COST OF CAPITAL
REBUTTAL TESTIMONY OF MICHAEL J. VILBERT
ON BEHALF OF
CALIFORNIA WATER SERVICE COMPANY
A.17-04-006
AUGUST 22, 2017
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California Water Service Company i Rebuttal Testimony of Michael Vilbert
TABLE OF CONTENTS
I. Introduction and Summary ...............................................................................................1
II. Mr. Rothschild’s DCF Based Estimates ...........................................................................4
A. Constant Growth “Sustainable Growth Rate” DCF ................................................... 4
1. There are fundamental conceptual inconsistencies in Mr. Rothschild’s
sustainable growth methodology. ....................................................................... 6
2. Mr. Rothschild’s Sustainable Growth DCF calculations contain technical flaws
and mathematical errors. ..................................................................................... 9
B. Mr. Rothschild’s Non-constant Growth DCF .......................................................... 19
III. Mr. Rothschild’s Discussion of CAPM ..........................................................................25
IV. Mr. Rothschild’s Criticisms of My Cost of equity Recommendations ...........................26
A. Market-Based Cost of Equity Recommendations .................................................... 27
B. Interest Rate Forecasts and the Risk-Free Rate ........................................................ 32
C. Mr. Rothschild’s Criticisms of EPS Growth Rate Forecasts and of Forecasts in
General ..................................................................................................................... 34
D. Company Specific Risk ............................................................................................ 37
E. Use of Market Value Capital Structures in Cost of Equity Analysis ....................... 38
California Water Service Company ii Rebuttal Testimony of Michael Vilbert
LIST OF EXHIBITS
Rebuttal Appendix A: Rothschild External Financing Rate Error
Rebuttal Appendix B: Corrected Rothschild Sustainable Growth DCF Calculations
California Water Service Company Rebuttal Testimony of Michael Vilbert
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I. INTRODUCTION AND SUMMARY 1
Q1. Please state your name and address for the record. 2
A1. My name is Michael J. Vilbert. My business address is The Brattle Group, 201 Mission 3
Street, Suite 2800, San Francisco, CA 94105, USA. 4
Q2. Did you submit direct testimony in this proceeding? 5
A2. Yes. My direct testimony is Exhibit E on behalf of California Water Service Company 6
(“Cal Water”, “CWS”, or the “Company”). 7
Q3. What is the purpose of your rebuttal testimony in this proceeding? 8
A3. I have been asked by Cal Water to respond to the testimony of Mr. Aaron L. Rothschild 9
(“Rothschild Testimony”) on behalf of the Office of Ratepayer Advocates (“ORA”) 10
with regard to his proposed return on equity (“ROE”) that the California Public Utilities 11
Commission (the “Commission” or the “CPUC”) should allow the Company an 12
opportunity to earn on the equity financed portion of its rate base. I also respond to Mr. 13
Rothschild’s criticisms of my own recommendations and supporting analysis presented 14
in my direct testimony dated April 3, 2017 (“Vilbert Direct Testimony”). 15
Q4. Are you sponsoring any supporting materials? 16
A4. Yes. I am sponsoring the following appendices to my rebuttal testimony: 17
• Rebuttal Appendix A – Rothschild External Financing Rate Error 18
• Rebuttal Appendix B – Corrected Rothschild Sustainable Growth DCF 19
Calculations 20
California Water Service Company Rebuttal Testimony of Michael Vilbert
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Q5. Were these appendices prepared by you or under your direction? 1
A5. Yes. 2
Q6. Please summarize your conclusions in rebuttal to Mr. Rothschild’s testimony. 3
A6. Mr. Rothschild’s recommended 8.22 percent ROE for Cal Water is unreasonably low 4
compared to the allowed ROE’s of other similarly situated regulated utilities as well as 5
based upon the cost of capital estimates from his own models. 6
His recommendation simply does not comport with financial market expectations and 7
regulatory norms for utility allowed returns in California and for water utilities in other 8
U.S. jurisdictions. Furthermore, Mr. Rothschild fails to justify his abnormally low 9
recommendation with supporting evidence and model results. His cost of equity 10
calculations focus on a single estimation method (his “sustainable growth” DCF 11
model), and his implementation contains fundamental conceptual inconsistencies as 12
well as technical errors that bias his results downward by at least 110 basis points. Mr. 13
Rothschild’s non-constant growth DCF calculations rely on non-standard assumptions 14
that are not justified and undermine the validity of the corresponding results. What he 15
refers to as an implementation of the CAPM is, in fact, nothing of the sort and does not 16
provide meaningful information for assessing the cost of equity for Cal Water. 17
Additionally, Mr. Rothschild falls into the trap of mechanically applying his calculation 18
methodologies without consideration of relevant context. His extensive discussion of 19
current capital market conditions and the “Goldilocks Economy” reflect a misguided 20
and unsupported view that historically low interest rates and higher-than-average P/E 21
ratios should be expected to persist throughout the period at issue in this proceeding. 22
California Water Service Company Rebuttal Testimony of Michael Vilbert
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Finally, Mr. Rothschild does not provide any convincing criticisms of my direct 1
testimony recommendations or analysis. His primary criticism—that my 2
recommendations are not “market-based”—is unfounded and inaccurate. And his 3
argument that my analysis is flawed because it is informed by forecasts of inputs such 4
as interest rates and EPS growth rates is undermined by his own reliance on Value Line5
forecasts for all manner of inputs, including stock returns, stock prices, dividends, book 6
value, share issuances, and return on book equity. 7
Q7. Why do you say that Mr. Rothschild’s recommendation is outside the norm? 8
A7. I say so because his recommended ROE of 8.22% for Cal Water is lower than any ROE 9
recently allowed for a water utility across the U.S. as well as below what was recently 10
allowed electric utilities in California. As my business partner and fellow Brattle 11
principal, Dr. Villadsen, details in her rebuttal testimony, Mr. Rothschild only 12
compares his recommendations to two specific water utility ROEs—9.10% in New 13
York and 9.25% in Virginia—that happen to be the lowest in the nation awarded this 14
year and are not representative of allowed ROEs for water utilities in U.S. jurisdictions. 15
As summarized in Dr. Villadsen’s rebuttal testimony, awarded water ROEs in 2016 16
and so far in 20171 have ranged from 9.0 to 10.1 percent, with an average of 9.6 percent 17
and a median of 9.8 percent. Additionally, the electric utilities subject to the 18
Commission’s jurisdiction recently were allowed ROEs in the range of 10.05% to 19
10.30% for 2018-2019, and were allowed ROEs 5 to 15 basis points higher than that 20
for 2017. 21
1 As of May 31, 2017.
California Water Service Company Rebuttal Testimony of Michael Vilbert
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Q8. How is the remainder of your testimony organized? 1
A8. Section II reviews Mr. Rothschild’s implementation of the DCF model, Section III 2
discusses why Mr. Rothschild did not provide any ROE estimates based upon the 3
Capital Asset Pricing Model even though he claims that he does, and Section IV 4
addresses Mr. Rothschild’s specific criticisms of my direct testimony analysis and cost 5
of equity recommendations, including a discussion of current economic conditions and 6
their likely effect on the ROE estimates from the CAPM and DCF models. 7
II. MR. ROTHSCHILD’S DCF BASED ESTIMATES 8
A. CONSTANT GROWTH “SUSTAINABLE GROWTH RATE” DCF 9
Q9. What DCF method does Mr. Rothschild rely on when recommending DCF-based 10
estimates? 11
A9. Mr. Rothschild relies primarily on the constant growth form of the DCF model, which 12
he describes as “used in determining the cost of equity when investors can reasonably 13
expect that growth of retained earnings and dividends will be constant.”2 The equation 14
for Mr. Rothschild’s sustainable growth DCF model can be expressed as 15
� =�
�+ (�� + ��)
where (br + sv) is the sustainable growth rate, as described on pages 28-29 of Mr. 16
Rothschild’s testimony. 17
2 Rothschild Testimony, p. 28.
California Water Service Company Rebuttal Testimony of Michael Vilbert
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Q10. How does Mr. Rothschild implement the constant growth DCF model? 1
A10. Mr. Rothschild uses historical information and forecasts from Value Line for book 2
value per share and dividends, as well as market price data from Yahoo! Finance to 3
calculate the market-to-book ratio and dividend yield for each company in the Water 4
proxy group as of 6/30/2017. He also calculates a dividend yield based on an average 5
of high and low prices over the past year.3 These values are used in the calculation of 6
the earnings retention rate (b), which Mr. Rothschild estimates by applying his assumed 7
rate of return on book equity (r) to 2017 book value per share and comparing to the 8
most recent quarterly dividend levels.4 For two of his estimates, he bases the return on 9
equity (r) on Value Line forward-looking estimates of expected returns on book equity 10
for 2020-2022. For the other half, he uses actual historical returns on book equity 11
calculated for fiscal year 2016. 512
Additionally, Mr. Rothschild uses forecasted information from Value Line to calculate 13
what he describes as the “external financing rate”. This is computed as the compound 14
annual growth between 2018 and 2021 in common shares outstanding and is used in 15
the calculation of the � × � portion of the sustainable growth calculation. He multiplies 16
the estimated external financing rate by an accretion ratio, which is estimated using the 17
market-to-book ratio that Mr. Rothschild calculates as described above.618
3 Rothschild Workpapers, Schedule ALR 3, p. 1. 4 Rothschild Workpapers, Schedule ALR 4, p. 1. 5 Rothschild Workpapers, Schedule ALR 3, p. 2. 6 Rothschild Workpapers, Schedule ALR 4, p. 1.
California Water Service Company Rebuttal Testimony of Michael Vilbert
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Q11. What are your reactions to this methodology? 1
A11. While there is nothing inherently wrong with using a sustainable growth rate when 2
implementing the constant-growth version of the DCF model, Mr. Rothschild’s 3
implementation relies on several fundamental logical inconsistencies that run counter 4
to Mr. Rothschild’s statements about the benefits of the sustainable growth approach. 5
Additionally, his calculations exhibit several technical errors and flaws that lead to a 6
substantial downward bias in his results. These errors include the use of an inaccurate 7
external financing rate, and the inclusion of inputs that imply an illogical negative 8
growth rate estimate for York Water such that these inputs should not be allowed to 9
influence the cost of equity estimates for the water sample. 10
1. There are fundamental conceptual inconsistencies in Mr. Rothschild’s 11 sustainable growth methodology. 12
Q12. What are the fundamental inconsistencies in Mr. Rothschild’s calculation of the 13
sustainable growth? 14
A12. The first and most fundamental inconsistency concerns the levels of the forecasted and 15
historical return on book equity inputs (r) that Mr. Rothschild employs in his 16
calculations. The sample average forecasted value of � he employs is 12.0%, while the 17
scenarios purportedly based on “actual [historical] returns” use an � of 11.0%. 18
However, as a basis for sustainable growth rates, these assumed levels of return on 19
book equity are fundamentally incompatible with Mr. Rothschild’s recommendation 20
that CWS by allowed to earn a rate or return on equity rate base of only 8.22%. 21
California Water Service Company Rebuttal Testimony of Michael Vilbert
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Q13. Please explain this first inconsistency further. 1
A13. The entire premise of a sustainable growth calculation of the type Mr. Rothschild 2
proposes to calculate is that it represents a level of earnings growth that the company 3
can sustain into perpetuity. As Mr. Rothschild explains, the � × � formulation 4
recognizes that reinvesting retained earnings in its business will generate new earnings 5
at the rate of the company’s return on book equity. In applying his � × �-based growth 6
rate in the constant growth version of the DCF, Mr. Rothschild effectively assumes that 7
investors expect the water sample to be able to earn a return of 12 (or 11) percent on 8
book equity into perpetuity. At the same time, however, Mr. Rothschild recommends 9
that CWS only be allowed to earn 8.22% on the equity portion of its rate base. If his 10
position is that the cost of equity estimates for the sample are representative for the 11
subject companies in this case, he does not explain how a regulated water utility 12
company with an allowed return on equity of 8.22% could be expected to “sustainably” 13
grow earnings in a manner consistent with the much higher assumed rates of return on 14
book equity that are the basis of his calculations. 15
Q14. Did you find other inconsistencies in Mr. Rothshild’s approach? 16
A14. Yes. A second fundamental inconsistency is that Mr. Rothschild claims that using the 17
“� × �” approach eliminates the “mathematical error” caused by a non-alignment 18
between the expectations for earnings per share growth and dividends per share growth. 19
He continues by saying that because his approach employs consistent estimates of 20
expected return on book equity and retention ratios, the results of the ““� × �” approach 21
California Water Service Company Rebuttal Testimony of Michael Vilbert
8
will be more accurate than other approaches.7 However, Mr. Rothschild contradicts 1
himself because he relies on historical dividend and book values in his calculation of a 2
sustainable growth rate instead of expected values. Return on book equity (r) and 3
growth in common shares outstanding are the only forecasts he uses, and the Value 4
Line forecasted return on book equity is only incorporated in two of his four cost-of-5
equity estimates.8 This means that two of Mr. Rothschild’s estimates are entirely based 6
on historical values, such that the only way they can reflect “what investors expect […] 7
at the time of the quantification of the stock price used in the DCF formula,” as Mr. 8
Rothschild asserts they must,9 is if investors expect the future to exactly mimic the 9
recent past. 10
A third inconsistency is that Mr. Rothschild criticizes the use of analysts’ EPS growth 11
rate forecasts as flawed and upwardly biased – yet he relies on Value Line’s forecasts 12
to drive the sustainable growth rate calculation in two of his constant growth DCF 13
scenarios. In contrast to my approach, which averages the EPS growth estimates 14
sourced from multiple independent analysts (i.e., Value Line and individual brokers 15
that contribute to IBES) Mr. Rothschild relies on a single source (Value Line) for his 16
forecasts. Importantly, he does not explain why he eschews one kind of forecast (i.e., 17
of EPS growth) but is willing to rely on a second kind (i.e., of return on book equity). 18
7 Rothschild Testimony, p. 30-32. 8 Rothschild Workpapers, Schedule ALR 4, p. 1. Forecasts of return on book equity are used in the
estimates labeled as “Based on Value Line” on Schedule ALR 4, p. 1, whereas the estimates labeled as “Based on Actual Returns” seem to rely on historical actual earnings calculated on Schedule ALR 6, columns 5, 6, and 8.
9 Rothschild Testimony, p. 31, lines 24-27 and p. 32, lines 16-17.
California Water Service Company Rebuttal Testimony of Michael Vilbert
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2. Mr. Rothschild’s Sustainable Growth DCF calculations contain 1 technical flaws and mathematical errors. 2
Q15. What are the technical errors and logical flaws in Mr. Rothschild’s sustainable 3
growth DCF analysis? 4
A15. First, Mr. Rothschild’s Workpaper ALR 6 shows his calculation of an external 5
financing rate. As mentioned above, he calculates this as the compound annual growth 6
rate in shares of common stock outstanding in the three years between 2018 and 2021, 7
and then calculates an average for the sample. The average compound annual growth 8
in shares for the Water Proxy Group is 0.61%. Mr. Rothschild then proceeds to round 9
this to 0.30%, which appears to be a mathematical error, as there is no logic behind this 10
rounding. 11
Second, and relatedly, the reason why the 0.61% average external financing rate that 12
Mr. Rothschild calculated for the sample is so much lower than the median rate of 13
1.36%10 is that York Water has a forecasted external financing growth rate of -1.98%. 14
Value Line forecasts a decrease in the common stock outstanding between 2018 and 15
2021, most likely due to York Water’s share buyback program as referenced in my 16
direct testimony as well as that of my Brattle partner, Dr. Villadsen.11 The impact of 17
this expected shrinkage in the number of shares outstanding on Mr. Rothchild’s 18
calculations for York Water produces a negative estimate of its sustainable growth rate. 19
10 The median of 1.36% reported on Mr. Rothschild’s Schedule ALR 6 is calculated excluding York Water, despite the fact that York is included in the average of 0.61%. Including York’s negative external financing rate in the calculation of the median results in a value of 0.92%.
11 Vilbert Direct Testimony, p. 49, and Villadsen Direct Testimony (i.e., Direct Testimony of Bente Villadsen in Application No. A.17-04-003), p. 40.
California Water Service Company Rebuttal Testimony of Michael Vilbert
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Negative growth is inherently not sustainable into perpetuity (since a company with 1
sustained negative earnings growth would go out of business). Therefore, in the 2
constant growth DCF model, it is not appropriate to include York Water when using 3
the negative �� + �� growth rate calculated using Mr. Rothschild’s methodology.124
Because Mr. Rothschild’s DCF estimates are all performed on the basis of sample 5
average inputs (rather than on an individual company basis), his results are substantially 6
downwardly biased by his inconsistent treatment of York Water in determining his 7
inputs. He leaves out York Water in some calculations (namely the average calculation 8
of the companies’ dividend yield and the median calculation of the companies’ external 9
financing rate) but includes it when calculating the average external financing rate as 10
well as the average and median market to book ratios and returns on book equity for 11
the sample. Mr. Rothschild’s estimates are also downwardly biased by his apparent 12
mathematical error in illogically rounding the sample average external financing rate 13
shown on Schedule ALR 6 down to 0.30%. He does not explain in his testimony why 14
0.30% is correct.1315
12 As an aside, if York Water is repurchasing its shares, then it is distributing cash to shareholders other than dividends, which, everything else equal, means its cost of equity estimate using the DCF model will increase if the additional cash distributions are considered. See Vilbert Direct Testimony at p. 49, lines 3-9.
13 In response to California Water Service Data Request # CSW-001, Question #5, Mr. Rothschild indicates that he derived this 0.30% external financing rate by observing an average change from 2018 to 2021 of 0.61%, and a slightly negative change indicated by Value Line reports from 2013 to 2018. Mr. Rothschild asserts that the 0.30% was obtained by considering both of those growth periods.
California Water Service Company Rebuttal Testimony of Michael Vilbert
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Q16. Do you have reason to believe that Mr. Rothschild’s use of 0.30% for the external 1
financing rate is the result of a mathematical error? 2
A16. Yes. In response to Golden State Water Company’s Data Request, Mr. Rothschild 3
produced “Attachment B-GSW–A.17-04-001–DR PM-1-Rothschild BXR Growth 4
Calculations.xlsx” (referred to herein as “Attachment B”). Within this workbook, Mr. 5
Rothschild calculates the external financing rate from Value Line reports over the past 6
year, used in preparation of Chart 5 of his Testimony. This includes the same April 14, 7
2017 Value Line reports used in Mr. Rothschild’s calculation of the external financing 8
rate in Schedule ALR 6. As demonstrated in Figure 1 below, the same Value Line data 9
produces very different share growth estimates in Mr. Rothschild’s Attachment B 10
calculations (column [5]) compared to his Schedule ALR 6 calculations (column [6]). 11
This is due to a mathematical error in the compound annual growth rate calculation Mr. 12
Rothschild performed in Attachment B, which assumed a growth period of five years 13
between 2018 and 2021. In Schedule ALR 6, Mr. Rothschild corrected this error to a 14
period of growth of three years between 2018 and 2021. However, the erroneous 15
Attachment B calculation results in an average external financing rate of 0.32%, which 16
rounds to 0.30%, the external growth rate used in Mr. Rothschild’s sustainable growth 17
DCF cost of equity estimation. 18
California Water Service Company Rebuttal Testimony of Michael Vilbert
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Figure 1 Calculation of Mr. Rothschild's External Financing Rate
Q17. In Mr. Rothschild’s response to California Water Service’s Data Request, he 1
states that the 0.30% is obtained by considering both past and future growth 2
periods.14 Is this explanation credible? 3
A17. No. Mr. Rothschild indicates that he derived the 0.30% external financing rate by 4
observing an average change from 2018 to 2021 of 0.61%, and a slightly negative 5
change indicated by Value Line reports from 2013 to 2018. Mr. Rothschild concludes 6
that the 0.30% is obtained by considering both of these growth periods.15 However, 7
Figure 1 above demonstrates that growth in common stock outstanding was only 8
“slightly “negative” for two of the eight companies over the 2013 to 2018 period—9
14 ORA response to California Water Service Data Request # CSW-001, Question #5. 15 ORA response to California Water Service Data Request # CSW-001, Question #5.
Common Stock Outstanding Compound Annual Growth
Company 2013 2018 2020-20222018-2021
(Attachment B)
2018-2021
(Schedule ALR 6)
[1] [2] [3] [4] [5] [6]
American States Water 38.7 36.7 37.0 0.16% 0.27%
American Water Works 178.3 179.0 187.5 0.93% 1.54%
Aqua America 177.9 178.5 180.0 0.17% 0.28%
California Water Serv. Grp. 47.7 48.0 50.0 0.82% 1.36%
Connecticut Water Services 11.0 11.5 12.0 0.85% 1.41%
Middlesex Water Company 16.0 16.8 17.0 0.30% 0.49%
SJW Corporation 20.2 22.0 23.0 0.89% 1.48%
York Water 13.0 12.8 12.0 -1.59% -1.98%
Average 0.32% 0.61%
Median * 0.82% 1.36%
Sources and Notes:
[2]: Value Line Company Reports, April 14, 2017.
[3]-[4]: Mr. Rothschild's Workpapers, Schedule ALR 6, p. 1.
[5]: Mr. Rothschild's Attachment B - BXR Growth Calculations, New Financing Growth. Calculated as ([4] / [3])^(1/5)-1.
[6]: Mr. Rothschild's Workpapers, Schedule ALR 6, p. 1. Calculated as ([4] / [3])^(1/3)-1.
* The Median is calculated excluding York Water, as Mr. Rothschild does in both Attachment B and his workpapers.
[3]: The common shares outstanding in 2018 for York Water is reported as 13.0 in Attachment B and as 12.75 in Mr.
Rothschild's Workpapers, Schedule ALR 6. Value Line reports this value as 12.75 in the April 14th, 2017 report.
California Water Service Company Rebuttal Testimony of Michael Vilbert
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American States Water and York Water. Therefore, the majority of the sample 1
experienced positive growth between 2013 and 2018, which undermines Mr. 2
Rothschild’s assertion that “the changed [sic] indicated in the Value Line reports from 3
2013-2018 [for the water sample] was slightly negative.”16 It is certainly not the case 4
that Mr. Rothschild’s assumed 0.30% external financing rate could represent any kind 5
of an average rate of growth based on both historical (i.e., starting 2013) and forecasted 6
(i.e., to 2020-2022) share balances reported in Value Line. 7
Additionally, even if the facts supported Mr. Rothschild’s statement (which they do 8
not), his explanation that he considered share growth from a historical period is at odds 9
with his repeated emphasis that inputs to the sustainable growth calculations should be 10
“what investors expect […] at the time of the quantification of the stock price used in 11
the DCF formula.”17 In my opinion, it is much more likely that Mr. Rothschild 12
corrected the mathematical error in his external financing rate calculation when 13
preparing Schedule ALR 6, but based the “rounded” 0.30% rate that he actually uses 14
in his cost of equity estimates on the mathematically erroneous Attachment B 15
calculations that underlie Chart 5 in his testimony. 16
Q18. Have you analyzed the impact of Mr. Rothschild’s errors in downwardly biasing 17
his sustainable growth DCF cost of equity estimates? 18
A18. Yes. I have replicated Mr. Rothschild’s analysis using his data sources, but on a 19
company by company basis. As shown in Figure 2 below, when Mr. Rothschild’s 20
16 ORA response to California Water Service Data Request # CSW-001, Question #5. 17 Rothschild Testimony, p. 32, lines 16-17.
California Water Service Company Rebuttal Testimony of Michael Vilbert
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methodological approach to the sustainable growth DCF calculation is implemented on 1
a company by company basis—which also implicitly corrects his mathematical 2
“rounding” error—it becomes clear that certain features of the data for York Water 3
company create illogical and anomalous results that downwardly bias Mr. Rothschild’s 4
results by a substantial amount. 5
Q19. Please explain how inclusion of anomalous and illogical inputs for York Water 6
downwardly biases Mr. Rothschild’s sustainable growth DCF cost of equity 7
estimates. 8
A19. As demonstrated in Figure 2 below, York Water Company has a very low retention rate 9
compared to the sample and negative financing growth due to a decrease in the forecast 10
of the shares of common stock outstanding. This results in an illogical negative 11
sustainable growth rate calculated using Mr. Rothschild’s methodology, and an 12
estimated cost of equity between -0.57% and 1.37%, depending on which versions of 13
Mr. Rothschild’s inputs are used. These results are anomalously low and cannot 14
reasonably be interpreted as meaningful estimates of York Water’s cost of equity. 15
Consequently, York Water should be excluded from all four versions of Mr. 16
Rothschild’s sustainable growth DCF analysis. 17
Figure 2 shows the results of Mr. Rothschild’s sustainable growth DCF approach on a 18
company by company basis with price and book value data as of June 30, 2017. As 19
shown in this Figure, York Water alone has a negative growth rate estimate of -0.47%, 20
as compared to the calculated sustainable growth rates for the rest of the sample, which 21
range from 5.77% to 9.33%, with an average of 7.67%. Mr. Rothschild estimates a 22
California Water Service Company Rebuttal Testimony of Michael Vilbert
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sustainable growth rate of 6.55% for the Water Proxy Group, which falls below the 1
sample average by approximately 110 basis points when York Water’s illogical result 2
is appropriately excluded.183
Figure 2 Mr. Rothschild’s Sustainable Growth DCF Calculations
Water Proxy Group Using 6/30/2017 Prices
18 Rothschild Workpapers, Schedule ALR 4, p. 1.
Company
Dividend
Yield on Market
Price
Market-to-book
Expected
Return on
Equity
Retention Rate
External
Financing
Rate
New
Financing
Growth
"Total Estimate
of Investor Anticipated
Growth"
Indicated
Cost of
Equity
(D/P) (M/B) (r) (b) (s x v) (br + sv)
[1] [2] [3] [4] [5] [6] [7] [8] [9]
American States Water 2.04% 3.51 14.00% 48.86% 0.27% 0.67% 7.51% 9.63%
American Water Works 1.92% 2.67 10.50% 51.14% 1.54% 2.57% 7.94% 9.94%
Aqua America 2.30% 3.19 12.50% 41.31% 0.28% 0.61% 5.77% 8.13%
California Water Serv. Grp. 1.96% 2.68 11.00% 52.40% 1.36% 2.27% 8.04% 10.07%
Connecticut Water Services 2.04% 2.65 11.00% 51.04% 1.41% 2.33% 7.94% 10.06%
Middlesex Water Company 2.13% 2.96 12.50% 49.55% 0.49% 0.96% 7.15% 9.36%
SJW Corporation 1.77% 2.39 11.50% 63.29% 1.48% 2.05% 9.33% 11.18%
York Water Company * 1.85% 3.91 12.50% 42.27% -1.98% -5.76% -0.47% 1.37%
Including York
Average 2.00% 2.99 11.94% 49.98% 0.61% 0.71% 6.65% 8.72%
Median 2.00% 2.82 12.00% 50.29% 0.92% 1.50% 7.73% 9.79%
Excluding York
Average 2.02% 2.86 11.86% 51.08% 0.98% 1.64% 7.67% 9.77%
Median 2.04% 2.68 11.50% 51.04% 1.36% 2.05% 7.94% 9.94%
Sources and Notes:
[2]: Mr. Rothschild's Workpapers, ALR 3, p. 1.
[3]: Mr. Rothschild's Workpapers, ALR 3, p. 1.
[4]: Mr. Rothschild's Workpapers, ALR 3, p. 2.
[5]: 1 - [([2] x [3]) / [4]]
[6]: Mr. Rothschild's Workpapers, ALR 6, Compound Annual Growth in Common Stock.
[7]: [6] x ([3] - 1)
[8]: [5] x [4] + [7]
[9]: [2] * (1 + 0.5 * [8]) + [8]
* York is excluded in the calculation of the Average and Median due to a negative growth rate (excluded numbers
are bold and italicized).
California Water Service Company Rebuttal Testimony of Michael Vilbert
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Q20. How do the sustainable growth rates calculated under Mr. Rothschild’s approach 1
compare to the growth rates used in your January 31, 2017 DCF analysis? 2
A20. When Mr. Rothschild’s sustainable growth rate calculation is performed on a company 3
by company basis, the resulting growth rates are very much in line with those used in 4
my January 31, 2017 DCF analysis, where I calculated a weighted average growth rate 5
using both growth rates implied by Value Line’s EPS forecasts and Thomson Reuters 6
IBES’s consensus estimates for 5-year EPS growth rates. Figure 3 below compares the 7
estimates used in my single and multi-stage DCF approach with the sustainable growth 8
rates calculated here under Mr. Rothschild’s constant growth DCF methodology. 9
California Water Service Company Rebuttal Testimony of Michael Vilbert
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Figure 3
Comparison of EPS Growth Rates Use in My Direct Testimony and Sustainable Growth Rates Calculated Using Mr. Rothschild’s Data and Methodology
Q21. What is the numerical impact of correcting the technical errors and other 1
technical flaws in Mr. Rothschild’s sustainable growth DCF analysis, but 2
otherwise replicating his approach exactly? 3
A21. After correcting the technical errors and logical flaws in Mr. Rothschild’s sustainable 4
growth DCF analysis, cost of equity estimates increase by approximately 110 basis 5
points in every scenario as compared to Mr. Rothschild’s original estimates, as 6
demonstrated in Figure 4 below. Since Mr. Rothschild’s “Indicated Cost of Equity” 7
for the proxy group of 8.25% is clearly based heavily, if not primarily, on his constant 8
Vilbert Approach Rothschild Approach
Company
Value Line Growth
Rate as of
1/31/2017
Weighted Growth
Rate as of
1/31/2017
Sustainable Growth
Rate as of
6/30/2017
[1] [2] [3] [4]
American States Water 8.90% 5.87% 7.51%
American Water Works 9.59% 7.88% 7.94%
Aqua America 6.70% 5.57% 5.77%
California Water Serv. Grp. 15.47% 10.32% 8.04%
Connecticut Water Services 3.25% 4.85% 7.94%
Middlesex Water Company 5.38% 5.38% 7.15%
SJW Corporation * 0.00% 0.00% 9.33%
York Water Company ** 6.82% 6.82% -0.47%
Average 8.02% 6.67% 7.67%
Sources and Notes:
[2],[3]:
[4]: Mr. Rothschild's calculation of sustainable growth rate = br + sv, as of June 30, 2017.
* SJW was excluded from the sample average in [2] and [3] due to its estimated cost of equity
not exceeding the cost of debt by 100 basis points.
** York Water was excluded from the sample average in [4] due to its negative growth rate.
Vilbert Workpapers, Table No. MJV-WATER-5, Estimated Growth Rates as of January 31,
2017. Weighted average includes both Thomson Reuters and Value Line LT EPS estimates.
Thomson Reuters estimates were missing for MSEX, SJW, and YORW at the time of analysis.
Therefore, the weighted average is based solely on Value Line for these companies.
California Water Service Company Rebuttal Testimony of Michael Vilbert
18
growth DCF cost of equity estimates19 that are logically inconsistent and downwardly 1
biased due to technical flaws as demonstrated herein, it is reasonable to conclude that 2
Mr. Rothschild’s recommendation should have been substantially higher (by as much 3
as 118 basis points) absent these flaws. 4
Figure 4 Downward Bias in Mr. Rothschild’s Sustainable Growth DCF Estimates
Due to Technical Flaws and Errors in His Calculations
Furthermore, less weight should be given to Mr. Rothschild’s DCF estimates “Based 5
on Actual Returns” because these estimates disregard the significance of forward-6
looking investor expectations and rather assume that the future is going to exactly 7
mimic the recent past. In summary, Mr. Rothschild’s constant growth DCF model, 8
implemented using his recommended inputs and formulas, but correcting mathematical 9
errors and excluding illogical and anomalous inputs in a manner consistent with Mr. 10
Rothschild’s stated principles that cost of equity estimates should reflect investors’ 11
19 Rothschild Testimony, p. 5 and Schedule ALR 2.
Rothschild Price and Book Value Timing Scenario
Average for Year Ending 6/30/2017 As of 6/30/2017
Rothschild Return on Book
Equity Input AssumptionAs Filed Corrected
Downward
BiasAs Filed Corrected
Downward
Bias
[1] [2] [3] [4] [5] [6]
"Based only on Value Line Future
Expected Growth"8.49% 9.67% -1.18% 8.63% 9.77% -1.13%
"Based on Actual Returns" 7.48% 8.61% -1.13% 7.62% 8.71% -1.09%
Sources and Notes:
[1],[4]: Mr. Rothschild's Workpapers, ALR 4, p. 1.
[2],[5]: Vilbert Rebuttal Appendix B, Workpapers #1-4.
[3]: [1] - [2]
[6]: [4] - [5]
California Water Service Company Rebuttal Testimony of Michael Vilbert
19
forward looking expectations, produces estimates in the range of 9.7% to 9.8%, which 1
exceed his cost of equity recommendations by approximately 150 basis points. 2
B. MR. ROTHSCHILD’S NON-CONSTANT GROWTH DCF 3
Q22. How does Mr. Rothschild implement his “non-constant growth” DCF model? 4
A22. As explained on pages 38-39 of Mr. Rothschild’s testimony and illustrated on page 2 5
of Schedule ALR 4, Mr. Rothschild computes the internal rate of return (“IRR”) 6
associated with a stream of estimated cash flows for each company in the water utility 7
sample. The estimated cash flows assume an investor purchases the company’s stock 8
at its 6/30/2017 market price, and holds the stock for four years, selling it on 7/1/2021. 9
During the assumed holding period, Mr. Rothschild assumes the investor expect to 10
receive the annual dividends forecasted by Value Line,20 with the first one (2017) 11
modeled as arriving on the original purchase date (i.e., 6/30/2017), and the last one 12
arriving on the date of sale (i.e., 7/1/2021). To calculate his assumed terminal price 13
(i.e., the price at which the investor sells the stock at the end of the holding period), 14
Mr. Rothschild multiplies the company’s 2017 market-to-book ratio (calculated based 15
on the 6/30/2017 price and Value Line’s 2017 book value per share estimate) by Value 16
Line’s forecasted book value per share for 2020-2022. 17
20 The Value Line data utilized by Mr. Rothschild includes forecasted annual dividends for 2017, 2018, and 2020-2022. As indicates in his testimony and schedules, Mr. Rothschild attributes the 2020-2022 dividend forecast to 2021, and interpolates 2019 and 2020 dividends based on the 3-year compound annual growth rate implied by the 2018 and 2020-2022 forecasts.
California Water Service Company Rebuttal Testimony of Michael Vilbert
20
Mr. Rothschild computes his non-constant growth DCF cost of equity estimate of 1
7.26%21 as the average of the calculated IRRs for all the water sample companies 2
excluding York Water.22 He does not explain why he excludes York from the average 3
in deriving his non-constant growth DCF estimate despite including the inputs leading 4
to its illogical negative sustainable growth rate and anomalously low indicated cost of 5
equity in his constant-growth DCF calculations. 6
Q23. In your opinion, is a DCF model that assumes a non-constant pattern of growth 7
in dividends a valid way to estimate the cost of equity? 8
A23. Yes. I routinely perform a multi-stage growth version of the DCF model, and have 9
done so in this proceeding. My multi-stage DCF analysis assumes that a company’s 10
dividends grow at a company-specific growth rate for 5 years and then transition 11
gradually over the next 5 years toward an estimate of the expected growth rate of the 12
overall economy (i.e., GDP growth). At the 10-year mark in my model, a terminal 13
value is calculated based on the assumption that dividends are projected to grow at the 14
rate of GDP from that point into perpetuity. This component of the model is necessary 15
to reflect the fundamental principle of finance that any future value of the stock (such 16
as the price it would sell for in 10 years) is itself a reflection of the dividends investors 17
expect to receive from that date forward—into perpetuity—discounted back to that 18
point in time at the cost of equity.2319
21 Rothschild Testimony, p. 5 and Schedule ALR 2. 22 Mr. Rothschild’s Schedule ALR 4, page 2 workpapers. 23 Vilbert Direct Testimony, pp. 46-47.
California Water Service Company Rebuttal Testimony of Michael Vilbert
21
In my direct testimony, I noted that while I considered the results of the multi-stage 1
DCF in making my recommendation, I note that several factors—including the 2
presence of expected stock repurchases among the proxy group members and very low 3
current estimates of long-term GDP growth—may cause a mechanical implementation 4
of the multi-stage DCF in particular to underestimate the cost of equity.245
Q24. Do you have any concerns about the assumptions underlying Mr. Rothschild’s 6
implementation of the non-constant growth DCF? 7
A24. Yes. His method of calculating his assumed 2021 sale price for each stock reflects a 8
non-standard approach that is inconsistent with fundamental finance principles 9
underlying the DCF. 10
As explained above, any financially sound DCF model must be consistent with the 11
fundamental assumption that the observed market price of a stock at any point in time 12
is equal to the expected value of all dividends or cash flows that investors will receive 13
from that time forward, discounted back to the relevant time at the cost of equity. This 14
is why the “terminal value” price in my multi-stage DCF model reflects the final 15
“stage” of dividend growth occurring into perpetuity at the rate of GDP growth, 16
according to the same formula that is the foundation of the single-stage DCF model. 17
Mr. Rothschild, however, does not calculate his terminal price in this manner. Rather 18
he calculates it based on a Value Line forecast of what each company’s book value per 19
share will be in 2020-2022, coupled with an assumption that the market-to-book ratio 20
24 Vilbert Direct Testimony, p. 56.
California Water Service Company Rebuttal Testimony of Michael Vilbert
22
at that time will be the same as it is now (or more precisely, the same as it is according 1
to Value Line’s 2017 book value estimate). Mr. Rothschild does not justify his 2
assumption that the market-to-book ratio will remain constant (as opposed to applying 3
a constant P/E ratio for example), nor does he explain why he is comfortable employing 4
Value Line forecasts of book value despite his repeated general objections to my own 5
use of forecasts. 6
More importantly, however, Mr. Rothschild does not reconcile his assumed terminal 7
prices with the fundamental underlying assumption of all DCF models that these prices 8
must equal the discounted value of expected cash flows from that time forward. 9
Q25. Why do you say Mr. Rothschild has not reconciled his assumed terminal prices 10
with the fundamental finance principle that these prices must equal the 11
discounted value of cash flows from that time forward? 12
A25. When asked in data requests whether he agreed that “the fundamental value of a 13
company’s stock at a given point in time reflects the discounted present value of all 14
expected future cash flows that investors expect to receive form that point forward,” 15
Mr. Rothschild responded as follows. 16
Yes. Other than the right to vote, the only reason investors purchase 17 stock is for the right to future dividends, including the “liquidating 18 dividend” that obtain upon sale.2519
The “liquidating dividend” Mr. Rothschild refers to is of course the price at which a 20
given investor sells the stock. Despite acknowledging this principle, Mr. Rothschild’s 21
25 Mr. Rothschild’s response to CWS Data Request # CSW-001, Question #6.
California Water Service Company Rebuttal Testimony of Michael Vilbert
23
analysis ignores the fact that the purchasing party will only agree to the sale if the price 1
reflects the market value of the right to receive dividends from that point forward, (and 2
so on for any subsequent sales of the stock). Mr. Rothschild’s non-constant growth 3
DCF implementation makes no explicit assumptions about what these dividends will 4
be, or how they will grow. Thus his analysis does not reconcile the assumed terminal 5
prices with the fundamental finance theory underlying all DCF models. 6
Q26. Have you attempted to reconcile the terminal price assumptions in Mr. 7
Rothschild’s non-constant growth DCF model with finance theory? 8
A26. Yes. I have done so by calculating the implied perpetual growth rate for each company 9
that—if applied to Mr. Rothschild’s forecasted 2021 dividend and discounted back to 10
2021 at his estimated cost of equity for that company—gives a value equal to his 11
assumed terminal price. As illustrated in Figure 5 below, these implied growth rates 12
vary widely, from a low of 2.74% for Connecticut Water Services Inc. (CWTS) to a 13
high of 8.11% for Aqua America (WTR). Mr. Rothschild provides no explanation for 14
why investors would expect such disparate rates of growth for the companies in the 15
water sample from 2021 forward, nor does he ground the assumed perpetual growth 16
rates in economic principles, as I do by linking perpetual company growth to the rate 17
of broader economic growth. These variable and unjustified implicit growth rates 18
reveal that Mr. Rothschild’s terminal price assumptions are not well grounded in 19
finance principles, casting doubt on the theoretical validity of his non-constant growth 20
DCF cost of equity estimates. 21
California Water Service Company Rebuttal Testimony of Michael Vilbert
24
Figure 5 Implied Terminal Growth Rates of Mr. Rothschild’s Non-constant DCF Model
Q27. Do you have any other comments about Mr. Rothschild’s non-constant growth 1
DCF results? 2
A27. Yes. An examination of Mr. Rothschild’s individual company IRRs from the non-3
constant growth DCF reveals that some of them are simply too low to form credible 4
estimates for the cost of equity of those companies. Specifically, Mr. Rothschild’s 5
estimates of 5.72% for California Water Services Group (CWT), 5.11% for 6
Connecticut Water Services (CTWS), and 5.51% for SJW Group (SJW) are barely 7
higher than the cost of debt for the companies in this proceeding, and only 100-150 bps 8
higher than the prevailing yield on an A-rated utility bond index. Given that equity is 9
CompanyStock Price
(2021)
Dividend
(2021)"DCF Result"
Implied Terminal
Growth Rate
[1] [2] [3] [4] [5]
American States Water $56.09 $1.35 7.18% 4.66%
American Water Works $99.84 $2.35 9.35% 6.83%
Aqua America $44.55 $1.15 10.91% 8.11%
California Water Serv. Grp. $41.32 $0.99 5.72% 3.25%
Connecticut Water Services $60.61 $1.40 5.11% 2.74%
Middlesex Water Company $46.70 $1.02 7.03% 4.75%
SJW Corporation $55.44 $1.12 5.51% 3.42%
York Water Company $41.94 $0.90 7.52% 5.26%
Sources and Notes:
[2]-[4]: Mr. Rothschild's Workpapers, Schedule ALR 4, p. 2.
[3]: Value Line projected dividend for 2020-2022 (midpoint 2021) as of April 14, 2017.
[4]: Internal rate of return based on cash flows from 2017 to 2021.
[5]: ([2] x [4] - [3]) / ([2] + [3])
[2]: Forecasted 2021 stock price calculated under the assumption that stock price will grow at
the same rate as book value per share.
California Water Service Company Rebuttal Testimony of Michael Vilbert
25
riskier than corporate debt, it does not make sense that investors would invest in stocks 1
with the expectation of earning returns that barely exceed what they could earn buying 2
a bond from the same (or a similar) company. 3
III.MR. ROTHSCHILD’S DISCUSSION OF CAPM 4
Q28. Have you reviewed the section of Mr. Rothschild’s testimony titled “Capital Asset 5
Pricing Model”? 6
A28. Yes. In conjunction with my Brattle partner and fellow Brattle principal, Dr. Villadsen, 7
I have reviewed Mr. Rothschild’s statements about the Capital Asset Pricing Model 8
(“CAPM”) and the accompanying calculations. In her rebuttal testimony, Dr. Villadsen 9
provides a detailed summary of what Mr. Rothschild refers to as his “implement[ation 10
of] the CAPM” and explains why it is not truly a CAPM analysis and why it does not 11
provide any meaningful information about the cost of equity capital in this proceeding. 12
Q29. Would you please summarize the conclusions you and Dr. Villadsen reached with 13
respect to Mr. Rothschild’s discussion of the CAPM? 14
A29. Yes. As Dr. Villadsen’s rebuttal testimony explains, Mr. Rothschild does not select 15
inputs for the risk-free rate of interest or the market risk premium, and thus has no basis 16
from which to criticize our own methodological approach to the CAPM. Additionally, 17
Mr. Rothschild’s calculation of the average mid-point Value Line forecast of total 18
returns for the 30 companies included in the Dow Jones Industrial Average (“DJIA” or 19
“Dow 30”) does not provide a meaningful benchmark, either for the expected return on 20
the market as a whole or for the comparison Mr. Rothschild undertakes of average betas 21
for the water sample versus the Dow 30. As Dr. Villadsen’s rebuttal testimony explains, 22
California Water Service Company Rebuttal Testimony of Michael Vilbert
26
the Value Line return forecasts that Mr. Rothschild relies on (despite arguing repeatedly 1
in his testimony that such forecasts are unreliable) do not exhibit any correlation with 2
the Value Line betas, and thus Mr. Rothschild’s attempt to use the 7.85% average Value 3
Line forecast as a “check” on his recommendations is invalid. Dr. Villadsen’s rebuttal 4
testimony also points out that Mr. Rothschild failed to consider financial leverage, 5
operating leverage, and other factors that prevent valid apples-to-apples comparisons 6
among levered equity betas for the Dow 30 companies and those of the water sample 7
companies or between the Dow 30 betas and those that should properly apply to the 8
California Class A Water Companies. 9
IV. MR. ROTHSCHILD’S CRITICISMS OF MY COST OF EQUITY 10 RECOMMENDATIONS 11
Q30. What are Mr. Rothschild’s primary criticisms of your cost of equity 12
recommendations? 13
A30. Mr. Rothschild’s testimony makes a general claim that my cost of equity 14
recommendation for Cal Water and those of the other companies’ witnesses in this 15
proceeding “cannot be considered market based.”26 This criticism stems from his belief 16
that forecasted Treasury bond yields, such as those I employ in my risk positioning 17
analysis do not constitute valid market indicators of what the risk free rate of interest 18
will be during the period rates are in effect.27 Mr. Rothschild also explicitly criticizes 19
me and my Brattle partner, Dr. Villadsen, for interpreting our DCF based cost of equity 20
results in the context of current financial market conditions. He further criticizes my 21
26 Rothschild Testimony, p. 49. 27 Rothschild Testimony, p. 49.
California Water Service Company Rebuttal Testimony of Michael Vilbert
27
caution against relying on the current results from mechanical implementation of cost 1
of equity models as the best indicators of what the cost of equity will be over the entire 2
2018-2020 period. 283
Beyond his claim that my cost of equity recommendations are not “market based”, Mr. 4
Rothschild lists as additional “concerns” about my and Dr. Villadsen’s analyses that 5
we (i) employ analyst estimates of EPS growth rates—which Mr. Rothschild asserts 6
are upwardly biased—in our DCF calculations and (ii) “combine [our] cost of equity 7
estimates with market value capital structures.”29 Much of my rebuttal in this section 8
is duplicative of material in Dr. Villadsen’s rebuttal testimony, in part because Mr. 9
Rothschild addresses our direct testimony recommendations and analyses essentially 10
as if they were one and the same, and in part because Dr. Villadsen and I worked jointly 11
on the non-company specific portions of the rebuttal. 12
A. MARKET-BASED COST OF EQUITY RECOMMENDATIONS13
Q31. How do you respond to Mr. Rothschild’s characterization of your 14
recommendations as not market-based? 15
A31. Mr. Rothschild’s characterization is inaccurate and unsupported by evidence. All of 16
the data and model inputs I employ are market-based, derived either from trading 17
platforms or from publications such as Blue Chip Economic Indicators, Thomson 18
Reuters IBES, and Value Line that aggregate financial market measurements and 19
28 Rothschild Testimony, p. 49-50. 29 Rothschild Testimony, p. 52.
California Water Service Company Rebuttal Testimony of Michael Vilbert
28
consensus economic forecasts of investment brokerage analysts who are themselves 1
participants in and influencers of the markets. 2
Mr. Rothschild’s real disagreement with my recommendation relates to my use of 3
forecasts to inform my implementation of the models and my interpretation of the 4
results in context of current conditions rather than relying on mechanical 5
implementations of the models using the specific inputs he recommends. 6
Q32. Why is it important to rely on forward-looking information when using and 7
interpreting cost of capital models? 8
A32. The cost of equity is a forward-looking concept—the expected rate of return that market 9
participants require to take on the risk of investing in a particular stock. It is not directly 10
observable, and estimating it requires the application of judgment on the part of the 11
analyst—both in selecting the inputs to estimation methodologies such as the CAPM 12
and DCF models, and in interpreting the results of the models as indicators of the 13
forward-looking expected returns investors require. The models require estimates of 14
what capital market conditions will prevail at the times market participants consider 15
whether to buy the stock. In the context of this proceeding, it is important to consider 16
not only the expected returns required by potential investors right now, but also 17
investors who may decide to invest (or not) at any time during the period rates will be 18
in effect (i.e., 2018-2020). 19
Mr. Rothschild admits in his testimony, “[i]f the cost of equity and overall cost of 20
capital is [sic] set too low, the California Class A Water Companies will not be able to 21
California Water Service Company Rebuttal Testimony of Michael Vilbert
29
access the capital needed to provide safe and reliable service.”30 However, he restricts 1
his recommendations for the cost of capital to what he can measure using a mechanical 2
implementation of his models based on current capital market conditions. This decision 3
necessarily reflects one of two views. Either Mr. Rothschild believes that the cost of 4
capital throughout the 2018-2020 period is not relevant, or he believes that estimates 5
made using mechanical implementations of the models in current capital market 6
conditions are the best estimates of what the cost of capital will be throughout that 7
period. Both of these views are misguided. 8
Q33. Why do you say that Mr. Rothschild implements his models mechanically? 9
A33. As I noted above in the discussion of Mr. Rothschild’s implementation of the DCF 10
model, he does not consider whether the estimates from the model make sense. Recall 11
that results of Mr. Rothschild sustainable growth rate DCF model estimate of York 12
Water Company’s ROE is 1.37%, which is less than the cost of debt, or the fact that 13
the implied terminal growth rate of dividends in his non-constant growth rate model 14
varied substantially among the sample companies without explanation. Dr. Villadsen 15
and I carefully consider the inputs and results of our models in the context of current 16
economic conditions and available forward-looking indicators when arriving at our 17
recommended ROEs. Mr. Rothschild mischaracterizes this practice as relying on our 18
“opinions” about what will happen in capital markets and inaccurately concludes that 19
our recommendations are not market based. On the contrary, our recommendations are 20
30 Rothschild Testimony, p. 7.
California Water Service Company Rebuttal Testimony of Michael Vilbert
30
informed by economic and market context to a degree lacking in Mr. Rothschild’s 1
analysis. 2
Q34. What is Mr. Rothschild’s general assessment of current capital market 3
conditions? 4
A34. Mr. Rothschild places a great deal of emphasis on his view that the U.S. is currently 5
experiencing a “Goldilocks economy” in which interest rates and volatility are low and 6
demand for stocks (as indicated by P/E ratios) is high.31 He asserts repeatedly—7
without or against evidence—that markets expect these conditions to continue,32 and 8
all of his recommendations are based on his view that mechanical implementations of 9
his models based on prevailing market interest rates, prices, and other model inputs 10
produce results that are representative of the cost of capital going forward. 11
Q35. Do you agree with Mr. Rothschild’s view that these conditions are likely to 12
continue? 13
A35. No. The recent past is a poor guide to the future as dramatic changes in the stock 14
market have repeatedly revealed. (For example, between January 2003 and July 2007, 15
the S&P 500 increased by more than 50% and then declined by almost 40% between 16
July 2008 and April 2009.33) Even the article Mr. Rothschild cites for the “Goldilocks 17
Economy” reference notes that “[t]he fact that everything's been awesome recently is 18
31 Rothschild Testimony, pp. 7-9. 32 See, for example, Rothschild Testimony, p. 17. 33 Yahoo Finance.
California Water Service Company Rebuttal Testimony of Michael Vilbert
31
little guide to the future of the economy or inflation – and the rise in stocks makes it 1
less likely the general awesomeness will continue.”342
While current government bond yields are near historically low levels, this is the result 3
of unprecedented global capital market events such as the financial crisis of 2008-2009, 4
as well as the effects of ongoing policies of central banks since the financial crisis that 5
were and are explicitly designed to bring down interest rates, particularly on long-term 6
securities. The Federal Reserve currently holds a substantial inventory of treasury 7
securities and mortgage backed bonds, which it expects to unwind. Statements by the 8
U.S. Federal Reserve indicate a gradual unwinding of these policies that will lead to 9
higher rates in the future.35 As noted above, credit spreads remain elevated relative to 10
their long-term historical levels—indicating either that risk premiums are elevated or 11
that risk-free rates are artificially depressed, or both.36 All indications are that interest 12
rates will not remain at historically low levels forever, and market participants expect 13
them to increase modestly in the near future as reflected in the forecasts I rely on in 14
selecting the inputs to my risk positioning models. 15
With respect to stock price levels, my direct testimony presented evidence that P/E 16
ratios vary inversely to interest rates, such that if interest rates rise in the coming years, 17
P/E ratios will likely fall. This in turn means dividend yields and/or expected growth 18
34 “Everything Is Awesome! Now Is the Time to Sell”, Wall Street Journal, July 6, 2017. 35 Federal Reserve Press Release, “Addendum to the Policy Normalization Principles and Plans,” June 14,
2017. 36 Vilbert Direct Testimony, p. 29.
California Water Service Company Rebuttal Testimony of Michael Vilbert
32
rates would rise, such that DCF-based measurements of the cost of equity would be 1
higher than they are when mechanically applied at current market prices.372
B. INTEREST RATE FORECASTS AND THE RISK-FREE RATE3
Q36. Is your analysis based on your “opinion” that interest rates are likely to increase? 4
A36. No. My analysis is based on market evidence that interest rates are expected to 5
increase. This evidence includes the current levels of credit spreads as well as 6
consensus estimates of U.S. Treasury bond yields for 2018. 7
Q37. Is it inappropriate to rely on interest rate forecasts such as those provided by Blue 8
Chip as Mr. Rothschild suggests? 9
A37. No. While neither economic forecasts nor indications of future expectations inferred 10
from securities prices are perfect predictors of the future, the relevant question is not 11
whether they are perfectly accurate all of the time, but rather whether they can be 12
expected to be unbiased predictors on average. While Mr. Rothschild purports to show 13
in his testimony that Blue Chip forecasts have tended to over-predict interest rates, his 14
analysis is limited to a small number of very long-range projections made in 2010.3815
This is hardly conclusive evidence, especially with respect to the shorter range 16
(approximately 1-year) projections of Treasury yields I relied on in my direct 17
testimony. In data responses, Mr. Rothschild admits he has not analyzed such closer-18
37 Vilbert Direct Testimony, pp. 22-23. 38 Rothschild Testimony, p. 21-22.
California Water Service Company Rebuttal Testimony of Michael Vilbert
33
range projections, nor has he conducted a systematic study of the accuracy of interest 1
rate forecasts in rising as well as falling interest rate environments.392
Q38. What does academic evidence say about the accuracy of interest rate projections? 3
A38. Research shows that while it is certainly true that expert forecasts of interest rates do 4
not always precisely predict eventual spot yields, such forecasts generally exhibit a 5
conservative “status quo bias”—tending to over-predict eventual spot yields during 6
falling interest rate environments and under-predict actual yields when interest rates 7
are on the rise.40 Unlike Mr. Rothschild, the Federal Reserve economists who 8
conducted this research considered evidence from historical periods where interest 9
rates were generally increasing as well as from periods of generally declining rates. 10
Since interest rates have generally followed a downward trajectory since the financial 11
crisis (and indeed, as Mr. Rothschild notes, since the early 1980s for long-term yields), 12
it is then not surprising that the handful of forecasts Mr. Rothschild analyzed—made 13
very close on the heels of the crisis itself—have tended to predict higher yields than 14
were eventually realized. However, when interest rates do rise, the academic evidence 15
suggests they may well do so more dramatically or at a faster pace than anticipated by 16
market participants. 17
39 Mr. Rothschild’s response to CWS Data Request # CWS-001, Question #8. 40 R.W. Hafer and Scott Hein, “Comparing Futures and Survey Forecasts of Near-Term Treasury Bill
Rates,” Federal Reserve Bank of St. Louis, May/June 1989.
California Water Service Company Rebuttal Testimony of Michael Vilbert
34
Q39. What about Mr. Rothschild’s assertion that “[a]ny expected rise or decline in 1
interest rates is already incorporated in the current market yield”?412
A39. It is unclear precisely what Mr. Rothschild means by this. If he means that future rates 3
cannot be expected to rise above the level of current yields, this is simply untrue and 4
contradicted by Mr. Rothschild’s own testimony with respect to the yield curve.425
Additionally, the yield curve itself is not static; rather it changes over time. At any 6
point in time, the market is evaluating the probability of a change in interest rates and 7
the yield curve changes as the probability of the magnitude and likelihood of changes 8
in interest rates change. The fact that the market is aware of possible interest rate 9
changes does not mean that interest rates cannot change more (or less) than anticipated 10
by the current yield curve. 11
C. MR. ROTHSCHILD’S CRITICISMS OF EPS GROWTH RATE FORECASTS AND OF 12 FORECASTS IN GENERAL13
Q40. How do you respond to Mr. Rothschild’s claims that the EPS growth rate forecasts 14
you employ in your DCF analysis are upwardly biased? 15
A40. I find Mr. Rothschild’s arguments on this point unconvincing. For one thing, Mr. 16
Rothschild has not presented any academic evidence that an upward or “optimistic” 17
bias in the earnings forecasts of equity analysts currently applies in the context of 18
regulated utilities. Importantly, more recent academic research has not only found that 19
41 Rothschild Testimony, p. 9. 42 Rothschild Testimony, p. 17. The fact that the yield curve is upward sloping such that longer-term bond
yields are higher than yields on 1-year T-bills means—according to the expectation hypothesis—that the market expects rates to by higher 1-year from now than today. This is true both for T-bill yields themselves as demonstrated in Mr. Rothschild’s footnote 41, as well as for longer-term Treasury bonds such as the 20-yr and 30-yr.
California Water Service Company Rebuttal Testimony of Michael Vilbert
35
“the median forecast bias [has] essentially disappeared,”43 but also studied how 1
industry characteristics impact analysts’ forecasts. The findings of several academic 2
studies44 show that analyst earnings forecasts turn out to be too optimistic for stocks 3
that are more difficult to value, for instance, stocks of smaller firms, firms with high 4
volatility or turnover, younger firms, or firms whose prospects are uncertain. These 5
are not characteristics of water utilities. 6
More directly, however, I find Mr. Rothschild’s criticisms inconsistent with the fact 7
that, as shown in Figure 3 above, his own calculations of forward-looking sustainable 8
growth rates for the water sample companies are completely in line—and even higher 9
on average—than the analyst EPS growth forecasts I employed in my direct testimony 10
analysis. 11
Q41. Do you have any other reactions to Mr. Rothschild’s repeated criticisms of 12
financial forecasts in general? 13
A41. As mentioned above, Mr. Rothschild is critical of my use of consensus forecasts for 14
both interest rates and company growth rates, and he makes repeated reference to the 15
notion that financial forecasting in general tends to be inaccurate or unreliable. For 16
example, he references research indicating that “predicting capital markets (e.g. interest 17
43 A. Hovakimian and E. Saenyasiri, “Conflicts of Interest and Analyst Behavior: Evidence from Recent Changes in Regulation,” Financial Analysts Journal, vol. 66, 2010.
44 These studies include the following: (i) Hribar, P, McInnis, J. “Investor Sentiment and Analysts’ Earnings Forecast Errors,” Management Science Vol. 58, No. 2 (February 2012): pp. 293-307; (ii) Scherbina, A. (2004), “Analyst Disagreement, Forecast Bias and Stock Returns,” downloaded from Harvard Business School Working Knowledge: http://hbswk.hbs.edu/item/5418.html; and (iii) Michel, J-S., Pandes J.A. (2012), “Are Analysts Really Too Optimistic?” downloaded from http://www.efmaefm.org.
California Water Service Company Rebuttal Testimony of Michael Vilbert
36
rates, stock prices) is not done well.”45 However, I find Mr. Rothschild’s criticisms 1
disingenuous given that he relies heavily and repeatedly on capital market forecasts to 2
inform his own analysis and recommendations. For example, after stating that capital 3
market predictions are “not done well”, Mr. Rothschild references capital market 4
predictions by Charles Schwab and McKinsey Global Institute in support of his 5
recommendations on the very next page of his testimony.46 Additionally, as discussed 6
above, Mr. Rothschild relies on Value Line predictions of total returns for the Dow 30 7
companies to inform his so-called CAPM analysis. Similarly, Mr. Rothschild relies 8
heavily on Value Line forecasts for his DCF calculations, including medium term 9
predictions of dividends, returns on book equity, price appreciation, book value, and 10
shares outstanding.47 Nowhere in his testimony does Mr. Rothschild explain how or 11
why the extensive capital market predictions he relies upon are any better or more 12
reliable than the limited projections and estimates I use to inform my cost of equity 13
analysis. 14
45 Rothschild Testimony, p. 5. In response to data requests, Mr. Rothschild indicated that the specific types and categories of capital market prediction were those he referred to in that quote: i.e., interest rates and stock prices. See Mr. Rothschild’s response to CWS Data Request # CWS-001, Question #4.
46 Rothschild Testimony, p. 6, Table 6. 47 Rothschild Testimony Schedules ALR 3, ALR 4, and ALR 6. See also Section II.A of this rebuttal
testimony.
California Water Service Company Rebuttal Testimony of Michael Vilbert
37
D. COMPANY SPECIFIC RISK1
Q42. Have you determined that the company specific risks mentioned by the cost of 2
capital witnesses for the California Class A Water utilities are all diversifiable? 3
A42. No. It is difficult to specify which risks are diversifiable and which are not in part 4
because a portion of a specific risk may be systematic (i.e., non-diversifiable) and a 5
portion may be diversifiable. Mr. Rothschild claims that the witnesses did not 6
demonstrate that the company specific are systematic,48 which is true, but of course, it 7
is equally true that Mr. Rothschild has not demonstrated that they are diversifiable 8
either. In any case, the point is that the risks exist and should be considered in a 9
regulatory proceeding. 10
Q43. Are you saying that diversifiable risks affect the Company’s cost of capital? 11
A43. No. According to financial theory, diversifiable risks do not affect a company’s cost 12
of capital, but that does not mean that they should not be considered in a regulatory 13
proceeding. This is because the ability of a regulated company to earn its allowed ROE 14
depends in part on company specific risks and how the regulator chooses to address 15
those risks. For example, the fact that the California Class A Water Companies earn a 16
90-day commercial paper rate on their outstanding WRAM balances means that the 17
companies will expect to earn less than their allowed ROE if every other cost and 18
revenue projection is perfectly accurate because the companies have to finance the 19
WRAM balances at a cost greater than 90-day commercial paper rates. Moreover, it is 20
possible and even likely that a portion of the company specific risks identified are 21
48 Rothschild Testimony, p. 5.
California Water Service Company Rebuttal Testimony of Michael Vilbert
38
systematic. The company specific risks should not be simply dismissed as irrelevant 1
as Mr. Rothschild has done. 2
E. USE OF MARKET VALUE CAPITAL STRUCTURES IN COST OF EQUITY 3 ANALYSIS4
Q44. What is your reaction to Mr. Rothschild’s “concern” about your use of market 5
value capital structures in deriving your cost of equity estimates? 6
A44. While Mr. Rothschild does not say what in particular concerns him about this aspect of 7
my analysis, I find it inconsistent of Mr. Rothschild to criticize me for such a thing in 8
the same section of his testimony that he also claims my recommendations are not 9
“market-based”. The dividends yields and betas that are inputs to my cost of equity 10
estimation methods for the publicly traded companies in the water sample are based on 11
market values (i.e., market stock prices determine the dividend yield and market stock 12
returns are used to estimate betas), so it should be intuitive to rely on the corresponding 13
market-value measures of capital structure, which is what I have done. 14
As to my use of market value capital structures in computing the overall weighted 15
average cost of capital and assets beta estimates for the water sample companies, I do 16
so because this is the standard textbook approach taught in every corporate finance 17
textbook of which I am aware.49 The fact that financial risk is a function of market 18
value financial leverage and that a company’s weighted average cost of capital is based 19
49 See, for example Richard A. Brealey, Stewart C. Myers, and Franklin Allen, Principles of Corporate Finance,12th Edition, 2017, pp. 505-507; Jonathan Berk and Peter DeMarzo, Corporate Finance, 3rd Edition, 2014, pp. 492-494; Stephen Ross, Randolph W. Westerfield, and Jeffrey E. Jaffe, Corporate Finance, 10th Edition, 2013, pp. 571-574; Leonardo R. Giacchino and Jonathan A. Lesser, Principles of Utility Corporate Finance, 2011, pp. 229-232.
California Water Service Company Rebuttal Testimony of Michael Vilbert
39
on its market value capital structure is not a matter of any academic controversy or 1
debate. 2
Q45. Do you, as Mr. Rothschild asserts, “add a leverage adjustment to account for the 3
difference between market value and book value capital structures?”504
A45. No. This is a mischaracterization of the role financial leverage plays in my approach to 5
estimating the cost of equity. My calculation of the overall after tax weighted average 6
cost of capital for the sample companies and my application of the standard Hamada 7
adjustment procedure for betas in my CAPM analysis are designed to account for 8
differences in financial leverage and corresponding financial risk levels inherent in the 9
market beta and cost of equity estimates among the sample companies and between 10
those estimates and the level of financial risk inherent in the regulatory capital structure 11
of Cal Water. 12
Q46. Does this conclude your testimony? 13
A46. Yes. 14
50 Rothschild Testimony, p. 50, lines 12-13.
Figu
re 1
Cal
cula
tion
of M
r. R
oths
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xter
nal F
inan
cing
Rat
e
Com
mon
Sto
ck O
utst
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ng
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d A
nnua
l Gro
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2018
2020
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220
18-2
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(Atta
chm
ent
B)
2018
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1(S
ched
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6)
[1]
[2]
[3]
[4]
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tate
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ater
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both
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[3]:
The
com
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shar
es o
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201
8 fo
r Yor
k W
ater
is re
porte
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13.
0 in
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and
as 1
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. Val
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ine
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is v
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as 1
2.75
in th
e A
pril
14th
, 201
7 re
port.
Application No. A.17-04-006 Vilbert Rebuttal Appendix A
Page 1 of 5
Figu
re 4
Dow
nwar
d B
ias i
n M
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oths
child
's S
usta
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row
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CF
Est
imat
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ue to
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hnic
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law
s and
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ors i
n H
is C
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iled
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otes
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. 1.
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5]: V
ilber
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[3]:
[1] -
[2]
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[4] -
[5]
Application No. A.17-04-006 Vilbert Rebuttal Appendix B
Page 1 of 6
Wor
king
Pap
er #
1 to
Fig
ure
4C
onst
ant G
row
th D
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ash
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quity
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ased
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xpec
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f 6/3
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Application No. A.17-04-006 Vilbert Rebuttal Appendix B
Page 2 of 6
Wor
king
Pap
er #
2 to
Fig
ure
4C
onst
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row
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te (e
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liciz
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mer
ican
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ater
and
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nect
icut
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er h
igh
and
low
stoc
k pr
ices
from
Yah
oo F
inan
ce a
re c
orre
cted
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ccou
nt fo
r err
or in
Mr.
Rot
hsch
ild's
Atta
chm
ent D
.
Application No. A.17-04-006 Vilbert Rebuttal Appendix B
Page 3 of 6
Wor
king
Pap
er #
3 to
Fig
ure
4C
onst
ant G
row
th D
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unte
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ash
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t of E
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roxy
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upB
ased
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etur
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s of 6
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row
th"
Indi
cate
d C
ost o
f Eq
uity
(D/P
)(M
/B)
(r)
(b)
(s x
v)
(br +
sv)
[1]
[2]
[3]
[4]
[5]
[6]
[7]
[8]
[9]
Am
eric
an S
tate
s Wat
er2.
04%
3.51
12.3
2%41
.90%
0.27
%0.
67%
5.84
%7.
94%
Am
eric
an W
ater
Wor
ks1.
92%
2.67
9.11
%43
.72%
1.54
%2.
57%
6.55
%8.
54%
Aqu
a A
mer
ica
2.30
%3.
1913
.06%
43.8
4%0.
28%
0.61
%6.
33%
8.70
%C
alifo
rnia
Wat
er S
erv.
Grp
.1.
96%
2.68
7.44
%29
.59%
1.36
%2.
27%
4.47
%6.
47%
Con
nect
icut
Wat
er S
ervi
ces
2.04
%2.
6510
.15%
46.9
3%1.
41%
2.33
%7.
09%
9.20
%M
iddl
esex
Wat
er C
ompa
ny2.
13%
2.96
10.5
6%40
.28%
0.49
%0.
96%
5.21
%7.
40%
SJW
Cor
pora
tion
1.77
%2.
3913
.03%
67.6
1%1.
48%
2.05
%10
.86%
12.7
2%Y
ork
Wat
er C
ompa
ny *
1.85
%3.
9110
.58%
31.8
0%-1
.98%
-5.7
6%-2
.39%
-0.5
7%
Incl
udin
g Y
ork
Ave
rage
2.00
%2.
9910
.78%
43.2
1%0.
61%
0.71
%5.
50%
7.55
%M
edia
n2.
00%
2.82
10.5
7%42
.81%
0.92
%1.
50%
6.09
%8.
24%
Excl
udin
g Y
ork
Ave
rage
2.02
%2.
8610
.81%
44.8
4%0.
98%
1.64
%6.
62%
8.71
%M
edia
n2.
04%
2.68
10.5
6%43
.72%
1.36
%2.
05%
6.33
%8.
54%
Sour
ces a
nd N
otes
:[2
]:M
r. R
oths
child
's W
orkp
aper
s, A
LR 3
, p. 1
.[3
]:M
r. R
oths
child
's W
orkp
aper
s, A
LR 3
, p. 1
.[4
]:M
r. R
oths
child
's W
orkp
aper
s, A
LR 3
, p. 2
.[5
]:1
- [([
2] x
[3])
/ [4
]][6
]:M
r. R
oths
child
's W
orkp
aper
s, A
LR 6
, Com
poun
d A
nnua
l Gro
wth
in C
omm
on S
tock
.[7
]:[6
] x ([
3] -
1)[8
]:[5
] x [4
] + [7
][9
]:[2
] * (1
+ 0
.5 *
[8])
+ [8
]*
Yor
k is
exc
lude
d in
the
calc
ulat
ion
of th
e A
vera
ge a
nd M
edia
n du
e to
a n
egat
ive
grow
th ra
te (e
xclu
ded
num
bers
are
bol
d an
d ita
liciz
ed).
Application No. A.17-04-006 Vilbert Rebuttal Appendix B
Page 4 of 6
Wor
king
Pap
er #
4 to
Fig
ure
4C
onst
ant G
row
th D
iscou
nted
Cas
h Fl
ow (D
CF)
Indi
cate
d C
ost o
f Equ
ity W
ater
Pro
xy G
roup
Bas
ed o
n A
ctua
l Ret
urns
for
Yea
r E
ndin
g 6/
30/2
017
Com
pany
Div
iden
d Y
ield
on
Mar
ket
Pric
e
Mar
ket-t
o-bo
ok
His
toric
al
Ret
urn
on
Equi
ty
Ret
entio
n R
ate
Exte
rnal
Fi
nanc
ing
Rat
e
New
Fi
nanc
ing
Gro
wth
"Tot
al E
stim
ate
of In
vest
or
Ant
icip
ated
G
row
th"
Indi
cate
d C
ost o
f Eq
uity
(D/P
)(M
/B)
(r)
(b)
(s x
v)
(br +
sv)
[1]
[2]
[3]
[4]
[5]
[6]
[7]
[8]
[9]
Am
eric
an S
tate
s Wat
er2.
19%
3.36
12.3
2%40
.25%
0.27
%0.
63%
5.59
%7.
85%
Am
eric
an W
ater
Wor
ks1.
94%
2.69
9.11
%42
.75%
1.54
%2.
61%
6.50
%8.
51%
Aqu
a A
mer
ica
2.40
%3.
1613
.06%
42.0
3%0.
28%
0.60
%6.
09%
8.56
%C
alifo
rnia
Wat
er S
erv.
Grp
.2.
10%
2.53
7.44
%28
.71%
1.36
%2.
07%
4.21
%6.
35%
Con
nect
icut
Wat
er S
ervi
ces
2.11
%2.
6210
.15%
45.6
7%1.
41%
2.29
%6.
92%
9.10
%M
iddl
esex
Wat
er C
ompa
ny2.
20%
2.93
10.5
6%38
.77%
0.49
%0.
95%
5.04
%7.
30%
SJW
Cor
pora
tion
1.84
%2.
4013
.03%
66.1
5%1.
48%
2.07
%10
.69%
12.6
2%Y
ork
Wat
er C
ompa
ny *
1.90
%3.
8810
.58%
30.3
5%-1
.98%
-5.7
1%-2
.50%
-0.6
3%
Incl
udin
g Y
ork
Ave
rage
2.08
%2.
9510
.78%
41.8
3%0.
61%
0.69
%5.
32%
7.46
%M
edia
n2.
10%
2.81
10.5
7%41
.14%
0.92
%1.
51%
5.84
%8.
18%
Excl
udin
g Y
ork
Ave
rage
2.11
%2.
8110
.81%
43.4
8%0.
98%
1.60
%6.
43%
8.61
%M
edia
n2.
11%
2.69
10.5
6%42
.03%
1.36
%2.
07%
6.09
%8.
51%
Sour
ces a
nd N
otes
:[2
]:M
r. R
oths
child
's W
orkp
aper
s, A
LR 3
, p. 1
.[3
]:M
r. R
oths
child
's W
orkp
aper
s, A
LR 3
, p. 1
.[4
]:M
r. R
oths
child
's W
orkp
aper
s, A
LR 3
, p. 2
.[5
]:1
- [([
2] x
[3])
/ [4
]][6
]:M
r. R
oths
child
's W
orkp
aper
s, A
LR 6
, Com
poun
d A
nnua
l Gro
wth
in C
omm
on S
tock
.[7
]:[6
] x ([
3] -
1)[8
]:[5
] x [4
] + [7
][9
]:[2
] * (1
+ 0
.5 *
[8])
+ [8
]*
Yor
k is
exc
lude
d in
the
calc
ulat
ion
of th
e A
vera
ge a
nd M
edia
n du
e to
a n
egat
ive
grow
th ra
te (e
xclu
ded
num
bers
are
bol
d an
d ita
liciz
ed).
** A
mer
ican
Sta
tes W
ater
and
Con
nect
icut
Wat
er h
igh
and
low
stoc
k pr
ices
from
Yah
oo F
inan
ce a
re c
orre
cted
to a
ccou
nt fo
r err
or in
Mr.
Rot
hsch
ild's
Atta
chm
ent D
.
Application No. A.17-04-006 Vilbert Rebuttal Appendix B
Page 5 of 6
Figu
re 3
Com
pari
son
of E
PS G
row
th R
ates
Use
in M
y D
irec
t Tes
timon
yan
d Su
stai
nabl
e G
row
th R
ates
Cal
cula
ted
Usi
ng M
r. R
oths
child
'sD
ata
and
Met
hodo
logy
Vilb
ert A
ppro
ach
R
oths
child
App
roac
h
Com
pany
Val
ue L
ine
Gro
wth
R
ate
as o
f 1/
31/2
017
Wei
ghte
d G
row
th
Rat
e as
of
1/31
/201
7
Sust
aina
ble
Gro
wth
R
ate
as o
f 6/
30/2
017
[1]
[2]
[3]
[4]
Am
eric
an S
tate
s Wat
er8.
90%
5.87
%7.
51%
Am
eric
an W
ater
Wor
ks9.
59%
7.88
%7.
94%
Aqu
a A
mer
ica
6.70
%5.
57%
5.77
%C
alifo
rnia
Wat
er S
erv.
Grp
.15
.47%
10.3
2%8.
04%
Con
nect
icut
Wat
er S
ervi
ces
3.25
%4.
85%
7.94
%M
iddl
esex
Wat
er C
ompa
ny5.
38%
5.38
%7.
15%
SJW
Cor
pora
tion
*0.
00%
0.00
%9.
33%
Yor
k W
ater
Com
pany
**
6.82
%6.
82%
-0.4
7%
Ave
rage
8.02
%6.
67%
7.67
%
Sour
ces a
nd N
otes
:[2
],[3]
:
[4]:
Mr.
Rot
hsch
ild's
calc
ulat
ion
of su
stai
nabl
e gr
owth
rate
= b
r + sv
, as o
f Jun
e 30
, 201
7.*
SJW
was
exc
lude
d fr
om th
e sa
mpl
e av
erag
e in
[2] a
nd [3
] due
to it
s est
imat
ed c
ost o
f equ
ity
not
exc
eedi
ng th
e co
st o
f deb
t by
100
basi
s poi
nts.
** Y
ork
Wat
er w
as e
xclu
ded
from
the
sam
ple
aver
age
in [4
] due
to it
s neg
ativ
e gr
owth
rate
.
Vilb
ert W
orkp
aper
s, Ta
ble
No.
MJV
-WA
TER
-5, E
stim
ated
Gro
wth
Rat
es a
s of J
anua
ry 3
1,
2017
. Wei
ghte
d av
erag
e in
clud
es b
oth
Thom
son
Reu
ters
and
Val
ue L
ine
LT E
PS e
stim
ates
.
Thom
son
Reu
ters
est
imat
es w
ere
mis
sing
for M
SEX
, SJW
, and
YO
RW
at t
he ti
me
of a
naly
sis.
Ther
efor
e, th
e w
eigh
ted
aver
age
is b
ased
sole
ly o
n V
alue
Lin
e fo
r the
se c
ompa
nies
.
Application No. A.17-04-006 Vilbert Rebuttal Appendix B
Page 6 of 6