Turbulence on the Western Front

Western Resources has plenty of vision, but investors wonder if the utility can manage to execute it.
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David Wittig has a plan. The chief executive of Western Resources (WR) knows the risks. The transformation of this Midwestern electric utility into a consumer services power is revolutionary. Unfortunately for Wittig -- and many investors -- initial enthusiasm over his vision has eroded into a malaise, with analysts wondering whether the former Wall Street banker can guide Western into the era of competition.

While all utilities have suffered amid higher interest rates and the uncertainty surrounding deregulation, Western's stock has slid more than most, dropping from a high of 43 to a recent low of just under 24. "The company hasn't done anything to excite investors," one buy-side manager says. "Everyone is restless with Wittig's leadership."

Instead, the company has done a lot to confuse investors, such as its move into home security, the swap of its natural-gas operations for ownership in natural-gas company

Oneok

(OKE) - Get Report

and, most recently, its purchase of a minority stake in direct marketer

Paradigm Direct

. "Western's story has become too complex for comfort," says the buy-sider. "It's no longer the traditional electric utility which makes many analysts and investors uncomfortable."

Wittig senses the frustration. The company entertained analysts and fund managers in New York earlier this month. The presentation focused on why Western fits the bill as a next-generation electric utility. While skeptical, analysts were attentive, knowing any creative spark in this oft-arcane business could be a ticket to profits.

Great Vision, Questionable Execution

The biggest challenges facing Western come from execution of Wittig's vision, not the vision itself. "David has a compelling vision," says Ed Tirello of

BT Alex. Brown

. "He's a very smart man. It's just a matter of getting all of the pieces working together."

Since arriving in 1995, Wittig has put one deal on top of another, similar to his days as head of M&A at

Salomon

. At first, his touch was golden. As he worked to transform Western from a utility to a consumer services company, he focused on home security. Along the way, he acquired alarm businesses from the likes of

Westinghouse

and

Multimedia

. Then, looking for the grand slam, he went after industry leader

ADT

. Wittig lost his bid to

Tyco

(TYC)

, but along the way amassed ADT stock that Western sold for an $800 million profit. He used the proceeds to acquire 85% of

Protection One

(POI)

, making Western a leader in the business.

At the same time, Wittig wanted to grow the electric business, meaning he'd have to find ways to buy neighboring utilities. After a mean-spirited battle with rival

Utilicorp

(UCU)

, Western prevailed in its bid to acquire

Kansas City Power & Light

(KLT)

, a deal yet to close. At the same time, Western spun off its natural-gas business, agreeing to swap it with Oneok for 45% of the company.

At that point, the pieces were in place and all Western had to do was bring them together. That has proven difficult. "Wittig is a dealmaker," says the buy-sider. "It's one thing to be a visionary; it's another to make all these pieces work together." When the deals slowed down, analysts looked to the ongoing business, and many weren't enamored with what they found.

While the traditional electric business seemed to be plodding along, the new deals raised concern. The KCP&L merger seemed to be dragging, a result of regulatory hurdles and some renegotiation. Most disturbing, though, was the security business, where revenue, expense and acquisition projections appeared unrealistic. "It all came to a head when Protection One, which was supposed to be the growth engine for Western, wasn't growing," says the buy-sider. "That's when people really began to doubt." That was last October, when Western was trading near its high of 44. Today, the stock trades at just above 26.

Regaining Confidence

After months of what seemed to many as avoidance, Western had to act to regain credibility for the business plan. That led to the meeting with analysts and fund managers in New York. "Our job was to regain the confidence of the investment community," Wittig said after the meeting. "Given all that's happened recently, it went better than expected."

The timing of the meeting was somewhat serendipitous. The week before, Western announced it would delay its annual filing with the

Securities and Exchange Commission

until some Protection One accounting issues are resolved. While the discrepancies -- involving the amortization of new account acquisition costs -- may be technical, it was just one more detail investors perceived Western to have missed. "It's probably the most embarrassing moment for me or anybody else in this company," admitted Wittig.

Wittig promised the company would work to get its house in order before looking to do more deals, saying, "We don't need to do another transaction now. We have everything we need to be successful." Added Doug Lake, Western's new chief strategic officer, "Our focus now is to get our house in order."

That includes completing the KCP&L merger and re-establishing profitable growth in the security business. Lake attempted to put it in terms shareholders like to hear: "Our focus is to provide a 15% annual return to our shareholders."

Skeptical Optimism

While the recent meeting cleared the air, Western still has a lot to prove. "Wittig was extremely candid about the prospects for Western Resources," says our buy-sider. "Now they have to execute."

In addition to issues already mentioned, there are others: First, the KCP&L merger agreement allows either party to walk away if Western's price isn't at least 29 7/8, a price it hasn't seen since February. "The price is a concern," says BT Alex. Brown's Tirello. "But I still think the deal gets done. It's too important to both companies."

The company will also have to address the future of its dividend. Currently paying out $140 million in dividends, nearly 85% of available cash, Western says it will evaluate its options next year. With more than 60% of Western shares in individual hands, any reduction could be difficult.

Still, with all its challenges, Western may provide good value for utility investors. "We think the company is seriously undervalued," says Tirello. "In an era when building a customer base will determine a utility's success, Western is a real leader."

Tirello may have a point. Western will serve more than 6 million customers across its business this year with a goal of 10 million by 2002. As deregulation creeps along, access to those customers may provide some interesting opportunities. "The current market price does not reflect the value of the parts that comprise this nontraditional utility," says Tirello, who rates the stock a strong buy with a 12-month price target of 46. (BT Alex. Brown has not provided banking services for Western in the past three years.)

Maybe he's right, but only if Western can execute.

Technically Speaking

Ask and you shall receive. That's the Power Lines motto. And because many of you ask for a technical opinion when we delve into a particular utility, we proudly supply one, by way of our friendly resident technician,

Gary B. Smith

.

Speaking of opinions, it's about time to express yours once again. So, do you have a question about electric utilities or a particular company? If so, shoot me an

email (please include your full name) and we'll devote an upcoming column to you, the most powerful readers in the world!

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At the time of publication, Edmonds' firm was long Protection One, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback at

invest@cjnetworks.com.