Investors Look to Take Plunge With Water Company

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Some investors think there’s money to be made in the water business, even at a company that just 16 months ago was in serious financial straits.

Last week, a group of institutional investors announced the purchase of SouthWest Water Co. in downtown Los Angeles for $275 million in cash plus assumption of debt, making the total purchase worth $427 million. That amounts to $11 per share, or 56 percent above the March 2 closing price of $7.07.

J.P. Morgan Asset Management and Water Asset Management LLC made the offer on behalf of the institutional investors, who plan to take the 1,285-employee company private.

The deal price far exceeded one analyst firm’s target estimate of $8 per share. Just hours after the March 3 announcement, Philadelphia-based Janney Capital Markets recommended that investors “sell shares into strength this morning.”

The sale, subject to approval by water utility regulators in California and four other states, represents a remarkable turnaround for SouthWest Water, which owns and operates 130 regulated water and wastewater systems under contract to municipalities and agencies.

Just 16 months ago, shareholders were rocked by news that the company had to restate earnings going back three years after auditors had discovered depreciation errors on its balance sheets. That sent the stock plunging to a 10-year low; the rash of shareholder lawsuits that followed remain pending.

At the same time, the company was forced to postpone much needed capital improvement and maintenance expenses because of the credit crunch.

Both problems arose shortly after a new management team led by Chief Executive Mark Swatek took the helm. Since then, Swatek and his team have divested noncore assets, such as the sale of a wholesale wastewater business in Texas. They have also tried to balance out the company’s two main lines of business, water utilities and contract management, which had skewed toward the lower-margin contract management side.

In January, SouthWest Water announced that David Stanton, the chief financial officer that had overseen the restatement process, had left the company.

This departure may have hastened SouthWest Water’s quest to find a buyer, according to Janney analyst Debra Coy.

As part of the deal announced last week, the institutional investors, who were not identified, would inject $16 million in immediate working capital into SouthWest Water to allow the company to work through its backlog of maintenance and other capital projects.

Coy raised the possibility of rate hikes for customers of some or all of the utilities in SouthWest Water’s portfolio.

“The purchase price implies a substantial premium to rate base that will need to be approved by the public utility commissions,” Coy said in Janney’s analysis of the deal.

The California Public Utilities Commission in March 2009 approved an 11 percent rate hike for SouthWest Water’s California utility operations.

If utility rate hikes aren’t approved, SouthWest Water may have to raise prices for its nonregulated management contracts, Coy said.

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Howard Fine
Howard Fine is a 23-year veteran of the Los Angeles Business Journal. He covers stories pertaining to healthcare, biomedicine, energy, engineering, construction, and infrastructure. He has won several awards, including Best Body of Work for a single reporter from the Alliance of Area Business Publishers and Distinguished Journalist of the Year from the Society of Professional Journalists.

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