Due Diligence - Establishing a Framework for Utility Acquisitions

SUMMARY Utility managers play a high-stakes game when they consider acquiring a neighboring or nearby utility or service area. 'Due diligence' is required, so engineering, operations, regulatory, staffing, customer service, logistics, and a host of other factors must be considered. But citing the disciplines involved fails to convey the complexity of the decision and utterly fails to convey the magnitude of the risk involved. Public policy issues insert themselves, data sources are limited and often questionable, public perceptions might be at variance with the basic facts of the situation, and still, sound decisions must be made. This presentation focuses on conveying the importance of the acquisition review process and on demonstrating how to create a workable framework to help evaluate potential utility acquisitions within the always-present constraints. The direct financial costs of an acquisition are significant, but the total costs are much higher, including the time of the senior management team and governing board, both in advance of and often for an extended period after an acquisition is accomplished. Key steps from identifying objectives, focusing early on data needs, including operational and staffing issues, and incorporating realistic financial projections are explored, and the presentation closes with advice on bringing a realistic view of the ultimate value proposition to light. ABSTRACT Located in the Tampa-St. Petersburg Metropolitan surrounding Tampa Bay in west central Florida between the Gulf of Mexico to the west and Tampa Bay to the East, Pinellas County Utilities operates Pinellas County's water and sewer enterprise funds to provide water, wastewater, and reclaimed water services to more than 100,000 retail customers and wholesale service to several surrounding communities. Pinellas County has historically had opportunities to acquire water, wastewater, or reclaimed water utility systems and customers both private and municipally owned. The Utility is reviewing its processes and activities related to how future potential utility acquisitions are to be evaluated with the objective of maximizing countywide benefits through acquisition decisions. Management's objectives for the review were to establish a process framework that allows for enhanced transparency and consistency, while employing sound industry practices to guide due diligence activities, identify needed capital improvements and renewal and replacement (R&R) needs, determine appropriate approaches for determining valuation, and ultimately understanding the likely impacts of the acquisition. A successful utility acquisition evaluation process and framework is one that if followed, allows managers to have a clearly defined value proposition and a comprehensive understanding of the stakeholder benefits, risks, and long-term impacts that can be communicated to the ultimate decision makers whether that be a Commission, Council, or Board. The framework needs to extend deeper and beyond a standalone financial analysis that determines the potentially acquired utility system's valuation. In fact, having a comprehensive framework will ultimately lead to a more robust, more realistic, and more meaningful determination of value that considers system condition, operational impacts, financial feasibility, rate payer impacts, legal considerations, and even political ramifications both near and long-term. To develop the framework, the first part of the project is to review the County's historical practices and evaluations including approaches for valuation. Next, a comprehensive data checklist is created to identify data about the potential utility system to be acquired relative to finance, customer billing, operations, inter-local agreements, historical and on-going R&R activities, engineering, and capital planning. In addition to the data checklist, a list of common considerations such as legal, inter-agency relationships, regulatory, and other information is identified. Once the checklist is developed, a series of workshops with key Pinellas County Utilities' staff is held to develop and identify a strategy for performing the preliminary due diligence activities including engineering analysis. No utility acquisition process would be complete without a detailed and thorough long-term financial feasibility and cash flow analysis and a discussion about valuation methodologies. As such, the presentation will outline the various approaches used throughout the industry for municipally owned utility systems identifying their strengths and weaknesses. It is imperative to understand that each approach can result in widely varied valuations, and to explore explicitly which approach applies best in each unique situation. After all, the cost of the acquisition could have long-term financial impacts on the Utility's financial sustainability and health, and on both existing and future rate payers. Next, an example financial feasibility and utility valuation model is developed that can be applied for future valuations. This is where the 'rubber meets the road' and financial planning tools represent a key step in communicating long-term value and future financial implications to help stakeholders and decision makers to engage the opportunity for utility acquisitions and the value proposition created during the process. The developed framework outlining a repeatable, transparent, and consistent approach while using sound financial and engineering industry practices for evaluating potential utility acquisitions will allow Pinellas County to continue to serve its mission and stakeholders given the uniqueness of each opportunity in a dynamic and ever-changing utility market. As a result, the project focuses on reviewing the County's previous practices to determine what has worked or didn't, developing a policy and practice framework to guide future acquisition evaluations, documenting required system, engineering, and financial data needed to support the due diligence and financial valuations, and development of an example financial valuation model to incorporate relevant data for the County to determine a valuation and value proposition consistent with stated objectives.