Franchise Purchase Option Analysis. Bill Herrington, WHH Enterprises, Inc. October 5, 2015

Transcription

1 Franchise Purchase Option Analysis Bill Herrington, WHH Enterprises, Inc. October 5, 2015

2 Introduction WHH Enterprises, Inc. is a small Florida consulting firm Provides services primarily to municipal utilities Consulting since 1997 Retains additional resources as needed on a task specific basis Prior to forming WHH Enterprises, served as Sr. Vice President, Electric Business Unit, Orlando Utilities Commission, retired after 28 years

3 Introduction WHH has provided services to most Florida municipal utilities including: Alachua Bartow Cape Coral Ft. Meade Ft. Pierce Fruitand Park Green Cove Springs FMPA Kissimmee Utility Auth Jupiter Island Live Oak Lake City Marco Island Marianna Mt. Dora Moore Haven Orlando Utilities Comm Quincy Vero Beach Winter Park Employed in the utility business for 42 years. Registered Engineer in Florida BSME Univ. of Fla MBA at Rollins College Additional post graduate work in finance at UCF

4 Presentation Outline Purchase Option Acquisition Cost (cost to exercise option) Benefits from Exercising Option Results Questions/Discussion

5 Purchase Option Franchise agreement between the City and Sumter Electric Coop (SECO) provides: At and after the expiration of this franchise, Grantor shall have the right to purchase the electric plant and facilities of Grantee located within the corporate limits of Grantor which are used under or in connection with this franchise or right, at a valuation of the property desired, real and personal, which valuation shall be fixed by arbitration as may be provided by law

6 Purchase Option 1. The City has the option to purchase the facilities pursuant to the franchise agreement 2. An option is a contract which gives the buyer (Bushnell) the right, but not the obligation, to buy or sell an underlying asset at a specified strike price on or before a specified date. 3. All options have value. 4. What is the value of this option???

7 Purchase Option What is the value of this option??? The value is the economic benefit from exercising the option less the cost to exercise the option. Benefits minus Costs

8 Costs to Exercise Option or Acquisition Costs Acquisition Costs are: 1. Customer/Facilities Purchase Price 2. Line Extension Costs 3. Stranded Costs

9 Costs to Exercise Option or Acquisition Costs Customer/Facilities Purchase Price Two Approaches 1. Market Mulitiple of EBITDA 2. Discounted Cash Flow

10 Market Multiple of EBITDA Approach 1. Identify firms with similar risks 2. Calculate current enterprise value as a multiple of EBITDA 3. Apply multiple to EBITDA of contested customers 4. Adjust to reflect risk premium for small companies

11 Market Multiple of EBITDA Approach 1. Identify firms with similar risks AGL, UTL, ATO, SWX 2. Calculate current enterprise value as a multiple of EBITDA. Average multiple is Apply multiple to EBITDA of contested customers. $380,000 x 8.14 = $3.1 million 4. Adjust to reflect risk premium for small companies. (100%-15%) x $3.1 = $2.6 million

12 Discounted Cash Flow Approach 1. Operating Cash Flow per kwhr x Sales = Annual Cash Flow (ACF) 2. PV of ACF escalated at 2% and discounted at 6.5% for 20 years 3. PV of $217,00 escalated at 2% = $3.35 million 4. $3.35 million includes a terminal value adjustment

13 Costs to Exercise Option or Acquisition Costs Customer/Facilities Purchase Price Two Approaches 1. Market Mulitiple of EBITDA = $2.60 million 2. Discounted Cash Flow = $3.35 million AVERAGE is $2.95 million

14 Costs to Exercise Option or Acquisition Costs Acquisition Costs are: 1. Customer/Facilities Purchase Price 2. Line Extension Costs 3. Stranded Costs

15 Line Extension Costs 1. SECO estimate $3.55 million 2. Power Services estimated $1.2 to $2.2 million 3. WHH high level estimate $2.4 million 4. Used $2.4 million in analysis

16 Costs to Exercise Option or Acquisition Costs Acquisition Costs are: 1. Customer/Facilities Purchase Price 2. Line Extension Costs 3. Stranded Costs

17 Stranded Costs Stranded Costs are the book value of investments made by SECO to serve the customers that would be acquired by the City 1. Distribution stranded costs Only two areas represent stranded distribution costs WHH estimate is $215, Transmission stranded costs Equals the pro rata value of transmission assets WHH estimate $116,000 Total Stranded Cost Estimate = $331,000

18 Costs to Exercise Option Summary Acquisition Costs are: 1. Customer/Facilities Purchase Price $2.95 million 2. Line Extension Costs $2.4 million 3. Stranded Costs $0.331 million 4. Other fees $0.4 million Total Acquisition Cost Estimate $6.1 million

19 Purchase Option What is the value of this option??? The value is the economic benefit from exercising the option less the cost to exercise the option. Benefits minus Costs Cost have been estimated to be $6.1 million

20 Benefits 1. Approach is to develop a 20 year financial model of all cash flows associated with newly acquired customers.

21 Cash Flow Pro Forma CASH FLOW PRO FORMA Number Customers Acquired in Annual Electric Consumption New Customers kw-hrs ,000,580 25,120,583 25,241,161 3 Projected Annual Consumption in Undeveloped Acq Territory kw-hrs 0 277, , ,600 4 Total Consumption in Acquired Territory kw-hrs ,278,446 25,676,316 26,074,761 5 Peak Demand Acquired Customers kw ,549 5,637 5,724 6 Average Bushnell Retail Rate $/1000 kw-hr $ $ $ $ Average SECO Retail Rate $/1000 kw-hr $ $ $ $ Gross Revenues New Customers $ $3,471,152 $3,618,270 $3,770,775 $3,928,852 9 Bulk Power Rate COB $/MW-hr $95.36 $99.75 $ $ Additional Bulk Power Supply Requirement kw-hrs 26,053,560 26,469,577 26,886,195 27,303, Bulk Power Supply Costs $ $2,484,566 $2,640,398 $2,794,256 $2,858, Net Revenues New Customers $ $986,586 $977,872 $976,519 $1,070, Incremental Electric Distr O&M and Capital Expenses $ $197,560 $207,516 $217,791 $228, Loss of Franschise Fees $ $181,981 $189,694 $197,689 $205, Operating Cash Flow $ $607,045 $580,663 $561,039 $636, Debt Service $374,828 $374,828 $374,828 $374, Acquisition Costs $6,105, Net Cash Flow from Acquisition -$6,105,525 $232,218 $205,835 $186,211 $261,172

22 Benefits 3 Scenarios were considered: 1. Bushnell charges City rates to newly acquired customers. 2. Bushnell charges SECO rates to newly acquired customers 3. Bushnell charges SECO rates and purchases bulk power supply on open market

23 Benefits Scenario 1 (City rates) Pro Forma for Scenario 1 CASH FLOW PRO FORMA Number Customers Acquired in Annual Electric Consumption New Customers kw-hrs ,000,580 25,120,583 25,241,161 3 Projected Annual Consumption in Undeveloped Acq Territory kw-hrs 0 277, , ,600 4 Total Consumption in Acquired Territory kw-hrs ,278,446 25,676,316 26,074,761 5 Peak Demand Acquired Customers kw ,549 5,637 5,724 6 Average Bushnell Retail Rate $/1000 kw-hr $ $ $ $ Average SECO Retail Rate $/1000 kw-hr N/A N/A N/A N/A 8 Gross Revenues New Customers $ $3,471,152 $3,618,270 $3,770,775 $3,928,852 9 Bulk Power Rate COB $/MW-hr $95.36 $99.75 $ $ Additional Bulk Power Supply Requirement kw-hrs 26,053,560 26,469,577 26,886,195 27,303, Bulk Power Supply Costs $ $2,484,566 $2,640,398 $2,794,256 $2,858, Net Revenues New Customers $ $986,586 $977,872 $976,519 $1,070, Incremental Electric Distr O&M and Capital Expenses $ $197,560 $207,516 $217,791 $228, Loss of Franschise Fees $ $181,981 $189,694 $197,689 $205, Operating Cash Flow $ $607,045 $580,663 $561,039 $636, Debt Service $374,828 $374,828 $374,828 $374, Acquisition Costs $6,105, Net Cash Flow from Acquisition -$6,105,525 $232,218 $205,835 $186,211 $261,172

24 Benefits Scenario 1 (City rates) Scenario 1 Results Summary: 1. IRR is 12.1 % 2. NPV is $4.1 million 3. # Years Negative Cash Flow is 0

25 Benefits Scenario 1 (City rates) Scenario 1 Conclusions: 1. It is financially feasible 2. Would require raising electric rates about 14 percent on acquired customers 3. Politically difficult to implement

26 Benefits Scenario 2 (SECO rates) Scenario 2 Results Summary: 1. IRR is 0 % 2. NPV is -$3.3 million 3. # Years Negative Cash Flow is 20

27 Benefits Scenario 2 (SECO rates) Scenario 2 Conclusions: 1. Maintains existing electric rates for acquired customers 2. Would be easier to implement since electric rates are unchanged 3. It is not financially feasible 4. No financial benefit to the City

28 Benefits Scenario 3 (SECO rates plus market priced bulk power supply) Scenario 3 Description Currently Bushnell is required to purchase all bulk power from FMPA All Requirements Project However, contract has a provision allowing market purchases of bulk power supply for all new load if this provision is exercised. Scenario 3 assumed market priced purchases of bulk power and SECO retail rates

29 Benefits Scenario 3 (SECO rates plus market priced bulk power supply) Scenario 3 Results Summary: 1. IRR is 21 % 2. NPV is +$12.6 million 3. # Years Negative Cash Flow is 0

30 Benefits Scenario 3 (SECO rates plus market priced bulk power supply) Scenario 3 Results Discussion: 1. Bushnell Existing Margin is about $44/MW-hr 2. Bushnell Margin with market priced BPS and SECO rates would be about $61/MW-hr 3. High returns are not surprising when margin increases 50% without any increase in costs

31 Benefits Summary IRR NPV Implementation Scenario 1 12% $4.1 million challenging Scenario 2 0% -$3.3 million N/A Scenario 3 21% $12.6 million relatively easy

32 What is the value of this option??? The value is the economic benefit from exercising the option less the cost to exercise the option. Benefits minus Costs Costs have been estimated to be $6.1 million Benefits (Scenario 3) have been estimated to be $12.6 million WHH concludes that the value of this option is $6.5 million.

33 CONCLUSION 1. The option franchise agreement has value (about $6.1 million). 2. City should continue to refine estimates of the valuation of the cost and benefits of this option. 3. City should engage in discussions with SECO regarding alternative positions that reduce costs to both parties.

34 Questions/Discussion?