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Robert Dove, infrastructure fund manager for the Carlyle Group, listens in September 2011 during a Montana Public Service Commission meeting in Missoula to discuss the then-proposed sale of Mountain Water Co. to the international investment firm.

The legal bill to defend the Carlyle Group’s ownership of Mountain Water Co. could surpass $1 million, according to an estimate from the global investment firm.

Win or lose, Missoula taxpayers would pay that bill.

“We intend to hire the most qualified lawyers,” said Robert Dove, infrastructure fund managing director for Carlyle. “Lawyers charge by the hour, so the longer the case drags on, the higher the overall cost is. We understand condemnation cases can take a long time, i.e., four to five years, even longer.”

The city of Missoula is in steady pursuit of its water system, but Carlyle has rejected offers of up to $65 million to purchase Mountain Water. Now, Mayor John Engen is prepared to use the city’s power of eminent domain to take control of both the company and Missoula’s water security.

In doing so, he pits the taxpayers of Missoula against one of the largest investment firms in the world.

“Clean, safe drinking water is critical to the health and welfare of all human beings,” Engen said in a recent presentation. “Management of that fundamental resource should not be the province of a private corporation beholden to distant investors.”

The Carlyle Group bought Mountain Water and its parent company, Park Water, in 2011. It anticipates holding investments in its infrastructure fund from five to seven years, and has pledged a strong defense should the city attempt to force a sale in court.

“We believe in the rule of law,” Dove said. “We strictly follow laws and regulations, and we will vigorously defend ourselves if our legal rights are violated, whether it’s in rural Montana or in a large metropolis.”

Last week, Dove provided written responses to questions from the Missoulian about his company’s ownership of Mountain Water, the potential condemnation case and any possible sale. The answers were provided by Carlyle spokesman Christopher Ullman.

Carlyle has more than $189 billion in assets under management, its responsibility is to turn a profit, and it reported a 14 percent appreciation in all funds in its most recent 2013 annual report. In his response to the Missoulian, Dove noted the firm has a “fiduciary duty to our investors to create the maximum value.”

In that regard, the behemoth enterprise may have help from Montana. A pending petition for judicial review of a water company rate increase shows Carlyle appears to be aided in its mission by the state agency charged in part with consumer protection, the Montana Public Service Commission.

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In a report to the Missoula City Council, Mayor Engen estimated transaction costs in a takeover of Mountain Water could run $4.24 million. The amount includes $400,000 for condemnation counsel as well as other costs for consulting engineers, bond counsel, and other lawyers and advisers.

The city would pay legal fees for both parties in a condemnation proceeding, and Engen has estimated that total bill could run some $800,000. Carlyle has not been involved in an eminent domain case in the past, but the firm estimates its legal defense alone could run more than $1 million.

“We expect to have multiple legal counsels, with expertise and experience in local Montana laws and eminent domain cases,” Dove said.

The city of Missoula made three reported bids to purchase Mountain Water, and the top $65 million offer is not shoddy, according to analyses from the city’s financial advisers and figures in Public Service Commission documents.

According to the commission’s 2011 order approving the transfer of Mountain Water Co. to Carlyle, the sale agreement noted Carlyle would pay $102 million for Park Water and its subsidiaries; that Mountain Water Co. accounted for 32 percent of Park’s customers; that Carlyle would pay $1.5 million in closing costs; and that it acquired $53 million in outstanding debt from Park Water.

Carlyle, however, suggested a $120 million sale price for Mountain Water, or roughly double its estimated value, according to the city’s analyses. The firm reports a 14 percent appreciation in its overall funds, but it does not disclose whether the performance of its $1.14 billion infrastructure fund falls in line with that of other investments.

In suggesting $120 million as a more realistic price tag for Mountain Water, Carlyle was taking into consideration the added costs of splitting a subsidiary from a parent company, according to Dove. Western Water Holdings formed to acquire Park in California, and along with it, Apple Valley Ranchos in California and Mountain Water here.

“The $120 million number was not a counter-proposal,” Dove said. “Rather, it was a back-of-the-envelope reference point for what the $65 million offer would need to increase to after taking into account the various extra costs associated with selling Mountain separate from Park.”

Carlyle will base its decision to sell on the company’s prospects, market conditions and its overall investment portfolio. It has in the past sold separately subsidiaries considered “non-core assets.”

“One example is Sequa, a conglomerate that made jet engine parts and evening formal wear,” Dove said. “We sold the latter to focus on the former.”

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Missoula’s mayor and his financial advisers reported using typical industry models to place a value on the utility. Carlyle, however, noted the city didn’t place all the options on the table, and “one person’s view on the financial prospects for Mountain Water and future market conditions could quite easily be different from another’s.”

“In a typical condemnation case, we understand the valuation is based on replacement cost less depreciation,” Dove said. “This was missing among the models presented. In addition, the same model with different assumptions on the future prospects for Mountain Water could lead to vastly different valuations.”

He declined to provide an estimate of the figures those calculations might yield. Repeatedly, however, Dove said Carlyle has not decided to sell Mountain Water, and it is not seeking a buyer for Mountain or Park Water; condemnation would not trigger a sale, and the firm anticipates holding investments in its infrastructure fund from five to seven years.

“However, we have a fiduciary duty to our investors to create the maximum value, so a sale before that timeframe is possible, depending on company performance and market conditions,” Dove said.

Carlyle declined to provide information on the rate of return it expects from public utilities. “However, the rate of return that Mountain Water achieves is regulated by the Montana Public Service Commission. This regulatory oversight would lapse should Mountain Water become a municipally owned water utility.”

In the case of city ownership, Mayor Engen has said the governing board overseeing rates likely would be made up of the mayor and council members, who are locally elected and responsible for other municipal rates.

The Public Service Commission regulates private utilities, and its current composition appears to bolster Carlyle’s bottom line. The Montana Consumer Counsel filed in January a petition for judicial review of the commission’s recent decision to mostly grant a rate increase requested by Mountain Water.

Only one commissioner, Travis Kavulla, dissented. Under family ownership in the past, Park Water saw interest rates of 9.22 percent and 10.12 percent, he said; under Carlyle, it has issued debt at a cost of 4.53 percent.

“This, of course, was the very benefit that was promised to consumers by the Carlyle acquisition,” Kavulla wrote in his dissent.

Ratepayers, though, are not reaping the rewards promised when the Public Service Commission approved the sale to Carlyle, according to the Consumer Counsel’s petition for judicial review. Rather, lawyer Monica Tranel said the PSC’s order set water rates as though a higher amount of money is required to service debt than is actually the case.

“Now, the time has come to realize the benefit, and the commission isn’t passing that onto you,” Tranel said. “The money is staying in the company coffers.”

Reach Keila Szpaller at @keilaszpaller, at keila.szpaller@missoulian.com or at (406) 523-5262.

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