Private Equity Ownership of Municipal Water in Montana

Lessons from the Sale of Mountain Water to the Carlyle Group

By Ada Montague

Water Privatization
What most people think of...

The Carlyle Group's Purchase of Mountain Water

Missoulian Headline Jan. 2, 2011:

"Carlyle Group: Major player in defense, aerospace set to buy Mountain Water Co."

Will this be Missoula's Future?

Thesis
The sale of Mountain Water to Carlyle is a keyhole through which to view the limited body of knowledge in Montana on private equity ownership of municipal water.

Background on Research

Community Service

Understanding the Sale of Missoula's Drinking Water

Four Parts to this Talk: 1. Facts: History of Missoula's Water Supply up through
recent Sale of Mountain Water to Carlyle

2. Issue: What does it mean for a private equity firm to own a

city's drinking water supply in Montana?

3. Rule: Law and Regulations at Stake 4. Analysis: Improvements to Montana's Regulations

Part I: History of Missoula's Drinking Water

Early Days Transfers of Ownership City's Attempts at Ownership o Missoula v. Mountain Water Co.
236 Mont. 442, 447 (Mont. 1989).

Sale to Carlyle
One-Eyed Riley or John Wayne?

Key Players in the Sale

1. The PSC 2. The City of Missoula 3. Park Water & Mountain Water 4. The Carlyle Group 5. The Montana Consumer Council 6. The Clark Fork Coalition

Outcome of the Sale

1. Negotiations 2. Agreements 3. Stipulations a. Ringfencing 4. Approval
""If I could negotiate in good faith with Park and Mountain today to purchase the utility, I would jump at the chance. Unfortunately, I'm left to take a leap of faith based on my understanding of business models, an old letter and hope that this process gives Carlyle what it needs to consider a sale to the City of Missoula when the times is right. I hope that time is much sooner than later." - Mayor Engen, PSC Proceedings re. Mountain Water sale to the Carlyle

Mountain Water's Water Rights

Water Uses 68 municipal 10 irrigation 1 multiple domestic well

Priority Dates

22 from 1868-1899 15 from 1900-1950 41 from 1951-1994 1 undated

Sources

47 from groundwater 16 from Rattlesnake Creek 9 from Miller Creek 7 from wells

Flow Rates

Total CFS: 226.37 Total GPM: 42,549.43

Total Volume Diverted

177,081.50 AF/yr

Part II: Issue What does it mean for a private equity firm to own a city's drinking water supply in Montana?

Part II: Issue

1. Private Equity vs. Privatized Water 2. Other Sales to Private Equity Firms 3. Conditions Imposed by Other Communities

Private Equity

Traditional Privatized Water Models

Private Water Companies in the World

Two companies, both based in France, control the majority of privatized water in the world:

Veolia Environment with subsidiaries in seventy-seven countries Suez Environnment with thirty-three subsidiaries on six continents.

Private Water Companies in the US

The United States is experiencing a trend towards privatization of public water services.

In 2000 private water companies owned about 16% of the nation's community water systems.

In 2009, 33% of all community water systems were privately held, approximately double the number since 2000.

Private Water Companies in individual States

The regulation of private municipal water is done by the individual states. The level of regulatory control varies greatly from state to state. Many states enable public entities to contract with private ones for longterm operation or lease of public water works facilities, or even to sell these facilities to private buyers, in some cases with few to no significant conditions to safeguard the public. However, other states have comprehensive privatization statutes that detail the types of privatization authorized, mandate specific standards and conditions, and provide procedures for the governance of local private water services.

The New Jersey Water Supply Public-Private Contracting Act, for example, has a series of twenty-seven statutes dealing with the provision of private municipal water.

Traditional Models Have Sometimes Proven Problematic

Atlanta, GA. 1999
1. 2. 3. 4. 20 year contract with United Water $21.4 million/year Canceled after 4 years an epidemic of water-main breaks and occasional boil only alerts caused by brown water pouring from city taps.

Private Equity Ownership of Municipal Water

1. New Trend 2. Only three other similar sales since 2005 3. Commission Reviews and Conditions

Other Private Equity Sales

AIG Global Investment Group (AIGGIG)

Conglomerate of international companies, managing approximately $532.9 billion in assets, with more than 1,600 employees in 44 offices around the world.
AIG Highstar Capital II, L.P. (Highstar) is AIGs equivalent of Carlyles Western Water Holdings. Highstar acquired Utilities, Inc., with approximately 305,000 customers in fifteen states. The review of the sale was subject to the review of each of the fifteen states public utility commissions and their various conditions.

Conditions
Pennsylvania:
Commissioner Wendell F. Holland issued a statement that AIGs corporate structure is complex and lacks transparency. It may not be in the public interest to have these regulated utilities as a part of an organization structured in this manner." Nevertheless, the Commission approved the sale.

Kentucky:
Highstar must "adequately fund, construct, operate and maintain Water Services treatment, transmission, and distribution systems; comply with all applicable Kentucky statutes and administrative regulations; and supply the needs of Water Services customers."

Florida:
In Florida, a citizen of one of the sixteen utilities in the state objected to the sale based on two issues; (1) lack of response to water quality, which exceeded state standards for levels of trithalomethane (TTHM), and (2) that the lack of operational utility experience of the buyer. The Florida PSC found that the citizen did not allege facts sufficient to show that he has a substantial interest in the outcome of the proceeding and that the buyer had provided sufficient details to show it was experienced in water and wastewater operations.

Other Private Equity Sales

Macquarie

Macquarie is a global provider of banking, financial, advisory, investment and funds management services with more than 70 offices in 28 countries." Aquarion operates in New England and was one of the ten largest privately owned municipal water suppliers in the US at the time of the sale. The sale fell under the purview of the public utility commissions of Connecticut, Massachusetts, New York and New Hampshire.

Conditions

Settlement Agreement: o Maintain the companys current management structure o Maintain a customer advisory council o Not seek to recover costs of the acquisition or maintenance of pension o
plans through rates To continue to maintain an office for bill payments and customer service in New Hampshire

Required New Hampshire Public Utility Commission to make a finding that: o Indirect acquisition of Aquarion-NH by Macquarie would not result in
adverse impacts on rates and was consistent with the publics interest.

Other Private Equity Sales

JP Morgan/Water Asset Managements

merger with SouthWest Water Co. (SWWC) in 2010. JP Morgan is a private equity firm, but its investment strategy is based solely on real estate and infrastructure. As of June 2010 the company had approximately $44.6 billion in real estate and infrastructure assets under management. SWWC is based in Los Angeles, CA. and operates 130 regulated water and wastewater systems representing about 160,000 residential and business connections in Alabama, California, Mississippi, Oklahoma and Texas. The merger was negotiated for approximately $275 million in cash. The merger functioned similarly to the ones previously discussed in this section, with individual state utility commissions review and approval.

Conditions

Settlement Agreement:

o o

19 general conditions 16 transaction rules

Conditions:

customer service, basis for rates, outstanding debt, and the capital
needed to run the public utilities in question

Transaction rules: o access to information, treatment of employees and affiliates, transfer

of property and debt, confidentiality and pricing of services

California Public Utilities Commission Review of Park Water Sale to Carlyle

Settlement Agreement: o Sets forth the regulatory practices and policies that will govern rates
and that rates will only be increased in accordance with CPUC approval.

Adjudicatory Judgement: o Mojave Basin adjudicatory judgment applied to the water rights held
by Park Waters subsidiary, Apple Valley Ranchos Water Company.

These water rights cannot be encumbered, diminished, or transferred by Ranchos, Western Water Holdings LLC, Carlyle Infrastructure Partners Western Water L.P., or Carlyle Infrastructure Partners, L.P., without specific order by this Commission.

Conditions: o Submission of a proposed plan for orderly transition by Carlyle within

eighteen months of the transactions completion

The provision of water is not like the provision of goods and services typical of the private sector.

Part III: Law and Regulations

Public Trust Doctrine o Background law based on Jus publicum Roman legal principle that certain aspects of the land, such as water were held by the government in trust for the public.

Part III: Law and Regulations

Montana Constitution
o

Mont. Const. Art. IX, 1 (2011) "The state and each person shall maintain and improve a clean and healthful environment in Montana for present and future generations." Mont. Const. Art. IX, 3(3) (2011) Inalienable right to basic human necessities such as water

Part III: Law and Regulations

Montana Statutes
o Regulation of municipal water Mont. Code Ann. Title 7, Chapter 13, Parts 43 & 44 o PSC authority to review sales Mont. Code Ann. Title 69 69-3-402. Action to challenge commission order. (1) Any party in interest being dissatisfied with an order of the commission fixing any rate, fare, charge, classification, or joint rate or any order fixing any regulation, practice, or service may, within 30 days, commence an action in the district court of the proper county against the commission and other interested parties as defendants to vacate and set aside any such order on the ground that the rate, fare, charge, classification, or joint rate fixed in such order is unlawful or unreasonable or that any such regulation, practice, or service fixed in such order is unlawful or unreasonable.

Part III: Law and Regulations

Montana Administrative Rules
o

Admin. R. Mont. 38.5.2506: PSC Review

Part III: Law and Regulations

Settlement Agreements & Stipulations

Agreement with the Mayor and the Clark Fork Coalition o Right of First Refusal o Protection of watersource Agreement with the MCC o Ringfencing

Part IV: Analysis

The privatization of municipal water is best authorized through comprehensive state legislation that sets forth the types of privatization authorized and the standards, conditions and procedures for approval and governance of locally privatized municipal water.

National Regulatory Research Institute - Red Flags

If the new company operates less efficiently or at a higher cost

Is forced to sell necessary assets to buy down acquisition debt

Installs management unfamiliar with a regulatory environment Compensates that management based on performance criteria inconsistent with the utility's public service function

Cuts costs in areas necessary for the maintenance and improvement its service quality
If the change of control is able to effect substantial cost savings, and those cost savings are not passed on to customers

Part IV: Analysis

Improvements to Montana's Regulations
1. Enumerating what types of water privatization is permissible and under what conditions. 2. Linking the PSCs review to Montanas existing environmental and health oversight bodies may improve accountability to the public. tandem review between PSC and the DNRC o future rate change decisions o any future negotiations to purchase o future sales of municipal water supplies tandem review between PSC and the DEQ o already implicated in the review of Carlyles ownership of

Mountain Water through its Public Water Supply Program

Analysis: Improvements to Montana's Regulations

Water Coordinator Position

Conclusion
The PSC's approval to sell Mountain Water to the Carlyle Group may result in:
1. Improved infrastructure 2. The chance for the City to finally obtain ownership

Conclusion
It may also result in:
1. Increased rates 2. Lack of public control for the foreseeable future 3. Poor service

Now What?
Only Time Will Tell.... 1. Stay informed 2. Contact your representative at the PSC with your concerns 3. Be aware of DNRC's pending adjudication of the Missoula Valley