I decided to try to create this breakdown using the city’s budgets and financial reports. To start, I asked the city to explain how it calculated the $15.6 million figure. They described the methodology as follows:

“The amount of $15.6 million presented in the report to council consists of the budget overruns from FY2025 and FY2026. $15.6 million is based upon $9,365,867 that was advanced to Electric from City’s General Fund and other department reserves in FY2025, $4,070,601 which was the unrestricted cash balance of the Electric Department as of 3/31/2024 (the Electric Department Reserves that were spent in FY2025), and $2,154,534 which was the negative cash balance for the electric department computed on a cash basis from our unaudited financials as of June 10, 2026 for FY2026.”

To translate that into table form, it looks like this:

I don’t believe this is an especially useful way to measure the financial challenge, and it doesn’t really match how the report described this figure, which was “expenditures exceeding budgeted levels.” For one, the Electric Department’s 2025 budget already anticipated the use of $6.5 million in reserves to fill the gap between revenues and expenses. Below is a table showing the budget summary across all funds for FY2025. I added the dotted box to highlight the Electric Department.

As another example, in FY2026 the city raised electricity rates partway through the year, though the adopted budget did not assume that increase. That unbudgeted revenue helped offset the cash deficit. If the deficit is treated as the budget miss, this methodology can understate the expense problem in a given year because unbudgeted revenue offsets the cash deficit.

Further, this methodology only looks at FY2025 and FY2026, even though the After Action Report’s explanation points to capital expenditure budget tracking problems that developed over a longer period.

In other words, $15.6 million represents a cash reconciliation, which conflates a variety of underlying factors. It doesn’t show how much electricity costs or capital expenditures exceeded budget, or when those variances occurred. So next, I tried to do that. The table below summarizes my findings.

I hesitated putting a total on this table. The total isn’t the important part, and I’m not trying to say the city’s figure is wrong because it’s too low. It’s wrong because it mixes together many different concepts that make it less useful as a tool to understand a problem.

My point isn’t to explain a complex problem with a single number. My point is that you can’t do that. The interesting takeaway to me is the breakdown of the total. As I’ll go on to describe, once the pieces are separated, the story becomes clearer: the electricity-cost miss explains itself; the capital expenditure miss does not.

Electricity Cost

This amount was fairly straightforward to measure. I just subtracted budgeted electricity costs in 2025 and 2026 from actual costs in 2025 and 2026 (the latter obtained via public records request).

The After Action Report attributed the budget miss to “capacity market volatility.” Overall, I think that explanation is broadly consistent with the data. There isn’t anything that stands out to me here as anomalous.

Starting at a very high level, electricity costs are volatile. The budgeting history shows that the city generally understood the long-term level of those costs. In aggregate, across the ten years before FY2025, actual electricity expense was, on average, 1% below budget.

But that average hides a lot of year-to-year volatility. The average absolute variance from budget was about 12% during that period.

In that context, misses of 16% in FY2025 and 19% in FY2026 were large, but not outliers.

Let’s look more closely at the detail. Electricity costs include the cost to purchase power and the cost to purchase capacity. The former is relatively easy to understand – it’s the cost the city pays to buy the electricity its customers use.

Capacity purchases are less intuitive. But, simply put, it works like this. The amount of electricity we use on a given day varies considerably over the course of a year (and indeed even within a given day). On the peak demand day (typically in the summer when air conditioning use is the highest) we use about 1.5x-2x more electricity compared to an average day. It’s important to be able to purchase enough electricity to meet the demand on any day (or really, at any given moment), including the peak. For that reason, market regulators require utilities to make sure that enough capacity exists to supply their peak demand (plus a safety margin). The mechanism for ensuring this is the capacity market. Utilities pay power producers just to have enough production capacity on standby to serve their peak demand.

This is a bit like renting a backup power generator. Renting a backup generator has two costs. You pay to have the generator reserved and sitting there in case the power goes out, and you also pay for the fuel if you actually run it. Capacity purchases are like the reservation fee. Power purchases are like buying the fuel.

With that background, let’s look at how the city’s electricity costs trended against two variables: 1) a wholesale power price proxy and 2) capacity market prices1.

From what I can see, the trends in the city’s electricity costs make sense relative to the trends in the underlying input costs.

I believe the $8.4 million budget miss came from ordinary market volatility. Further, I don’t think the problem is the budget miss itself; electricity costs are volatile. I think the problem is where that volatility sits. I’ve seen the recommendation a few places now (including the After Action Report) that the city should adopt a rate mechanism that passes this volatility through to customers and I agree with that takeaway. The collective balance sheet of the Electric utility’s 10,000 customers has a better capacity to absorb this volatility than the city’s budget. This doesn’t necessarily mean a permanent rate increase. It means rates fluctuate up and down to reflect changes in power costs.

Capital Expenditures

Measuring the budget impact of capital expenditures required a different approach. A one- or two-year budget comparison misses the way capital projects are authorized, delayed, reappropriated, and completed across multiple fiscal years. So I built a capital budget-authority roll-forward beginning in 2018 to determine the cumulative amount of over- or underspending across a longer time-frame.

This analysis starts with 2018 reappropriations (spending that was approved in fiscal years before 2018, but not yet spent), adds new budgeted capital appropriations for each year as they occurred, and subtracts actual capital spending. On this reconstructed basis, cumulative Electric Department capital expenditures exceeded identified capital budget authority by approximately $10.1 million by the end of FY2025 and $11.9 million by FY2026.

One note on what this analysis does and doesn’t capture. This roll-forward includes only capital authority identifiable from adopted budgets, reappropriation schedules, and the separately approved A-Mrazek building acquisition. It does not capture any supplemental appropriations or other adjustments that were not apparent in the annual budgets.

There was also a comment in the After Action Report that says the effect of the capital spending was “to advance five to seven years of planned capital investment into a span of two fiscal years.” I think this is saying that the overspending in recent years didn’t just come from previously-approved work, but also pulled forward projects that were meant to occur in future years. It’s hard to see how this fully reconciles with the data.

The FY2026 five-year capital plan outlined $4.4 million of total capital spending in fiscal years 2027-2030. Most of this ($2.8 million) relates to recurring distribution line replacements, which are not the kind of projects that can easily be pulled forward into a single year. But even if you treat the full $4.4 million as additional budget authority, that still leaves you with $7.5 million in cumulative spending beyond the approved budget authority.

I’ll end with this. If the goal is to measure and identify the underlying causes of the budget problem, the city’s $15.6 million figure is too muddled to do that. A cleaner reconstruction points to roughly $20.3 million of identified budget variance: $8.4 million from electricity costs above budget in FY2025 and FY2026, and $11.9 million from capital spending beyond identified public spending authority.

But those two components should not be treated the same way. The electricity-cost miss is broadly explainable as ordinary-course volatility and acute challenges in the power market. The capital-spending shortfall is different. Capital projects should be authorized, tracked, reappropriated, and visible in the public budget trail. On the record I reviewed, that trail does not fully reconcile. That is why the $11.9 million capital figure is the more important number.

As a reminder, a rate case is the series of regulatory proceedings through which a utility seeks a rate increase. This process starts when a utility submits its proposed rate increases to the regulator.

If we sell to MAWC, the transaction doesn’t stop when they cut the check. We have to pay their rates forever thereafter. So understanding what those rates are is just as important as understanding the sale price.

I’m going to lay out some of the numbers that are in their filing and compare what they’re seeking to Kirkwood rates today. Before I do that, a couple things to keep in mind.

First, this is just MAWC’s proposal, it still needs to be reviewed and approved by the state regulator. What gets approved is often less than what a utility asks for. In MAWC’s past two rate case filings, state regulators have approved roughly half of the increase they’ve asked for.

Second, as I’ve discussed before, I believe the right framework for a transaction like this is one that considers the sale price and future rate impact together, rather than trying to evaluate either of those factors in isolation. So while it’s important to understand how our rates compare to MAWC, that’s only part of the picture.

With that, the table below shows how Kirkwood’s rates compare to MAWC’s current rates1, the rates they’re asking for, and the rates if regulators allow half of the increase.

Put simply, Kirkwood is modestly more expensive than MAWC today, but cheaper than the rate MAWC is now asking regulators to approve.

Saturday mornings are already pretty exciting for our family because we take the kids out for donuts. So you can imagine the emotional state in our house when I saw that Kirkwood’s water utility was the Post-Dispatch’s top story. The article reported that American Water (I’ll call them MAWC from now on1) made an offer to acquire Kirkwood’s water utility for $27.5 million. I’ve previously written at length about this topic, so I thought I would share my quick thoughts on this development.

My view is that we should not accept the offer at anything close to the current price, but we also shouldn’t ignore it. Choosing not to sell is the same thing as choosing to invest $27.5 million to own our utility. So we should give this decision the same level of deliberation as we would any investment decision of that magnitude. The right response is a disciplined process: evaluate the offer, preserve the city’s option value, and address the state-law cliff that penalizes Kirkwood.

Putting the offer price in context

Without repeating everything in my valuation analysis, I’ll summarize it this way:

• State regulators oversee utilities

• These regulators tell utilities what they are allowed to charge customers

• Regulators determine that amount, in part, based on how much money utilities have invested in their systems (we’ll call this “Net Capital Assets”)

• As a result, when utilities are bought and sold, they tend to trade as a multiple of their Net Capital Assets2

  • This is a bit like valuing a home based on price per square foot. Said differently, you apply a dollar multiple to the home’s square footage.

The offer price, $27.5 million, is exactly 1.0x the water utility’s fiscal year 2025 Net Capital Assets, and fairly close to the $31.6 million sale price I assumed in my analysis3, so not much of a surprise there.

Is the offer compelling?

I don’t think so. First, I want to be clear here - this is an unnegotiated offer so it’s likely that a negotiated price would be higher. But to avoid speculation I’m going to base my comments on the offer price on the table. Again, I’ll briefly summarize the framework I’m using to evaluate the offer. If you want more detail (some have told me too much detail!) then you can find that here.

First, I’ll illustrate my framework with an example. I like using real estate because it’s a type of transaction familiar to many people.

Imagine you are deciding to sell your house either this year or next year. If you sell this year, you believe you will sell for $100, but then you need to find a place to rent. Let’s say rent costs $5 for the year.

If you wait until next year, you believe you can sell it for $107. But if you keep the home, you have to pay property taxes, insurance, maintenance, etc.; let’s say these cost $2 for the year.

As a result, you have two scenarios to compare.

1. Sell your house today for $100 and pay $5 of rent

2. Keep your house for one year and pay $2 of costs before selling for $107 next year.

All told, you can conclude that selling today costs you 10% (the $7 higher sale price you give up by not waiting a year plus the $3 of additional cost). This is what I call “economic cost” in my analysis. Next, you can compare that 10% to other ways you could raise $100 to see if that economic cost is a good trade or not. Maybe you can borrow $100 for a year at 4%? In that case, 10% is pretty expensive4. You’re better off waiting to sell. But maybe your other financing options cost 12%. In that case selling makes more sense.

This is identical to my framework for evaluating the MAWC offer. I am comparing two scenarios:

1. We sell the utility today for $27.5 million and then pay MAWC rates for the next 10 years

2. We keep the utility for 10 years and incur the costs of operating and maintaining the system before selling in year 10

Comparing these two scenarios lets you calculate the economic cost of the transaction. You can then compare that economic cost to the city’s cost to borrow for 10 years (i.e. asking, is it better to raise $27.5 million by selling the utility or by raising that amount of debt?). Kirkwood’s cost to borrow for 10 years is 3.6%.

With this framework, if a sale has a higher economic cost than 3.6% it is better to keep the system. This framework is useful because it allows you to boil the transaction down to a single measurement, rather than needing to discuss sales price and rate impact separately.

In my model, the sale implies an annualized economic cost of 10.6%, meaning the city would effectively be paying 10.6% per year to raise $27.5 million through a sale rather than through borrowing (or about 3x the city’s cost of debt).

This model relies on a few critical assumptions, which I’ve summarized below. I won’t go into how I made these assumptions here, but you can see that spelled out in detail in prior parts II and III of my previous analysis

With this framework, we’re trying to look into the future. And the future is uncertain. So it makes sense to look at sensitivities to these critical assumptions.

Below, I lay out a downside sensitivity5 to my base case model for the two variables I consider the riskiest6. The table shows the economic cost of selling at a range of assumptions for the annual growth rate in Kirkwood’s cost to operate the system and MAWC’s rates. The bottom-right cell in the table is the base case assumption in my model. As you move up and to the left, the case for a sale becomes stronger (as the economic cost is lower and, in the top-left cell, less than the city’s 3.6% cost of debt).

Notice that you really have to believe a lot for this trade to make sense relative to the city’s cost of capital. The only scenario in the table where the economic cost of the deal is lower than the city’s cost of capital is where you assume that MAWC rates grow at 4% annually, while the city’s costs to maintain rise 9% annually (both of which are considerable departures from recent history).

What’s more, by not selling today you preserve the option to sell at any point in the future, especially in a scenario where our costs and MAWC rates trend in vastly different directions. Here is that same sensitivity table, this time showing the economic cost in a sale in year 5.

What this says is that waiting and seeing has immense value (all the numbers are considerably higher). We can watch an adverse scenario play out and still execute a transaction that is beneficial to the city.

The 8,000 customer cliff

Reasonable people can and will disagree with the assumptions I’m making in my analysis, or how to consider the transaction’s risk factors. But one aspect of this transaction is hard to defend. There is a law in Missouri that prevents Kirkwood from selling its water utility at a fair price.

Again, I’m going to skip over a lot of the detail (which is laid out here), but simply put, there is a state law that lets buyers (in practice, really just MAWC) pay higher prices for water utilities that serve fewer than 8,000 customers. Our water utility serves around 10,000 customers so we get none of this benefit, which I believe costs our city around $20-$30 million.

I don’t think this law is fair. As it happens, our state representative, Mark Boyko, serves on the Utilities Committee, so he seems well-placed to help us understand this issue and whether there is a path to fixing it. Specifically, regardless of where you stand on keep versus sell, I think we should first ask Rep. Boyko to explain the legislative history and help us identify whether there is support for legislation to eliminate the 8,000-customer cliff, phase it out, or otherwise allow Kirkwood to receive a fair sale price.

Process

Outside of reporting the offer itself, the article also raises questions about how the city handled the offer. I’ll touch on this briefly, but I want to break it down into two separate issues:

1. The offer was not disclosed publicly

I think city leaders need the ability to deliberate before bringing a topic like this to the public. This is especially important for a topic like this where the intuitive response may conflict with what a careful analysis suggests. It’s intuitive to think “if we sell we can lower our rates and get $27.5 million for the city, so of course we should sell.” But a careful analysis would consider the opportunity cost of selling, the direction of MAWC rates, the direction of Kirkwood’s costs if it continues to own the system, and the option value of not selling. It took me 11,000 words to consider these factors – not at all intuitive!

That said, this perspective presumes that the city is limiting public disclosure during active deliberations. So the second issue is:

2. The offer was not under active consideration by city leadership.

I’ll say it again, choosing not to sell is the same thing as choosing to invest $27.5 million to own our utility. Just because “keeping” is the status quo, that doesn’t mean it isn’t a choice. And that choice means leaving a lot of money on the table for right now. A decision of that significance deserves timely and rigorous consideration. Based on the reporting, this does not appear to have happened. We elect our city leaders to make decisions, not to let inertia carry us where it will.

Conclusion

So my bottom line is this: I don’t think Kirkwood should accept the current offer. But I also don’t think the city should treat it as something it can just stick in a drawer.

Keeping the utility is not a passive decision. It is an active decision to continue investing city capital, attention, and resident dollars into a water system that will require substantial work over time. That may well be the right decision. Based on my analysis, I think it probably is. But it should be made deliberately, with a clear framework and a public understanding of the tradeoffs.

At this point, I think the city should do five things.

1. Develop a formal framework for comparing a sale, continued ownership, and other options like a concession or operating partnership.

2. Create a long-term financial plan for the entire water utility operation (not just capital expenditures) so residents can understand what continued ownership would look like.

3. Work with Rep. Boyko to understand whether the 8,000-customer cliff can be eliminated, phased out, or otherwise fixed so Kirkwood can realize a fair sale price.

4. Engage with MAWC to clarify key terms of its offer beyond the headline price (including ratepayer protections, investment commitments in our city, willingness to retain Kirkwood water employees, and any other material terms).

5. Set a public timeline for evaluating the issue. Not because this entire process should happen in public, but because a decision this significant deserves a process residents can follow.

I worry that the Post-Dispatch story will create pressure for a rushed process. The better outcome would be a new sense of urgency to start the process, and then to carry it out thoroughly, so that whatever path we choose is the result of analysis rather than inertia.

Introduction

Let’s return one more time to the key questions we’ve been working through in this analysis so far. Remember, each of these questions serves as the input into the economic cost model. The questions are below again, but I translated each one into the name of the variable I will use in my model to represent that question.

We are trying to look into the future here, so there is a lot of uncertainty. The table below shows point estimates for each of these assumptions, but hopefully in prior parts of this analysis you have seen my explanation for where uncertainty can surround these amounts.

1. How much is the utility worth today? becomes:

Proceeds from Sale Today

2. How much will the community pay over the next 10 years as MAWC customers? becomes:

Net Community-Wide Cost as MAWC customers

3. How much will the utility be worth in 10 years? becomes:

Proceeds from Sale in Year 10

4. How much will it cost to operate and maintain the utility over the next 10 years? becomes:

Total Cost of Ownership

Below is the table that includes each of these inputs.

Now, we can return to the example I laid out in Part I, comparing this economic cost model to a loan:

But this time, instead of using illustrative numbers, here is the chart with the actual figures from this analysis (this shows the data from the blue shaded row in the table above):

Let me briefly explain what economic cost means as it relates to the cash flows presented here. Economic cost converts all of these cash flows into a single figure that represents the annual implied cost of selling the water utility. Said differently, we would be economically indifferent between making the trade outlined here and borrowing $31.6 million at a 9.3% interest rate1. As we’ve discussed before, the city is able to borrow at rates much cheaper than 9.3%, so economically speaking this deal is not good for the community.

As I said before, this model relies on point estimates, when in reality there is a lot of uncertainty behind these estimates. We can use a sensitivity analysis to examine what happens if our assumptions turn out to be wrong on any of the key variables. Below I have laid out five sensitivities next to the base case assumptions in the model.

I’ll explain what each of these represents:

1: Kirkwood Five Year Capital Plan. As I mentioned in Part III, there is a debate around how much of the aging water main in our system we should replace each year. A third-party study recommended 1.5%. Kirkwood’s five year capital plan assumes around 1%. My base case uses the higher replacement rate, but changing that from 1.5% to 1% increases the implied economic cost of selling the utility from 9.3% to 13.6%.

2: 0.9x Multiple on Year 10 Sale. My model assumes we can sell the system for an amount equal to the net capital assets at the time of the sale x 1.0x. If instead, we realize 0.9x then the implied cost of the deal falls from 9.3% to 8.2%.

3: 8% Operating Expense Growth. Kirkwood’s operating expenses grew around 7% annually over the last 5 years, but that was during a period of elevated inflation so my base case model assumed a lower number, about 6% annual expense growth. If that number instead is 8% (greater than any recent historical period), the implied cost of the deal falls from 9.3% to 7.5%.

4: 4% MAWC Rate Growth. MAWC rates grew about 4% (after accounting for changes in federal taxes) before the introduction of new laws that encourage faster capital deployment. If their rates grow at this slower pace compared to my base case assumption of 7%, the implied cost of the deal would fall from 9.3% to 5.5%.

5a: 2-4 Combined. This case layers in the assumptions from the three previous sensitivities (i.e. Kirkwood’s expense growth increases from 6% to 8%; the future sale multiple falls from 1.0x to 0.9x, and MAWC rates grow at 4% instead of 7%). In this case, the economic cost of the deal is 1.5%.

5b: 2-4 Combined – 5 Year Exit: This case takes the same inputs as #5, but assumes we sell after 5 years when it becomes clear that our cost of ownership is becoming permanently misaligned with MAWC’s rate structure. And this highlights a crucial aspect of this transaction. It’s reversible, but only in one direction. If we elect not to sell now, we have the option to wait and observe how costs and rates evolve and decide to sell at the right point in the future. In this scenario, doing so is still beneficial relative to the cost of capital benchmark.

This is one of the most important conclusions of the analysis. As I said before, the decision is not ‘sell’ versus ‘keep forever.’ It is ‘sell now’ versus ‘keep the option to sell later.’ If we sell now, the option is gone. If we keep the utility, we can continue to observe MAWC rates, Kirkwood’s own operating costs, capital needs, and any changes to FMV ratemaking rules. Unless the sale price today is compelling enough to compensate us for giving up that option, waiting has a lot of value.

This is why the FMV ratemaking topic is so important. If we could sell our utility for 1.9x (the same multiple as MAWC’s recent deal to acquire Neosho’s system), the implied economic cost falls to 3.5%. At that point, it’s all about the non-financial considerations. But we’re not at that point yet.

Concluding thoughts

That brings us to the end of the financial analysis. In a future part I will dig into some of the non-financial considerations. But I did want to leave with one more thought. There is something somewhat puzzling about why, on the one hand, this analysis seems to indicate quite strongly that the right fiscal decision is to retain the utility, yet, on the other hand, the situation at the water utility feels urgent, maybe even dire. Perhaps nothing highlights this urgency more than the most visible financial aspect of the water utility - its rates compared to MAWC. Today, Kirkwood customers are paying about 10% more than MAWC customers:

I haven’t spent much time talking about Kirkwood water rates in this analysis. And that’s because our rates are merely a function of a) the underlying costs of ownership and b) a decision around how to finance those costs. The former I have covered at length in this analysis, the latter I will touch on briefly here (only briefly because rate setting starts to intersect with political considerations, which I do not feel qualified to weigh in on beyond my personal opinion).

Let’s explore this question. If the utility is sensible to own, how did we go from having lower rates than MAWC to higher?

Broadly speaking, there are two ways to fund our utility’s cost of ownership - customer charges and debt. If we are comfortable funding more of the operation by issuing debt, we need less money from customers and thus can have lower rates. However, the opposite case has played out in recent history.

The chart below shows our water utility’s debt as a percentage of its net capital assets over time.

In FY 2017, debt represented 52% of the utility’s net capital assets, but by FY 2025 it had fallen to 22% of net capital assets. And in fact, in that time the absolute amount of debt fell from $10 million in 2017 to $6 million in 20252. Meanwhile, the net capital asset base grew from $19 million to $28 million. What that means is that in the last decade, customer charges have done an enormous amount of heavy lifting, funding not only the entire amount of capital investment, but also $4 million of debt repayment and $3 million in transfers to the general fund.

Should we use more debt? I know very little about municipal finance, and I realize there is a lot of local sensitivity to a rising municipal debt balance, so take this as one person’s opinion. I believe it is sensible to modestly increase the debt balance to give some relief to customer rates. I believe this for a few reasons:

• Investor-owned utilities tend to fund 50-60% of their net capital assets with debt

• Debt is a cheaper funding source than customer funding (I can’t borrow for 10 years at 3.6%!)

• The water utility itself does not appear to be the source of Kirkwood’s debt pressure

  • The water utility appears to have a quite modest capital structure and has been reducing debt over the last decade, while also sending cash back to the general fund

• It makes financial sense to match spending on long-lived capital assets (these pipes last 50+ years!) with long-term funding sources.

• Increasing the amount of debt funding allows us to give rate relief to customers which makes what I consider to be the sound fiscal choice (keep the utility) more politically tolerable

To illustrate this point, I returned to my trusty financial model. Below, I show a scenario where Kirkwood sets its customer rates equal to a 10% discount to my projected MAWC rates. This creates a funding gap equal to the difference between customer charges at those rates and the total cost of ownership plus existing debt service.

In this plan, debt as a percent of net capital assets peaks at 36%. I haven’t done the research to understand how that compares to other similar municipally-owned systems, but relative to investor-owned systems this is still quite modest. That said, debt issuance is so interconnected to Kirkwood’s broader set of municipal activities in ways that I don’t understand yet, and I realize that there are plenty of people in the community that will be averse to a plan that suggests raising $26 million of additional debt. So for now I will leave this as something to explore for further discussion, rather than something I feel strongly about.

However, I do feel that creating a transparent plan with targets for both Kirkwood’s rate discount relative to MAWC and the utility’s debt as a percentage of net capital assets would create a clear and simple benchmark by which the community can assess the utility’s performance and health, rather than simply relying on a comparison of rates alone.

That is where I land: do not rush into a sale process that will likely result in us selling cheap, do not sell before understanding the FMV question, and if we keep the utility, manage it with clear targets for rates, debt, and long-term capital investment That’s it for now!

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Introduction

I’ll start once again with our four key questions. In this part, I will address questions 2 and 4.

1. How much is the utility worth today?

2. How much will the community pay over the next 10 years as MAWC customers?

3. How much will the utility be worth in 10 years?

4. How much will it cost to operate and maintain the utility over the next 10 years?

I want to point out that this is not directly a comparison of Kirkwood rates versus American Water rates. If the system remains under Kirkwood ownership, ultimately the costs we as a community incur are the direct costs of operating the utility. Rates are just one mechanism (among others) through which we finance those costs. The purpose of this analysis is to compare the community-wide costs of one scenario versus another. I’ll have a brief discussion tying things back to rates in Part IV, however.

Again, if you just want the key takeaways, I think they are:

• How much will the community pay over the next 10 years as MAWC customers?

  • I believe Kirkwood’s current water customers would pay about $12.6 million in fiscal year 2028 under MAWC rates1

  • I project MAWC rates to grow around 7% annually for the next 10 years

  • As a partial offset to this amount, the community would receive property taxes from MAWC following a sale

  • I project this amount to be around $640,000 annually2

  • Taken together, the community as a whole would incur a net cost of around $162 million over the next 10 years

• How much will it cost to operate and maintain the utility over the next 10 years?

  • Kirkwood’s water utility incurs operating expenses and capital expenditures

  • Both of these are cash outflows, but with very different economic implications

  • Operating expenses are around $5 million annually today, I project these growing around 6% annually for a cumulative 10-year total of $87 million

  • Capital expenditures are more of a controlled cost; we decide how much water main we want to replace each year

  • My model assumes a 1.5% replacement rate for $82 million in cumulative spending over 10 years3

  • Taken together, these two categories represent $169 million in spending over 10 years

  • However, capital expenditures increase the value of the utility, we would recover this amount in a future sale (net of depreciation)

  • Therefore, the total economic cost of ownership over 10 years is $107 million4

Question 2: How much will the community pay over the next 10 years as MAWC customers?

If we decide to sell, the water utility’s 10,400 customers would become customers of MAWC, paying MAWC rates. It’s relatively straightforward to estimate the amount that those 10,400 customers would pay under those rates (I say estimate because water consumption volumes vary and rates differ slightly depending on customer category).

MAWC’s rates (like Kirkwood’s) consist of a fixed monthly charge plus a variable charge based on the amount of water consumed. The table below outlines how much in total current Kirkwood’s water utility customers would pay today on MAWC rates.

On MAWC rates, current customers of Kirkwood’s water utility would pay $11.4 million in aggregate at today’s rates.

We can also look at how this amount would have trended over time had we been on MAWC rates historically. To remove the impact of fluctuations in customer count and water consumption volume, I am showing this on a constant-customer, constant-consumption basis. Therefore this shows only the impact to the collective water bill due to changes in rates.

There is a striking inflection point in this chart. Rates were virtually flat from FY 17 to FY 22, and then increased sharply thereafter. However, to translate this into something that is useful for predicting the rates going forward we need to account for a few factors that impacted the historical period:

• Corporate tax rates fell from 35% to 21% in January 2018. MAWC (like all investor-owned utilities) is allowed to pass taxes on to its customers. When tax rates fall, the amount they are allowed to charge customers falls in lockstep. Without this effect, the average annual increase in rates from FY 17 to FY 22 would have been about 4%.

• Inflation increased from 2.5% between FY 17 and FY 22, to 4.4% from FY 22 to FY 26.

• In 2021 the Missouri Legislature passed a law that allows MAWC to accelerate the pace at which it can increase rates to customers following capital investments. This is called the Water and Sewer Infrastructure Rate Adjustment (WSIRA).

I want to go into a little bit more detail on the effect of WSIRA. American Water considers this one of the key growth drivers for the company. Below is a slide from a recent American Water presentation to its shareholders which lists it among other growth-enabling legislation (I added the dotted box to highlight this particular one). I’ll come back to this slide again a bit later.

WSIRA replaced a similar, but more limited, type of “infrastructure mechanism”. Infrastructure mechanisms are ways for utilities to shrink the amount of time between making an investment and earning a return on that investment. Without these mechanisms in place, utilities can only increase their revenue through the standard laborious rate case process. Often, years go by between new general rate cases (MAWC averages about two years between theirs). This means that capital investments made between rate cases don’t generate a return for extended periods of time. Here is a simple example to illustrate the importance of this: if I lend you $10 and you pay me back $11 a year later, my annual return is 10% ($1 of profit divided by $10 of investment). If instead I need to wait another year to collect my $11, my total return stays the same (10%) but my annual return falls to 5%, since I now have to spread the return over two years.

With these mechanisms in place, however, utilities can increase customer rates in between the larger rate cases through a shortened process for a qualified list of investment categories, though often subject to a cap. WSIRA broadened the list of eligible categories and increased the cap. With WSIRA in place, MAWC can increase rates almost in lock-step with its capital investments at a much higher volume compared to previous laws. When investments generate higher returns, companies do more of them. And that is just what we see in MAWC data. Before the WSIRA legislation, MAWC grew its Missouri rate base by $117 million per year. Since WSIRA, the rate base has been growing by $335 million per year, a 3x increase5.

I point all of this out for two reasons. First, given the effect WSIRA has on MAWC’s incentives to deploy capital, and the direct effect capital deployment has on customer rates, I think there is reason to believe that the growth profile for rates in the next 10 years is more likely to resemble what we saw in the period after FY 22, rather than before. American Water thinks so too. In 2016, they anticipated 5-6% long-term growth in their rate base (see the top slide below). Today, they are anticipating 8-9% annual rate base growth for the next decade (see bottom slide)6.

Also worth pointing out that while the entire American Water rate base grew 10% annually from 2020 to 2025, over the same period MAWC’s rate base growth far outpaced that at 14% annually.

The other reason I think rate base growth will remain high is that in March 2025 the Missouri Legislature passed another growth-enabling law called Future Test Year which takes effect in July 2026. I’ll return again to this slide, but now highlighting a different box. Future test year is another growth-enabling law.

The Future Test Year law has a very similar effect to WSIRA. Even under WSIRA, a utility can only get rate base credit, and therefore earn a return on, actual capital investments made into the system over a prior period. They show up to the rate case and provide schedules documenting the capital they have deployed in the past, and the regulator allows them to recover a return on that in the future. There is still a lag between the time of making a capital investment and the time you start to earn a return on that investment.

Under Future Test Year Laws, however, the rate base MAWC will use to establish rates is based on an assumed future period. MAWC will show the regulator their capital deployment plan for the 1 year period after rates are supposed to become effective (and essentially commit to that plan). The regulator will then use that plan to establish their rates. The practical implication is that the interval between capital deployment and earning a return on that capital is virtually 0 (and could conceivably be negative for some investments). Just like WSIRA, the Future Test Year law will increase the expected return on capital investments for MAWC and, I believe, will encourage faster capital deployment in the area in the immediate future7.

Let me try to bring all of this together into an answer to Question 2 by laying out the datapoints I considered.

• MAWC rates grew 11% annually over the last 5 years largely due to rapid capital investments

• The introduction of the Future Test Year law is a reason that the pace of capital investments could plausibly accelerate

• However, inflation should be a couple percentage points lower in the future compared to the prior 5 years, that argues for slower rate growth

• American Water plans to grow the company-wide rate base by 8-9% per year and MAWC has been growing meaningfully faster than the entire company

With all of that, I settled on assuming 7% annual growth in MAWC rates over the next 10 years. Here’s how I got there. You can roughly split the MAWC rates into the amount that is paying them a return on their rate base and the amount that is reimbursing their operating expenses. I grew the rate base component at 8.5% (the mid-point of their company-wide range8) and grew the operating expense component at 5% (which is roughly in-line with the 10-year average growth for this item).

Below is the chart again that shows the community-wide cost of paying MAWC rates, this time updated to add the 10-year projection period.

Before we can move on to an assessment of the cost to self-manage the utility, there is one more financial aspect to consider in the scenario where we sell to MAWC. If we sell the utility, the buyer would pay property taxes on the system. Most of those property taxes would flow directly back into the Kirkwood community in some fashion (predominantly the school district). As outlined below, a transaction would generate around $900k in property taxes annually.

I think it’s reasonable to debate which recipients we should include as a benefit to the community in this analysis. But my focus was looking community-wide so I’m including any recipients that predominantly serve the people of Kirkwood.

So that does it for Question 2. Below is my full multi-year forecast for this one in table form for the sake of transparency9. With that, on to question 4.

Question 4: How much will it cost to operate and maintain the utility over the next 10 years?

There are two broad cost categories that come with operating a utility: operating expenses, which include things like repairing leaks, purchasing water10, billing customers, and administrative expenses; and capital expenditures, which include replacing aging water mains, upgrading pump stations, and replacing lead service lines.

Starting with operating expenses, I broke this down further into two categories: purchased water, and everything else. Let’s start with the “everything else” bucket. This mostly includes distribution system maintenance and administrative expenses. In fiscal year 2020, the utility had $2.7 million of these expenses. By fiscal year 2025, that grew to $4.0 million. This represents an average annual growth rate of 8.1%. Inflation was elevated in that period compared to the market outlook for the next 10 years (4.2% versus 2.4%, respectively11). The growth rate from 2020 to 2025 was 3.9% above inflation (8.1% - 4.2%), so I kept that same margin to inflation and applied it to the current 10-year inflation outlook (say inflation one more time!). Accordingly, my assumption for annual growth for this category is 6.3%. For some context, the city had a report prepared in 2025 which used 4.0% for cost growth. So I’m conservative by that standard.

Purchased water is a bit trickier to forecast. There is a contract between Kirkwood and MAWC that spells out the key terms, but which I could not find (nor have I yet made a records request). That said, it appears that the rates in the contract are at least in part set through MAWC’s rate case process. I can’t tell you much more than that. But basically I just looked at the trend in those rates and compared that to the trend in MAWC’s retail rates (those are the rates we were discussing at length above). The wholesale rate MAWC charges Kirkwood grew at about 70% of the growth rate in MAWC’s retail rates. So I just took 70% of my MAWC retail rate growth assumption (7%) and ended up with about 5% assumed annual growth for purchased water expenses. All together, I’m assuming operating expenses grow about 6% annually.

Next up are capital expenditures. In the 5 years from 2021 to 2025, the city spent an average of $1.7 million in capital expenditures each year. The main driver behind the capital expenditures is replacing aging and leak-prone water mains. In that period, we replaced 0.5% of the system each year.

By all accounts, this is too low. One industry survey found that across the US, utilities were replacing about 0.8% of their systems annually. A recent study Kirkwood had prepared by an engineering firm called CMT recommended 1.5%. Kirkwood’s 5-year capital plan outlined in the latest draft of the fiscal year 2027 budget proposed 1%.

I don’t know which of these is right. I deferred to the most conservative assumption (the one with the highest replacement rate). This is the CMT report. They forecast $6 million per year in water main replacement capital expenditures. I then added the rest of the capital expenditures from the 5-year capital plan ($1.5 million per year) and then added an estimate of the cost of improvements to Park Pump Station #2 (which the CMT report noted would likely be needed, but was not included in the 5-year capital plan). In all, I am assuming $82 million of capital expenditures over the next 10 years (this includes $38 million over the next 5 years, roughly double the city’s latest 5-year plan).

I mentioned this in a prior part of this analysis but it’s worth repeating. Unlike operating expenses, capital expenditures create assets that are likely to increase future sale value. Those investments increase the value of our utility to any third party buyer, so we are very likely to get paid back for those investments in a future sale.

Here is the consolidated forecast for the cost to operate and maintain the system.

One last point. You may wonder why I’m excluding two other very material costs – the debt service and interest expense requirements of the water utility’s debt that exists today. I am doing this to intentionally separate the economic decision (keep or sell the utility) from the decision of how to finance that choice. This is probably the most difficult part of this analysis to describe as it relies on a fair bit of corporate finance theory and is not at all intuitive. But I’ll give it a shot. Let’s take each of those cost items in turn:

• Debt service: If I include these payments in the analysis, they would represent an additional cash outflow for the water utility. However, when the debt matures we have the option to refinance debt (i.e. issue more debt to cover the maturing debt, so the total debt balance stays the same). If we make that assumption, then on a net basis debt service payments are 0 and the utility’s debt balance stays the same. And therefore this would have no impact on my model.

• Interest expense: Let’s stick with the hypothetical scenario I just described, where we constantly refinance debt as it matures. That means the only remaining cost is interest expense. How much is that interest expense? It’s equal to about 3.6% (the city’s current cost to borrow for 10 years) multiplied by the current debt balance. But remember the basic framework of this analysis. I am going to compare the economic cost of selling the utility against our current cost of debt. If the economic cost of selling is higher, it makes sense to keep the utility. The inverse of that decision is comparing the economic benefit of keeping the utility against the same benchmark. If the benefit of keeping the utility is greater than the cost it would take to finance keeping it, then it makes sense to keep the utility. These are identical analyses, just different ways of framing them. Let’s stick with the economic benefit framing for a moment. Since I’m saying that the benefits of this deal need to exceed the interest expense required to do the deal, I am effectively already including the cost of interest. To risk belaboring the point, let me give you one more concrete example.

  • Say you want to make a trade that costs you $100 today but would pay you $110 next year. That trade has a 10% return ($10 of profit divided by $100 investment = 10%). Let’s say you can finance this trade by raising $100 at a 5% interest rate. That means there are two ways to look at this:

    • You can say, I know that my return before interest is 10%, and that interest only costs me 5% so I should do the deal. This is what my analysis does. No need to include the interest cash flows in your model – they are the benchmark.

    • Alternatively, you can say, I’m going to make $10 in profit before interest, but then pay $5 in interest, so my profit next year will be $5. $5 is more than $0 so I should do the deal. You can do this, but it gets technically quite difficult because there are many different ways you could approach financing a deal, and they each have different risks / benefits. So it’s easier to tackle that question separately rather than creating a model that relies on a specific set of financing assumptions.

I’m sorry if I lost you there. I’m happy to try explaining again if it’s still not clear. But hopefully that doesn’t impede understanding of the rest of the analysis.

I’ll leave you with one last table, a side by side (or I guess top to bottom?) comparison of the MAWC scenario vs. self-operated scenario, which also lays out the economic cost of ownership math.

That’s it! In the next part I will bring all of these inputs together into a model that produces the economic cost estimate. I will also show how that estimate varies by changes to some of the key assumptions. Find out now in Part IV!

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Introduction

As a reminder, in the last part we talked about the questions we need to answer to complete the economic cost calculation. I’ve repeated those below. In this part, I will address questions 1 and 3.

1. How much is the utility worth today?

2. How much will the community pay over the next 10 years as MAWC customers?

3. How much will the utility be worth in 10 years?

4. How much will it cost to operate and maintain the utility over the next 10 years?

We’re about to talk about municipal water utility valuation at length. If that is interesting to you, then you are in store for a wild ride. If it’s not, I’ll just give you my key takeaways now:

• How much is the utility worth today?

  • I believe the water utility is worth $47 million to $60 million

  • However, there is regulation in place in Missouri that creates a barrier to us realizing that value today

  • That regulation means we are likely to realize only around $32 million if we sell today

  • I believe that before we seriously consider a sale, we should explore ways to navigate this regulation to potentially unlock more value for the city

• How much will the utility be worth in 10 years?

  • This is directly a function of how much we spend on capital investments over the next 10 years

  • If we pursue the capital plan that calls for ~$90 million of investments over the next decade, the water utility will be worth around $94 million in 10 years, but if we spend less, it will be worth less

Read on if you want to see how I got there!

Valuation framework

The most common way to value a business is based on how much income it generates. If business A and business B are identical in every way, but business A earns twice as much income as business B, you would pay twice as much to own business A compared to B.

Of course, it gets a lot more complicated than that, but the important points are:

1. You can use income as a proxy for value

2. You can determine value by multiplying income by some factor

Just as one example, in announcing its deal to acquire Warner Bros., Paramount stated that the transaction,

“values [Warner Bros.] at an enterprise value1 of $110 billion, representing a multiple of 7.5x …2026 EBITDA2”

Put more simply, Paramount agreed to acquire Warner Bros. for its income multiplied by 7.5.

Utilities, however, are unusual businesses.

Broadly speaking, as far as water utilities go, you have two categories. Municipal systems (like Kirkwood’s) and investor-owned systems (like MAWC). Although Kirkwood stands out as one of the few municipalities in the area that owns its water utility, this is quite common nationwide. In fact, nationally, 87% of the population is served by a municipal system, with only 13% served by investor-owned systems.

Investor-owned utilities are regulated monopolies. This means that in exchange for permission to serve a captive customer base (you can’t choose who you buy your water from, there is only one set of pipes), a regulator tells them how much they can charge customers. In Missouri this regulator is called the Public Service Commission. I will use the general term “regulator” when talking about jurisdictions outside of Missouri, and the term Public Service Commission when specifically discussing our state.

Regulators allow utilities to earn an amount that gives them a fair return on their assets. Water utilities own a lot of assets (pipes, pump stations, storage tanks, treatment plants, etc.). If they didn’t earn a reasonable return on these assets, they wouldn’t bother investing in our water systems. Instead, they would invest their money elsewhere (e.g. stocks, bonds, real estate, etc.). As a society we would like investments in our water system. So to attract capital into those investments we agree to provide a fair return (but not a windfall) to the enterprise that makes them.

So, the basic formula for determining consumer rates looks like this:

1. Take the amount of money the utility has invested into the system (this is called the “rate base”)

2. Multiply that by a fair rate of return

3. Add reasonable expenses required to maintain the system and serve customers

The resulting amount equals the revenue the utility is allowed to earn from its customers. From there, the revenue is structured into customer rates based on average water consumption volumes, number of customers, customer types, etc.

Although the formula is straightforward, the inputs are highly subjective. For example, what amount of return is “fair”? which expenses are “reasonable”? which assets should count as part of the rate base? All of these questions are addressed through a lengthy series of regulatory proceedings between the regulator on one side and the utility on the other. Ostensibly the regulator is acting in the best interest of the public, while the utility is acting in the best interest of its shareholders. The set of proceedings that result in establishing new rates in a territory is called a “rate case”.

During these proceedings, a utility makes an application to change rates, submits evidence and provides expert testimony. That evidence and testimony is then challenged by the regulator and the public until a resolution is reached. I say all of that to point out that there is some element of unpredictability that goes into any of these proceedings. I don’t want it to seem like it’s just a matter of pulling numbers out of a spreadsheet.

As for MAWC, here is a simplified and approximate version of the revenue formula the regulator agreed to as the outcome of their most recent rate case, which decided rates that became effective in May 2025:

I mentioned that this is a lengthy and subjective process. MAWC applied for new rates in April 2024 by asking for $650 million in revenue, and the process concluded over a year later in May 2025 with the Public Service Commission agreeing to $580 million in revenue.

All of this is a very long way of saying that for most businesses, income is a useful proxy for value. For utilities, there is a better proxy – the rate base. For traditional businesses, income is the output of a complex and immeasurable set of inputs. For utilities, it’s the output of a very clear and measurable input – the rate base! In the regulated utility sector, it is common to look at company valuations as a multiple of the subject company’s rate base. Here is an excerpt from a fairness opinion (basically an appraisal for a publicly-traded company) completed in connection with an in-process American Water merger:

“Moelis selected TEV/Rate Base transaction multiples due to the variability in P/E and TEV/EBITDA transaction multiples and availability of data on the transactions3”

Here Moelis, an investment bank, is saying that they preferred using rate base multiples to value the companies in this deal rather than the income multiples4.

See, I’m not making this up!

With that background, we’re ready to start answering the key questions.

Question 1: How much is the utility worth today?

I will summarize the discussion above with the following equation:

Value = Rate Base x Rate Base Multiple

Let’s take each part in turn.

Rate Base

As a municipal system, Kirkwood’s utility is not subject to Public Service Commission regulation so it does not have a rate base, technically speaking. But we can use the net cost basis of its capital assets as a pretty close measure of what its rate base would be5. So let’s change that formula slightly to be consistent with our situation:

Value = Net Capital Assets x Rate Base Multiple

Kirkwood’s fiscal year 2025 audit listed the water utility as having $27.5 million in net capital assets on March 31, 2025. This is a good starting point, but it’s about a year old. This amount increases when the city makes more capital investments into the water utility (replacing aging water mains, for example), and decreases with depreciation.

To roll it forward a year, I added the budgeted capital expenditures and subtracted an estimate of depreciation like so:

$31.6 million is our proxy for the water utility’s rate base.

Rate base multiple

Helpfully, there is a fair amount of data to support this input and they all point to a similar answer. We can look at large publicly-traded water utilities, which trade in the public markets at a median rate base multiple of 1.6x:

And we can look at large water utility acquisitions, which point to a similar range:

Note that in this table I highlighted a recent American Water purchase.

One shortcoming of all of these multiples so far, however, is that they reflect companies that are much larger than our utility, which had 10,400 customers in FY 2025. So lastly, I pulled together a list of transactions in the last 10 years involving water utilities with 2,500-25,000 customers (despite that upper limit in my screen, I didn’t find any transactions with more than 11,000 customers)6:

Valuation

Virtually all of these analyses say the same thing. Our utility is worth about 1.7x our rate base proxy. Revisiting our formula, that would suggest:

$31.6 million x 1.7x = $53.7 million

So we can sell our utility for $53.7 million, right? Not quite. Unfortunately, there is one crucial caveat which presents a barrier to us realizing that value and it’s called “fair market value ratemaking.” Bear with me, it’s going to get fairly technical for a second.

Fair market value (“FMV”) ratemaking

FMV ratemaking has to do with how regulators assess a utility’s rate base after it acquires another utility. The laws that govern this vary state by state, but essentially fall into two categories:

1. Original cost ratemaking: When a buyer acquires a utility (the “target”), its rate base increases by the amount of the target utility’s net capital assets. These rules exist in 35 states.

2. FMV ratemaking: When a buyer acquires a utility, its rate base increases by the target utility’s fair market value. These rules exist in 15 states, including Missouri.

Fair market value is determined by an appraisal process. Without going into full detail on the appraisal methodologies, suffice to say that the appraised value is virtually always greater than the amount of net capital assets. Thus, if rules exist that allow a buyer to add more to its rate base through an acquisition, and more rate base equals more income (as we discussed above), it follows that buyers will pay more for a target when FMV ratemaking rules apply. But this isn’t just conjecture. There is a lot of data to support this idea.

Although it might seem counterintuitive, large utilities are the greatest proponents of FMV ratemaking despite it resulting in them paying higher prices to acquire assets. Like all companies, they want to grow. One way to grow is by acquiring smaller utilities. FMV rules allow large utilities to pay higher prices to smaller municipal utilities without compromising the economics of the deal. The higher prices, in turn, induce the municipal systems to sell. Here is what American Water had to say about the FMV ratemaking rules in Missouri (emphasis mine):

“Missouri’s Fair Market Value law (RSMo 393.320) empowers communities to leverage the financial and technical strength of the private sector by providing a fair and transparent method for valuing their water or wastewater system. Previously, an investor-owned utility could only pay the original cost minus depreciation to acquire another utility system. Because of this, communities were restricted from receiving the true value of their system.”

You can also look at the pace of acquisitions. I looked at Illinois, which has FMV ratemaking rules that have been around since 2013 and data that is relatively easy to parse. In that state, the pace of acquisitions increased 2.4x after the adoption of FMV ratemaking rules. Buyers were able to pay more to induce sales. And they did.

Lastly, we can look at MAWC’s acquisition history:

What this tells us is that when MAWC had FMV ratemaking treatment for its acquisitions, it paid 1.5x rate base (and 1.9x in the most recent, and largest acquisition). But when it had original cost ratemaking treatment, it only paid around 1.0x rate base. They also tell you that directly too. Here is their quote I shared earlier again, this time with different emphasis added:

“Missouri’s Fair Market Value law (RSMo 393.320) empowers communities to leverage the financial and technical strength of the private sector by providing a fair and transparent method for valuing their water or wastewater system. Previously, an investor-owned utility could only pay the original cost minus depreciation to acquire another utility system. Because of this, communities were restricted from receiving the true value of their system.”

But what is the problem if Missouri has laws allowing for FMV ratemaking? Unfortunately, those rules only apply when a large utility is acquiring a smaller utility that serves 8,000 or fewer customers. Kirkwood serves 10,400 customers, so it falls above this threshold. This means that if MAWC were to acquire our entire utility, we would not realize, in their own words, “the true value” of our system.

To be clear, the regulation does not say MAWC cannot pay more than the net capital assets in acquisitions. There is no legal restriction on them paying us what the system is worth, just an economic one. MAWC very well may pay us what the utility is worth (they won’t).

I’m not going to get into whether or not it’s fair that a system in Neosho, for example, could fetch a higher price than ours likely would despite serving around half the customers (you can probably guess my opinion on that) but the practical takeaway is that, at this moment, we are too large to benefit from FMV ratemaking rules.

The value in receiving FMV ratemaking treatment on our system is significant, representing around $15 million to $25 million in additional value. I do not believe it’s prudent to seriously consider a sale without first carefully examining the possibility of achieving FMV ratemaking treatment on our system in the future. Like I said before, MAWC could theoretically pay us more than the net capital assets. And we could go through the process of getting an appraisal and letting that tell us what the system is worth. I just don’t trust that process to result in us maximizing the value of this asset when the regulations are working against us.

Two ideas to consider, though I’m sure there are others:

1. Is it operationally and legally feasible to sell only part of our system? There are examples of municipal utilities selling parts of an otherwise interconnected larger system, including Glenview and Oak Brook in Illinois. The legal system tends not to like “cute” solutions like this if the purpose is solely to circumvent laws, but perhaps there are logical reasons to sell only part of our system.

2. What is the likelihood of the 8,000-customer threshold changing? Illinois (sorry to keep bringing up Illinois!) previously had a similar threshold concept in their statute (in their case, 6,000 customers), but they dropped the threshold in 2022. We should understand the likelihood of that happening here before seriously considering selling at a low price. The legislature has shown an appetite for MAWC-friendly legislation lately, which I’ll cover more in the next part.

To bring this all together into an answer to our Question 1:

I think that as it stands today, the value of our system in a sale under present regulations looks like this:

$31.6 million x 1.0x = $31.6 million

I believe the value of our system under fair market value ratemaking is (I will use a range this time):

$31.6 million x 1.5x - 1.9x = $47.4 million - $60.0 million

Question 3: How much will the utility be worth in 10 years?

Here, we can use the same framework to determine this amount. Let’s look again at the formula we used to estimate the value today:

Value = Net Capital Assets x Rate Base Multiple

Recall that net capital assets increase with capital investments (like replacing aging water mains), and decrease with depreciation. So the formula for estimating the value in 10 years looks like this:

Value = [Net Capital Assets today + Capital Investments - Depreciation] x Rate Base Multiple

I bolded capital investments because it’s worth lingering on this point. A lot of public discussion has surrounded the amount of capital investments in our water utility. Most of this investment is the cost of replacing aging water mains. The discussion has related to how much of the system we replace annually. I have no opinion on that from an operational perspective, but I want to make clear that from an economic perspective we should not view those capital investments the same way we view operating expenses7. Capital investments in a utility are value-enhancing in a very direct way. Even without FMV ratemaking treatment, they increase the rate base MAWC would add by acquiring our system. Money we spend on capital investments isn’t lost. We would get that money back in a future sale (and possibly more if we can somehow unlock FMV ratemaking treatment).

In the next part of this analysis, I will explain how I made the 10-year capital investment forecast. And because there is debate around how much we should be spending annually, eventually we will look at a range of scenarios. But for now I will show you a point estimate for the sake of presenting a tangible answer to Question 3.

[Net Capital Assets today + capital investments - depreciation] x Rate Base Multiple becomes:

[$31.6 million + $81.4 million - $19.0 million] = $94.0 million x 1.0x =

$94.0 million value in 10 years

Note that I’ve chosen to use a 1.0x multiple (rather than the 1.5x-1.9x I believe the data justify) for a future sale scenario as there is no guarantee that we can achieve FMV ratemaking treatment. There is also the reality that the Public Service Commission places more scrutiny on deals where the aggregate difference between the fair market value and net original cost is higher. Who knows what will happen over the next 10 years, but as it stands today, I believe this deal would be the largest in the Public Service Commission’s history by that standard, so would surely face immense scrutiny. All that said, I would advise our city leaders to seriously examine, along with my recommended examination into unlocking FMV ratemaking for our system, the likelihood that we could be earning 1.5x-1.9x on our future capital investments. If true, that certainly affects how I would think about a sensible investment cadence.

This is why I am hesitant to draw a single sale-price threshold. If our only realistic path is original-cost ratemaking, then a price around $60 million is financially attractive. But if there is a realistic path to FMV treatment, either now or later, then selling for $60 million may still be too cheap. The FMV question does not just affect what the system is worth today. It affects whether each future dollar we invest in the system is worth one dollar, or something materially more than one dollar.

That’s it for valuation, next up is estimating the recurring cost impact!

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Introduction

I moved to Kirkwood last fall and quickly noticed a lot of attention on financial issues (credit ratings, budget deficits, real estate valuations, and ownership of utilities - to name a few).

Before moving to Kirkwood, I spent many years working in finance (investment banking and private equity). These days I mostly spend time with my kids, volunteer, and work on a few projects I care about. But I still enjoy thinking about financial questions, especially when they connect to real decisions.

I started The Kirkwood Ledger as a place to explore that interest and, hopefully, to shed some light on issues that matter to this community.

I realize some of these issues are quite sensitive, and have important considerations that go well beyond numbers in a spreadsheet. To the extent any of those considerations can be informed by data, I will attempt to present that information clearly. But I am not trying to bring an ideological lens to any of this. My goal is to present the facts as I see them, offer a point of view based on a logical interpretation of those facts, and to also be clear about where the numbers end and subjective judgement begins.

My first subject is Kirkwood’s water utility, though I hope to cover other local issues over time as well. And please tell me if I get something wrong or where you disagree. I’d be delighted just to know someone else is reading this!

With that, on to Part I.

What should we do with our water utility?

I wanted to research this topic because, in essence, this is M&A1. And there is a lot to sink your teeth into, finance-wise, with M&A. More importantly, despite hearing a lot of discussion about the water utility, including some fairly strong points of view, I had not seen any financial analysis outlining the transaction. I felt I couldn’t have a point of view without that. So I decided to dig in and try to frame the issue in a way that made the economics easier to think about.

Before we get started, just a couple points to clarify. First, if we sell it would almost certainly be to Missouri American Water (the large utility that serves the rest of St. Louis County). Much of my analysis is framed with that assumption so I wanted to make that clear at the start.

Second, throughout this analysis I am going to reference both Missouri American Water (which I will refer to as MAWC for short) and MAWC’s parent company, American Water (which is a large publicly-traded multi-state water utility). I’ll use MAWC when solely referring to their Missouri operations, and American Water when referring to the company as a whole.

Back to the analysis. The decision we are facing is not ‘sell’ versus ‘keep forever.’ It is ‘sell now’ versus ‘keep the option to sell later’. So with that in mind, to evaluate the economics of this deal, I compared two scenarios:

1. Sell the system now: In this case the community would:

a. Receive a large payment today2

b. Incur certain costs (MAWC rates) on a regular basis

2. Sell the system in the future (in my model, 10 years from now): In this case, the community would:

a. Receive a large payment in the future

b. Incur certain costs (system operating expense and capital investment requirements) on a regular basis

If we choose to sell the system now, ultimately, we are choosing to take a large payment today in lieu of a large payment in the future (with some additional cash flows in between). This tradeoff, cash today versus cash in the future, is the basis for most of corporate finance and is effectively the same structure as any financing transaction.

Take, for example, a loan. A borrower receives a large amount of proceeds initially in exchange for making a large repayment in the future (with interest payments in between). The illustration below highlights the similarities between my analytical framework for the water utility (top) and a simple loan transaction (bottom):3

Accordingly, I think it is helpful to view this as a financing transaction, rather than an outright sale. This framing lets us compare the economics of this deal to other financing options available to the city.

Going back to the comparison I made above, if you take out a loan, there is a number that tells you how much that loan costs – the interest rate.

Just the same, in this analysis I will lay out how much this deal would cost. The math is identical to how you would calculate the cost of a loan but I’m going to call it “economic cost” instead of “interest rate” because the latter has a fairly specific meaning. Once we know the economic cost of selling the water utility, we can compare it to the yield4 on the city’s existing debt.

Because I’m looking at a 10-year scenario, I will compare the economic cost of this transaction to the yield on the city’s 10-year debt. The city has certificates of participation that mature in 2036 that are yielding 3.6%, so I’ll use that as Kirkwood’s cost of capital benchmark.

With this framework, if the economic cost is greater than 3.6% then it is value-destructive to sell the water utility. If the economic cost is less than 3.6%, it is value-enhancing.

Without this type of analysis, it’s easy to talk past each other by focusing separately on the upfront proceeds on the one hand and future water bills on the other. Instead, using economic cost, we can assess the trade as a whole.

Let me try to explain what this analysis is doing with a concrete example.

Imagine you are deciding whether to sell your house this year or next year. If you sell this year, you will receive $100. If you wait until next year, you believe you will receive $105. Based only on that information, you would conclude that selling today costs you 5%: the $5 gain you would have received by waiting one year, divided by the $100 you receive by selling today. If you need $100 now, and you can only borrow at a rate above 5%, then selling now may be a good decision.

It gets slightly more complicated, however, because selling this year means you pay a year of rent, while keeping the house means you incur a year of ownership costs. To get the full picture, you need to compare those costs as well. That is what this analysis does.

Back to our specific case, one caveat to this analysis is that the costs and benefits of this decision do not all show up in the same place. Water customers pay rates. The city would receive sale proceeds. There is a property tax benefit to selling which would mostly go to the school district. This analysis is treating all of these entities as a single group. I am first asking whether a deal makes sense in the aggregate. If it does, figuring out how to allocate the benefits of that decision across the various stakeholders is the next question. If it does not, allocation cannot rescue the economics.

It’s also important to note that there are plenty of non-financial factors that play into this decision. It’s not as simple as blindly making a decision based on a comparison to a benchmark. I just hope, with this analysis, to outline the financial considerations. If you still feel that the non-financial factors should overrule the economic factors, then at least you can know how much those considerations cost us.

Anyway, if you want me to just get to the point without taking you through pages of detailed financial analysis here it is: I do not recommend selling the water utility at anything close to the price we are likely to get today.

Based on the assumptions I will walk through in the next part, I believe we are likely to realize a price in the high-$20 million to low-$30 million range. At these prices, I believe selling the water utility, under fairly conservative assumptions5, implies a 9.3% economic cost, or more than 2.5x the city’s 10-year cost of funds. This would be similar to borrowing money at 9.3% when the city can borrow at roughly 3.6%.

I am hesitant to draw a line in the sand with a sale price that I would support. In my model, a sale price around $60 million is where the transaction starts to look financially attractive, but that includes a crucial assumption around regulation which I believe we need to fully examine before moving forward with any sale process.

My conclusion is not that Kirkwood should never sell the water utility. My conclusion is that selling today, at a price likely constrained by current regulation, appears economically unattractive. Waiting has value because it preserves the option to sell later if the facts change.

So that’s my overall takeaway. Now I’ll take you through how I got there.

Determining economic cost requires translating the two scenarios I outlined earlier into a set of four questions. The answers to these questions are the basic inputs into the economic cost calculation.

1. Sell the system now

a. Receive a large payment today

Question 1: How much is the utility worth today?

b. Incur certain costs (MAWC rates) on a regular basis

Question 2: How much will the community pay over the next 10 years as MAWC customers?

2. Sell the system in the future

a. Receive a large payment in the future

Question 3: How much will the utility be worth in 10 years?

b. Incur certain costs (system operating expense and capital investment requirements) on a regular basis

Question 4: How much will it cost to operate and maintain the utility over the next 10 years?

I will give my answers to questions 1 and 3 in part II, and 2 and 4 in part III6, then I will translate all of that into the economic cost calculation in part IV. Lastly, in part V I will try to outline some of the non-financial risks on each side of the trade.

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