Bringing the co-op advantage to new service areas.

• Author: Collet, Bill

In the early morning hours of November 1,2002, wire transfers were winding their way through the Federal Reserve banking system, and the Kauai Island Utility Cooperative (KIUC) was born with the closing of the $215 million purchase of Kauai Electric from Citizens Communications. With the upcoming third anniversary of this watershed event, two questions are worth pondering: 1) How has KIUC performed compared to expectations as a brand new cooperative financed with 100% debt? And 2) Was the KIUC acquisition a one-time event or the beginning of a trend for electric cooperatives across the U.S.?

As to the first question, KIUC has exceeded even the most optimistic expectations and is ahead of schedule on every financial metric. More than $10 million has been returned in rate rebates or patronage capital in just three years. The KIUC Equity Management Plan projects total patronage capital and rate rebates of more than $70 million in the first 10 years. Margins in 2004 totaled almost $13 million. Free cash flow after debt service has exceeded $32 million, and equity is now at eight percent, up from zero as of the closing, and on pace to reach almost 30 percent in l0 years. And it is of note that the cooperative's financial success has been achieved despite the continuation of rates in effect since 1995 with no base rate increases projected through 2013.

As to the second question, the KIUC transaction now looks like a model in a developing trend being replicated across the country--cooperatives are buying rural investor-owned (IOU) service territory, providing accelerated growth in cooperative membership for the 21st century. Since the KIUC transaction, Midwest Energy, Inc., in Hays, Kan., bought 10,500 customers from incumbent IOU Westar Energy; Vermont Electric Cooperative more than doubled in size by acquiring the adjacent IOU territory in northern Vermont; Rock County Electric Cooperative in Janesville, Wis., and Jo-Carroll Energy in Elizabeth, Ill., teamed to acquire all of the Illinois electric and natural gas customers of Alliant Energy through a competitive bidding process managed by Merrill Lynch & Co.; and Tri-County Electric Cooperative signed an agreement to acquire service territory in Oklahoma and Kansas from Southwestern Public Service (SPS), a subsidiary of Xcel Energy, Inc.

The stunning success of KIUC did not come easily, and lessons learned in the process were significant. Like all pioneers, KIUC's organizing board of directors has the scars to prove that being on the point will attract bullets and arrows. On the afternoon of August 14, 2000, the KIUC board learned via fax that the Hawaii Public Utilities Commission had denied their first attempt at the acquisition. It seemed that the dream of the first cooperative utility in Hawaii would never become reality. But some goals are just too worthy to abandon, and with the tenacity and dedication befitting his Marine Corp training, KIUC's chairman simply refused to allow the dream to die on the battlefield.

Victory--At Too High a Price

In July 1999, Citizens Communications headquartered in Connecticut--made the strategic decision to exit their regulated utility businesses and focus on telecommunications, a move prompting the sale of Kauai Electric on the Hawaiian Island of Kauai. Dedicated Kauai citizens quickly formed an Interim Organizing Board of Directors for the islands' first cooperative. The KIUC board, working under an extremely constrained timeframe, formulated an offer in the competitive bidding process. After several rounds of bidding, the good news was that KIUC won the bid! The bad news was the purchase price had escalated to almost $300 million all-in.

"In the first deal, the initial price we offered was not that far off from what we ended up paying with the second, successful transaction," said Gregg Gardiner, KIUC chairman. "But, we didn't have the expert negotiator with big deal experience on our side. We were out-gunned and out maneuvered throughout the process. We wanted so badly to control our energy destiny that we were afraid to let the deal go."

Indeed, the price became the focal point for community opposition and, ultimately, caused the PUC to turn the deal down because the financial projections showed no margin for error, likely prompting a rate case.

KIUC was challenged to reestablish its credibility and better prepare for another transaction. "Acquisitions involve professional skill sets that are not part of the toolbox we use to run our everyday business," Gardiner said. "As smart as we thought we were, we learned the hard way what we should have understood already--you don't go to your dentist if you need major surgery. There is a layer of sophistication that comes with multi-million dollar deals that adds a significant...