Uranium, Inc.

hen the privatization of the U.S. Enrichment Corp. is completed-and it is expected to be finished sometime this year-it will be the largest spinoff of a federal agency since the complicated, $1.6 billion sale of Conrail, the government's former freight railway, a decade ago.

The sale of USEC, a wholly owned government corporation that enriches uranium so that it can be used as fuel for nuclear power plants, has the potential to be even more lucrative. But the proposed sale shows many of the pitfalls inherent in efforts to turn federal operations-particularly those with national security implications-over to the private sector.

If all had gone according to plan, the sale would have been closed by USEC's third anniversary last July. But it has been held up for a variety of reasons, ranging from finding an acceptable calculation of USEC's value to concerns about whether a privatized USEC would follow through on potentially unprofitable deals to purchase Russian uranium to keep it off the black market.

Whenever privatization comes, USEC and Clinton administration officials are sure taxpayers will reap the benefits. Price estimates range from the administration's estimate of $1.6 billion in its fiscal 1998 budget proposal to the General Accounting Office's best-case price tag of $3.5 billion.

USEC officials decline to speculate on the price because the corporation may be sold via an initial public offering of stock, and Securities and Exchange Commission rules bar them from talking about USEC's value. But in a June 1995 report recommending privatization, USEC estimated the price would be in the range of $1.5 billion to $1.8 billion. Subtract the transaction fees of $100 million or so to be paid to investment banking firms and a one-time payment to USEC of perhaps $200 million for working capital, and you have the share deposited into the Treasury.

"The government will receive a large check at the time of privatization,'' says Henry Shelton Jr., USEC's vice president and chief financial officer.

As of late February, no decision had been made on whether the U.S. Enrichment Corp. would be sold through an initial public offering or sold to a private company. But once it is in the private sector, the company-with annual revenues of about $1.5 billion-would rank among the top 300 industrial firms, according to the 1995 USEC report.

Despite the fact that Congress and the Clinton administration have already agreed to privatize USEC, the process has trudged along. As of early this year, USEC was waiting for the official go-ahead from President Clinton to begin the sale process. At his confirmation hearing in January, Energy Secretary-designate Federico Pena said that the "process is moving along," and he expected it to be completed this year.

That pleased Sen. Wendell Ford, D-Ky., who has been a major proponent of the sale. "It's taken us 10 years to get [here]. Let's hope it won't be 10 more. I hope we can do it this year," Ford told Pena.

"The USEC transaction has been complicated,'' says Mozelle W. Thompson, principal deputy assistant secretary of the Treasury for government financial policy and the department's point man on the USEC deal. "There are a lot of issues that are very complex that the federal government has never really considered very much before, or at least not for a long time.''

A Government Business

Talk of privatizing the United States' uranium enrichment business began at the executive branch level in 1969, when President Nixon asked the Atomic Energy Commission to operate its uranium enrichment facilities as a separate entity. At the time, nuclear energy was on the rise and the U.S. was the free world's only supplier of enriched uranium. Additionally, the facilities were operating at 40 percent of capacity and U.S. defense needs were waning. Nixon suggested that the government should get out of the business "at such a time as various national interests will best be served, including a reasonable return to the Treasury.''

The United States was the first nation in the world to turn raw uranium ore into nuclear fuel. Today, the enrichment process is the only step still in U.S. government hands. Before it is enriched, natural uranium must be milled into uranium oxide and converted into uranium hexafluoride, called "yellowcake.'' After being enriched, the uranium is sent to a fabricator, where it is turned into pellets or fuel rods.

USEC operates enrichment plants in Paducah, Ky., and Piketon, Ohio. Both employ a process called gaseous diffusion to increase the concentration of uranium isotope-235, the only part of uranium that can be used as fuel for commercial reactors. In its natural form, uranium contains less than 1 percent of isotope-235. At USEC's plants, it is enriched to up to 5 percent, depending on the customer's needs.

When the plants opened in the 1950s, they produced high-enriched uranium for defense purposes. Then, with the advent of nuclear energy, the government turned to manufacturing low-enriched uranium for commercial use. Now USEC only produces low-enriched uranium.

Since Nixon's recommendation that the United States get out of the enrichment business, several competitors have popped up in Europe, Asia and the former Soviet Union. These public-private conglomerates have been more responsive to the market and sold enriched uranium at cheaper prices than the United States. Consequently, they've cut the U.S. world market share from a virtual monopoly to a little more than 33 percent. As those foreign entities began selling to nuclear power plants in the United States, the Energy Department did little to prevent it. USEC now sells commercial-grade uranium fuel to about 80 percent of the U.S. market.

In 1990, Congress, fearing that domestic utilities were too often turning to foreign suppliers for enriched uranium, began seriously considering selling the uranium enrichment operation so that it would be more competitive. The effort got a huge boost when a report from the investment banking firm of Smith Barney, Harris Upman & Co. estimated that the sale of enrichment facilities could net upwards of $5 billion, according to several sources who read the document. The report was presented to Congress by Smith Barney's William H. Timbers Jr., who is now USEC's president and chief executive officer.

Two years later, Congress passed the Energy Policy Act of 1992, which created the government corporation known as USEC and charged it with readying the uranium enrichment agency for sale. The corporation, which began operating July 1, 1993, was established to ensure a domestic supply of enriched uranium, but was also supposed to operate like a business to compete with foreign producers and earn profits free of congressional budget cycles and political whims. It has a board of directors, is owned by the U.S. government and pays an annual dividend to the Treasury. Since opening its doors, USEC has paid dividends of $30 million in 1993, $55 million in 1994 and $120 million in both 1995 and 1996. It expects to pay another $120 million in 1997.

Shelton attributes USEC's financial success to doing the "unglamorous things'' and "paying attention to detail,'' such as stepping up maintenance at the gaseous diffusion plants. That resulted in production records in recent years, which in turn generated more business.

"Normally you would think of plants of this type setting production records a couple of years after they're constructed and all the kinks have been ironed out,'' Shelton says. "These plants were built in the mid-1950s, but it happened to us in the '90s.''

Stock Option

While shoring up the day-to-day operations, USEC officials were developing a plan for privatization. They submitted the report to Clinton and Congress the day before USEC's second anniversary in 1995-as mandated by the Energy Policy Act. In it, Timbers and USEC's five-member board of directors recommended a "dual-path'' method, meaning they would simultaneously explore whether the corporation should be sold to another company through a merger or acquisition or to the public through a stock offering.

"The reason the dual path was chosen, even though it is substantially more work, was that [there] was quite a time between the submission of the plan and the actual transaction,'' Shelton says. "Markets could change and we needed to get the best deal for the U.S. government.''

Though USEC officials are ready to begin the sale process, they still need official presidential approval. USEC officials are hopeful they will get the go-ahead soon, so they will be able to complete the sale by this fall.

Several criteria must be satisfied under the Energy Policy Act before final approval of the sale: It must be the best financial deal for the government; USEC may not be sold to a foreign-controlled enterprise (or it will lose its Nuclear Regulatory Commission certification); and the new owner must maintain a viable domestic source of enriched uranium for commercial and national security uses.

Additionally, the Energy Policy Act bars current directors, officers and employees of USEC from buying stock in the initial public offering. Of course, whoever buys USEC could choose to offer stock options to employees down the road.

If USEC is acquired by another company, the new owner would decide who would run it. This, critics told The New York Times last August, gives USEC executives an incentive to push for the stock route because that would keep them in control and in position to cash in on stock options later.

Once USEC gets the go-ahead, eight investment banking firms hired by the corporation will help locate buyers. Morgan Stanley & Co. Inc. is the transaction manager, and will act as the lead player if the stock route is taken and as an adviser if USEC is bought by another company. The other firms that will assist in the event of a stock offering are: Merrill Lynch & Co. Inc., Dean Witter Reynolds Inc., Janney Montgomery Scott Inc., Lehman Brothers Inc., M.R. Beal & Co., Prudential Securities Inc. and Salomon Brothers Inc.

Setting the Price

Why sell USEC if it has been successful serving as a government corporation and has paid dividends amounting to more than $325 million in less than four years?

Because it will be even more successful as a private company, say USEC officials. A privatized USEC, they argue, will be able to raise capital for new technologies much more easily than under government management. That will enable the company to react faster to marketplace pressures and keep costs competitive, something it has only just begun to do in its quasi-government status. USEC also argues that maintaining labor peace and running a streamlined operation is easier in the private sector.

Losing the steady dividend flow should not be a concern, Shelton says, because the federal government will be collecting taxes from the privatized company. As a government corporation, USEC is exempt from federal and state taxes.

The ultimate answer to the question of whether selling USEC makes sense, though, depends on how much Uncle Sam can get for it.

In its 1995 privatization plan, USEC estimated its sale price to be between $1.5 billion and $1.8 billion. Using those figures, the General Accounting Office concluded a privatized USEC would return $1.7 billion to $2.2 billion to the Treasury over eight years. But, GAO said, USEC's projected price was too low because it was based on low-ball estimates of the company's value.

Nevertheless, in its fiscal 1998 budget, the Clinton administration scored the proposed sale at $1.6 billion. That's a far cry from the $5 billion figure included in the Smith Barney report.

"The amazing thing to me is the amazing shrinking price,'' says Richard Miller, a consultant to the Oil, Chemical and Atomic Workers union. "It's possible the government could get fleeced.''

That won't happen, says Robert Civiak, a program analyst in OMB's energy and science division, who spends half his time on the USEC deal. OMB studies indicate that "the projected sales price is several times the value of keeping [USEC] in the government,'' says Civiak.

"People who were estimating the value of the company over time got a better understanding of the company and its value,'' says Thompson. "I'm hoping [the $1.6 billion budget score] is a conservative number. I think it's a matter of testing the market. Fortunately, we have a very good market and strong economy now, and I'm cautiously optimistic that we will do better than that.''

The Pitfalls of Privatization

Even if the government does get a good price for USEC, some analysts question whether putting uranium enrichment in private hands is a wise idea. USEC's recent negotiations to purchase Russian uranium point to some of the problems inherent in privatizing such a sensitive function.

Under an agreement signed in 1993, USEC plays the role of executive agent in purchasing uranium that Russia has blended down from weapons-grade quality to reactor fuel. The problem with that arrangement, critics say, is that in the interest of protecting national security by making sure Russian uranium stayed off the black market, the deal forced USEC to buy uranium at above-market prices and sell it to its customers below cost. The Russians could potentially renegotiate the deal every year and force USEC to pay more for the uranium. That made USEC uncomfortable.

In early 1996, according to The New York Times, USEC declined a Russian offer to purchase six more tons of material than it was contractually required to buy. The decision enraged Sen. Pete V. Domenici, R-N.M., who arranged part of the deal as chairman of the Senate Appropriations Energy Subcommittee. Domenici complained to Deputy Energy Secretary Charles Curtis, who leaned on USEC, the newspaper reported. Finally last November, USEC agreed to an amended deal that clarifies how much uranium USEC must purchase from Russia and for what price.

Still, the new pact only runs through 2001 and covers about one-third of the uranium the United States has pledged to buy.

All of which begs the question of whether it is appropriate to set up a private firm to act on behalf of the government in a sensitive area like buying uranium. Harold Seidman, a senior fellow at National Academy of Public Administration, says it's not a problem so long as the government compensates the company for decisions it makes that are detrimental to its business but in line with the country's objectives.

However, Seidman argues that in the absence of explicit direction from Congress, the private firm should have no obligation to make national security a paramount concern. "The problem is that for a private, profit-making company with stockholders, the board of directors' fiduciary responsibility is to that corporation,'' he says. "You try to earn them money on their investment.''

Despite such concerns, which have long delayed the effort to put USEC on the market, Shelton says the privatization is "an excellent opportunity to do something very important in government.'' He says it fulfills the mandates in the 1992 Energy Policy Act and pays a financial reward for 40-plus years of investments for taxpayers.

"In my eyes, this is a win-win situation,'' Shelton says. "And along the way it demonstrates what can be done if the right processes are put in place.''

Eric Moses is a reporter for City News Service, a regional wire service in Los Angeles.