Wednesday, April 25, 2018

SJW Group aka San Jose Water Company (2018 Shareholder Meeting)

SJW Group (SJW) held its annual shareholder meeting on April 25, 2018. About twenty people, mostly employees, showed up. Coffee, bottled orange juice, fruit cups and pastries were available but without paper plates.  
The big news is twofold: 1) a "merger of equals" with Connecticut Water Service, Inc. (CTWS), against which Eversource Energy (ES) counter-offered; and 2) Eric W. Thornburg's official succession to the CEO/President role on November 5, 2017, coinciding with W. Richard Roth's retirement. 

Before we get to the nitty gritty, let's provide some background. Private water companies are strange beasts, dependent on municipalities and their voters for rate increases or higher taxes to grow and for infrastructure investment. The more you pay for water, the more money private water companies make, but their business model must contend with conservation efforts (you use less water, they often make less money); Mother Nature (droughts, mercury contamination, cleanup); and the replacement, maintenance, and acquisition of aging water systems. A private corporation doesn't need to manage a municipality's water supply, but as public sector unions refused to reduce long-tail fiscal obligations after the dot com crash, privatization became easier to sell to voters. Whether we can ensure corporations taking over work previously done by government agencies don't become just as corrupt is a separate question, one we'll examine below. 

We know increasing attenuation between elected officials and the provision of an essential and limited resource lubricates the process for rate increases and other financial shenanigans (e.g.surcharges, including the following gem: "To amortize the under-collection in the Mandatory Conservation Revenue Adjustment Memorandum Account, a surcharge(s) per 100 cubic feet is to be added to the quantity rate shown for a period of time beginning with the effective date of advice letter(s).") When grandma needs a lawyer to understand her water bill, something's not right, and I say this as someone who generally favors small government. 

Before privatization, if elected officials wanted to raise water usage charges without measurable improvements, they would face the public's ire head on. Today, most private water companies hold shareholder meetings where only one or two non-employees attend, and PUC meetings aren't much different. Perhaps unsurprisingly, this apathy extends beyond something as essential as water. Overall public engagement has declined so precipitously, just 61.4% of eligible Americans voted in the national 2016 election and only 28.5% of eligible Americans voted in the related primaries, which resulted in the nominations of Hillary Clinton and Donald Trump. I'm no sociology or history expert, but when 28.5% of any group can effect massive change, it's not a question of "if" but "when" corruption occurs. What does this have to do with SJW or your water?

In 2016, SJW switched its state of incorporation from California to Delaware. I asked whether this change had caused any downsides. General counsel answered she knew of no downsides. Interestingly, from her perspective, making "it more difficult for... stockholders to elect directors and take other corporate actions," including frustrating or preventing "any attempts by stockholders... to replace or remove its current management" (SJW 2017 10-K, pp. 17) doesn't qualify as a downside. Modern corruption is baked into the system, aided by a conduit of overwhelming complexity, all the way from grandma's water bill to states vying for money. Muhammad Ali once said, "Your hands can't hit what your eyes can't see," and anyone wishing to be James Stewart going to Washington D.C. or even the local city council must first possess knowledge of intricacies so minute, they're impossible to feel or understand until after you've been punched. Corruptissima re publica plurimae leges, indeed. 

Additionally, while good executives don't need charisma, they do need common sense, and former SJW executive W. Richard Roth has the demeanor of someone unwittingly inviting another French Revolution through a lack of self-awareness, such as his response to my question at a prior meeting about board diversity. I recall asking why only 2/9 directors were female and, at the time, 9/9 looked Caucasian. 
Gov unions may be corrupt, but do their executives get one mil in stock in one year? 10-K, pp. 62.
Roth said the company hires the best people, and when I followed up with, "You're saying in a county where about 40% of residents were born out of the country and at least 40% are female, the best people you can find are 100% white and almost 90% male? "Yes" was his answer, but at least he had the decency to look downwards after his brain caught up to his mouth. 

Today, SJW's board is still 2/9 female, but if memory serves me well, it appears they've replaced the other white female with an Asian one. (Strangely, the incumbent female, Katherine Armstrong, an Aryan-looking specimen, approached me post-meeting and remarked she had ancestors from the Azores.) When I asked the new CEO Thornburg about his plans to increase diversity, he delivered a spiel that would make a marketing expert proud. When I followed up about specific plans or processes to increase diversity without sacrificing quality, he finally admitted his "plan" was waiting for the merger to go through and essentially absorbing the other company's greater diversity. 

If that sounds like progress to you, you're missing the point. With attenuation comes reduced accountability, and the Roths and Thornburgs of the world do not have to give a damn about you. As long as they avoid massive mistakes such as embezzlement or mercury contamination that reaches the public water supply, they can retire fat and happy or merge their way out of mistakes. 
Even New Jersey's corrupt gov executives don't try for 2.8 mil in cash severance payments. And why is Thornburg, the current CEO, getting severance in the first place?
Remember: the complaint against "big government" was that they showed up and got paid regardless of results and also had the temerity to saddle cities with unpredictable long-term fiscal obligations. 
2017 shareholder materials, pp. 66.
Look at Thornburg's employment agreement carefully: "70 percent of Mr. Thornburg's target equity awards are in the form of performance based RSUs which are based on a three-year performance period" and "Mr. Thornburg's target annual incentive cash compensation is 50 percent of his base salary starting with the 2018 fiscal year." 

These performance criteria, sometimes called KPIs, have included "$121,000,000" in "Capital Additions." (2017 shareholder materials, pp. 38) Does a city need a new treatment or water recycling plant? If your bonus depends on it ordering one, do the chances of objective advice increase or decrease? Also, because SJW is a private corporation, we, the voters and water consumers, have little say in the employment agreement's terms or KPIs/SLAs. Consequently, we've moved from a world where voters, including myself, demanded results to a world where we're getting results that may be against our own long-term interests. 

After exiting, I was taking my 30 USD L.L. Bean backpack out of my 2009 Hyundai Accent's trunk when I saw an African driver waiting outside in a black suit and shiny black SUV, presumably to chauffeur around SJW's executives. Meanwhile, San Jose's mayor, Sam Liccardo, can be seen biking around the city wearing a helmet, cutely nerdy in the way you'd expect from a Harvard Law graduate. In the end, I can't put my finger on it, but something smells, and it's not the stench of wastewater. 

Bonus 1: I was extremely impressed with Andrew R. Gere and Craig S. Giordano, who took the time to explain technical details to me

Bonus 2: Andy Gere kindly sent me the following email, which helps understand SJW's perspective. I've met a lot of suits in my life, and Mr. Gere is both an officer and a gentleman. 

Thanks again for coming to the shareholders meeting today. Your article touched on several topics and I appreciate the opportunity to respond. 

Regarding privatization, your article seems to suggest that San Jose Water (SJW) came about through some privatization effort. It might surprise you to know that SJW has, and continues to be, an investor owned utility since its inception in 1866. Before the notion of public water systems existed as we know it to be today, SJW incorporated to provide the residents of Santa Clara Valley with safe, high quality and reliable water service. That mission remains today more than 150 years later. We have seen and grown with the Valley from its origins as the Valley of Hearts Delight to modern day Silicon Valley. In fact, two of our employees have over 50 years of service, and we have also had generations of families who have proudly been a part of the SJW family. It is this commitment, dedication, and doing right by the community where we live, work, and serve that has and will continue to be the foundation of SJW. 

On the issue of rate increases and their approvals, cities and municipalities do not set the rates for SJW. SJW is regulated by the California Public Utilities Commission (CPUC) and they are the ratemaking body for investor-owned water utilities. All CPUC-regulated utilities go through a stringent and comprehensive process called a General Rate Case to establish water rates. A GRC application typically takes a minimum of 14 months to process and where dozens of CPUC staff, including those from the Office of Ratepayer Advocates, thoroughly review the application to ensure that our proposed expenses and capital improvements are just, reasonable, and necessary to deliver safe, high quality, and reliable water service. This process includes a public participation hearing, and I would be hard pressed to find another proceeding where such scrutiny occurs. 

Lastly, the water business is a long term business. Our infrastructure investments have useful lives of anywhere from 50-100 years and that is the perspective we must have. Just as previous generations have invested in the water system so that we can enjoy safe, high quality, and reliable water service today, it is now our turn to invest for future generations. This is not just SJW’s challenge but that of all water utilities in the US (check USEPA and ASCE water report cards). Doing anything less is just kicking the can down the road and saddling future generations with greater costs and less reliable service. That is simply not the SJW way. I hope this information is helpful to you, and I’d be happy to clarify or expand on any of these topics.

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