Opinion: Why are Municipal Water Utilities Not Up for Mergers and Acquisitions?

Daniel J. Van Abs | August 10, 2015 | Opinion
New Jersey is missing opportunities for better management of these crucial governmental entities

Daniel J. Van Abs
A routine headline in New Jersey involves the possible acquisition of a publicly owned water utility (which I’ll call a “municipal utility” here) — most often a water supply but sometimes a sewer — by an investor-owned utility such as Aqua America, American Water, United Water, Middlesex Water, or their peers. In other cases, public-private partnerships are formed in which the municipal utility is operated under contract by an investor-owned utility.

All these private utilities have every right to their business models. Recent (and controversial) changes to state law make outright sales even easier.

Local governments may no longer want to operate their own water supply or sewerage utility for various reasons. Perhaps costs are rising too fast or the system has become too difficult for municipal management. That is a decision they make. Why, though, aren’t other publicly owned utilities stepping up as possible partners or purchasers? Why aren’t the current local owners looking for public partners instead of to the private sector?

Over the years, I’ve had a number of conversations with water professionals about this issue, and it seems that there are several answers. Some seem reasonable, but others raise major questions that we should examine as a society.

A major problem with public-to-public mergers or acquisitions is that these utilities are government agencies. They were established to provide a specific service for a specific area. Many regional water utilities that might seem a good fit are actually very strictly constrained. They may operate a water-treatment plant and a single large pipeline, but no local distribution systems. They may offer water-supply or sewer services to member municipalities but have no legal ability to extend their services.

To add a new service or service area, essentially they must be reconstructed in terms of their charter, their governance, their leadership, their staffing, in many cases their operational capabilities, and their finances. That process can be a very tough sell. In some cases, utility managers themselves are not interested in anything that makes their system more complicated — physically or politically.

Contrast this with an investor-owned utility, which has the purpose of handling (for a profit) any required services for their customers within any specific service area (a “franchise area”). The private sector is able to staff up or down, expand or contract, and apply appropriate technology to address any acquisitions or contracts.

This one difference is fundamental. Let’s say that a regional water supply agency with many municipal members wants to take on the distribution system of a single municipality within its service area. The process of internal negotiations and legal work could take a very long time before they could even start discussions with the selling municipality. The private sector utility can prepare and submit a bid in far less time, and has a major incentive to do so.

A second problem is that many municipal utilities are standalone systems with no natural partner, such as a neighbor or a regional utility. In this case, it might be sensible for several such utilities within an area to merge into a regional utility authority that provides services to each of the service areas. In this way, the municipalities would hand management responsibilities to a larger entity that could better manage the system. My favorite example, likely never to be done, would involve merging the various small sewer utilities of Hunterdon County (Readington-Lebanon, Clinton, Raritan, Frenchtown, and Lambertville) into a single regional system, with all of the benefits for increased technical capabilities, shared finances, and the like.

A third problem is one of political control. It may seem strange, but some municipalities are very concerned about the potential for “losing control” of their utility to a public entity they don’t control, but seem willing to sell their utility outright to an investor-owned company. The municipality would retain more influence through a merger of public entities, but instead they divest entirely.

A fourth problem is one of money, which raises a lot of complicated issues. If a municipality sells its water supply or wastewater utility to another entity, what is the local system worth? And who gets the money if there is a cash payout? If the new owner takes on the debts of the municipal utility, then the customers continue to pay for that debt (though perhaps at a higher rate). I have no conceptual problems with this, since the debt was raised to benefit the customers through capital projects (at least, that is how it is supposed to work) and the new debt will continue to pay for these earlier costs.

However, New Jersey has many examples in which a municipal system is sold to an investor-owned utility for cash. The municipality often will use that cash for general government purposes, not to improve the water utility or pay back its customers. Let us remember that most municipal utilities were built using customer dollars, connections fees from developers (which ultimately are paid by their customers), and grants or low-interest loans from the state and federal governments. In nearly all cases, local property taxes didn’t pay for the system. If cash from the new buyer goes to the municipality, you can bet that the investor-owned utility isn’t providing that cash out of kindness. It is a business decision, and it expects to recover every dollar from their customers. The result is that the customers pay twice — for the original system and its upkeep, and to repay the cash that went to the municipality.

A related issue is one of determining how much the municipal system is worth. A well-maintained system could have a significant net worth, but a poorly maintained system might have a negative net worth; perhaps the municipality should really be paying the new owner to take the system! I have yet to see a situation in which the net worth of the sold municipal utility is truly known, something that requires a high level of information. I suspect that a municipality utility with that level of knowledge would be so well run, and a point of municipal pride, that nobody would want to sell it.

And this brings me to a final problem. The municipal utilities that get sold are generally small and are owned by small municipalities with limited ability to finance changes and improvements. They often have major problems.

Municipal leaders find that they are taking too much time and effort to understand and operate their systems, and look to offload the responsibility in a way that minimizes local liabilities and perhaps puts some cash in the kitty. In other words, these sales are often when the system is at risk of falling apart. The fundamental questions are why we let any of our water utilities (public or private) get in this condition in the first place, and how to avoid doing so in the future.

But when a sale is appropriate, we should have a system in which public and private entities can compete on a level playing field, each capable of making a good argument for merging, acquiring, or managing small systems within their larger utility operation. Every potential buyer or partner should know the actual worth of the municipal utility, and cash payouts should benefit those who paid for the utility in the first place.