Utility M&A: A Case Study in the Sale of a Utility s Service Area

Transcription

1 Utility M&A: A Case Study in the Sale of a Utility s Service Area NARUC Accounting and Finance Meeting, March 8, 2016 Victor Prep, P.E. Byron S. Watson, CFA Denver, Colorado ,

2 Introduction o Victor Prep, P.E. Executive Consultant BSME from OU, MBA from Univ. of PA, Wharton Registered P.E. in CO, LA, and PA, and Certified Energy Manager Retired Nuclear Submarine Naval Officer o Byron S. Watson, CFA, CRRA Senior Consultant BSEE from SMU, MBA from Emory University o Members of the Firm act as Advisors to the Council of the City of New Orleans ( Council ). Our Services as Advisors are in Certain Ways Comparable to Those of a Commission s Staff 1

3 Introduction: Background Map of New Orleans 2

4 Introduction: Background o Prior to September 1, 2015, Retail Electric Service in the City of New Orleans was Provided by two Separate Entergy Operating Companies In the 15 th Ward of New Orleans (a.k.a. Algiers or the West Bank ), Entergy Louisiana, LLC ( ELL or Seller ) Provided Retail Electric Service to 22,187 Customers In New Orleans, Except for Algiers, Entergy New Orleans, Inc. ( ENO or Seller ) Provided Retail Electric Service to 169,856 Customers o The Council was the Retail Regulator of both Utilities Each Utility had Separate and Different Rates, a Different Allowed ROE, and Separate Rate Actions Before the Council Each Utility Owned or Contracted for its own Generating Capacity, Largely From Different Generating Units Each Utility had Separate Transmission and Distribution Plant O&M-Related Services Were Provided to Both Utilities by a Single Energy Subsidiary (Entergy Services, Inc.) 3

5 Introduction: Background o As a Result of Negotiations, Seller (ELL) Agreed to Transfer its Electric Service Operations to Buyer (ENO) and Also Sell Related Utility Plant and Rights to Generating Capacity Buyer Would Become the Single Retail Electric Utility Provider for All of New Orleans The Council Would be the Retail Regulator of One Electric Utility, the Buyer, and Would No Longer Regulate the Seller Buyer Would own, Operate, and Maintain all Electric Utility Plant Previously Owned by Seller in Algiers Franchise Rights to Operate in New Orleans Would be Transferred form Seller to Buyer Buyer Would Enter into a Purchased Power Agreement (PPA) with Seller to Continue Access to an Agreed-Upon Portion of Seller s Generating Resources 4

6 Introduction: Background o On October 30, 2014, Buyer and Seller Jointly Filed for Approval to: Sell Seller s Assets Located in Algiers to Buyer at Net Book Value Transfer all Franchise Rights to Provide Retail Service to Buyer so that Seller Would Have no Remaining Operations in New Orleans Create a New PPA Providing Buyer a Slice of Seller s Generating Fleet Capacity and Energy (1.84% of Each of Seller s Units for the Life of Each Unit) Leave Retail Base Rates Unchanged (i.e., Two Separate Rate Structures) Until a Later Combined Rate Case Could Set a New Single Set of Retail Rates for All of New Orleans Receive other Related Relief, Such as Modifications to Franchises o The Filing s Requested Relief was Collectively Called the Algiers Transaction ( Transaction ) o Separately, ELL (Seller) and Another Entergy Operating Company, Entergy Operating Company, Entergy Gulf States Louisiana, L.L.C. ( EGSL ) were Merging Closing the Merger After the Transaction was Critical 5

7 I. PUBLIC GOOD THE CASE FOR REGULATORY CONSOLIDATION 6

8 Net Ratepayer Savings o Increased Costs are Offset by Administrative Savings Averaging an Estimated $1.6 million per Year Regulation at both the FERC and in Local Jurisdiction Avoided Duplicative Rate Cases and FRP Evaluations o Annual Revenue Requirement Related to Service Algiers is Expected to Increase by Approximately $1.5 Million (Average) Algiers PPA is Based on FERC ROE of 11% vs. Seller s Allowed ROE of 9.95%. FERC May Reduce the ROE as Part of Docket ER Recovery of Transaction Implementation Costs Increased Costs Related to Changes in Participation in RTO Markets o Net Measurable and Expected Ratepayer Savings Average Approximately $0.1 Million Annually o Additional Ratepayer Savings Related to Future Regulatory Actions Difficult to Quantify 7

9 Advantages Other o Reduce Customer Confusion Relating to Differing Rates and Rate Schedules in the Same City o Eliminate Uneconomic Signals Presented by Differing Commercial and Industrial Rates in Same Geographic Area o Eliminate any Perceived Inequity due to Different Allowed ROEs o Reduce Administrative Burden on Local Regulators o Fewer Interventions at FERC Proceedings o Allow Relatively Small Algiers to Participate in Economies Available to Larger Buyer Direct Ownership of Generating Units Securitization of Storm Costs Access to A Large (i.e., $75 Million ) Storm Reserve Our Review Suggested no new Procurement Economies 8

10 II. TRANSACTION SUMMARY 9

11 Transaction: Steps o Transaction in Three Steps, Each Occurring in Immediate Sequence o Step 1: Create New Subsidiary to Receive Plant Located in Algiers o A Key Transaction Objective was to Maintain Book Value Basis for Assets Sold to Buyer 10

12 Transaction: Steps o Step 2: Seller Sells the New Subsidiary to Buyer At Assets Net-book Value 11

13 Transaction: Steps o Step 3: Merge New Subsidiary into Buyer o Transaction Maintains Book Value for Assets 12

14 Transaction Balance Sheets Algiers Asset Summary Seller Balance Sheet Illustration ($000) Seller Pre- Transaction Algiers Assets Seller Additions to Algiers Assets Algiers LLC Account Categories / Titles Utility Plant 9,947,569 88,956 1,700 90,656 Accumulated Provision for Depreciation, Amort, Depl (3,943,655) (28,527) (28,527) Nuclear Fuel - Net 147,385 Net Utility Plant 6,151,299 60,429 1,700 62,129 Other Property and Investments 1,160,798 Current and Accrued Assets 680,844 3,500 3,500 Deferred Debits (Regulatory Assets) 2,371, ,698 24,575 Total Assets 10,364,217 64,806 25,398 90,204 Common Equity and Preferred Stock 2,975,652 60,051 60,051 Long-Term Debt 2,961,670 Other Noncurrent Liabilities 664,861 2,106 2,106 Current and Accrued Liabilities 368,612 Accumulated Deferred Income Tax 2,492,629 19,150 8,501 27,651 Deferred Credits 900, Total Liabilities and Stockholder Equity 10,364,217 21,652 68,552 90,204 13

15 Transaction Balance Sheets Algiers Asset Summary Buyer Balance Sheet Illustration ($000) Buyer Pre- Transaction Algiers LLC Buyer Post- Transaction Account Categories / Titles Utility Plant 1,141,404 90,656 1,232,060 Accumulated Provision for Depreciation, Amort, Depl (532,067) (28,527) (560,594) Net Utility Plant 609,337 62, ,466 Other Property and Investments 11,533 11,533 Current and Accrued Assets 143,942 3, ,442 Accumulated Deferred Income Tax - Step-up 27,651 27,651 Deferred Debits (Regulatory Assets) 201,784 24, ,359 Total Assets 966, ,855 1,084,451 Common Equity 226,063 28, ,338 Long-Term Debt 225,944 28, ,219 Other Noncurrent Liabilities 10,253 2,106 12,359 Current and Accrued Liabilities 121, ,274 Short-Term Debt (Money Pool or Credit Facility) 3,500 3,500 Accumulated Deferred Income Tax 27,651 27,651 Intercompany Payable (due to Seller) 27,651 27,651 Deferred Credits 383, ,459 Total Liabilities and Stockholder Equity 966, ,855 1,084,451 14

16 Tax Considerations o Transaction had to Close Prior to The ELL/EGSL Merger to Avoid Loss of ADIT and Related Tax Recapture (i.e., Maintain Tax Deferral Represented In ADIT Balance) o ADIT as Of Transaction Close Date Associated With Algiers Assets is Retained by Seller Seller Must Eventually Pay Taxes Equal to ADIT Buyer Must Eventually Pay Taxes Equal to any new ADIT That Accumulates After Transaction Close o Buyer Records Offsetting ADIT Debits And Credits Associated With Step-Up ADIT Substantially Equal to The Algiers Assets ADIT as of The Transaction Close (i.e., Zero Effect on Owner Equity) o Zero-Interest Note Payable From Buyer to Seller Equal to Step-Up ADIT. Intercompany Payable Recreates Effect of ADIT Liability on Buyer s Books and Compensates Seller for Increased Tax Liability 15

17 III. KEY ASPECTS OF TRANSACTION 16

18 Purchase Price o Purchase Price of Seller s Assets was Net Book Value Basis of Rate Base in Ratemaking, Provides Continuity Accumulated Depreciation Represents Capital Costs Already Recovered by Ratepayers, So a Higher Amount Could Result in Double-Recovery of Costs o Sale at Net-Book Value (Gross Cost less Accumulated Book Depreciation) Raises Tax Basis Pre-Transaction, Tax Basis of Assets Were Lower Than Book Basis Tax Basis is Increased by Related ADIT (Transaction Debits Tax Basis by ADIT Amount) ADIT Debit is Paid By Zero-interest Note of Same Amount Payable to Seller. Note Amortizes as ADIT Balance Reverses Neither ADIT Debit nor Note Payable are to be Included in Buyer s Future Rate Action Cost Studies 17

19 Evaluation Issues o Prior to the Transaction, the Cost to Provide Service in Algiers was Determined in Large Part by an Allocation of the Seller s Overall Costs Throughout its Entire Service Territory Algiers Represented About 2-3% of Seller s Overall Costs of Service o Also, Seller was in the Process of Merging with EGSL Merger was Scheduled to Close After the Transaction, in Part to Prevent a Taxable Gain on ADIT Step-Up o At the Time of the Transaction, Seller s Algiers Area was Subject to a FRP, With Four Annual Evaluations Remaining o Transaction Made Such FRP Evaluations Unfeasible Merger of Algiers Assets and Operations into Buyer s Accounts Fatally Clouds any Algiers-Specific Accounting o Parties Agreed to Suspend the Algiers FRP and Freeze Rates 18

20 Transaction Conditions o Conditions on Transaction Approval to Protect the Public Interest Buyer Not to Request Rate Action that Singles Out One Service Area, to Prevent Cherry Picking Service Areas to Maximize Revenues Rate Freeze Until the Mid-2018 Combined Rate Case Filing (Discussed Later) Transaction-related Changes To Algiers Base Rate Revenue Requirement are not Reflected in Rates Until the Combined Rate Case No Algiers FRP Evaluations (Discussed Later) Regulatory Cost Reduced By Eliminating Three FRP Evaluations Previously Scheduled in Recent Rate Case Settlement o Transaction Had to Close Prior to The ELL/EGSL to Avoid Loss of ADIT and Related Tax Recapture o ADIT Step-up and Intercompany Payable not to be Included in Future Buyer Rate Action Cost Studies 19

21 Rate Making Issues o The Transaction Closed On September 1, 2015 o The First Full-year Test Year Available for a Cost Of Service Study on Buyer s Combined Operations Would be CY 2016 In Our Experience, a Split-Year Test Year had Proven to be Problematic o Seller was in The Second Step of a 4-Step Annual Algiers Retail Rate Ramp-up Scheduled to Finish In 2017 At the End of the 4-step Rate Ramp-up, Algiers Rates Will be Roughly Comparable to Those Currently Charged by Buyer o In the Interest of Rate Stability, Parties Negotiated a Rate Freeze Through 2018, When a Combined Rate Case Based on a 2017 TY For the Buyer s Combined Operations May Set New Rates 20

22 Interim Ratemaking Issues o Until New Rates can be Established for all of New Orleans Through a Combined Rate Case, the Following Interim Provisions Were Adopted A Combined Fuel Adjustment Clause Important Rate Differences Between Algiers and Buyer s Original Service Area A Combined (Blended) Environmental Adjustment Clause Separate RTO (i.e., MISO) Cost Recovery Riders Phase-in Of Previously Approved Rate Increases in Algiers to Continue Separate Energy Efficiency / DSM Program Budgets and Funding Sources 21

23 IV. ACCOUNTING METHODOLOGIES 22

24 Accounting Methodologies o Objective to Determine Net-book Value of Assets Sold to Buyer o Complications Most Distribution Assets Were Accounted for With Mass Property Accounting Where Individual Assets were not Identified The Original Cost of Most Distribution Assets Physically in Algiers was Unknowable The Sales Price of Most Distribution Assets was Established by Allocating a Portion of all Of Seller s Distribution Assets Allocation was Based on the Same Factors From the Most Recent Rate Case for Algiers Some Transmission Assets Carried Across the Boundary Between Buyer and Seller Asset Purchase Price and Related O&M was Divided Between Buyer and Seller Based on Length of Transmission on Either Side of Boundary Accounts Receivable based on Differing Billing Cycles and Different Collection Rates 23

25 Accounting Methodologies o Complications (Cont.) Seller and Buyer Have Different Depreciation Rates. Upon Close of Transaction, Algiers Assets Begin Depreciation According to Buyer s Approved Depreciation Rates Regulatory Assets Were Transferred at Their Book Value net of Amortization Property Right to Collect Securitization Bonds Servicing Costs Extends to Algiers ADIT is Substantially Eliminated on Buyer s Books due to Tax Basis Step-up Effect of ADIT is Recreated Through Intercompany Note Algiers Benefits from Buyer s Existing Storm Reserve 24

26 Compliance Filing o Within Three Months of Close of the Transaction, Buyer was Required to Make an Accounting Compliance Filing Identifying and Valuing the Algiers Assets as of Transaction Close Showing Supporting Data Showing all Assumptions and Computations, and Formulae o 60-day Review Period Following Filing of Accounting Compliance Filing Upon Completion of Review Period, Parties may File List of Unresolved Issues o 6-month Period to Resolve Issues With Accounting Compliance Filing Unresolved Issues may Call for Supplemental Procedural Schedule 25

27 V. OBSERVATIONS and Q&A 26

28 Considerations for Regulators o In M&A Activity, How is the Public Interest Determined? Determination of Regulators of Both Buyer and Seller Required How to Determine What Benefits Reasonably will Materialize o How to Treat Seller Assets That are Difficult to Physically Identify Allocate Based on Factors From Recent Rate Action Physical Plant Survey Detailed Audit of a Statistical Sample of Property Accounting Entries o How to Provide Generating Capacity to Sold Region PPA of Slice Of Seller s System PPA or Ownership Interest in Specific Generating Units Buyer to Purchase Capacity / Energy in RTO Auctions / Markets 27

29 Considerations for Regulators o What are the Tax Effects of an M&A Transaction? How to Properly Allocate Affected Tax Costs to Appropriate Party How to Avoid New Tax Expenses o Prevent Double-Recovery of Plant Investment Is Accumulated Depreciation Balance Maintained? If Purchase Price is Above Net Book Value, Should Goodwill be Recovered? o What Regulatory Assets, Including Regulatory Assets Related to Stranded Assets, are Appropriately Transferrable in Utility M&A? 28