By Greg Roumeliotis
(Reuters) - Private equity firm KKR & Co LP on Thursday kicked off a joint venture with Suez Environment to run the water and wastewater systems of a New Jersey city it hopes will become a model for cash-strapped local authorities in the United States.
KKR and Suez subsidiary United Water will pay $150 million to the city of Bayonne for the rights to a 40-year concession, allowing them to collect water and wastewater revenues but also requiring them to come up with another $157 million over the life of the contract to manage and upgrade the systems.
The cost of repairing and expanding U.S. drinking water infrastructure will top $1 trillion in the next 25 years, an expense that is likely to be met primarily through higher water bills and local fees, according to the American Water Works Association, a non-profit think tank.
The Environmental Protection Agency estimated in 2007 that the U.S. must invest $390 billion over the next 20 years to update or replace aging wastewater infrastructure.
But the U.S. water industry, run for the most part by the public sector, remains highly fragmented, comprising about 52,000 water systems - over half of which serve a population of 500 or less - and 16,000 wastewater facilities.
Concessions such as the one awarded by Bayonne are rare due to political opposition or reluctance from local authorities to give up control of what they see as essential infrastructure, especially when they can tap the municipal bond market for their financing needs.
"We are slowly starting to see more cities looking at these partnerships given all the fiscal pressures they're facing. But for every three cities that evaluate these options seriously, at least two ultimately can't get to the finish line," said Brandon Freiman, a principal at KKR's energy and infrastructure team.
"The one that gets to the finish line generally appreciates that these are win-win deals that are good for all constituents. So while we think that there should be more of these deals, progress has been very slow," Freiman added.
Last week, another private equity firm, Table Rock Capital, said it had finalized a 30-year concession worth more than $300 million, in partnership with Veolia Water, to run the water and wastewater systems of the city of Rialto in California.
Bayonne will pay off over $130 million of its debt with the money it gets from KKR and United Water, cutting its municipal debt burden in half. It will see the two firms take over more than 96 miles of water mains and more than 83 miles of sewers serving the city's 63,000 residents.
Consumers and businesses in Bayonne will see an initial 8.5 percent bump in their water and sewer charges, translating to an additional $5 per month for residential users. Rates will then freeze till January 2015 and then rise annually based on an inflation-linked formula.
"The partnership will invest in our aging infrastructure, and provide resources that the Bayonne Municipal Utilities Authority could not otherwise deliver. Simply put, this transaction will result in a more efficient and reliable water and sewer system for today and future generations," the authority's executive director Steve Gallo said.
Infrastructure investments of such kind usually deliver internal rates of return of a little over 10 percent, lower than those typically seen in the buyouts of companies but much safer in their risk profile.
KKR will fund 90 percent of the joint venture with United Water. Two thirds of the investment will be financed with debt on an average interest rate of about 5 percent.
KKR, which has $66.3 billion in assets under management, is making the investment through a dedicated infrastructure fund pool of $2.4 billion, that includes dedicated accounts with some of its investors.
Nassau County, located on Long Island just east of New York City, and among the wealthiest counties in the U.S., is negotiating a similar water and wastewater concession with United Water to help address its budget deficits.
(Reporting by Greg Roumeliotis in New York; Editing by Hans-Juergen Peters)