Why there's optimism on PGW sale

Posted: April 26, 2013

Now that the city has hired a heavyweight like JPMorgan to sell Philadelphia Gas Works, it raises the question: Who would want to buy an aging utility with limited growth prospects, large numbers of low-income customers, 19th-century pipes, and a hostile political climate?

"It would have been hard to imagine 20 or even 10 years ago that any private company would have been seriously interested in buying PGW," Mayor Nutter said Wednesday in announcing the selection of JPMorgan and Loop Capital Partners as brokers for the gas utility. "To be brutally honest, at that time it was an embarrassing liability."

But PGW, the largest municipal gas utility in the country, has turned its performance around since it flirted with default a decade ago and city government bailed it out. In the current market, Nutter's financial advisers say, PGW might actually fetch a premium price.

"This is a very robust market," said Paul Dabbar, managing director of JPMorgan's global mergers and acquisitions group. "We believe this is going to generate a lot of potential interest."

PGW's potential suitors might include more than the obvious choices, such as nearby gas utilities like UGI Utilities or Peco, which already sells electricity to PGW's customers.

In recent years, private-equity investors and pension funds have been buying utilities, attracted by the steady if unspectacular returns that are practically guaranteed by regulators.

"For investors, utilities became something of a safe haven in 2012," said a recent Ernst & Young report on utility mergers and acquisitions. "Amid volatile stock markets and artificially low U.S. Treasury yields, regulated utilities benefited from lower-risk predictable cash flows."

SteelRiver Infrastructure Fund North America L.P. of San Francisco, which bought Peoples Natural Gas in Western Pennsylvania in 2010, announced in December 2012 plans to expand its territory in Pittsburgh by acquiring Equitable Gas Co. for $720 million.

If approved by regulators, the acquisition would make Peoples the largest gas utility in Pennsylvania, with 660,000 customers.

Current low borrowing costs can also drive up the price buyers are willing to pay.

Pure-play utilities that derive most of their earnings from regulated distribution systems - as opposed to earnings from ultracompetitive businesses like generating power - are trading at record multiples, said George W. Bilicic, a vice chairman of Lazard Freres & Co., which is serving as Philadelphia's financial adviser.

Last year, Lazard estimated that PGW might sell for as much as $1.85 billion and net the city as much as $496 million after paying off the utility's liabilities. Bilicic said those estimates were unchanged.

"This is an optimal time to test the proposition here," he said. "Values are at an all-time high. There is robust [mergers and acquisition] interest."

Although a third of PGW's 500,000 customers are low-income and the utility has struggled with collection issues, Philadelphia is still an attractive market, according to advisers.

The city's aging infrastructure may actually be a lure to investors. The Pennsylvania Public Utility Commission is pressuring operations like PGW to replace old pipes, and is willing to give them the rate increases they need to make those investments attractive.

Private owners would have more flexibility to enter into profit-making investments than the city-owned utility, whose ventures must be approved not only by City Hall but by the Philadelphia Gas Commission. Private owners would have to report only to the PUC.

But opposition to PGW's sale is likely to be fierce, and critics are already raising fears about what private-equity owners might want to extract from customers and employees.

Frank Keel, a spokesman for the gas workers' union, said he anticipates "escalating rates, the loss of hundreds of family-sustaining union jobs, and thousands of poor in Philadelphia without gas because they've lost their subsidies."

Nutter said rates would be frozen until 2016. And subsidized rates tied to customers' income are protected by the state and would be unaffected no matter who owns PGW.

"The city has owned PGW for 176 years," the mayor said. "There was a time when that made sense. I believe that time has long since passed. We are perfectly positioned to maximize this opportunity for residences and businesses here in Philadelphia."


Contact Andrew Maykuth at 215-854-2947, @Maykuth or amaykuth@phillynews.com.

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