Peerless' Reasons for Merging with SCWC

Zastrow decided to sell Peerless because of his age and health, and because he believes a sale is in the best interests of the company and customers. Zastrow believes that because of Peerless' small size, lack of capital, cash flow, age and condition of its facilities, the company could not survive as an independent operation given the allegedly necessary improvements. Thus, Zastrow decided to sell to another company that could resolve his concerns about addressing increased water quality standards and updating Peerless' water system.

SCWC is one of the largest water utilities in the nation and has the largest investor-owned water utility system in Southern California. Zastrow believes this translates into economies of scale that small investor-owned and mutual water companies, or municipal districts, cannot achieve. SCWC also serves customers in Lakewood and Paramount and is well-staffed to address the water quality issues faced by the company. In addition, its parent, American States Water Company (ASW), is currently listed on the New York Stock Exchange and has ready access to the capital markets. Thus, in Zastrow's opinion, SCWC possesses the size, experience, expertise and financial ability to satisfy the operating, water quality and infrastructure replacement demands now existing within the Peerless service area, and is capable of providing uninterrupted, responsive customer service.

Zastrow also contends SCWC provided the best terms for the company's customers, employees and investors. SCWC agreed to provide employment to Peerless' three experienced operating employees, including Zastrow's son. These employees will be able to serve an even wider service area, thereby benefiting existing SCWC customers.

The merger will be accomplished on a tax-free basis to Peerless' shareholders, due to ASW's status as a publicly traded company. This results in a reduced purchase price for SCWC and tax advantages for the Peerless investors. According to Zastrow, the other potential purchasers did not offer all of these advantages.

Zastrow rejected Bellflower Somerset's proposal to purchase Peerless for several reasons. First, Bellflower Somerset is a small company (the size of a Class B water utility, with approximately 5,000 customers) that faces most of the same operating and water quality challenges now faced by Peerless. However, it appears to Zastrow that Bellflower Somerset, unlike SCWC, will simply defer addressing the water quality concerns in the Peerless/Somerset service areas.

Second, if Bellflower Somerset acquired Peerless, Zastrow believes it will place complete reliance on serving new Peerless customers through water purchased from member agencies of the Metropolitan Water District (MWD), rather than addressing required infrastructure improvements to increase supply. The cost for purchased water has increased in the last several years substantially above costs for pumped groundwater. These prices are likely to increase even further as the MWD and other water wholesalers extensively restructure their rate design. The other drawback to total MWD reliance, according to Zastrow, is the potential threat of insufficient water supply. If MWD supply fails, the service territory is left without this reliable source.

Third, if Bellflower Somerset acquired Peerless, Zastrow believes customers would have no assured, cost-free recourse to address service difficulties or other problems. Bellflower Somerset is a mutual water company with no applicable government oversight or consumer complaint procedure, whereas customers of an investor-owned utility like SCWC have the protection of regulation by the Commission.

Fourth, Zastrow contends that Bellflower Somerset failed to provide a competitive offer.

Finally, the most troubling aspect of Bellflower Somerset's proposal to Zastrow was the impact that an acquisition by a mutual water company would have on each Peerless customer. Zastrow believes in order to receive service from a mutual water company, each customer would be forced to pay the acquisition cost of the Peerless system and water rights by purchasing shares or securities issued by the mutual water company. This could prove a potentially impossible financial burden on the company's middle- and lower-income residential customers. In contrast, if an investor-owned utility acquires the company, the utility must finance the acquisition price.

Zastrow is also concerned that if Bellflower Somerset acquired Peerless, the latter's customers could be subject to special assessments to raise capital to fund necessary improvements for this small utility system. On the other hand, SCWC and other large investor-owned utilities finance these projects through external sources of capital or equity investment.

In Zastrow's opinion the Commission has been reluctant to permit mutual water companies to acquire investor-owned utilities. He claims the more favored buyer has been the large investor-owned utility company, which appears to better satisfy the Commission's and California Legislature's express goals of combining smaller water companies with local Class A investor-owned utilities. (Zastrow provides no citations to support this contention.)