the revenue side, as utility rates are highly regulated."

Williams did acknowledge that KKR could improve revenues through growth in volume, rather than pricing, due to Arizona's rapid expansion. But he still sees more opportunity on the cost side of the equation. For example, he pointed out that interest rates are currently at 40-year lows, so the utility's debt load -- while larger -- could be cheaper to service. Even so, he says, the company will have a tough time slashing its overall cost structure.

"Costs related to plant and line maintenance are closely scrutinized to ensure that adequate capital is spent for reliability and dependability," Williams said. "It's going to be hard for KKR to cut corners."

He also sees roadblocks to the "classic leverage buyout strategy" of selling off nonstrategic assets to quickly pay down debt.

"The company will be hard-pressed to get 70% to 75% of book value for generation in the current depressed energy sector," he said. "There are a lot of merchant assets for sale but few takers at current prices."

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