Why this big water-and-sewer merger doesn’t impress investors, so far

As shareholders of American Water of Camden and Bryn Mawr-based Essential Utilities prepare to vote Feb. 10 on a merger to create a combined $40 billion private water and sewer company, regulators in New Jersey and Pennsylvania are weighing the company’s latest rate increase requests.

American Water’s New Jersey affiliate filed for an average 10% water and 8% sewer rate hike last week for 2.9 million customers in that state, which it said would fund improvements to aging water and sewer systems, if approved by the Board of Public Utilities. Customers would pay an average of $18 more a month.

Pennsylvania’s Public Utility Commission said last month that it would consider the company’s request to boost water and sewer rates on 2.4 million customers by an average 15%, or $20 a month.

Investors are showing no great interest in the deal between American Water and Essential. American Water shares fetched over $140 for most of last year but closed Friday at $130.74 and have been trading at close to that discount since CEO John C. Griffith announced the deal in October.

Essential, which operates the Aqua America water utilities and Pittsburgh’s natural gas utility, has so far shown none of the premium that typically enriches shareholders of a healthy company as it is to be acquired. It closed Monday at $39.32, flat from its preannouncement price.

The merger “would be highly favorable” for American Water in many ways but not so good for shareholders of Essential, which negotiated only with American Water and didn’t look for a better offer from other potential buyers such as France’s Veolia or Florida-based NextEra, according to Ryan Connors, a Bucks County-based utilities analyst who’s been following both companies for 20 years.

American Water says planning for the merger is advancing as the vote approaches. Vice president Jimmy Sheridan and past Essential chief operating officer Rick Fox head an integration planning team, and they hired consultant McKinsey & Co. to help.

Though they’ve been competing for more than a century, both companies, like the handful of other private water operators active in the U.S., have faced grassroots opposition to to privatizing water distribution.

The Pennsylvania Supreme Court on Jan. 21 crushed American Water’s yearslong campaign to take over the Chester Water Authority, which serves 40 mostly affluent suburbs in Chester and Delaware Counties and a Lancaster County township. The court ruled the counties, which oppose a sale, can block the deal, which cash-strapped Chester City’s state-appointed financial administration favored.

Analyst Connors, who sat through recent American Water rate hearings in Harrisburg, Scranton, and in Exeter Township, Berks County, says that company has been making a more effective case recently for the Pennsylvania rate hikes it will need to keep updating and eventually acquiring more municipal systems.

In Exeter, it was American Water staff and vendors who packed seats for a state regulatory hearing on the company’s latest rate increase. Vocal opponents who dominated the last such hearing two years ago stayed home. Connors said their leaders told him they felt “defeated” that rates still went up despite the 2024 protests, though not as much as the utility wanted.

Another “parade of vendors,” recruited openly by American Water, dominated a recent Harrisburg city rate hearing and testified in the company’s favor, Connors told clients of Northcoast Research in a Jan. 21 report.

In the latest round of rate-hike hearings, only in Scranton did state, county and city officials show up to complain about repeated increases by American Water’s Pennsylvania-American Water Co. affiliate. “The recurring theme could not have been more clear, with nearly every politician stressing the rapid-fire rate increase requests in recent years,” Connors said.

Buying Essential’s Aqua-Pennsylvania water companies would add Aqua’s customers in some of Pennsylvania’s richest towns to American Water’s rate base. American Water has been “socializing” its rates — charging rich towns on the Main Line more and effectively subsidizing poor towns, Connors said.

But Connors is still urging Essential shareholders to vote against the merger, defying chief executive Christopher Franklin and the company’s board.

American Water’s offer “undervalues” Essential shares and creates “fundamental risks,” including pressure on American Water to avoid rate increases to prevent political opposition in Pennsylvania, Connors said.

He cites estimates of Essential’s real value from the statement sent to shareholders urging them to approve the deal. Bank of America, the buyer’s adviser, said Essential is worth as much as $63 a share, considering its assets and cash flows.

Essential’s adviser, Moelis & Co., says its cash flows imply the company is worth as much as $52 a share, a roughly 25% premium over its current price.