PENNSYLVANIA PUBLIC UTILITY COMMISSION Harrisburg, PA 17105-3265

Public Meeting held September 28, 2006

Commissioners Present:

Wendell F. Holland, Chairman James H. Cawley, Vice Chairman Bill Shane Kim Pizzingrilli Terrance J. Fitzpatrick

Application of Penn Estates Utilities, Inc., A-210072F0003 Utilities, Inc. of Pennsylvania and A-210063F0003 Utilities, Inc. – Westgate for Approval of Stock A-230013F0004 Transfer Leading to a Change in Control of their A-210093F0002 Parent Corporation, Utilities, Inc.

OPINION AND ORDER

BY THE COMMISSION:

Before the Commission for consideration and disposition is the record developed in this proceeding following the reconsideration and remand directed by the Commission in the Opinion and Order entered March 31, 2006, at these dockets. History of the Proceeding 1

On August 17, 2005, the Joint Application of Penn Estates Utilities, Inc. (PEUI), Utilities, Inc. of Pennsylvania (UIP) and Utilities, Inc. – Westgate (UIW) (collectively, Applicants) was filed with the Commission requesting approval of the transfer of stock of the parent corporation. The Applicants are subsidiaries of Utilities, Inc., which is a wholly owned subsidiary of Nuon Global Solutions USA, Inc. (NGSU). As proposed, the acquisition was structured so that Hydro Star, L.L.C. (Hydro Star) acquired 100% of the stock of NGSU from Nuon Global Solutions USA, (BV) (NGSU BV). As a result of a 2001 transaction, Utilities, Inc. became a wholly owned subsidiary of NGSU, which is a wholly owned subsidiary of NGSU BV, which is a wholly owned subsidiary of N.V. Nuon. NGSU and NGSU BV have no business or operations other than their ownership of Utilities, Inc. The transaction for which approval was sought involved a shareholder substitution between NGSU BV and Hydro Star. The resulting structure is that Utilities, Inc. and the Applicants are indirect wholly owned subsidiaries of Hydro Star.

On October 3, 2005, the Office of Consumer Advocate (OCA) filed a Protest to the Joint Application. Among the reasons for the OCA protest were allegations regarding the quality of service within the UIW service territory. On January 23, 2006, the Applicants and the OCA filed a Joint Petition for Approval of Proposed Settlement (Proposed Settlement). The Proposed Settlement contained several conditions designed to alleviate service problems in the UIW service territory. (See, I.D. at 4-5). By Initial Decision dated January 31, 2006, Administrative Law Judge Jones found that the Proposed Settlement was in the public interest and recommended approval of the Joint

1 The history of this proceeding is summarized from the Initial Decision of Administrative Law Judge Angela Jones. The complete history may be found at pages 1 through 3of that Initial Decision. 632419 2 Application. (Id. at 7-8). On February 28, 2006, Administrative Law Judge Jones’ Initial Decision became final by operation of law.

On March 31, 2006, the Commission entered an Opinion and Order at these dockets which determined that this proceeding should be reconsidered (March 31 Order).2 The Commission expressed concern regarding the public interest findings relating to this transaction due to the status of the acquiring party as an equity investor. (March 31 Order at 1). Because of that concern, the Commission reopened the record for the receipt of additional information and directed the Office of Trial Staff (OTS) to intervene. The Commission directed the Parties to address ten specific issues:

(1) The capital to be allocated to ongoing operating and maintenance expenses; (2) Corporate governance/Sarbanes Oxley compliance; (3) The expected term of ownership; (4) The buyer’s experience as an owner and operator of water and wastewater utilities; (5) The community presence of the buyer; (6) The complex nature and objectives of the various affiliated relationships involved; (7) The fees paid to and service performed by affiliates; (8) The use of leverage to eliminate or maximize income tax liabilities; (9) The transparency on corporate structure issues; and (10) Entity creditworthiness.

(March 31 Order at 2).

2 We note that although we decided to reconsider our prior approval of this matter, our March 31 Order expressly provided that “the status quo approval of the application remains in effect…” (March 31 Order at 2). 632419 3 A prehearing conference was held before Administrative Law Judge Jones on May 8, 2006. The Applicants, OTS and OCA, appeared. A further hearing was held on May 22, 2006, where it was determined that the OTS would present written Direct Testimony on June 16, 2006, and the Applicants, if they chose, would present Responsive Testimony on June 23, 2006. The OCA indicated that it would not present any testimony in this portion of the case. The Direct Testimony and OTS Exhibit No. 1 of the OTS were submitted on June 14, 2006. Responsive Testimony by the Applicants was submitted on July 10, 2006. On August 4, 2006, the Parties filed a Joint Stipulation of Testimony and Exhibits and requested that the OTS’ Direct Testimony and OTS Exhibit 1, and the Applicants’ Responsive Testimony be admitted into the record. On August 14, 2006, the OTS and the Applicants filed a Joint Motion to Close the Record, indicating that there was no need for cross-examination or additional evidentiary hearings. The OCA agreed with the Motion.

The record in the remanded preceding is now before the Commission for disposition.

Discussion

As set forth above, we directed the Parties to address ten specific issues. The OTS propounded two rounds of discovery which sought responses from the Applicants to each of the ten issues. The Applicants’ responses are set forth in OTS Exhibit 1. In addition, the OTS’ Direct Testimony summarizes the Applicants’ responses and concludes that there is sufficient evidence on the record for this Commission to reach a determination on each of the issues. The Applicants’ Responsive Testimony indicates agreement with the OTS’ Direct Testimony and provides additional information regarding the public interest standard by which the transaction is to be reviewed. We will address each of the issues in turn.

632419 4 The Capital to be Allocated to Ongoing Operating and Maintenance Expenses

OTS Exhibit 1 provides information regarding amounts of operating and maintenance (O&M) expenses for the years 2002-2004 and the average for the three years. The Applicants stated that they anticipated that the O&M expenses would continue to increase over time; however, they did not anticipate filing a base rate case in the immediate future other than to satisfy the conditions of the Proposed Settlement relating to UIW service upgrades. (OTS Exh. 1 at 1; Applicants’ Responsive Testimony at 3).

The testimony and information provided in response to this issue does not suggest a need for any additional conditions on the underlying transaction. Important factors in this determination are the anticipated length of time of commitment as well as the commitment to retain current operational management of the operating companies. Those issues are addressed below.

Corporate Governance/Sarbanes Oxley Compliance

Based upon OTS Exhibit 1 and the OTS’ Direct Testimony, it appears that most of the entities involved in this transaction are not subject to Sarbanes-Oxley requirements. (OTS Direct Testimony at 6, OTS Exh. 1 at 2, 26). However, to the extent that Sarbanes-Oxley is applicable to American International Group, Inc., of which Hydro Star is a part, American International Group, Inc., is in compliance. (Id.). The Applicants do not disagree with OTS on this issue but state that whether Sarbanes-Oxley certifications extend to Hydro Star is not settled.

632419 5 The evidence gathered on this issue does not indicate that any additional conditions are necessary for the transaction. As noted, most of the entities involved are not subject to Sarbanes-Oxley requirements. In addition, we reiterate that several statements in the remanded proceeding serve to assure this Commission and the operating companies’ customers that management teams will not change, nor will the corporate approaches of the operating companies be affected. The transaction is intended to be transparent to Pennsylvania customers. (Applicants’ Responsive Testimony at 7). Thus, the additional evidence on corporate governance and Sarbanes-Oxley compliance indicates that no additional conditions are necessary in this regard.

The Expected Term of Ownership

The Applicants provided information that Hydro Star’s expectation is for a return of principal over a reasonable period of time with a return on investment commensurate with the regulated rate of return. (OTS Exh. 1 at 3, OTS Direct Testimony at 7). Hydro Star’s investment approach seeks stability, stable cash flow and good downside protection. Economic or regulatory factors may lengthen or shorten the expected investment horizon, but there is no indication that Hydro Star is investing for a “quick hit.” In this regard, Hydro Star employs a relatively conservative approach. (Id.).

This issue does not suggest the need for any additional conditions on the transaction. We specifically note the Applicants’ commitments to the improvement of service quality in the UIW service territory as further corroboration of the expected ownership term. (See, I. D. at 4-5).

The Buyer’s Experience as an Owner and an Operator of Water and Wastewater Utilities

632419 6 Again, the Applicants stress that there will be no change in the operations management of the Applicants, and current management teams will remain in place after the transaction is closed. Nor will the transaction result in any direct ownership or control over the Applicants. (Applicants’ Responsive Testimony at 7). However, the Applicants do provide information relating to water and waste water experience of the buyer in this transaction. AIG Highstar Capital II, L.P.3 and Hydro Star specifically have substantial experience with regulated entities, including water and wastewater utilities. In particular, Highstar Managing Director John Stokes has “extensive experience in the water business over seven years. He was President and CEO of a business that owned 22 regulated water and wastewater utilities, in addition to providing engineering, construction, operations and related services to municipal utilities across much of the U.S. and Canada.” (OTS Exh. 1 at 4; Applicants’ Responsive Testimony at 8-9).

Given the evidence that there is intended to be no change in the operational management or control of the Applicants, together with the information relating to the experience of senior personnel in the Buyer’s investor structure, no additional conditions on the transaction are necessary regarding this issue.

The Community Presence of the Buyer

The Buyer has no community presence with regard to the jurisdictional operating companies involved. As structured, the transaction is not expected to change that. However, “it is Hydro Star’s intent to encourage and aid Utilities, Inc. and the jurisdictional utilities to continue their efforts and practices with regard to utility outreach, especially the Customer Advisory Boards.” (OTS Direct Testimony at 9).

3 Highstar Capital II, L.P. is an investor in Hydro Star. 632419 7 At this point in time, particularly in view of the Applicants’ establishment of Customer Advisory Boards as set forth in the Proposed Settlement, there does not appear to be any need to impose additional conditions on this transaction.

The Complex Nature and Objectives of the Various Affiliated Relationships Involved

Hdyro Star is a newly created entity, created for the sole purpose of purchasing NGSU stock from NGSU BV. AIG Highstar Capital II, L.P. (Highstar) and its affiliates are investors in Hydro Star. Highstar’s affiliates include AIG Highstar Capital II Prism Fund, L.P. and AIG Highstar Capital II Overseas Investors Fund, L.P., which were created for the purpose of providing investment vehicles for certain groups of Limited Partners. Highstar is a fund sponsored by AIG Global Investment Group (AIGGIG). A fund’s sponsor is the entity that typically stands behind the general partner’s obligations with respect to the fund and is required to commit a certain percentage of capital to the fund. In the case of AIGGIG and Highstar, AIGGIG stands behind the obligations of Highstar. The Applicants have indicated that AIGGIG, through its affiliates, has an obligation to commit no less than 10% of the aggregate capital to Highstar. AIGGIG is an indirect subsidiary of American International Group (AIG). Neither AIG nor AIGGIG will have any direct control over UI or the operating companies. In addition, neither AIG nor AIGGIG will own a majority of the limited partnership’s interests in Highstar.

The foregoing sets forth the corporate/partnership relationships in this transaction and is taken verbatim from the OTS Direct Testimony at 10-11. As we set forth in our discussion of Issue 3 relating to the anticipated term of ownership, the Buyer’s objective is a conservative investment with returns commensurate with the regulated rate of return and a return of principal stated over a reasonable horizon. Again,

632419 8 the record on this issue does not suggest that any additional conditions need to be placed on the transaction.

The Fees Paid to and Service Performed by Affiliates

In response to this issue, the Applicants state that every affiliate transaction is governed by affiliated interest agreements approved by the Commission. Specifically, each of the operating companies has entered into an approved agreement with Water Service Corp. (WSC). WSC is an affiliate of Utilities, Inc. WSC provides executive, engineering, operational, accounting, legal, billing, regulatory, and customer relations services to all of Utilities, Inc.’s subsidiaries. The operating subsidiaries pay WSC the cost of those services without markup. The actual dollar amounts are set forth in the Applicants’ Annual Reports on file with the Commission. There is no intent to change this structure after the transaction closes. (OTS Direct Testimony at 12).

Given the representation that the current operations will not be altered post- transaction, and the affiliated interest agreements have been approved by the Commission, we see no need for additional conditions relating to this issue.

The Use of Leverage to Eliminate or Maximize Income Tax Liabilities

Again, the Applicants stress that the transaction is intended to be transparent to the customers of the Applicants. The transaction will have no tax consequences to the ratepayers in Pennsylvania. The Applicants will continue to use the jurisdictional statutory tax rate for ratemaking purposes. (OTS Direct Testimony at 13).

632419 9 There is no indication that any additional conditions need to be placed on the transaction regarding this issue. In any event, to the extent this particular issue becomes relevant, it will be managed in a ratemaking context.

The Transparency on Corporate Structure Issues

Initially, the Applicants indicated that they were unclear as to what was required in response to this issue. Further inquiry by the OTS elicited the response that AIG was the subject of significant investigations regarding certain corporate practices and had reached settlements resulting in the payment of more than one billion dollars in restitution and penalties as well as mandated reforms of various accounting practices. (OTS Exh. 1 at 91-131).

Our concern related more to the particular operating companies within our jurisdiction and the immediate parent. However, the information supplied in response to Issue Nos. 2, 3, 4 and 6 are responsive and indicate that no additional conditions need to be placed upon the transaction. We add that while AIG’s history is of great concern, we note the Applicants’ assurances that the current operating structure and management teams will remain. Also, we note the Applicants’ assurances that the transaction is intended to be transparent to Pennsylvania.

Entity Creditworthiness

In response to this issue, the Applicants provided information showing the Moody’s, Standard & Poor’s and Fitch’s long-term debt and financial strength rating for AIG. Based upon the ratings as set forth in AIG’s 2005 Annual Report, it appears that creditworthiness is not an issue.

632419 10 Conclusion

The foregoing discussion indicates that there is no need for additional conditions to be placed upon this transaction as a result of the record developed on remand. Accordingly, we will adopt the Initial Decision of Administrative Angela Jones in this matter. However, we must indicate our concerns regarding the operations of the Applicants, particularly that of UIW, which were replete with violations of water potability standards and inadequate of service. These problems were not corrected until the Applicants were confronted by the OCA in the context of this proceeding.

The record before us contains emphatic representations that the transaction is in the public interest, in part, because the acquiring entity will provide UIP, PEUI and UIW with enhanced acquisition to capital and financial resources backed by the Buyer. (See, I.D. at 6; Applicants’ Responsive Testimony at 8). The Applicants state: “These financial resources will only enhance the ability of the operating subsidiaries in Pennsylvania to grow and to continue to meet their service obligations.” (Id.). Based on these representations in the record, it appears that the Applicants’ Pennsylvania operations will not deteriorate. We certainly expect that there will not be any repetition of the UIW experience both as to severity and the time required to rectify the problem. Although we are approving the transaction as conditioned by the Proposed Settlement,4 we will continue to monitor the Applicants’ jurisdictional service quality.

Based upon the foregoing discussion, we will adopt the Initial Decision of Administrative Law Judge Angela T. Jones which approved the Proposed Settlement and the underlying transaction as it is in the public interest; THEREFORE,

4 We also note that the matter of Horvath, et al. v. Utilities, Inc. – Westgate, C-20055305, has become final and enforceable. 632419 11 IT IS ORDERED:

1. That the Initial Decision of Angela T. Jones dated January 31, 2006 at these dockets is adopted as the Commission’s action in this matter.

2. That the terms and conditions contained in the Joint Petition for Approval of Proposed Settlement submitted by Penn Estates Utilities, Inc., Utilities, Inc. of Pennsylvania, Utilities, Inc. – Westgate and the Office of Consumer Advocate filed on January 23, 2006 at these dockets are approved.

3. That the Protest of the Office of Consumer Advocate at these dockets is deemed withdrawn.

4. That the Joint Application of Penn Estates, Inc., Utilities, Inc. of Pennsylvania and Utilities, Inc. – Westgate for Approval of Stock Transfer Leading to a Change in Control of Utilities, Inc. is approved as set forth in our Order at these dockets entered February 28, 2006.

632419 12 5. That the Commission’s Bureau of Fixed Utility Services shall monitor compliance with the conditions of the Joint Proposal for Settlement referenced in Ordering Paragraph No. 2 and shall report to the Commission upon completion of those conditions.

6. Upon the filing of the Bureau of Fixed Utility Services’ report referenced in Ordering Paragraph No. 5, this proceeding shall be marked closed.

BY THE COMMISSION,

James J. McNulty Secretary

(SEAL)

ORDER ADOPTED: September 28, 2006

ORDER ENTERED: October 2, 2006

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