Oregon Public Utility Commission Rejects Texas Pacific Group's Application to Acquire Portland General Electric Company

By John A. Cameron
[March 2005]

In a unanimous decision issued March 10, 2005, the Oregon Public Utility Commission (OPUC or “Commission”) rejected the leveraged buy-out of Portland General Electric Company (PGE) proposed by Texas Pacific Group (TPG), a private equity management firm. The order was issued in OPUC Docket No. UM 1121. The order brings to a close TPG’s effort to acquire PGE from bankrupt Enron Corp., holder of
100 percent of PGE’s equity. Assuming the OPUC does not reverse itself on rehearing, Enron is now left with two alternatives—either finding another buyer or distributing PGE’s equity shares to unsecured creditors in its bankruptcy proceeding. The latter alternative would recreate PGE as an independent, Portland-headquartered corporation with its stock traded on a public exchange.

It was not particularly troubling to the OPUC that the likely effect of its rejection order would be to prolong the time PGE will remain under Enron ownership. The Commission was comforted by the fact that Enron has allowed PGE to continue serving its 750,000 retail customers in the Portland metro area and the Willamette Valley as a stand-alone company. Unlike its parent, PGE is not bankrupt. It retains an investment-grade credit rating with a stable cash flow and a corporate focus on local operations. Far from viewing the status quo as a serious negative, the Commission viewed PGE’s current condition as an acceptable base case against which to assess the alleged pros and cons of TPG’s acquisition.

In making that assessment, the OPUC held that the applicant had the burden under Oregon law of demonstrating by a preponderance of evidence that the acquisition would yield a “net benefit” to PGE’s customers while also imposing no detriment on other Oregon citizens. This standard is more onerous than the one applied in other states where “no harm” is the rule by which utility mergers and acquisitions are judged. Thus, TPG was required to show that its acquisition would improve on PGE’s status quo situation, which the Commission viewed with some favor.

The acquisition proposed by TPG entailed the formation of Oregon Electric Company, LLC, a new public utility holding company with the sole purpose of acquiring and holding 100 percent of PGE’s common stock. TPG would have 79.9 percent of the economic interest in Oregon Electric and 5 percent of the voting control. However, the remaining 95 percent of voting rights would be subject to TPG rights of consent. The purchase price, fees and expenses of the acquisition would approximate $1.47 billion. The acquisition was to have been financed with $524 million in equity from TPG and other investors, $707 million in new Oregon Electric debt with the rest coming from $240 million in PGE retained earnings that were to be given to Oregon Electric in the form of dividends when the acquisition closed. Debt service on the Oregon Electric debt would be funded with future PGE dividends. TPG was candid in acknowledging that its investment strategy involved future sale of its PGE investment within 12 years.

The OPUC order is long on details about the “potential harms” of the proposed acquisition, which it found substantial, and short on “potential benefits,” which it found to have little or no value to PGE ratepayers. Fundamentally, the order is a statement that the Commission does not like the idea of a leveraged utility buy-out. The transaction was dependent on an amount of debt, including variable-rate debt, which the Commission found excessive. The specter of a lower credit rating for PGE and the pressure on PGE to pay dividends to Oregon Electric to support acquisition debt loomed large for the OPUC. “We find that these potential harms point to the possibility that PGE will not be able to raise capital as cheaply as it would as a stand-alone company.” Applicant’s proposed safeguards and assurances to the contrary proved unconvincing to the Commission.

TPG’s stated intention to resell its investment was also a major point of concern to OPUC staff and the intervenors who argued that TPG would be motivated to cut costs inordinately in order to enhance profits and thereby obtain a higher resale price for its PGE asset. Although the OPUC was not thoroughly convinced by these arguments, it was troubled by pragmatic limits in the effectiveness of regulatory oversight. “The Commission has broad regulatory authority, but the utility will always have better information about its system and operations.” The OPUC was concerned that any TPG decision to shortchange PGE O&M or utility investments might not come to light until after a detriment had occurred—perhaps not until after TPG had resold its investment to successor.

Interestingly, the OPUC rejected an argument by TPG’s opponents that regulation would be hamstrung by the fact that TPG is not a publicly traded company with publicly available financial records. The Commission held that it had adequate statutory authority under ORS 756.040 “to protect … customers … from unjust and unreasonable extractions and practices and to obtain for them adequate service at fair and reasonable rates.” The OPUC read this authority to apply both to PGE and to TPG, as an entity exercising control over PGE. Similarly, ORS 757.511, governing utility-affiliate transactions, would apply to PGE and its affiliate, TPG.

In its treatment of the acquisition’s “potential benefits,” the OPUC reviewed seven different claims by TPG. The first related to a proposed rate credit of $43 million to retail customers, spread over a five-year period commencing in 2007. This was found to be “only minimal benefit to customers,” in part because the proposed credit was made subject to offset against any other rate reductions the OPUC might order in future rate cases. Five other alleged benefits were found not to be dependent on the proposed transaction and likely to happen even if TPG’s application were rejected. Thus, the OPUC discounted (1) TPG assurances regarding certain indemnifications by Enron, (2) extension of certain existing PGE “service quality measures,” (3) TPG’s assurance of a “local focus” by an Oregon Electric board of directors consisting of at least five Oregonians, (4) annual monetary commitments to low-income customers, and (5) the observation by TPG that its acquisition would accelerate the end of Enron ownership. Finally, the OPUC rejected TPG’s offer of its expertise in turning around troubled companies, largely because TPG has no prior experience in the utility industry.

Given this analysis, the OPUC found no “net benefits” that would allow it to approve the transaction. Although holding the applicant to this higher threshold standard, the Commission probably removed this legal issue from any subsequent appeal by deciding in effect that the applicant had not even met the lesser “no harm” standard. “We conclude that the collective risk these harms represent outweigh the potential benefits of the acquisition, which we have shown are minimal.”

Significantly, the Commission declined the opportunity to rebalance the pros and cons by crafting a set of conditions that TPG would be compelled to satisfy in return for OPUC approval. Staff and intervenors had presented a host of possible conditions. The OPUC declined to accept them, determining that it had no basis to decide on the appropriate set of interrelated conditions and that doing so would essentially require it to rewrite the applicant’s proposal. It also concluded that many conditions proposed by intervenors were unrelated to the proposal and thus beyond the OPUC’s authority to impose.

This case had several sidelights that attracted more than its share of media attention, including personal scandal. Two side issues commanded the attention of the OPUC. First, TPG’s due diligence studies of the proposed transaction, submitted to the OPUC under protective order, were leaked to the media by one or more parties to the case. The Commission viewed this ethical breach as detrimental to future proceedings. “We intend to investigate and determine how the protected documents were disclosed, and to take appropriate action.” Second, much was made in the media of the fact that for several years Enron paid no federal or state income taxes while PGE retail rates included projected costs reflecting significant tax liabilities. Enron was able to use deductions and losses available from its other businesses to offset PGE profits in Enron’s consolidated tax returns. Although this is proper under current OPUC ratemaking practice, a separate investigation of the treatment of taxes for ratemaking purposes has been opened, and the OPUC declined to address the issue in its order on the TPG acquisition.

TPG now has 60 days in which either to seek rehearing from the Commission or to appeal the administrative decision to an Oregon Circuit Court.

Please direct questions about this DWT Energy Advisory to:

John Cameron Portland, Oregon (503) 241-2300 JohnCameron@dwt.com

This Advisory is a publication of the Energy Department of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory is to inform our clients and friends of recent developments in energy law. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.

Copyright © 2005, Davis Wright Tremaine LLP.

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