The Keys to the Vault

One of the great ironies in the water industry ? in addition to the central irony that we generally pay so little for something of such irreplaceable value ? is the fact that so many cities are in desperate need of investment in infrastructure while so much money is available, but seemingly just out of reach. We are like blind beggars, still sitting on the same street corner waiting for the same meager handouts, while plentiful food, shelter ? and jobs ? are being handed out on the next street over.

It does seem to be finally sinking in for the water industry that the meager handouts from Washington are over. The hangover from years of binge government spending will result in a morning after that will last a long time. The efforts to ramp up the State Revolving Funds (SRFs), to get more stimulus money, or to create a trust fund or infrastructure bank that will materially benefit investment in water infrastructure, have all fizzled. They are unlikely to be revived any time soon, despite President Obama?s recent brave attempt to jumpstart a new jobs plan that includes an infrastructure bank component. Even if the bank could make it through the toxic swamp that passes for the political process these days, it would likely only be useful for large regional water transmission or storage projects, not the vast array of smaller local projects that need funding.

Meanwhile, there are billions of dollars in capital sitting on the sidelines, in the hands of investors who would like nothing better than to put their money into water projects, if only they could figure out how.

In fact, more than $150 billion in capital has been committed to infrastructure via privately managed infrastructure funds over the past five years, with many more billions to follow if enough transactions begin to materialize. Much of this ?private equity? is actually public capital ? that is, state and local government employee pension funds and university endowments. The California Public Employees Retirement System (CALPERS), for example, voted in September to invest up to $800 million in public and private infrastructure projects in California over the next three years, in addition its overall commitment of $4.5 billion for infrastructure projects across the United States and globally as a way to hedge against inflation. These large institutional investors are reliant on steady, predictable cash flows to meet their payment obligations to members over a long period of time. Amid the turmoil and volatility on Wall Street, they are looking for stability and risk management, rather than high returns.

Water is a particularly attractive asset class for this type of investor. Water rates on average are still relatively low compared to other utilities, giving room for growth over time. The industry is structurally stable, without the competition and volatility experienced in the telecom industry, for example, and assets like water mains and treatment plants have a relatively long life, allowing costs to be spread out over a number of years.

This stability is a key reason why investor-owned water utilities have performed well during the recent stock market downturn. The largest, American Water Works, has seen its stock price appreciate more than 15 percent year to date, while the S&P 500 index has declined about 5 percent. When these companies issue equity, investors are willing to pay a premium to their asset value, in return for steady dividends and predictable performance over time.

So why aren?t investors putting their money to work in municipal water and sewer projects?

There are several reasons, but perhaps the biggest is the reluctance of the industry to leave the zone of comfort ? the unwillingness of the beggar to leave the street corner where he?s been getting some quarters in his cup. We?re used to relying on government subsidies for water, whether through tax-exempt muni bonds or direct grants and loans, and we?re not keen to try something new.

Many municipalities fear that the cost of private capital is materially higher than for traditional municipal bonds, which induce investors to accept a lower return by eliminating the tax liability on their investment earnings, though in fact the variance has declined recently. Under pending federal legislation that would remove the cap on private activity bonds, private capital would be put on a level playing field with tax-exempt municipal bonds, removing this disincentive for municipalities to explore public-private partnerships. Partnerships that are incentivized to improve operating efficiencies can also help to reduce costs.

Overall, while it is true that investor capital requires some return ? who among us wants to put money in a pension plan or retirement account that won?t grow over time? ? it is also true that projects can be privately funded without significantly increasing the cost to ratepayers.

It?s time to walk across the street and explore some new alternatives, don?t you think?
Debra G. Coy is a principal with Svanda & Coy Consulting, which serves customers in the water sector. She launched her independent consulting practice in 2010 after 20 years covering the water environmental sectors for institutional investors for Wall Street firms, including Janney Montgomery Scott, Schwab Capital Markets and HSBC Securities. She has been recognized as the industry?s leading analyst and ran Wall Street?s top water conference for more than a decade.

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