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The future of Rio de Janeiro state water utility Cedae is surrounded by uncertainty as its controller faces a challenging fiscal scenario and a plan to privatize the company is likely to face legal opposition.
Years of excessive spending and a drastic drop in tax collection (mainly due to lower oil revenues) have forced the Rio de Janeiro state government to target Cedae for privatization in order to raise cash.
A privatization would help the Rio government pay a loan of 3.5bn reais (US$1.1bn) that it obtained from the federal government to cover late payments to public servants.
"The government is planning to privatize Cedae but there are no people from the sanitation area involved in the discussion. The only perspective discussed, so far, is the need for the state to raise cash, not the needs of the company," Roberval Tavares de Souza, president of the Brazilian sanitary and environmental engineering association (ABES), told BNamericas.
"Cedae, like any other sanitation company, has as its main asset the service contracts. Those contracts are a legal instrument between the company and the cities. From the moment it is privatized, the contracts become null, attracting no interest from investors in Cedae," Souza added.
Local prosecutors have said that the privatization of Cedae would be unconstitutional since the state government is planning to use the proceeds to cover late payments to state employees.
Rio's government recently hired local think tank Fundação Getúlio Vargas to put a value on Cedae. Separately, national development bank BNDES hired a consultancy to evaluate the possibility of a privatization process.
As the privatization evaluation is moving forward other alternatives are also viewed as options for the cash-strapped government.
"Privatization is not the only alternative for the state government to raise cash via Cedae. One of the alternatives is to sell a stake in the company, via a share offering or sell a stake via a private offering to a specific investor or company," Alexandre Montes, an equity analyst covering utilities at the Lopes Filho consultant firm, told BNamericas.
With investor demand now on the rise in Brazil, a Cedae sale could attract some heavy weight investors, including international fund managers and major private equity firms, according to Montes.
Even the sale of a stake in Cedae would require large investment amounts, which in turn would exclude smaller investors from the process, he added.
Cedae was created in 1975 from the merger of three companies, Empresa de Águas do Estado da Guanabara (CEDAG); Empresa de Saneamento da Guanabara (ESAG); and Companhia de Saneamento do Estado do Rio de Janeiro (SANERJ).
Cedae operates and maintains the collection, treatment, and distribution of water networks, as well as the collection, transportation, treatment and final destination of the sewage from most cities in the state.
As the host of 2016 Summer Olympic Games, Rio de Janeiro undertook a series of infrastructure projects to prepare the city for the global sports event.
Cedae was involved in some large initiatives, such as the works in the Marina da Glória, considered crucial for the competitions that took place in the Guanabara bay area.
For the Olympics and Paralympics games, Cedae also carried out essential works, such as the sanitation of the Eixo-Olímpico region, which connected stretches of the Barra da Tijuca and Jacarepaguá districts to the sewage network.
The company is investing 3.4bn reais (US$1.09bn) in water and sanitation works in the low income areas of the Baixada Fluminense region. Of the total, 3.1bn is financed by the state-run bank Caixa.
The goal of the works is to solve Baixada Fluminense's water supply problems with the help of a new station that will have a flow of 12,000l/s, reservoirs with storage capacity of 161mn of liters of water and 800km of distribution network, as well as thousands of new connections, which will cover the municipalities of Queimados, Nova Iguaçu, Mesquita, Nilópolis, São João de Meriti, Belford Roxo and Duque de Caxias.
This package of works began in the second half of 2015 and is expected to be completed within five years, benefitting 2.2mn habitants in the region.
Despite the challenges faced by its controller, Cedae is a profitable company.
Last year, it posted a net profit of 379mn reais, up from 249mn in 2015. Gross revenues were up 5.52% to 4.28bn.
Cedae also managed to reduce its net debt by 4.36% to 793mn reais at the end of 2016.
The state capital represents almost 80% of Cedae's revenue. The water supply and sewage services agreement between the company and the city of Rio de Janeiro was signed in 2007 for a period of 50 years, which can be extended by another 50 years under certain conditions.
Cedae's financial performance shows that the only reason for privatizing the company is the financial problems of the state government, Montes pointed out.
The huge sewage challenge
Although Cedae can provide a high level of water supply for its consumers, there is a huge challenge regarding sewage collection.
Last year, the water supply for the population in the area served by Cedae reached 88.1%, while sewage collection coverage was only 35.6%.
"In the coming years, the company will need a lot of money to expand sewage collection services. It is almost impossible to calculate the value, but the necessary investments will be huge," said Alexandre Ferreira Lopes, VP of the Brazilian association for private concessionaires of public water and sewage services (ABCON).
Even with new funding, the improvement of sewage collection will demand additional investments through public-private partnerships, according to Ferreira.
Private investors who may be interested in Cedae must also consider that it is a company that operates in a highly regulated sector where prices, for example, cannot be freely raised, said Lopes.