Adjusting to the new performance paradigm
2012 was a year of change in the contract operations market, as traditional O&M contracts gave way to performance-based models. Which companies are best positioned to ride the new wave?
The combined revenues of the big five private sector contract operators active in the US water sector declined last year for the first time since 2007, as the market adjusted to a paradigm shift in the way major municipalities look to maximise the potential of their water and wastewater infrastructure.
Total revenues for the five largest firms declined by 2% year-over-year in 2012, to $1.64 billion (see first chart), but that was accompanied by the rise of a new breed of contracts, as major operators rolled out new strategies to counter slow growth in traditional outsourcing contracts.
Despite its pioneering role in developing performance-based contracts in the US water sector, market leader Veolia Water saw the largest revenue decline last year (9%), while CH2M Hill OMI grew its revenues by 9%. United Water, Severn Trent Services and American Water were all essentially flat year-over-year.
Since late 2011, the market has seen a wave of consulting and efficiency contracts put out to tender (see table second image), most recently including one for the Washington Aqueduct, an independent water system that serves Washington, DC.
DC Water General Manager George Hawkins told GWI that the spike in performance-based consultancy contracts is due to the harsh US economy and the need for cities to justify higher tariffs to ratepayers. Cities cannot ignore deteriorating infrastructure, and efficiency contracts help utilities explain why new projects and expensive upgrades are needed. “The trend perhaps five to 10 years ago was to have a private firm come in and effectively take over,” Hawkins said. “That raised challenges on political fronts, and I think a lot of us have wondered whether it’s worth it if you can achieve many of the same benefits without having to go through the political question of a private firm running what most people consider a very public asset.”
The largest private operators seem to agree, and many are changing course. In 2012, the contract ops market saw the advancement of two emerging models for public-private partnerships: Veolia’s Peer Performance Solutions (PPS) model and United Water’s private-equity-backed “Solution,” which it is implementing in Bayonne, New Jersey. While Veolia has moved away from traditional O&Ms to chase high-profile performance-based contracts, United Water has embraced a new breed of long-term lease contract. Under this model, the company operates existing assets whilst achieving returns for a private equity partner which makes an initial upfront payment to the municipality in order to defease debt, eliminate unfunded pension liabilities, or otherwise bail out the cash-strapped municipality.
While this model enables the public sector client to retain ownership of its systems, it is less likely than a performance-based contract to deflect political flak from unions and antiprivate sector lobbyists. The emergence of non-profit organisation Lehigh County Authority as the apparent high bidder for the 50-year lease contract in Allentown (PA) earlier this month further underscores the pitfalls for private water operators looking to promote this type of model (see story "Bidding to justify the profit motive").
In 2012, Veolia parlayed the success of its PPS model – which it demonstrated via contracts won in Winnipeg and New York City in 2011 – into signature wins in Pittsburgh and St. Louis (although the latter is on hold due to political opposition). In both cases, Veolia will earn revenues through a combination of fixed fees and a percentage of the operational efficiencies it is able to create.
“A few years back, the market was a bit flat and boring,” Veolia Water North America CEO Laurent Auguste told GWI. “I would absolutely not say that today. I think it’s a pretty exciting time because if the needs of the clients can be met by some of the new products that are brought to the market by us and the competition, it is becoming a more active and dynamic place.”
The examples of New York City, Pittsburgh and St. Louis have inspired other major US metropolitan areas to get in on the act. In late 2011 and 2012, San Diego and Los Angeles released a series of RFPs to optimise various elements of their water systems, although Los Angeles’s status as a general law city meant that it did not include a longer-term operations component in its RFP for large meter maintenance and chemical environmental services, which may go some way to explaining why it received only one proposal (understood to be from Veolia). Seattle and Washington, DC, continued the trend towards performance-based consultancy contracts by issuing RFPs earlier this year (see table second image).
Veolia was not, however, able to sell its PPS model to the City of San Diego, which awarded a more conventional consultancy contract to CH2M Hill in February this year. CH has a comparatively broader focus when it comes to municipal outsourcing contracts, providing services outside of water and wastewater. The firm’s 30 years of experience using the performancebased model to help cities operate their utilities more efficiently suggests it could successfully ride the wave of big-city water and sewer contracts started by Veolia two years ago.
Meanwhile, United Water achieved a milestone for private equity investment in the US water sector when it partnered with KKR to win a 40-year O&M in Bayonne. Due to KKR’s involvement, Bayonne will be able to reduce its utility debt, stabilise its water and wastewater rates and invest millions in capital improvements over the life of the contract.
“It’s very positive that each of the players is trying to propose innovative new models,” United Water CEO Bertrand Camus told GWI. “I think that each one is playing on its own strengths. All of that is going in the right direction. In three or four years’ time we’ll see who was the most successful.”
The success of new business models could not have come at a better time for the major private operators. The Big Five have in recent years faced increasingly intense competition from regional firms that make up the middle tier of the US contract ops market. Georgia-based ESG Operations – a $36 million-per-year O&M firm founded by former CH2M Hill employees – took over from CH in Barnesville, Georgia, last year, marking the only contract not to have been successfully renewed by the top five firm last year. Middlesex Water subsidiary Utility Service Affiliates, meanwhile, beat out incumbent American Water for a 10-year O&M contract in Avalon, New Jersey, while American Water was also defeated in Cohasset, Massachusetts, by Maine-based Woodard & Curran.
As both national and regional O&M firms continue to find their niches in what remains a tight contract ops market, one former leading light is fading from view. Although the company declined to speak to GWI for the purposes of this article, it is abundantly clear from anecdotal evidence that SouthWest Water (SWWC) has scaled back its activity considerably in the contract ops business. Having exited a number of unprofitable or marginally profitable contracts, SWWC has gradually been letting short-term agreements with municipal utility districts in Texas expire as they mature.
Many of those contracts have since been taken over by Severn Trent, and in March 2013, the City of Sugar Land, Texas, approved a plan to let Severn Trent assume the remaining three months of SWWC’s contract for certain distribution and collection system repairs. The firm’s non-regulated business is not entirely dead, however: in early 2013, SWCC picked up a contract for consulting services on a water supply project in Midland (TX) that is being designed and built by a consortium led by Black & Veatch and Garney Construction.
Despite the major breakthroughs it achieved for its PPS model, US market leader Veolia saw its total contract ops revenues decline by 9% year-over-year to $618 million in 2012. Scott Edwards, executive vice president of communications for Veolia Water North America, told GWI that much of the revenue decline was due to a fall-off in design-build revenues (which are contained in our totals) owing to the conclusion of certain capital projects delivered under the DBO model.
Veolia added only two municipal O&Ms with Cascade Water (WA) and the City of Rialto (CA) last year, while six existing O&M contracts reverted to local control and two were lost to competitors. The firm’s renewal rate of 83% was consequently considerably lower than those of United Water (95%) and CH2M Hill (97%) last year.
The Pittsburgh Water and Sewer Authority (PWSA) hired Veolia in June to provide interim executive management services for at least 12 months, with an optional six-month extension. In December, Veolia was selected by the St. Louis Water Division for a short-term operational efficiency and value-creating consulting contract. In February 2013, however, the St. Louis contract was put on hold, and the mayor is currently making an effort to sell the deal to a sceptical public. Veolia’s Laurent Auguste told us he is optimistic both about the outcome in St. Louis, and the continued uptake of performance-based contracts in the US.
“I believe everybody’s watching what’s going on in New York and Pittsburgh, and people see that this is actually developing very well,” Auguste said. “The first projects are definitely moving in the right direction, and they are successful, so I think the question is: will there be more momentum building in 2013? I consider this a pretty critical year in that respect, but I’m really optimistic about it. I am confident that there will be more of these opportunities in the market because it’s a good product and something that major cities need.”
Veolia captured its 30-year water and sewer concession in Rialto after negotiations between the city and American Water fell apart. Veolia’s local familiarity played a role in its selection – the firm had operated the city’s wastewater system for nearly a decade. Financier Rialto Water Services (a joint venture between Ullico Investment Advisors and Table Rock Capital) provided the city with an upfront payment of $35 million, and the contract is expected to be worth about $300 million to Veolia.
Despite its successes elsewhere, the DBO market was unkind to Veolia in 2012. The company lost out to CH2M Hill in a bid for a $35 million wastewater DBO in its stronghold of Woonsocket (RI), and walked away from the $250 million Davis-Woodland water supply project in California. “The US water market is very active, and during what became a lengthy procurement process, we believed it was in our strategic interest to shift resources to other projects and market opportunities,” Edwards said of the Davis-Woodland project.
The withdrawal of such a high-profile candidate from one of only a very few DBOs under active tender in the US water sector last year proves that clients cannot afford to indulge in protracted bidding processes (see GWI March 2013, p20).
Auguste emphasised that Veolia will continue to focus on long-term operations contracts with capital components, despite the apparent push for shorter performancebased consulting contracts. The firm’s wastewater O&M in New Orleans, which it inherited through the acquisition of Professional Services Group, has been renewed a number of times since 1991, and will expire in January 2014. Competitive bidding is currently underway for a 10- to 20-year renewal.
United Water’s contract ops revenues were flat year-on-year in 2012. The Suez Environnement subsidiary continued with its strategy of portfolio optimisation, letting go of a handful of small, conventional O&M contracts in favour of selling new clients on long-term contracts structured under inventive business models. The company’s focus is on large, long-term, complex transactions where it can offer a competitive edge, and United CEO Bertrand Camus justifies this approach by emphasising that it is difficult to apply group-wide standards in terms of compliance and health and safety to smaller projects, whilst remaining profitable versus local operators.
In 2012, United was successful in retaining most of the contracts for which it chose to compete, winning 19 out of 20 renewals. Its only loss came at the hands of Severn Trent in DeSoto County (MS).
United’s crowning achievement of 2012 represented a strong contrast to the emerging performance-based consulting model. In August, the company finalised a deal to operate the water, wastewater, stormwater and combined sewer overflow systems of Bayonne (NJ) for a period of 40 years. United and its private equity partner KKR agreed to provide the city with an upfront payment of $150 million and to fund $14.5 million in capital improvements, making it the first instance in the US in which a long-term water and sewer O&M contract will leverage private equity. Camus emphasised, however, that there is no exclusivity between United Water and KKR in terms of bidding for future projects, and that the company’s strategy will be to look for projects and then invite partners, rather than the other way around.
United has branded the Bayonne model “Solution,” and it is actively trying to sell it to other municipalities. “Now that we have this reference, we need to see a couple of other ones being modelled in the market,” Camus told GWI. “We don’t say it is ‘the’ solution, but it is a very attractive solution and we are promoting it whenever we can.”
United also secured a long-term O&M contract in Nassau County (NY), although the county separately bid out the financing of the deal, which will include a $750 million upfront payment to help it reduce general debt. Thirteen investment firms – including KKR – expressed interest in financing the Nassau County concession last July, but political gridlock over the county’s 2013 budget has stalled the process. In addition, torrential rains from Superstorm Sandy in late October flooded one of the county’s sewage treatment plants, and Camus said the county is currently focused on securing federal relief to fund infrastructure repairs.
The DBO market is still a priority for United, and while it was defeated by CH2M Hill on the wastewater DBO in Woonsocket in June last year, the company remains in the running for the Davis-Woodland water supply project. United officials are, however, losing patience with the lack of clarity over risk allocation in the contract proposal, while CDM Smith – United’s design-build partner – threatened to pull out of the bidding process in January.
Camus emphasised to GWI that United’s ideal DBO project would be similar to its East Providence (RI) reference, in which United was able to take over operations from day one, while its DB partner performed retrofits on an existing plant. Like other projects before it, the Davis-Woodland project’s DB component has grown in complexity, and United has expressed concerns that the operations element is taking something of a back seat. In order for a DBO project to become interesting, United traditionally requires around two thirds of the contract’s longterm value to be accounted for by the operating element.
While DBO opportunities in the US remain few and far between, United is looking further afield at some of the upcoming opportunities that are emerging in Canada. The Capital Regional District of Victoria, British Columbia, is planning a regional wastewater programme that will use the DBFO model to develop a Can$205 million (US$201 million) biosolids facility, and a United Water/ AECOM team has unofficially indicated its interest in responding to an RFQ later this year. United is also understood to be closely monitoring a plan by the City of Regina in Saskatchewan to move forward with a wastewater treatment plant expansion under the DBFO model.
CH2M Hill OMI
CH2M Hill OMI grew its municipal and industrial contract ops revenues by 9% year-over-year in 2012, as it pulled away from American Water to underscore its position in the top three. Like its competitors, CH did not report many new opportunities for conventional municipal O&Ms last year, although it has been adept at maintaining its existing client base, enjoying a 97% renewal rate last year. The firm only failed to renew one existing contract in 2012, losing to ESG Operations in a bid to retain its contract in Barnesville (GA).
CH2M Hill’s key municipal win last year was its DBO contract in Woonsocket (RI), and it is in a favourable position to capture another marquee DBO contract in 2013 – the Davis-Woodland water supply project. Rich D’Amato, the firm’s senior vice president and global director of business development, told GWI that the company has remained patient with regard to the project’s protracted procurement process, which has grown in complexity since the teams led by Veolia, United and CH2M Hill were pre-qualified in June 2011. “These are big, complicated deals,” D’Amato noted. “It takes a lot of stakeholder engagement and involvement to get to a point where these communities are comfortable in their decision. We’re just trying to work with them and provide them information so they can make the best decision they can make.”
While CH’s industrial operations revenues were slightly down year-overyear, D’Amato indicated that that segment is poised for future growth. CH picked up two industrial water and wastewater treatment contracts with clients in the mining and manufacturing sectors last year. Regulatory pressures and rising energy prices are among the catalysts driving demand for the company’s facility management services. D’Amato said that industrial client relationships which begin with smaller tasks such as environmental consulting can sometimes morph into DB contracts for water and wastewater infrastructure. CH2M Hill is targeting opportunities for DB and DBO projects in mining, oil & gas and power, and recently secured a DB project with a mining client.
“We are starting to see an increased demand for a turnkey-type approach from a lot of these industrial and private sector clients,” he said. “We didn’t see that for a while. That seems to be picking back up, where they want us to do design-build and maybe even design-build-own-operate.”
American Water spent most of 2012 pruning its existing contract operations portfolio in an effort to enhance group-wide shareholder value, leading to something of a plateau in its contract operations business. The company continued to retool its efforts and shift its focus away from short-term, traditional O&M agreements, which resulted in its contract ops revenues rising slightly from $230.5 million in 2011 to $232.7 million in 2012. The increase came despite a decline in the total number of O&M contracts in its portfolio from more than 100 in 2011 to just over 80 in 2012, driven partly by the loss of smaller contracts held by its Applied Water Management Group subsidiary, which was sold to Natural Systems Utilities in late 2011.
American Water did not sign any new municipal contracts last year, and its contract with the City of New Albany (IN) ended in December after the city took operations back in-house. The company also lost a number of competitively bid renewals to competitors, including Cohasset (MA), Huron/Elgin (ON), and Avalon (NJ), while two industrial O&M contracts transferred to Woodard & Curran in 2012.
David Choate, president of American Water’s Contract Services Group, said the company has been focusing on longerterm contracts with more favourable risk profiles. He acknowledged that American Water was largely absent from municipal contract solicitations in 2012, but he said that is attributable to the company’s broader corporate strategy.
“We’ve really had a focus on optimising our portfolio. That has been a focus for us over the last couple of years. We haven’t been as active in responding to some of those shorter-term O&M contracts, and we haven’t been very active in the DBO market,” Choate told GWI. “We continue with that strong focus of optimising our portfolio and our operating model. That isn’t to say that we’re not going to pursue those opportunities going forward if they’re a good fit […] but we remain most active in developing opportunities that we believe can deliver long-term value and growth potential.”
The final outcome of American Water’s long-running saga in Rialto will likely be viewed as the largest blemish on the company’s 2012 record. After being approved by the Rialto City Council in March 2012 for a 30-year operations deal, contract negotiations fell apart in August 2012. Veolia replaced American as the city’s chosen operating partner, and the final decision seems to have been influenced heavily by relations with local labour unions. While unions undoubtedly played a role in the decision to eschew offers by American Water and United Water and move forward with a non-profit operator in Allentown (PA), Choate does not see labour tensions as posing a material threat to the business in the long run.
The company’s taste in contracts seems to have drifted more to deals that blur the line between contract operations and outright asset ownership. The company has continued to prioritise 50-year privatisation deals of US military bases, for example. Several such contracts have moved forward in recent months, including deals to privatise the utility assets of Grand Forks Air Force Base (AFB) in North Dakota, Eglin AFB in Florida and, most recently, Wright-Patterson AFB in Ohio. Choate confirmed that American submitted a number of proposals for such contracts last year, and expects to chase more in 2013. American also intends to prioritise regional water supply contracts in the years ahead. The company recently responded to a request for expressions of interest on one such project for the Gloucester County Utilities Authority and Salem County Improvement Authority in New Jersey. The deal, which may proceed as a PPP, could be worth $325 million.
Severn Trent Services
Of the country’s largest operators, Severn Trent was perhaps the least adventurous in 2012, with the notable exception of its business development activities in Bridgeport (CT), where it is in pole position to secure a long-term renewal of the sector’s most notorious contract. On the whole, however, the company largely stayed the course that it has followed for the past several years, chasing mid-sized contracts too small for its larger peers to pursue profitably. As a result, O&M revenues for 2012 were flat, at $153 million.
“We’re sticking to the knitting,” confirmed Severn Trent Services’ vice president of operating services Dana Kaas. “We’re staying focused on the size of the projects and the make-up of the projects that we’ve traditionally pursued.” This strategy has been been reaffirmed by the changing strategies of a number of its competitors, which have reduced the level of competition for certain projects that fall into STS’ sweet spot. “We think we’ll have less competition from the big players, but we will see increased competition from the smaller players,” said Kaas.
The company signed four new municipal contracts in 2012, including Fulshear (TX), and a deal to operate nine wastewater treatment plants for the DeSoto County Regional Utility Association in Mississippi – a contract it took from United Water. Severn Trent Services also saw a much improved renewal rate, which increased substantially from 68% in 2011 to 90% in 2012. The company picked up a large number of short-term contracts with municipal utility districts (MUDs) in Texas, a business that has historically been dominated by SouthWest Water. In 2012 alone, Severn Trent secured more than 30 such contracts, 24 of which include an operations component (the rest of Severn Trent’s MUD contracts are for non-utility services such as billing).
Kaas told GWI that the company’s flat revenues were due to executive changes and internal efficiency reviews, rather than an inability to advance Severn Trent’s offerings. When current STS CEO Martin Kane replaced outgoing boss Len Graziano in April 2012, he made a priority of sizing up the company’s capacity to support growth, which Kaas expects to be substantial over the next several years. The company has invested heavily in IT and support services in anticipation of future gains, he told GWI.
“We expect to grow in the neighbourhood of approximately 12%,” Kaas said of the company’s goals for its 2013-2014 fiscal year, which began on 1st April. “We have a number of initiatives underway that are going to test whether our organisation can […] support some of the explosive growth that we’re expecting.”
Some of the projected growth may well come from a renegotiated contract to operate two wastewater treatment plants in Bridgeport, Connecticut. The original 10-year contract was awarded to Aquarion Services Company for $110 million in 2003, but has been burning a hole in parent company Kelda’s accounts ever since. When United Water bought Aquarion’s contract ops portfolio in 2007, it was with the proviso that the Bridgeport contract remain with Kelda, where it is currently the subject of an “onerous contracts provision”.
The RFP for the renewal is understood to have been originally released as a carbon copy of the original, and understandably attracted no interest from a sceptical market. When the city subsequently showed a greater degree of willingness to negotiate on terms and conditions, however, Severn Trent Services recognised the opportunity, and was ultimately able to negotiate what it considers to be a less risky agreement with the city. STS will take over plant operations from Kelda when its contract runs out on 30 April.
- For a comprehensive overview of upcoming contract operations opportunities in the US water and wastewater sector, see our Project Tracker section starting on page 51.