Why would anyone want to buy a troubled water utility with rotting pipes, angry customers and $1 billion of debt?
Because if you’ve got the time and the money, you’ve got a pretty solid formula for profit.
“What makes a utility that is struggling attractive is that you have well-established needs to make necessary infrastructure investments that are recoverable through customer rates" said Heike Doerr, principal analyst with S&P Global Market Intelligence.
In other words, the more that needs to be fixed, the more a utility can invest and recover at a rate of return that hovers around 10 percent on average.
That’s why private equity-backed infrastructure funds don’t shy away from aging utility systems like the Pittsburgh Water and Sewer Authority. They flock to them.
Peoples Natural Gas, the North Shore-based utility that has been vying for a deal to invest in the PWSA, wasn’t all that different from the water system when it was acquired by the SteelRiver Infrastructure Fund in 2008, said Peoples CEO Morgan O’Brien.
That's why it would be a neat fit for the private equity fund, he said this week. While his proposal hasn’t gotten off the ground, he thinks it’s instructive to look at SteelRiver’s purchase of Peoples, T.W. Phillips in 2010 and Equitable Gas in 2013.
All were underfunded utilities with aging infrastructure that have been turned around with aggressive pipeline replacement programs and better management.
“It’s the same model,” he said. “It’s water, not gas, but it’s replacing old pipes with new pipes.”
San Francisco-based SteelRiver, which formed a decade ago, also owns electric transmission lines in California, a set of port terminals in the South, and a railroad company that operates in 13 states. It specifically targets infrastructure investments that have a long life and steady customer payments in environments where rates (and rates of return) are regulated.
On the day last February that Peoples announced its latest acquisition, a gas utility in Kentucky, Mr. O’Brien sent an e-mail to Mayor Bill Peduto and his then-chief of staff Kevin Acklin, attaching the press release about the acquisition. "We are a growing Pittsburgh based company that can execute transactions that protect the public, employees while increasing capital investment," he wrote in the e-mail.
Mr. Peduto had made it clear he wasn’t interested in privatizing the authority, so Peoples drafted its proposal in the format of a public-private partnership. Peoples offered to pay off all of the PWSA’s outstanding debt and then inject it with private capital to rehab the system.
Mr. Acklin recalled that the proposal, submitted last year, would maintain the annual payments to the city, valued at more than $7 million, and would contain a “certain level of pricing control” to keep rates from ballooning. He said the new capital would come from a combination of newly issued debt and equity.
While the PWSA board has been responsible for setting customer rates, the Pennsylvania Public Utility Commission plans to take over that function later this year. That means it will approve the rates of return on debt and equity.
Other regulated water utilities in Pennsylvania — several of which Mr. Acklin said expressed interest in PWSA — have realized average rates of return on equity between 8 percent and 13 percent since 2011, according to the latest data available from the PUC.
The PUC also has a separate mechanism to speed up pipeline replacements. Instead of spending the money to fix the system and then folding those costs into the next rate case, utilities are allowed to recover that investment as they go — through a customer surcharge. The permitted rate of return on that is 9.75 percent.
Ms. Doerr noted that while rates do often rise after a private company takes over a public system, that’s offset somewhat by cost cutting on the operations side and faster system improvements.
The idea of a natural gas utility getting into water isn’t unprecedented, she said, ticking off recent examples in Oregon and Connecticut.
“The business model is very similar. The regulator is similar. And the pipe replacement cycle is very similar,” she said.
Mr. O’Brien said the same this week.
“I’ve got my call center. I‘ve got my billing processes already in place. Every customer of PWSA is a customer of mine,” he said. “Not only that but I’m tearing up streets replacing gas lines. (On) those same streets, we could be replacing gas and water lines at the same time.”
While the conversations with the mayor's office had stopped last summer, Peoples is "absolutely" still interested in a deal, he said.
“I’m sitting on the sidelines hoping they reach the right conclusions.”
Anya Litvak: alitvak@post-gazette.com or 412-263-1455.
First Published: February 23, 2018, 3:33 p.m.
