It could take two years to close the deal, but Philadelphia Mayor Michael Nutter favors selling the city’s 175-year-old gas company if price and conditions are acceptable.
“The time is right to consider a sale of Philadelphia Gas Works,” the mayor said in a statement.
“Lazard believes that the privatization of PGW could generate sufficient interest from potential acquirers,” said the investment bank, which the city retained in July 2010 at a cost of $200,000.
Initial reaction from a local municipal market observer was favorable.
“In general, the enterprise risk associated with an operation like this outweighs any potential benefits,” said Alan Schankel, a managing director at Philadelphia-based Janney Capital Markets. “The city should stick to its central functions. By selling it they might break even or even make a few bucks.”
Officials say the city could get up to nearly $2 billion for a privatized PGW. Messages seeking comment were left with budget director Rebecca Rhynhart.
According to Lazard, the city could realize a net $496 million from the sale after accounting for PGW’s liabilities, and could also collect real estate taxes from a privatized utility, though potential tax revenues could be lower than the current $18 million annual franchise fee.
The report said PGW has $1.15 billion in revenue bonds outstanding. Other key liability components, according to Lazard, include $95 million in debt defeasance costs and a further $60 million for what it called termination payments and transition costs. They include termination of guaranteed investment contracts and interest-rate swaps, and Lazard’s estimate of likely transaction advisory costs.
The firm, in a call for the city to explore opportunities to reduce PGW-related liabilities and-or increase its sale value, urged the city to consider structuring an offering that would leave some or all of PGW’s existing tax-exempt bonds outstanding, “although this is judged unlikely to be practical in the present situation.”
It also recommended the city push for legislation that, while adhering to existing bond indenture provisions, would allow existing PGW revenue bonds to remain outstanding.
The Pennsylvania Budget and Policy Center reported last month that Philadelphia has lost $331 million in net interest payments and cancellation fees related to swaps, and that the city could lose a further $240 million in net interest payments from still-active swaps between city agencies and financial institutions if interest rates remain low.
According to Moody’s Investors Service, PGW also has about $225.5 million in variable-rate demand obligation bonds outstanding. Last August Moody’s affirmed its rating of Baa2 on most PGW credits, save for $5.4 million of outstanding 1998 subordinate general ordinance bonds, which it rates Baa3.
The public utility sold $88.9 million of Series 1998 and 1975 refunding bonds on Sept. 14, with Bank of America Merrill Lynch as lead manager.
Moody’s praised PGW’s management team, strong relationship with the Pennsylvania Public Utility Commission and supply cost management, while also citing the utility’s “high leverage, improved yet still narrow internal liquidity, and narrow Moody’s-calculated net revenue debt-service coverage ratio that has averaged 1.25 [times] over the last five years, improving annually since fiscal 2007.”
Nutter, who said the city would sell PGW only at a profit, wants the proceeds to defray long-term obligations such as pensions. Moody’s said in August that the utility’s pensions were funded at about 83%, with a 20-year amortization schedule for the unfunded portion, up from a low of 68% in 2009.
Conditions to a sale would include retention of special payment and discount programs for senior citizens and low-income residents, a rate freeze through August 2016, keeping the corporate headquarters in Philadelphia in the short term, and the honoring of employee contracts.
Schankel doesn’t think the restrictions will deter suitors. “Speaking in general, it could be an issue with price,” he said. “If they couldn’t raise rates for four years, that would translate into some kind of numbers.”
According to Nutter, due diligence, bidding and negotiations could take 12 months, with another year necessary to receive approvals from the Pennsylvania Utility Commission and the City Council.
Although neither Nutter nor the Lazard report identified any possible suitors, David Fiorenza, a Villanova School of Business professor and former chief financial officer of Radnor Township, Pa., cited Peco Energy Co. of Philadelphia, a subsidiary of Chicago’s Exelon Co., as a logical candidate.
According to its website, Peco serves 1.6 million electric and 490,000 natural gas customers in southeastern Pennsylvania.
“Once a utility comes in, you can have better economies of scale. They have their own infrastructure, staffing and personal equipment in place, and can probably command better credit,” Fiorenza said.
