Acquisition Adjustments
Selby P. Jones III
Principal, AUS Consultants
ausconsultants.com
@ausconsultants
AUS Consultants
Services provided:
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Offices:
Rate of return
Cost of service & rate design
Depreciation analysis
Lead/lag studies
Business Enterprise Valuation
Public/private partnership
Valuation
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ausconsultants.com
Mount Laurel, NJ (HQ)
Camp Hill, PA
Greenville, WI
Tejeras, NM
@ausconsultants
What is an Acquisition Adjustment?
Adjustment for the difference between the depreciated original
cost of a utility and the purchase price for that utility
General premise of adjustment – allows necessary investment in utility
infrastructure
• Done by one system purchasing another system that does not have ability to upgrade
their infrastructure otherwise
NAWC/NARUC Best Practices
• Enables utilities to provide safe and reliable service to their rate payers through
policies and mechanisms
Reasons to Acquire a System
• Systems too small to generate enough
revenues through reasonable rates
• Troubled/non-viable systems
• Quality of service issues
• Environmental regulations not being met
Benefits to Customers
• Repair/replace infrastructure
• Better quality of service
• Rates stay reasonable even
with better quality of service
Benefits to Acquiring Companies
Encouraged Consolidation
• Incentives (Acquisition Adj. or Higher ROE)
• Add to existing rate base and number of customers
• Consolidation of Several Small Systems at once
• Buying multiple smaller systems to add to rate base/revenue stream
Potential of filing separately from general rate case to institute new
acquisitions into rate base (depending on the state)
Low cost financing is easier to obtain for larger utilities
• Can be used as part of infrastructure replacement once utility is acquired
Potential Challenges to Acquiring
Systems
Proximity of acquiring to acquired system
• Systems should be in close proximity to
one another
Mutual agreements – willing buyer and willing
seller
• Generally, business best-practice – just
good business
• Current Market-to-Book Ratios
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Electric Companies – 164.5%
Combination E&G – 181.0%
Gas Companies (LDC) – 188.9%
Water Companies – 216.3%
• Risk associated with this gap
• Some or all booked assets may not be
allowed to be claimed in rate base (premium
may not be allowed in RB)
• Acquisition could be seen as credit negative
by ratings agencies
Gap between book value and market value
• Challenge is getting fair market value
• Original Cost Study – can be done by both
acquiring and/or acquired utility
• Valuation methods – values systems based
on income, cost and market models
Consumer Advocate Groups – need to
provide burden of proof
• Definition of burden of proof can be different
between utility/advocacy groups
Credit Ratings – How Are They Affected?
Dependent on the overall viewpoint – results are mixed
• One company may be seen as favorable, the other is not
• Both can be seen as credit positive or both seen as credit negative
• Current Acquisitions
• Wisconsin Energy Purchasing Integrys Energy
• WEC keeps A- rating but is on ratings watch negative, subs currently unaffected
• Due to increased leverage once TEG is added to mix
• Delays management’s plans to reduce current parent level debt
• Rating could take effect if cash flows are affected via rate freezes / ratepayer concessions
• Nextera Energy Purchasing Hawaii Electric
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NEE maintains A- rating
FPL maintains A rating
HE mantains BBB+ rating
Improves on current NEE business risk profile due to NEE’s operational performance, renewable
energy development and cleaner fuel profile
ROE Changes
Acquisition Adjustments may be a reason to lower/raise utility
ROE
• Because it is an incentive mechanism
• Reduces regulatory burden
• Aligns customer/shareholder interests
If adjustment is reflected in rate base, the ROE may be lower
Possibility that states who offer any type of adjustment could
grant a lower ROE since there is compensation elsewhere in
the rate filing
• This is not an end-all-be-all, the exact opposite could be true
• The need to weigh benefits/drawbacks to customers becomes evident
Rate Base Formula for Adjustment
1.
Option: Take dollar-for-dollar amount of acquisition cost and add to rate base
2.
Option: California PUC
• Fair market value establishes rate base value
• If it exceeds reproduction cost, it is up to the commission to determine if the excess is fair and reasonable
3.
Option: Pennsylvania PUC
• Credit acquisition adjustment – if utility pays less then depreciated original cost, the difference
is amortized as an addition to income and add in depreciated original cost into rate base
• Debit acquisition adjustment – if utility pays more than depreciated original cost, then excess is
included in rate base unless it does not meet requirements set forth in 66 PA. C.S. 1327 (a)
• Utility needs to provide burden of proof
Rate Base Formula for Adjustment
Market-to-Book Adjustment for Rate Base
• Utilities should be allowed to maintain a market-tobook of 100%
• Market-to-Book for AUS Utility Report Groups
• Electric – 164.5%, Combination E&G – 181.0%, LDC –
188.9%, Water – 216.3%, Average Utility – 187.7%
• Formula
• MTB x BV of Acquired Utility = New Addition to Rate Base
ROE Formula for Adjustment
ROE Formula for Adjustment
ROE Formula for Adjustment
Note: Acquisition Adjustment is 1/4 of spread from previous slide.
Incentive-Based Acquisitions
States at the Forefront
• Arizona
• Pennsylvania
• North Carolina
Arizona
2014 NARUC Summer Committee Meeting
• Presentation from Chairman Bitter-Smith
• Spoke about the process of working with larger/financially stable utilities to
purchase small/non-viable utilities (revenues under $250,000/year)
• ACC is in process of first case
Policy
• Applies only to positive acquisition adjustments
• recovery is amount paid above book value (Negative acquisition is not recognized
in rate base)
• OR utility can opt for premium to the rate of return
• Either scenario is determined by ACC Staff
North Carolina
Increases rate base on a dollar-for-dollar amount for acquisition
costs
• Also accounts for repairs that will be done or are done prior to the next
rate case
• Need to provide evidence that overpayment for acquired utility was
prudent and customers will not be negatively affected by the acquisition
Next Steps
Where to go from here…
• Wait & See Approach
• Begin Immediate Implementation of Adjustment
• Do Nothing
What state commissions should consider…
• How much of an adjustment to give utilities
• Whether to do rate base or ROE adjustment, both or neither
Should commissions implement this type of adjustment…
• YES! It looks like a positive scenario for all parties involved in utility
service
Conclusion
Overall, acquisitions are beneficial for all parties concerned
• Utilities
• Customers
• State Commissions
Collaboration between parties need to exist
Willing buyer and willing seller
• No hostile acquisitions
Comments, Questions?
Thank You!
Selby P. Jones, Principal
AUS Consultants
155 Gaither Drive, Suite A
Mount Laurel, NJ 08054
856.242.3028
ausconsultants.com
@ausconsultants