March 3 (Bloomberg) -- Philadelphia agreed to sell its natural gas utility to UIL Holdings Corp. for $1.86 billion, in an effort to give the fifth-largest U.S. city a needed cash injection for its pension fund.
Proceeds from the sale of Philadelphia Gas Works, the nation’s largest municipally-owned natural gas utility, may add at least $424 million to a pension plan that’s now less than 50 percent funded, Mayor Michael Nutter said in a statement today. UIL agreed to keep rates frozen for three years, establish a second corporate headquarters in the city and maintain at least 1,350 jobs at the utility.
Philadelphia, which has $5.1 billion in unfunded liability from its city-worker pension system, began steps to sell the utility two years ago. The transaction and use of the proceeds for the pension fund require approval from the city council. Financing retiree benefits is a deepening challenge for localities nationwide as they recover from the 18-month recession that ended in 2009.
“Gas utilities are hot properties,” Kit Konolige, a New York-based analyst for BGC Partners LP, said in a phone interview today. “If you’re having problems with your finances, as a lot of local governments are, that’s definitely an area where you’d think you could make a lot of money.”
UIL was one of 33 bidders that expressed interest in the utility, which was founded in 1836 and supplies about 500,000 customers in the city. The New Haven, Connecticut-based company said the transaction will give it access to customers near the booming Marcellus and Utica gas-shale formations.
The sale has faced opposition from some on the city council and a local union. Along with the council, it also needs approval from state regulators, UIL said today in a statement.
“Philadelphia has a reputation as a tough political environment,” UIL Chief Executive Officer James Torgerson said on a conference call with analysts today. “We’re going to have some challenges with the city council, there’s no doubt.”
UIL can quit the deal if the council doesn’t approve it by July 15, he said. Its stock fell 4.5 percent to $36.97 at the close in New York, the biggest decline since August 2011.
The purchase, expected to close by the first quarter of 2015, will immediately add to UIL’s cash flow, Torgerson said. UIL expects to increase profit after 2017 by accelerating replacement of 1,500 miles (2,400 kilometers) of aging cast-iron pipe, Torgerson said on the call. That upgrade would take a century at the current pace, he said.
The city will gain $424 million to $631 million for the pension system after paying off utility debt and fully funding Philadelphia Gas Works’ retiree-payment plan, Nutter said in the statement.
Local officials in at least 10 states are trying to cut pensions or eliminate defined-benefit plans to cope with rising costs. The median pension-funding ratio for states fell to 69 percent in 2012, from about 83 percent five years earlier, according to data compiled by Bloomberg.
Billionaire investor Warren Buffett called public pension plans a “gigantic financial tapeworm” that threatens the health of U.S. cities and states in the next decade. “Public entities promised pensions they couldn’t afford,” Buffett wrote in his annual report to shareholders of Berkshire Hathaway Inc., released March 1.
Morgan Stanley agreed to a $1.9 billion loan to finance UIL’s acquisition. Tudor, Pickering, Holt & Co. acted as lead financial adviser to UIL, while Morgan Stanley served as financial adviser and Sullivan & Cromwell LLP as legal counsel. Lazard Ltd. advised the city.
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