ABSTRACT: The
Board of Directors, Monterey Peninsula Water Management District, Special Meeting/Board Workshop, November 12, 2019, agenda packet, including
AGENDA,
Preliminary Valuation and Cost
of Service Analysis Report, October 29, 2019, by Raftelis Financial
Consultants, Inc. (“Raftelis”) (EXHIBIT 2-A) and Barclay’s
Letter of Confidence (EXHIBIT 2-B) document copy is embedded. The Executive Summary and Findings and Conclusions of the Preliminary Valuation and Cost of Service Analysis Report
are reproduced.
AGENDA
Special Meeting/Board Workshop
Board of Directors
Monterey Peninsula Water Management DistrictTuesday, November 12, 2019, 6 pm
Monterey
Peninsula Water Management District
Preliminary Valuation and Cost of Service Analysis Report
October
29, 2019
Raftelis
Financial Consultants, Inc. (“Raftelis”)
John
M. Mastracchio, CFA Vice President
William
Stannard, P.E. Chairman of the Board
2-A Preliminary Valuation and Cost of Service
Analysis Report
2-B Barclay’s
Letter of Confidence
Monterey Peninsula Water Management District
Preliminary Valuation and Cost of Service Analysis Report
October 29, 2019
Executive
Summary
The purpose of this
report is to document the findings of a preliminary valuation assessment and
cost of service evaluation completed to support the Monterey Peninsula Water
Management District (“MPWMD” or “District”) in evaluating the feasibility of
securing and maintaining public ownership of the Monterey Water System. The
preliminary valuation assessment consisted of completion of a preliminary
desktop valuation assessment of the Monterey Water System to estimate the cost
required to be incurred to acquire the Monterey Water System. The cost of
service analysis was completed to compare the cost of public ownership,
operation, and maintenance of the Monterey Water System (i.e. the public
ownership scenario) with a status quo scenario, which is the anticipated cost
of continued ownership, operation, and maintenance of the system by California
American Water (“CAW”). The cost of service analysis was compared in terms of
the annual Monterey Water System revenue requirements and typical residential
customer bill impacts associated with the various scenarios that were developed.
CAW currently
provides water service to approximately 41,000 customer connections and a
population of approximately 99,794 in its Monterey County District. The “Main”
system within the Monterey County District serves approximately 38,325
customers and includes customers within the incorporated cities of
Carmel-by-the-Sea, Del Rey Oaks, Monterey, Pacific Grove, Sand City, Seaside,
and the unincorporated areas of Carmel Highlands, Carmel Valley and Pebble
Beach. The Main system is generally located within the MPWMD boundaries. The
Monterey County District also includes the areas of Bishop, serving
approximately 385 customers, Hidden Hills, serving approximately 454 customers,
and Ryan Ranch, serving approximately 212 customers, which are areas that are
also within the MPWMD boundaries.1 The Central Satellite areas include the
areas of Ambler, Ralph Lane, Chualar, Toro, and Garrapata, which are located
outside of MPWMD boundaries and serve a total of approximately 1,086 customers.
The subject of the preliminary valuation and cost of service analysis is the
portion of the water system located within the boundaries of the District.
Preliminary
Valuation Assessment
The valuation of the
Monterey Water System was prepared for acquisition feasibility purposes
considering three
methods of valuation: the Income Approach, the Sales Comparison Approach, and
the Cost Approach. The definition of value used in the valuation assessment was
fair market value as the term is defined in California’s Eminent Domain Law (Code
of Civil procedure Section 1263.320), and the date of the valuation estimate
was January 1, 2020.
The income approach is based on
the premise that the value of a property is the present value of the future
economic benefits of owning the property. The underlying principle in this
approach is that buyers invest in assets with the expectation of receiving the
anticipated future net benefits. This approach is relevant when the property
being valued generates or is anticipated to generate net income, profits, or
free cash flows. The value estimate of the Monterey Water System calculated
using the income approach ranged $222 million to $255 million. An 80% weighting
was placed on the results of this valuation method.
The Market Approach is a general
way of determining an indication of value of an enterprise by comparing the
subject to similar businesses that have been sold. The valuation estimate under
the market approach was prepared using the Guideline Transactions Method, which
is a method whereby pricing multiples are derived from transactions involving
companies engaged in the same or similar lines of business. Certain factors,
such as the location, date of sale, physical characteristics, and technical and
economic factors relating to sales transactions were analyzed for their
comparability to CAW’s Monterey Water System. Based on this analysis, the
average value of the Monterey Water System under the market approach was
estimated to be approximately $272 million. A 20% weighting was placed on the
results of this valuation method.
Under the Cost Approach, the
value of the assets is typically derived by subtracting the amount of depreciation
from the replacement or reproduction cost of the assets. The value under this
approach is estimated by the sum of the parts of the system, i.e. physical
asset components, land, water rights, etc. Depreciation in this context
represents the loss in value caused by physical deterioration, functional obsolescence,
and economic obsolescence. The reproduction cost new less depreciation
(“RCNLD”) amount was calculated and estimated to be approximately $464 million.
No weighting was placed on the results of this valuation approach because it
tends to place an absolute ceiling on the market price, which most frequently
is not approached in actual market negotiations associated with regulated
public utilities.
Combining these three valuation
methods with their weightings, the base estimated value of the Monterey Water
System (portion located within MPWMD jurisdictional boundaries) as of the valuation
date (January 1, 2020) was estimated to be approximately $245 million. This
estimate is a preliminary estimate of value that was prepared based on a
desktop analysis described above for feasibility purposes and information
available as of the date of this report. This value estimate may be higher or
lower than the conclusion of value that may result from the completion of a
formal appraisal.
This base estimate excludes the
value of asset additions, such as construction-work-in-progress, 30% of the
Monterey Pipeline and Pump Station value deemed by the California Public
Utilities Commission (“CPUC”) not to be “used and useful” in conjunction with
CAW’s Monterey Water System, the value of the desalination plant currently
under development, and the value of non “used and useful” land parcels. The
value of the Monterey Water System, including the base value and the identified
asset additions, was estimated to be approximately $359 million.
CAW has incurred other expenses
that CPUC has approved for recovery through Monterey District water rates over
time. It is possible that MPWMD may be required to compensate CAW for these unrecouped
expenses as part of a potential taking of the Monterey Water System. These
expense items and their potential amounts include unrecouped portions of tank
painting expenses, San Clemente Dam removal costs, the portion of the
“acquisition premium” allocable to the Monterey Water System that was approved
by the CPUC in 2001 in connection with CAW’s acquisition of the California
assets of Citizens Water Company, the portion of the “acquisition premiums”
allocable to the Monterey Water System associated with the acquisition of the
Bellflower Municipal Water System, the Rio Plaza Water Company, Fruitridge
Vista Water Company, and Hillview Water Company that are proposed under CAW’s
Special Request No. 11 in its 2019 General Rate Case Application to the CPUC,
plus the unrecovered portions of various balancing accounts. These net expenses
were estimated to total approximately $155 million as of the valuation date,
and adding these net expenses to the value estimate of the “base” water system
results in a total value estimate, plus adjustments, of approximately $513 million.
A summary of the valuation and adjustments is provided in Table ES-1.
This value estimate,
with adjustments, does not include the potential value of other assets that are
not currently included in CAW’s rate base, except for the value of land which
has been considered. These assets either have not been deemed to be “used and
useful” for the provision of water service or were developer contributed and
are not allowed by CPUC to be included in rate base. It is possible that some of
the non “used and useful” assets may become “used and useful,” and recoverable
in water rates in the future. However, the value of these assets is not likely
to be substantial. CAW reports a value of $20.2 million of “contributions-in-aid-of
construction” and “advances-in-aid-of-construction”, which are contributions of
money or property contributed by developers pertaining to the expansion,
improvement, or replacement of water system assets. However, since CAW is not
allowed to include the value of these assets in rate base, they have been
excluded from consideration in the value of the Monterey Water System.
MPWMD may also be
required to pay severance damages to CAW for acquiring the Monterey Water System.
These damages may relate to not taking the satellite water systems owned and operated
by CAW within their Monterey District, but outside of MPWMD’s jurisdictional boundaries.
Severance damages in this instance would consist of increased inefficiencies in
CAW’s provision of service to these smaller pockets of customers and
potentially higher costs per customer to do so. It is somewhat difficult to
evaluate and quantify such severance damages, which would involve better
understanding CAW’s current service model, how CAW could most effectively
modify its service model in the post-District acquisition scenario, and how
much of the work formerly performed by local CAW staff could effectively be
transferred to other nearby CAW field offices or centralized locations. In
addition, given that CAW would likely be entitled to include reasonable
increased marginal operating costs in its next rate filing(s) to the CPUC with
respect to the “remainder” of its Monterey District, it is questionable whether
CAW would suffer any net profitability losses at all. Given these
uncertainties, and the likelihood that CAW could mitigate some or all of its
severance damages through the CPUC ratemaking process, our tentative conclusion
is that CAW is likely to suffer minimal, if any, severance damages, and any
severance damages it does suffer would not be so significant as to materially
affect the conclusions of the District’s feasibility analysis. If the District
does proceed to prepare a formal appraisal of just compensation for the acquisition
of the Monterey Water system, however, it is recommended that the severance
damages issue be further reviewed at that time.
Cost
of Service Evaluation
The cost of service
evaluation consisted of preparing a 20-year financial projection of CAW continuing
to own and operate the Monterey Water System (status quo), analyzing and
identifying the incremental cost differences associated with MPWMD owning and
operating the Monterey Water System in comparison to the status quo, preparing
an annual cash flow projection of two district ownership scenarios, and estimating
customer bills under both the CAW status quo and District ownership scenarios.
The following cost of service scenarios were prepared:
A. Status Quo – CAW
ownership
B. MPWMD Ownership
with District staff operations
C. MPWMD Ownership
with contract operations
The cost of service modeling
results indicate that significant annual reductions in revenue requirements
Water System. The estimated revenue requirement in 2022 under the MPWMD
ownership scenario with District operations (Scenario B) was projected to be
approximately $13.6 million or 11.9% lower than the status quo CAW ownership
scenario (Scenario A). Scenario B is estimated to have a net present value
savings from 2021 to 2040 of approximately $267 million. The estimated revenue
requirement in 2022 under MPWMD ownership and contract operations (Scenario C)
was projected to be approximately $10.2 million or 8.9% lower than the status
quo CAW ownership scenario (Scenario A). Scenario C is estimated to have a net
present value of savings from 2021 to 2040 of approximately $213 million. These
net present value savings estimates include the debt service costs associated
with the District paying fair market value for CAW’s Monterey Water System.
These cost of service modeling results are summarized in Table ES-2.
The projected reductions in
revenue requirements are a result of the following differences between CAW and
MPWMD ownership and operation:
1. Lower corporate and
administrative overhead costs. An estimated $7.2 million in CAW corporate
administrative overhead would be avoided under MPWMD and replaced with approximately
$1.8 million in District operations and administrative costs.
2. Operating cost differences.
The District’s ability to utilize existing administrative staff and eliminate
redundant positions, net of higher pension and benefit costs under public
ownership.
3. Cost of public financing (4.0%
interest rate) vs. rate of return and CAW profit (7.61%). The tax exempt annual
debt interest rate for MPMWD is lower than taxable corporate debt and CAW’s allowable
rate of return. The public financing interest rate was reviewed by Barclays and
was deemed to be reasonable.
4. Reduction in revenue
requirements of an estimated $10.1 million per year (2021 estimate) under public
ownership due to avoidance of property and income taxes.
5. Elimination of rate regulatory
expenses estimated at $330,000 per year (2021 estimate).
Based on the information and
estimates summarized in this report, which are reasonable considering the currently
available information, the acquisition of the Monterey Water System by MPWMD
appears to be economically feasible. Economic feasibility was assessed by
comparing the estimated revenue requirements of the water system under MPWMD
ownership versus CAW ownership and indicated that significant revenue
requirement savings could be achieved under the MPWMD ownership scenarios that were
evaluated
6. Findings and Conclusions
Set forth below is a
summary of the findings and conclusions which Raftelis has reached regarding
its preliminary valuation and cost of service feasibility study. For a complete
understanding of the estimates and assumptions upon which these opinions are
based, this report should be read in its entirety.
1. The
base estimated value of the Monterey Water System (portion located within MPWMD
jurisdictional
boundaries) as of the valuation date (January 1, 2020) is estimated to be approximately
$245 million. This estimate is a preliminary estimate of value that was
prepared based on a desktop analysis described above for feasibility purposes
and information available as
of the date of this
report. This value estimate may be higher or lower than the conclusion of
value that may result
from the completion of a formal appraisal.
2. This
base estimate excludes the value of asset additions, such as
construction-work-in-progress, 30% of the Monterey Pipeline and Pump Station
value deemed by CPUC not to be used and useful, the value of the desalination
plant, and land estimated to be non “used and useful.” The potential value of
these additional items was estimated separately and total approximately $114 million.
In addition, it was assumed that MPWMD would assume the anticipated SRF loan
and any public agency financing associated with the desalination plant (estimated
at approximately $181 million), therefore, these amounts were excluded from the
valuation estimate but were considered as part of the cost of service
evaluation. The value of the Monterey Water System, including the base value
estimate and the identified asset additions, was estimated to be approximately
$359 million.
3. CAW
has incurred other expenses that CPUC has approved for recovery through
Monterey District over time.
It is possible that MPWMD may be required to compensate CAW for these unrecouped expenses
as part of a potential taking of the Monterey Water System. These expense items and their
potential amounts include unrecouped portions of tank painting expenses, San Clemente Dam removal
costs, the portion of the “acquisition premium” allocable to the Monterey Water System
that was approved by the CPUC in 2001 in connection with CAW’s acquisition of the
California assets of Citizens Water Company, the portion of the “acquisition premiums” allocable
to the Monterey Water System associated with the acquisition of the Bellflower Municipal
Water System, the Rio Plaza Water Company, Fruitridge Vista Water Company, and Hillview
Water Company that are proposed under CAW’s Special Request No. 11 in its 2019
General Rate Case Application to the CPUC, plus the unrecovered portions of various balancing
accounts. These net expenses were estimated to total approximately $155 million as of the
valuation date, and adding these net expenses to the “base” water system value estimate, results in
a total value estimate plus adjustments of approximately $513 million.
4. Non-Regulated
Assets of CAW’s Monterey Water System. Other non-regulated assets of CAW’s Monterey Water System may include other assets that are not currently included
in its rate base, except for
the value of land which has been considered. These assets either have not been deemed to be
“used and useful” for the provision of water service or were contributed by developers and are
not allowed by CPUC to be included in rate base. It is possible that some of these non “used and useful” assets may become “used and useful”
and could become recoverable in rate base in the
future. However, the value of these assets is not likely to be substantial. CAW reports a value of
$20.2 million of “contributions-in-aid-of-construction” and
“advances-in-aid-ofconstruction.” However, since CAW is not allowed to include
the value of these assets in rate base, they have been excluded from
consideration in the value of the Monterey Water System.
5. Severance
Damages. MPWMD may be required to pay severance damages to CAW for acquiring the Monterey Water System. These damages may relate to not taking the satellite
water systems owned and operated by CAW within their Monterey District, but
outside of MPWMD’s jurisdictional boundaries. California Code of Civil
Procedures Section 1263.420 states that where the public entity is taking less
than an entire piece of property, the possibility of severance damages to the
remainder should be considered. These damages may relate to not taking the
satellite water systems owned and operated by CAW within their Monterey
District, but outside of MPWMD’s jurisdictional boundaries. Our tentative
conclusion is that CAW is likely to suffer minimal, if any severance damages
and any severance damages it does suffer would not be so significant as to
materially affect the conclusions of the District’s feasibility analysis. If
the District does proceed to prepare a formal appraisal of just compensation
for the acquisition of the Monterey Water system, however, it is recommended
that the severance damages issue be further reviewed at that time.
6. The
cost of service modeling results indicate that significant annual reductions in
revenue requirements and projected monthly water bills can be realized by MPWMD
acquiring and operating the
Monterey Water System. The estimated revenue requirement in 2022 under the MPWMD ownership scenario with District operations (Scenario B) was projected to be approximately
$13.6 million or 11.9% lower than the status quo CAW ownership scenario (Scenario
A). Scenario B is estimated to have a net present value savings from 2021 to
2040 of approximately $267
million. The estimated revenue requirement in 2022 under MPWMD ownership and
contract operations (Scenario C) was projected to be approximately $10.2
million or 8.9% lower than
the status quo CAW ownership scenario (Scenario A). Scenario C is estimated to
have a net present value of savings from 2021 to 2040 of approximately $213 million. These net
present value savings estimates include the debt service costs associated with the
District paying fair market value for CAW’s Monterey Water System.
7. Based
on the information and estimates summarized in this report, which are reasonable considering the currently available information, the acquisition of the
Monterey Water System by MPWMD appears to be economically feasible. Economic
feasibility was assessed by comparing the estimated revenue requirements of the
water system under MPWMD ownership versus CAW ownership, which indicate
significant revenue requirement savings could be achieved under the MPWMD
ownership scenarios that were evaluated.
REFERENCE:
District Releases Measure J Feasibility Study for Public Takeover of Cal Am
