Franchise Purchase Option Analysis Bill Herrington, WHH - - PowerPoint PPT Presentation

Franchise Purchase Option Analysis

Bill Herrington, WHH Enterprises, Inc. October 5, 2015

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

Introduction

• WHH has provided services to most Florida municipal utilities

including:

• 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

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

Presentation Outline

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

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

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???

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

Costs to Exercise Option or Acquisition Costs

 Acquisition Costs are:

• 1. Customer/Facilities Purchase Price
• 2. Line Extension Costs
• 3. Stranded Costs

Costs to Exercise Option or Acquisition Costs

 Customer/Facilities Purchase Price  Two Approaches

• 1. Market Mulitiple of EBITDA
• 2. Discounted Cash Flow

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

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 8.14

• 3. 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

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

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

Costs to Exercise Option or Acquisition Costs

 Acquisition Costs are:

• 1. Customer/Facilities Purchase Price
• 2. Line Extension Costs
• 3. Stranded Costs

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

Costs to Exercise Option or Acquisition Costs

 Acquisition Costs are:

• 1. Customer/Facilities Purchase Price
• 2. Line Extension Costs
• 3. Stranded Costs

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 $215,000
• 2. Transmission stranded costs
• Equals the pro rata value of transmission

assets

• WHH estimate $116,000

Total Stranded Cost Estimate = $331,000

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

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

Benefits

• 1. Approach is to develop a 20 year financial

model of all cash flows associated with newly acquired customers.

Cash Flow Pro Forma

CASH FLOW PRO FORMA 2016 2017 2018 2019 2020 1 Number Customers Acquired in 2016 591 591 591 591 2 Annual Electric Consumption New Customers kW-hrs 24881150 25,000,580 25,120,583 25,241,161 3 Projected Annual Consumption in Undeveloped Acq Territory kW-hrs 277,867 555,733 833,600 4 Total Consumption in Acquired Territory kW-hrs 24881150 25,278,446 25,676,316 26,074,761 5 Peak Demand Acquired Customers kW 5462 5,549 5,637 5,724 6 Average Bushnell Retail Rate $/1000 kW-hr $139.51 $143.14 $146.86 $150.68 7 Average SECO Retail Rate $/1000 kW-hr $121.90 $125.07 $128.32 $131.66 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 $103.93 $104.69 10 Additional Bulk Power Supply Requirement kW-hrs 26,053,560 26,469,577 26,886,195 27,303,415 11 Bulk Power Supply Costs $ $2,484,566 $2,640,398 $2,794,256 $2,858,481 12 Net Revenues New Customers $ $986,586 $977,872 $976,519 $1,070,370 13 Incremental Electric Distr O&M and Capital Expenses $ $197,560 $207,516 $217,791 $228,394 14 Loss of Franschise Fees $ $181,981 $189,694 $197,689 $205,976 15 Operating Cash Flow $ $607,045 $580,663 $561,039 $636,000 16 Debt Service $374,828 $374,828 $374,828 $374,828 17 Acquisition Costs $6,105,525 18 Net Cash Flow from Acquisition

• $6,105,525

$232,218 $205,835 $186,211 $261,172

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

Benefits – Scenario 1 (City rates) Pro Forma for Scenario 1

CASH FLOW PRO FORMA 2016 2017 2018 2019 2020 1 Number Customers Acquired in 2016 591 591 591 591 2 Annual Electric Consumption New Customers kW-hrs 24881150 25,000,580 25,120,583 25,241,161 3 Projected Annual Consumption in Undeveloped Acq Territory kW-hrs 277,867 555,733 833,600 4 Total Consumption in Acquired Territory kW-hrs 24881150 25,278,446 25,676,316 26,074,761 5 Peak Demand Acquired Customers kW 5462 5,549 5,637 5,724 6 Average Bushnell Retail Rate $/1000 kW-hr $139.51 $143.14 $146.86 $150.68 7 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 $103.93 $104.69 10 Additional Bulk Power Supply Requirement kW-hrs 26,053,560 26,469,577 26,886,195 27,303,415 11 Bulk Power Supply Costs $ $2,484,566 $2,640,398 $2,794,256 $2,858,481 12 Net Revenues New Customers $ $986,586 $977,872 $976,519 $1,070,370 13 Incremental Electric Distr O&M and Capital Expenses $ $197,560 $207,516 $217,791 $228,394 14 Loss of Franschise Fees $ $181,981 $189,694 $197,689 $205,976 15 Operating Cash Flow $ $607,045 $580,663 $561,039 $636,000 16 Debt Service $374,828 $374,828 $374,828 $374,828 17 Acquisition Costs $6,105,525 18 Net Cash Flow from Acquisition

• $6,105,525

$232,218 $205,835 $186,211 $261,172

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

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

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

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

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

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

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

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

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.

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.

Questions/Discussion

?