Philadelphia should sell its gas utility, the largest municipally owned system in the U.S., to reduce the city’s financial risk, Lazard (LAZ) Ltd. said in a report.
The city may gain as much as $496 million from a sale, after accounting for costs tied to the utility, Lazard said in the study released yesterday. It placed the 176-year-old Philadelphia Gas Works Co.’s potential value to a buyer at $1.4 billion to more than $2 billion, depending on what is included.
“We are surely at the beginning of a tremendously complicated process,” Philadelphia Mayor Michael Nutter said yesterday at a briefing for reporters at City Hall. “One that will strengthen city government on the behalf of the taxpayers while at the same time provide a bright future for ratepayers.”
A sale would remove operational and financial risks for the city while maintaining services to customers, who already pay among the state’s highest rates, Lazard said. The utility serves more than 500,000 accounts, the most of any government-owned system, according to the American Public Gas Association in Washington. Philadelphia is the fifth-most-populous U.S. city.
“It could be a crown jewel in someone’s system,” said James H. Cawley, a member of the state Public Utility Commission, which regulates the gasworks.
“You would have to make improvements, but utilities take the long-term view,” Cawley said before the report was released. The gasworks has about $1.2 billion in rated bonds outstanding, as well as about $225.5 million in variable-rate obligations, Moody’s Investors Service said in an August report. It is the oldest municipally owned system in the U.S., according to the gas-industry group.
Infrastructure investment funds and companies serving other parts of Pennsylvania and New Jersey may be potential bidders, Paul Patterson, an industry analyst in New York with Glenrock Associates LLC, said today by telephone. Nearby utilities could reduce costs through sharing systems and employees with the municipal gasworks, he said.
Exelon Corp., based in Chicago, might be able to boost the city system’s rate of return while expanding its Peco Energy Co. subsidiary, Patterson said. Also known as PECO, the Philadelphia-based company is the state’s largest utility, with 1.6 million electric and 490,000 gas customers, according to its website. An Exelon spokesman wasn’t immediately available for comment.
The Philadelphia Gas Works’ retirement plan had about 83 percent of the money needed to cover projected obligations, up from 68 percent in 2009, Moody’s said in the August report. It also lacked about $636 million of the money needed to cover other future post-employment benefits, Moody’s said.
By covering pension-related liabilities, the city may raise the system’s value to as much as $2.15 billion, Lazard said in the study. The city’s potential gain also may be limited if those costs are retained, Lazard said, putting the potential city gain as low as $146 million.
Nutter said a buyer would be required to maintain services for low-income and older residents; honor employee contracts, and keep rates frozen through August 2016. Selling the system may eliminate the need for a 2016 rate increase, Lazard said.
One in four Philadelphia residents lives below the federal poverty level, compared with 14 percent nationwide, according to U.S. Census Bureau data. The gas utility’s services to a large disadvantaged population result in higher rates than competitors such as PECO, Moody’s said.
Removing Financial Risk
Selling the system would remove associated financial risk, said Rebecca Rhynhart, the city budget director. While a $45 million Philadelphia loan was repaid in 2008, there’s no flexibility to do that again, she told reporters.
From 2004 through 2010, the city refunded the system’s annual $18 million municipal payment. It kept the money last year. The Lazard study counted the loss of the payment against any gain from selling.
A sale would help the city by letting it concentrate on vital services, said Alan Schankel, director of fixed-income research at Janney Montgomery Scott in Philadelphia.
“It’s important to focus on government’s main functions and when you deviate from that, it can create problems,” he said today. A protracted sale process will mitigate immediate effects on the city’s debt, he said.
A Philadelphia bond maturing in 2020 traded today at a yield of 2.7 percent, down from 2.82 percent on Feb. 7, according to data compiled by Bloomberg. The bond is rated Aa3 by Moody’s, its fourth-highest investment grade. A Bloomberg Fair Value index of top-rated 10-year municipal bonds rose to 1.87 percent from 1.77 percent over the same period.
Proposals from advisers seeking to guide the process will be sought next month, Nutter said. The city may use any proceeds to offset longer-term obligations such as pensions, he said.
Selling the system would require City Council and state commission approvals, he said, and may take two years.
The gasworks’ debt load, which is higher than for a typical system, has hindered past attempts at a sale or lease, said John Medina, a Moody’s analyst, before the Lazard study was released. The New York-based company rates most of the system’s credit Baa2, the second-lowest investment grade.
Lazard, based in Hamilton, Bermuda, is the largest independent merger adviser.
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