[No. 819] IN THE MATTER OF PEOPLES LIGHT AND POWER COMPANY File No. 56-32. Promulgated July 24, 1939 SALE OF PUBLIC UTILITY SECURITIES BY REGISTERED HOLDING COMPANY. Application, filed by a registered holding company pursuant to Section 12 (d) of the Public Utility Holding Company Act of 1935 and Rule U-12D-1 promulgated thereunder, for approval of the sale of all the outstanding securities of its subsidiary, approved, there appearing to be no affiliation between the purchaser and the applicant or its subsidiaries the requirement for maintenance of competitive conditions is met, the consideration being not unreasonable and the sale a logical step toward partial compliance with the integration requirements of Section 11 of the Act. FINDINGS AND OPINION OF THE COMMISSION Peoples Light and Power Company, a registered holding company, incorporated in the State of Delaware, has filed an application pursuant to Rule U-12D-1 promulgated under Section 12 (d) of the Public Utility Holding Company Act of 1935. The application is concerned with the sale by Peoples Light and Power Company (hereinafter sometimes called "Peoples") of all the outstanding securities of its subsidiary, Kansas Public Service Company, also a Delaware corporation (hereinafter referred to as "Public Service”), consisting of $350,000 principal amount of 5% first mortgage bonds, due 1961 and 2,000 shares of common stock without par value. The voting trustees of Peoples Light and Power Company appointed pursuant to a voting trust agreement, dated February 9, 1938, have also filed an application pursuant to Rule U-12D-1 in connection with this transaction. A hearing was held after appropriate notice. No member of the public requested to be heard. The applicant has waived the right to have submitted to it a report by the trial examiner; to have submitted to it proposed findings of fact by the Commission; to file a brief and to oral argument before the Commission prior to the making of findings of fact and the entry of orders by the Commission. Having considered the record, the Commission makes the following findings: Public Service is a gas utility company, purchasing natural gas under a long-term contract from Cities Service Gas Company, a non affiliated company, and distributing such gas to the general public in Lawrence, Kans., and environs. The property of Public Service consists principally of a gas distribution system which contained, at December 31, 1938, 4,721 gas meters and 74.78 miles of gas distribution mains. The capitalization including surplus of Public Service, as of February 28, 1939, was as follows: First mortgage bonds, series A, 5% due 1961. The property account of Public Service as of February 28, 1939, was recorded at $775,007, of which $678,760 represents tangible property and $96,247 intangibles.2 The retirement reserve of Public Service, as of February 28, 1939, was recorded at $296,491, equivalent to about 44 percent of the gross tangible property account. The net tangible property account per books as of that date was therefore $382,269. Accordingly, the longterm debt of Public Service is equal to 52 percent of its gross tangible property and 92 percent of its net tangible property, as of February 28, 1939. Operating revenues of Public Service for the 12 months ended February 28, 1939 were $266,038. Operating expenses and taxes, including provision for retirements were $242,496, resulting in gross 1 The gross operating gas revenues of Public Service for the 12 months ending February 28, 1939, were $264,112, of which approximately 66 percent was derived from residential sales, about 13 percent from commercial sales and about 21 percent from industrial sales. The gross property account, it is stated, is based on an appraisal of reproduction value new, determined by Ralph E. Davis, engineer, as of July 1, 1926, of $681,826, plus subsequent net additions at cost of $93,181. It is stated that while all the records of the predecessor company of Public Service are not available such predecessor company acquired the gas properties in Lawrence, Kans., in 1905 for $505,000, consisting of mortgage bonds ($225,000), capital stock ($240,000), and cash ($40,000). Expenses incident to the change from manufactured to natural gas of $20,000 were also incurred. According to an audit report the amount of $525,000 is believed to include a considerable amount, stated to be $300,000, for "good will." The record discloses that an affiliate of Public Service purchased at arm's length the property of the predecessor of Public Service in 1926 and 1927 for $420,021, consisting of cash ($395,000) and other expenses ($25,021). These properties were transferred in January 1927 by such affiliate to Public Service, which had been incorporated in December 1926, for $534,366, consisting of first mortgage bonds ($300,000) and common stock (stated value $234,366). The consideration was based on the above-mentioned appraisal by R. E. Davis which, as of July 1926, determined a reproduction cost new, of $681,826, and observed depreciation of $147,460 resulting in a reproduction value new, less observed depreciation, of $534,366. There appears, therefore, an intercompany write-up of $114,345. It is stated that no revaluations of fixed assets have been noted on the books of the Public Service since its inception. 3 operating income of $23,542. Total gross income amounted to $21,954. Thus interest on the first mortgage bonds, amounting to $17,500, was earned 1.25 times for the 12 months ended February 28, 1939.* THE AGREEMENT OF SALE The securities of Public Service are, according to an agreement dated May 1, 1939, to be sold by the applicant, Peoples Light and Power Company, to one D. E. Dunne, Jr., of Wichita, Kans., for $410,000 in cash, plus interest from March 1, 1939 at 5% per annum, until the date of final payment. It appears from the record that Mr. Dunne, who is a municipal bond dealer, is not affiliated with the applicant or any of its subsidiaries. There are several methods of arriving at an approximate value of the properties of Public Service and thus an approximate value of the securities which are being sold: (1) The purchase at arm's length in 1926 and 1927, heretofore mentioned, at a price of $420,021, plus net property additions, less the accumulated retirement reserve since that date, results in a value of $364,171 as of February 28, 1939. If to this were added net current assets at that date of about $76,000, a value of approximately $440,000 is arrived at. (2) A calculation similar to (1) above, using $225,000 as the value of the property in 1905 as taken from an audit report after eliminating "good will" estimated at $300,000, results in a value of about $404,000. (3) Capitalizing the income available for the securities to be sold at various rates, and adding thereto the net current assets results in the following values: Public Service has followed, since 1936, the depreciation policy of accounting by charging annually to income an amount equal to 2.675 percent of the gross book value of depreciable property. For the 12 months ended February 28, 1939, provision for retirements was equal to 6.7 percent and maintenance to 2.7 percent, a total of 9.4 percent of gross revenues. • During 1938 Public Service paid $3,000 in common stock cash dividends to the applicant. In April 1939 Public Service declared out of earned surplus and paid in corporate property 594 shares class B common stock, $1 par value, and 594 shares cumulative convertible preferred stock, $25 par value, of the applicant. Rule U-12D-1 requires us to find that the consideration to be received is not detrimental to the public interest or the interest of the investors or consumers. The sale price was arrived at following negotiations at arm's length. Furthermore, such price appears to be justified in the light of the above recited figures of capitalized income. We find, therefore, that the consideration to be received is not detrimental to the public interest or to the interest of investors or consumers. It is stated that a commission of 3 percent of the purchase price, is to be paid to one C. B. Holmes, a real estate dealer in Lawrence, Kans. The record discloses that the management of the applicant made several attempts to dispose of the properties of Public Service, all of which were unsuccessful. Mr. Holmes, it is stated, was instrumental in procuring the buyer for the securities of Public Service. The record shows that Mr. Holmes was in touch with various prospective buyers without success until he finally succeeded in interesting Mr. Dunne. Mr. Holmes stated that he attempted to find a buyer for Public Service in 1938 and spent considerable time and effort in doing so. Since October 1938 he has spent most of his time on this sale. Mr. Holmes contrasted his commission of 3 percent of the purchase price to schedules of commissions on the sale of business properties of the Real Estate Board of Kansas City, Mo. Such schedules establish a sales commission of 5 percent on the first $25,000 of the selling price and 3 percent on any balance over $25,000. It was testified that the work involved in selling the securities of Public Service was more burdensome and required greater effort than the work involved in selling real estate for the same consideration. While the exact amount of fees and expenses, other than the sales commission, has not been definitely determined, such amount is, however, estimated as follows: Counsel for applicant---- Local counsel for opinion with respect to state laws_. 'Trustee and its counsel for release of securities. Transfer stamp tax (state and federal) – Out-of-pocket expenses-- Total $750.00 100.00 500.00 320.00 330.00 2, 000. 00 The fees and commissions as estimated amount to 32 percent of the purchase price or $14,300. We cannot say that such fees and commission are unreasonable or detrimental to the public interest or the interest of investors or consumers. THE PROCEEDS FROM THE SALE The securities which are the subject of this sale, together with other securities, are pledged with the trustee under applicant's indenture securing its collateral lien bonds. Such indenture requires the deposit of the proceeds from the sale of any securities as a basis for their release from the lien. All monies received by the trustee in substitution for securities released from the lien thereof may at the request of the applicant be applied to the payment of the principal of outstanding bonds upon redemption thereof at the principal amount plus interest, or the purchase of bonds in the open market or on tender at less than par, or paid over to the applicant upon pledge and deposit of substituted security consisting of securities of subsidiary companies. As yet no decision has been made as to how the proceeds will be used. FUTURE OPERATION OF KANSAS PUBLIC SERVICE COMPANY Mr. Dunne, the proposed purchaser of the securities, testified that there was no intention of selling the common stock to the public, and that if any was sold privately it would be sold up to 50 percent to Mr. George Docking, of Lawrence, Kans. It will be held for investment. It was further stated that he expects to follow the present operating and financial policies of Public Service, and no change in personnel is presently contemplated. It is planned to retire the presently outstanding mortgage bonds of Public Service with the proceeds from the sale to the public of new mortgage bonds in the principal amount of $350,000 secured by a lien on all the property of Public Service. As we have indicated earlier in this opinion, a long-term debt of $350,000 amounts to 52 percent of Public Service's gross tangible property per books and 92 percent of its net tangible property per books. This latter ratio is unreasonably high. While it is true that in 1937, in In the matter of Peoples Light and Power Company, et al., 2 S. E. C. 829 (1937), as part of a reorganization plan, we permitted a declaration regarding these securities to become effective, it was pointed out that we felt bound by a release of this Commission's General Counsel, and did not, therefore, feel free to insist upon changes in the terms of the securities being issued. However, we feel it our duty to state that if the reserve for depreciation reflects an accurate depreciation of the property (and we express no opinion as to it), and further if the question of the issuance of the same amount of bonds were before us now, with no increase in the property account, it is doubtful that we would permit a declaration to become effective. 5 The new bonds will be issued under a closed mortgage, will bear 4% interest, and will mature serially over a period of from 2 to 20 See Holding Company Act Release 54. |