UNITED STATES
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THIS FILING CONSISTS OF A TRANSCRIPT OF A CONFERENCE CALL HELD BY UNISOURCE
ENERGY CORPORATION ON NOVEMBER 24, 2003.
Conference Call of November 24, 2003
Transcipt
Set forth below is a transcript of the UniSource Energy Corporation ("UniSource
Energy") conference call and webcast of 9:00 a.m. EST on November 24, 2003. In
this conference call James S. Pignatelli, Chairman, President and Chief
Executive Officer of UniSource Energy and Kevin P. Larson, Vice President,
Treasurer and Chief Financial Officer of UniSource Energy, described the
proposed acquisition of UniSource Energy which had been publicly announced
earlier that morning and responded to questions from members of the financial
community. The bracketed language included below consists of clarifications of
certain responses made in the discussion.
X X X X X X X X X X X X X X
UniSource Energy shareholders are urged to read the proxy statement regarding
the proposed transaction when it becomes available because it will contain
important information. The proxy statement will be filed with the U.S.
Securities and Exchange Commission by UniSource Energy, and shareholders may
obtain a free copy of the proxy statement when it becomes available and other
documents filed or furnished by UniSource Energy with the SEC at the SEC's web
site at www.sec.gov. The proxy statement and other documents filed or furnished
by UniSource Energy may also be obtained for free by directing a request to
UniSource Energy at (866) 275-4867. Those documents will be mailed to all
UniSource Energy shareholders.
UniSource Energy and its directors and executive officers may be deemed to be
participants in the solicitation of proxies from UniSource Energy's shareholders
in favor of the merger. Investors may obtain a detailed list of names,
affiliations and interests of participants in the solicitation of proxies of
UniSource Energy shareholders to approve the merger at the following address:
UniSource Energy Tower, 1 S. Church Avenue, Tucson, AZ 85701. Shareholders of
UniSource Energy may obtain additional information regarding the interests of
the participants by reading the proxy statement when it becomes available.
X X X X X X X X X X X X X X
PRESENTATION
OPERATOR 1
Good morning. My name is Tamiha, and I will be your conference facilitator. At
this time, I would like to welcome everyone to the UniSource Energy investor
conference call. (OPERATOR INSTRUCTIONS).
I would now like to turn the call over to Ms. Jo Smith, UniSource Energy
Director of Investor Relations.
JO SMITH, UNISOURCE ENERGY - DIRECTOR OF INVESTOR RELATIONS 2
Good morning. This is Jo Smith, Director of Investor Relations. With me this
morning is James Pignatelli, UniSource Energy's Chairman, President an Chief
Executive Officer; also Kevin Larson, UniSource Energy's Chief Financial
Officer.
Before we begin the call, I need to notify you that certain statements included
in this call are intended as forward-looking statements. These statements
include assumptions, expectations, predictions, intentions or beliefs about
future events, particularly regarding the proposed acquisition of UniSource
Energy Corporation. UniSource Energy cautions that actual future results may
vary materially from those expected or implied in any forward-looking
statements. Some of the key factors that could cause actual results to vary
materially from those expressed or implied include the receipt of required
regulatory approval, which are significant, and the satisfaction of other
conditions precedent to the consummation of the transaction, including the
approval of the transaction by the shareholders of UniSource Energy Corporation
and the availability of financing of the transaction. There can be no assurance
that such conditions will be satisfied or that such transactions will be
consummated. More information about the risks and uncertainties relating to
these forward-looking statements are found in the UniSource Energy's SEC filings
which are available free of charge on the SEC's Website, http://www.sec.gov.
With that, I will turn the call over to James Pignatelli.
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 3
Good morning. Nice to see so many active participants today. It is my pleasure
to inform you that the UniSource Board has voted to an accept an offer from
Saguaro Utility Group to sell all the outstanding shares of UniSource Energy
common stock for $25.25 per share. This is an all-cash transaction representing
a 30 percent premium to closing price over that which we closed on Friday.
The price represents a 1.7 times EBITDA book value at 6.5 times EBITDA. The
Saguaro Utility Group is composed of Kohlberg, Kravis & Roberts, J.P. Morgan
Partners and Wachovia Capital Partners. This transaction will materially benefit
our shareholder as well as strengthen the electric and gas utility operations.
The transaction involves the infusion of approximately $260 million in cash to
TEP. This will bring our equity to 40 percent [excluding capital lease
obligations] and pay off an existing $95 million intercompany loan. This will
increase our access to capital and our overall financial flexibility. We will
utilize the $260 million to address our capital situation and to retire some of
our debt.
These sponsors have additionally committed capital as required to provide safe
reliable service, as well as for growth in our territory. The partners, the
buying group, is also committed to the Arizona communities which we serve.
Headquarters will remain in Tucson, and current management will be retained.
This has no impact on our employees compensation or benefits, nor our existing
union contracts. The partners have committed to maintaining safe reliable
service in our service territory, as well as continuing the commitment to local
and community programs. This transaction is subject to approval by our
shareholders, which we will seek in the first quarter of next year, as well as
Arizona Corporation Commission approval, SEC approval, FERC approval and
naturally Hart-Scott-Rodino.
We are very pleased with this transaction; we are very pleased with the
opportunity to work with the fine group that makes up the Saguaro Utility Group.
With that, I will open this call to questions.
QUESTIONS AND ANSWERS
OPERATOR 1
(OPERATOR INSTRUCTIONS). Robert Howard, Prospector Partners.
ROBERT HOWARD, PROSPECTOR PARTNERS - ANALYST 2
Good morning. It is kind of early over there I guess, an early start for
the day for you guys?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 3
It's an exciting day.
ROBERT HOWARD, PROSPECTOR PARTNERS - ANALYST 4
You are saying you expect this to be done at the end of year?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 5
No. We will soliciting shareholder approval in the first quarter, first to
second quarter of next year. I would anticipate ACC approval to be in the
second, or ACC consideration, to be in the second or third quarter of next year.
ROBERT HOWARD, PROSPECTOR PARTNERS - ANALYST 6
And that would be all that you -- and then the SEC or other things too, right?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 7
We don't see difficulties with SEC, FERC or Hart-Scott-Rodino.
ROBERT HOWARD, PROSPECTOR PARTNERS - ANALYST 8
Does this group have any utility experience in terms of having big investments
with them?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 9
The group has extensive experience. Both Kohlberg, Kravis & Roberts have been
active in this sector, and J.P. Morgan Partners has been active in the energy
sector, although not in the vertically integrated utility sector.
ROBERT HOWARD, PROSPECTOR PARTNERS - ANALYST 10
What kind of role, if any do you see? Are they going to have some -- what have
they been talking to you about in terms of as a role for them in the Company at
all? Does that mean they are just going to say go to, Jim, and that is it?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 11
They have indicated that their business strategy is to buy strong management and
strong organizations in growth areas. They are committing all operating
decisions to existing management.
ROBERT HOWARD, PROSPECTOR PARTNERS - ANALYST 12
Okay. I guess the one concern we have a little bit is that we may not be getting
enough. I guess when I think about Springerville 4 possibly coming online, if
that happens, if that is another 30 cents a share possibly, and then we get rid
of Millennium or Global Solar and that being maybe another 30 cents a share, now
you've got 60 cents a share. You put a 10 multiple on that; that is $6.00; $6.00
on top of $19.40 is $25.40. We are getting $25.25, and yes, we are getting the
$25.25 a little sooner, but --?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 13
Rob, I think if you look back at the underlying strength of the utility, the
utility right now is selling at a premium, and this is an excellent premium over
what the current market is. We have had advice on this transaction, and the
Board has received a fairness opinion from Morgan Stanley. We feel this is an
excellent transaction for our shareholders.
ROBERT HOWARD, PROSPECTOR PARTNERS - ANALYST 14
Okay. I mean 15 minutes of analysis looking at it this morning. I have
definitely have more I have got to look at, but that is the first thing that
just struck me.
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 15
I think if you look at the projections and where the Company is, you will come
to the same conclusion that we have. We've got another five or six calls in the
queue, so I'm going to have to --
ROBERT HOWARD, PROSPECTOR PARTNERS - ANALYST 16
That is all I have. Thanks, guys. We will be talking to you.
OPERATOR 17
Sam Coprob (ph), Quattro Global Capital.
SAM COPROB, QUATTRO GLOBAL CAPITAL - ANALYST 18
Can you comment on the capital structure in the financing of the transaction and
if the transaction is contingent on anything?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 19
This is Kevin Larson. The investor group will fund their acquisition in the
following manner -- they will contribute approximately $557 million in equity.
They also have $660 million of debt financing. The debt financing includes a
bank commitment of $360 million, and they also anticipate issuing a note of
approximately $300 million at closing.
In combination with approximately $1.2 billion, the dollars or the proceeds
would be used to fund the cash purchase price which is approximately $880
million. They also make the contributions that Mr. Pignatelli referred to of
$260 million in the Tucson Electric Power Company. TEP will use or it is
anticipated that TEP will use those proceeds to retire debt at the operating
company level, and then there is also some costs for general corporate purposes
and transaction costs.
In addition to that, the bank group has committed a $50 million revolver at the
UniSource level at closing. They will also have a commitment for a $40 million
revolver at UES, which is the entity that owns our recent acquisition of the
Citizens assets. It is also contemplated that we would upon TEP restructuring
and recapitalizing after it had the $260 million infusion that we would
refinance TEP's existing bank facility on a smaller scale.
SAM COPROB, QUATTRO GLOBAL CAPITAL - ANALYST 20
Thanks for that detail. Can you comment on whether or not there any performance
requirements that transactions can (inaudible) and if due diligence is
completed?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 21
In terms of performance, due diligence has been completed by the investors and
subject to closing conditions. One is that there is an absence of any material
adverse change in the business.
SAM COPROB, QUATTRO GLOBAL CAPITAL - ANALYST 22
Okay. Thank you.
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 23
I would like to try to limit the questions to one each because we do have a long
list of people in the queue. Next question?
OPERATOR 24
Scott Pearl, Senco (ph) Capital.
SCOTT PEARL, SENCO (PH) CAPITAL - ANALYST 25
Congratulations, guys. I was wondering if you can comment a little bit more
about the requirement that the dividend restriction at Tucson Electric Power be
lifted? Is that to be removed completely? I believe currently it is at 75
percent of net income.
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 26
Yes, currently the Tucson Electric Power Company has a couple of different
limitations. Its binding limitation at this point in time is it can only pay 65
percent of net income, and that is based off of our bank agreement at Tucson
Electric. It is expected that with the recapitalization of TEP and again with
the infusion of $260 million, we will be able to eliminate that restriction from
the bank group.
In addition to that, the ACC has a limitation that only 75 percent of net income
can be paid up unless TEP's equity is greater than 40 percent, so it is
anticipated as part of this process that TEP's equity as it is calculated by the
ACC, which excludes capital leases, will be equal to or greater than 40 percent.
So in that case, we would be able to pay or anticipate we can pay up to 100
percent of our net income from Tucson Electric Power Company to the parent.
SCOTT PEARL, SENCO (PH) CAPITAL - ANALYST 27
So I guess presumably you need ACC approval of lifting that dividend restriction
as part this transaction?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 28
The ACC has already indicated the restrictions as so laid out by Kevin. We will
receive ACC approval for the transaction. That is required.
SCOTT PEARL, SENCO (PH) CAPITAL - ANALYST 29
They must make comments about the dividend restrictions as part of that your
agreement? It's obviously an important issue, so I am just trying to clarify.
What does KKR require of you with regard to this dividend restriction? Do they
require a positive affirmation from the ACC on it, or are they going at risk for
it?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 30
The group just requires that we get ACC approval under terms which do not have a
material impact on the economics. [Section 7.02(d) of the Acquisition Agreement
(filed with the SEC as on exhibit to UniSource Energy's Current Report on Form
8-K on November 24, 2003) sets forth the scope of regulatory approvals required
as a condition to the closing of the acquisition. With respect to dividend
restrictions, the provisions of the Acquisition Agreement generally require
that, after giving effect to the proposed recapitalization of TEP, there can be
no law, order, approval or contract that would restrict, or could reasonably be
expected to restrict, the ability of TEP to pay dividends of all of its net
income.]
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 31
Scott, currently in holding company orders and prior decisions from the ACC,
there is specific language that says if you have less than 40 percent equity at
TEP, you can only pay up to 75 percent of net income. To the extent you increase
it to 40 percent or greater, then you have the flexibility under current orders
from the ACC that we can pay 100 percent dividend.
SCOTT PEARL, SENCO (PH) CAPITAL - ANALYST 32
And 40 percent excluding capital leases?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 33
Yes. 40 percent excluding capital leases. That is correct.
OPERATOR 34
Matthew Mark, Jet Capital.
MATTHEW MARK, JET CAPITAL - ANALYST 35
Could you describe the process the Board and management underwent to establish
that this was the best offer for shareholders at this point?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 36
Certainly. We have been looking at this transaction for quite a few months now.
The Board established a committee which retained its own counsel, as well as its
own financial advisor. The Company also had counsel and financial advisors from
the time in the past that this is being looked at. The Board was intimately
involved with the transaction, the structure of the transaction, negotiations
with their advisors participating, and the Board based on the advice of their
advisors determined that it was an appropriate transaction.
MATTHEW MARK, JET CAPITAL - ANALYST 37
Did the Board do any market testing of the price with other third parties?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 38
The Board has already done preliminary marketing of the company with other
strategic investors.
MATTHEW MARK, JET CAPITAL - ANALYST 39
Thanks very much.
OPERATOR 40
Richard Howard, White Mountain Advisors.
RICHARD HOWARD, WHITE MOUNTAIN ADVISORS - ANALYST 41
I assume I cannot talk you out of this?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 42
You could always vote your shares, Richard.
RICHARD HOWARD, WHITE MOUNTAIN ADVISORS - ANALYST 43
If there is a third quarter closing, does that mean we are going to be beginning
dividends in the interim?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 44
Yes. That is subject to the Board approving the dividends. There's no provision
in the transaction documents for [prohibiting the payment of regular quarterly
cash] dividends.
RICHARD HOWARD, WHITE MOUNTAIN ADVISORS - ANALYST 45
Okay. Thanks.
OPERATOR 46
Michael Ludsvick (ph), IO Energy.
MICHAEL LUDSVICK, IO ENERGY - ANALYST 47
Did the investors come to you or did the UniSource Board go out and seek an
outside investment?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 48
These investors came to us. J.P. Morgan Partners had been interested in us for
many years even when they were back as the Beacon Group. The Board's financial
advisor, however, went out and looked at alternative investors.
MICHAEL LUDSVICK, IO ENERGY - ANALYST 49
Thank you.
OPERATOR 50
Jeffrey Coviello, Duquesne Capital Management.
JEFFREY COVIELLO, DUQUESNE CAPITAL - ANALYST 51
I just wanted to see if there were any terms of the deal that made it contingent
on -- I know there is an upcoming rate review by the commission in June, is
there anything in the deal that addresses that?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 52
The ACC approval we believe will be considered separate from the 2004 rate
review. The 2004 rate review is to be filed June of '04, but not acted upon
until probably the following year, 12 months later in '05. We are hoping to get
ACC approval by the time that we finance -- excuse me, that we submit the '04
rate case.
OPERATOR 53
Michael Emerald, Longfellow Investment.
MICHAEL EMERALD, LONGFELLOW INVESTMENT - ANALYST 54
In the merger agreement, is the material adverse change clause quantified?
Meaning are there any financial thresholds that UniSource has to meet in order
for the merger, or is it all boilerplate?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 55
No, yes. It is all boilerplate.
OPERATOR 56
Luka Epalito (ph), Chesapeake Partners.
LUKA EPALITO, CHESAPEAKE PARTNERS - ANALYST 57
Thank you and congratulations. I am trying to understand the financial structure
of the transaction a little bit better. You said they are putting in $557
million plus $260 that they are infusing, and you indicated that the EBITDA
multiple is about 6.5 capital. So if I hear you right, given the assumption of
debt, it is very roughly a 3 billion enterprise value?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 58
That is correct.
MICHAEL EMERALD, LONGFELLOW INVESTMENT - ANALYST 59
Ballpark? Then, you are assuming between the Springerville and other
improvements an EBITDA of about 450 on a run-rate as opposed to 300 on an LTM
basis? Is that an approximately correct statement?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 60
I think the EBITDA number would be roughly in the $400 million range or slightly
above that on a going forward basis.
MICHAEL EMERALD, LONGFELLOW INVESTMENT - ANALYST 61
Okay. And how much of that change versus LTM is due to the Citizens, and how
much is due to the Springerville?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 62
Well, Springerville Unit 3, that transaction was recently closed. The financial
closing was completed in October. However, that project will not be completed,
and the generation unit is not online until late 2006. So it won't start to
impact UniSource until 2007. I think we have indicated previously that the
EBITDA performance of the Citizens acquisition, which we call UES, UniSource
Energy Services, is in the range of $40 to $50 million worth of EBITDA.
MICHAEL EMERALD, LONGFELLOW INVESTMENT - ANALYST 63
Okay. And so then the rest of the improvement that gets you from 300 to 400 plus
is internal, organic?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 64
Yes. It is primarily Tucson Electric Power Company.
MICHAEL EMERALD, LONGFELLOW INVESTMENT - ANALYST 65
Excellent. Thank you. What are the approximate pro forma coverage ratios, and
what is a reasonable expected blended cost of interest?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 66
At this point, the closing of the transaction, as Jim indicated, is probably six
to nine months away, and market pricing terms will change between now and then.
So I am not going to give you that level of detail because I just don't know
what the final pricing would be or terms would be.
MICHAEL EMERALD, LONGFELLOW INVESTMENT - ANALYST 67
Okay. Thank you and congratulations. OPERATOR 68
Ed Ganesis (ph), Tidaman (ph) Capital.
BRETT POTALSKY, TIDAMAN (PH) CAPITAL - ANALYST 69
Actually. It is Brett Potalsky (ph). A quick question, a follow-up. I am a
little confused on the process. They approached you and then the Company, the
special committee, spoke to other buyers. Was the process complete? Meaning it
was like an auction where the best bids came in and this was the highest and
best bid, or were there other companies conducting due diligence and the process
is not complete and there's a potential that hey can come back? Have we seen all
the potential interested parties submit their final bid, and was this the best
offer?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CE0 70
There was not an auction process. But we will give a full discussion of the
exact process in our proxy.
BRETT POTALSKY, TIDAMAN (PH) CAPITAL - ANALYST 71
There were other bidders that had done due diligence. Was this the best and
final bid, like the highest priced?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 72
As I indicated (technical difficulty)-- there were other parties that had over
time looked at the financials of the organization under confidentiality. The
full details of the process will be put out in our proxy.
BRETT POTALSKY, TIDAMAN (PH) CAPITAL - ANALYST 73
Okay.
OPERATOR 74
David Frank, Zimmer Lucas Partners.
DAVID FRANK, ZIMMER LUCAS PARTNERS - ANALYST 75
Congratulations, Jim. Sounds like a great deal. I just want to ask you, are you
asking or is anyone asking as part of this acquisition any special regulatory
treatments for anything? I heard you comment about the '04/'05 rate case, but
are there any other requirements?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 76
No. Other than approval, there are no requirements. There are no special
treatment to be obtained, no changes in policy as they currently exist.
DAVID FRANK, ZIMMER LUCAS PARTNERS - ANALYST 77
No request to change the rates or treatments of any aspects of the utility or
anything like that?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 78
No. That is correct.
DAVID FRANK, ZIMMER LUCAS PARTNERS - ANALYST 79
Congratulations again.
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 80
We will see you soon.
OPERATOR 81
Denato Effie (ph), Royalists Independent Equity Research.
DENATO EFFIE, ROYALISTS INDEPENDENT EQUITY RESEARCH - ANALYST 82
Good morning and congratulations as well. I'm curious if there is a long-range
plan with this KKR Group and what their intentions are? Is this an interim step
to something else, or is this just a one-off transaction? What you know of --
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 83
I think that that is more appropriately addressed to the partners of Kohlberg,
Kravis & Roberts and J.P. Morgan Partners. I guess we will say that they are
both actively interested in the sector. KKR has made other investments in the
transmission side of the business in the Northeast, as well as the partial
acquisition of there investment in Dayton Power and Light. I hope they want to
be active. That will just await time.
DENATO EFFIE, ROYALISTS INDEPENDENT EQUITY RESEARCH - ANALYST 84
Thank you and congratulations again.
OPERATOR 85
Jeffrey Coviello, Duquesne Capital.
ZACK SCHREIBER, DUQUESNE CAPITAL - ANALYST 86
Hey, it is Zack Schreiber and congratulations. (multiple speakers)
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 87
How are you?
ZACK SCHREIBER, DUQUESNE CAPITAL - ANALYST 88
Good, sir. How are you? I just wanted to beat a dead horse here and make sure we
totally understand. From the regulatory perspective, all you need is approval on
a change of control, that is it, out of the Arizona Corporation Commission?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 89
Yes. It's not really a change in control. We have to file for a -- I am trying
to think of what they call it -- a reorganization under their affiliated
transaction rules. So the holding company, although it is not subject to
regulation by the ACC under the affiliate rules, when you have a reorganization
of any affiliate, you have to seek approval. That is the approval that we will
be soliciting.
ZACK SCHREIBER, DUQUESNE CAPITAL - ANALYST 90
Got it. Under a hypothetical scenario, which is what obviously I have to worry
about, if by chance the commission decided to open up the whole rate deal in the
2004 general rate case, and if in a very low probability I recognize that they
decide to address the hypothetical capital structure, is that risk on the
buyers, or is that risk on shareholders?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 91
Actually we take care of the hypothetical cap structure --
ZACK SCHREIBER, DUQUESNE CAPITAL - ANALYST 92
With the infusion?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 93
Right. That is one of the benefits to the transaction from a regulatory
standpoint is the fact that we returned Tucson Electric Power to a 40 percent
equity component, which the regulator has been hoping we could get to for --
well, when I came here, it was negative. So we are going to get to 40 percent
[excluding capital lease obligations]. That removes that issue from the
regulator in the future.
ZACK SCHREIBER, DUQUESNE CAPITAL - ANALYST 94
So basically what you are saying, though, that risk is being born by KKR and
J.P. Morgan, and if that risk ended up evolving into a real risk, that does not
constitute a material adverse change?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 95
The material adverse change language in my opinion -- and it is something I
think you have to verify by looking at what we will file in our 8-K -- but that
material adverse vis-a-vis rates, is triggered by a rate decrease, which has a
significant impact on the economics. The fact that we are infusing capital and
bringing TEP to 40 percent should mitigate that concern of a possible rate
decrease.
ZACK SCHREIBER, DUQUESNE CAPITAL - ANALYST 96
But I thought you said from an accounting perspective that the outcome of the
rate case would not be known for months until after the deal was closed, so that
risk would be on KKR, or will they have the ability to actually see how that
rate case develops, see if it's going to be a rate decrease, and roll that into
their estimate of whether to close or not, sort of the MAC language?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 97
No, they did not have that ability. If the commission approves the transaction
and then later adjusts the rates in the 2004 rate case, that is the risk of the
buying group.
ZACK SCHREIBER, DUQUESNE CAPITAL - ANALYST 98
So the rate decrease and the MAC language is only as part of the approval of the
merger and not as part of the separate rate case?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 99
That is correct. [The regulatory condition set forth in Section 7.02(d) of the
Acquisition Agreement requires that the regulatory approvals not impose terms or
conditions that have caused or could reasonably be expected to cause the rates
of any utility subsidiary of UniSource Energy to be less favorable than current
rates.]
ZACK SCHREIBER, DUQUESNE CAPITAL - ANALYST 100
Have you spoken to the commissioners at all? Have there be any discussions in
terms of -- I got on the call a little bit late -- in terms of briefing them?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 101
I have talked to four of the five commissioners, and the other commissioner was
having a medical procedure, and I talked to his aide. In general, I am
optimistic that the benefits of this transaction, the commitment to keep the
headquarters in Tucson and retain current management, as well as the commitments
to the community and to the continuation of our attitude towards safe and
reliable service, when you take all that together, I am optimistic that the
commission will approve this transaction.
ZACK SCHREIBER, DUQUESNE CAPITAL - ANALYST 102
Thanks so much. Congratulations.
OPERATOR 103
Ivan Presivic (ph), Elliott Associates.
IVAN PRESIVIC, ELLIOTT ASSOCIATES - ANALYST 104
Would you please tell us -- you mentioned earlier in the call that I believe the
transaction was roughly at 6.5 times pro forma EBITDA multiples; is that
correct?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 105
That is the number approximately. Yes.
IVAN PRESIVIC, ELLIOTT ASSOCIATES - ANALYST 106
Also, I think the comment was made that the run-rate or pro forma EBITDA is in
the low 400 range. So let's say it is at 410, that is about 7.3 times multiple.
I am just trying to get to how you get to 6.5 times if the enterprise value is
around $3 billion?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 107
The enterprise value that we mentioned of $3 billion includes our gross debt.
There are different ways of calculating the EBITDA. One way would be or the
multiple -- one way would be to back out from the gross debt, cash on our
balance sheet, as well as the Company has purchased in the past debt as part of
our leases, and we hold it as an asset. That could be netted out against the $3
billion number as well. I think if you make those adjustments, then you will get
closer to the multiple Mr. Pignatelli was describing.
IVAN PRESIVIC, ELLIOTT ASSOCIATES - ANALYST 108
One other question. With respect to the buyer's requirement to finance its
portion of the deal, you mentioned that the $360 million of bank loans is
already committed. Is there a market out for those loans, even without
commitment of some sort, as well as is there a financing out on a part of the
buyer with respect to $300 million of bonds that are likely to issue at the time
of the closing?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 109
The condition of closing is the availability of the financing from the bank
group. But we anticipate or we believe it's a very viable financing structure in
that we can get the closing as a way it has been designed, and we do have
commitments from the bank group.
IVAN PRESIVIC, ELLIOTT ASSOCIATES - ANALYST 110
I am sorry; I did not understand that. Other than the MAC clause that you have
with respect to your business, is there another out for the buyer other than the
MAC itself if they cannot raise the financing (inaudible) what they would deem
to be reasonable terms at the time of the closing?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 111
No.
IVAN PRESIVIC, ELLIOTT ASSOCIATES - ANALYST 112
Thank you.
OPERATOR 113
Ed Ganesis.
ED GANESIS, TIDAMAN (PH) CAPITAL - ANALYST 114
My question has been answered.
OPERATOR 115
Neil Stein, John Levin & Company.
NEIL STEIN, JOHN LEVIN & COMPANY - ANALYST 116
Just a couple of questions. First, are there any state regulations governing
holding company leverage in Arizona?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 117
Could you repeat that question?
NEIL STEIN, JOHN LEVIN & COMPANY - ANALYST 118
Are there any state regulations governing holding companies leverage in Arizona?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 119
No.
NEIL STEIN, JOHN LEVIN & COMPANY - ANALYST 120
The second question, with respect to the ACC approval process, are there any
statutory requirements that would require them to look at -- is the transaction
in the public interest, or would it simply not have to have an adverse impact on
customers? What would the basis for approval be?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 121
The state of the law in Arizona is that it does not have an adverse impact.
NEIL STEIN, JOHN LEVIN & COMPANY - ANALYST 122
Okay. On what basis would they make that determination? Are there any criteria
that they spell out?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 123
There has not been a lot of case law on that. I don't feel confident to answer
that question.
NEIL STEIN, JOHN LEVIN & COMPANY - ANALYST 124
Thank you very much and congratulations.
OPERATOR 125
Maurice May, Power Insight.
MAURICE MAY, POWER INSIGHT - ANALYST 126
Good morning and congratulations. My question really is just very simple -- why
now are you doing this? We saw earlier in the year you have been cleaning up
Millennium. If we read the tea leaves a little better, could we have read
something into that, or perhaps there is a need for capital and a fear of the
trueup and lower rates? Maybe last week with the Portland General deal, that may
have influenced you all to move a little quicker? Give us some color on why now.
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 127
Looking forward at the prospects, we had concluded the two elements of our
strategic direction, i.e. the acquisition of the old Citizens property and the
closing of the Springerville 3, we took a long look at what we could see going
out as far as a reasonable expectation of earnings per share. We were watching
what is happening to the equivalent companies of our size on the stock market,
and we felt that this was a premium at this point in time that was very good for
our shareholders.
MAURICE MAY, POWER INSIGHT - ANALYST 128
Thank you, Jim. Can you give us any insight as to what might happen to
Millennium between now and the closing?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 129
Millennium will continue to be operated as it currently is.
MAURICE MAY, POWER INSIGHT - ANALYST 130
Do you sense that KKR has any interest in Global Solar?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 131
Global Solar is really an intimate part of our renewable portfolio standard in
the State of Arizona and an integral part of TEP's environmental concerns. So I
believe that KKR and J.P. Morgan Partners and Wachovia Capital Partners see that
it is a part of an overall strategy, which is necessary for the base utility.
MAURICE MAY, POWER INSIGHT - ANALYST 132
Well, thank you folks and again congratulations.
OPERATOR 133
Howard Weissenfeld (ph), DKR.
HAROLD WEISSENFELD, DKR - ANALYST 134
I just wanted to clarify something. A gentleman earlier had asked whether there
was some kind of out for KKR based on the market for financing. It is clear that
if they have a financing condition, there is some kind of an ability for them to
walk away, and I was wondering what the nature of any outs they have within
their financing tax with banks or others?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 135
The investor group has to use [reasonable] efforts to close the financing, but
if they don't get it, they don't have to close. So it is contingent on the
availability of the debt financing.
HAROLD WEISSENFELD, DKR - ANALYST 136
But if we are voting on this transaction in the first quarter or second quarter,
we quite clearly don't have any kind of market out if for some reason we feel
our company is worth a lot more? Is there any reason why you negotiated that
kind of imbalance?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 137
The Company has as part of the agreement -- the agreement will be filed as part
of an 8-K. We do have a fiduciary out. The Board could effectively change their
mind if they decided to.
HAROLD WEISSENFELD, DKR - ANALYST 138
After the shareholder vote?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 139
Yes. [Section 6.03 of the Acquisition Agreement sets forth circumstances which,
prior to the shareholder vote, would permit the UniSource Energy board of
directors, in order to permit compliance with fiduciary duties, to withdraw or
modify the board's recommendation to shareholders to approve the transaction.
For such a change of board recommendation relating to an alternative proposal to
acquire UniSource Energy, the Acquisition Agreement may be terminated. In the
absence of any alternative proposal, the board of directors may, in order to
comply with its fiduciary duties, withdraw or modify its recommendation.
However, notwithstanding such a change in board recommendation, UniSource Energy
would continue to be required to hold a shareholders meeting and shareholders
would vote on whether to approve the acquisition.] This is the last question we
will take and the last one queued up.
OPERATOR 140
Aaron D. Nag (ph), Reuters.
AARON D. NAG, REUTERS - ANALYST 141
I just wondered if you could tell us what sort of growth rate are you expecting
over the next three to four years? Also, give us some idea on your cost of
capital going forward?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 142
Can you repeat that question?
AARON D. NAG, REUTERS - ANALYST 143
If you could give us some idea of your cost of capital you have taken into
account while valuing this transaction going forward?
KEVIN LARSON, UNISOURCE ENERGY - CFO, VICE PRESIDENT,TREASURER 144
The details in terms of the cost of debt financing at this point will not be
discussed, in part because we are really eight to nine months away from the
potential closing in the market. Terms will probably change, but the market will
dictate the way that is going now.
AARON D. NAG, REUTERS - ANALYST 145
Is there any kind of penalty fee if the deal does not go through from either
side, any breakup fee?
JAMES PIGNATELLI, UNISOURCE ENERGY - CHAIRMAN, PRESIDENT, CEO 146
Yes. There is a breakup fee in certain circumstances up to $25 million to be
paid by the company.
Thank you all for participating on our call concerning our transaction. We are
very optimistic on this transaction. We feel it is a very good transaction
vis-a-vis our shareholder as we look at our prospects going forward. We hope
that when you have a chance to review the proxy material, as well as the 8-K
material which will fully delineate the transaction, that you will come to the
same conclusion as we have.
Thank you. I look forward to talking to you again in the future.
OPERATOR 147
This concludes today's UniSource Energy investor conference call. You may now
disconnect.