Thames Water – Macquarie checks out

Back in 1989, when the ten water companies were on the privatisation block, Thames Water aspired to be in a league above its nine country cousins, including Severn Trent; indeed, Thames was floated on the lowest yield of the ten companies.

However, despite its 15 million customer base in London and in neighbouring counties, subsequent years proved far less productive for Thames.

After six years of ownership by Germany utility, RWE – whose star has also waned – Thames ended up in 2006 being acquired by a consortium of private equity investors, led by Australia’s Macquarie.

Although Macquarie has now sold its 26 per cent stake in Kemble, Thames’ parent company, it remains a major UK infrastructure player, through its ownership of stakes in power stations, water companies, the M6 toll road, airports and the Arqiva radio masts and mobile communications business.

From time to time, Macquarie recycles its asset base and this partly explains its exit from Thames.

Moreover, with substantial UK investments undertaken over the last two years, not least as a member of the winning consortium to buy the 61 per cent stake in National Grid’s gas business, the proceeds from the Kemble disposal will certainly come in handy.

It is also, more controversially, seeking to buy the Green Investment Bank, which the government is privatising; this deal still has to complete.

The buyers of Macquarie’s 26 per cent stake in Kemble are the Toronto-based Borealis – part of the wealthy Ontario Municipal Employees Retirement Scheme (OMERS) – and the Kuwait Investment Authority, a long-established sovereign wealth fund.

Like Macquarie, Borealis is a well-known international infrastructure asset investor; it has built up key stakes in both Associated British Ports (ABP) and the HS1 rail link to Paris. Less successfully, it was a spurned bidder for Severn Trent.

Since Canada avoided much of the financial carnage associated with the 2008/09 credit crash which engulfed much of Wall Street and many leading UK and EU financial institutions, its financial services sector has prospered in relative terms.

Borealis, like Macquarie, fully recognises the attractiveness of long-term, stable revenue streams that can be deployed to finance long-term pension liabilities: UK water companies fit this bill perfectly, although certain assumptions about the impact of future periodic reviews are necessary.

In terms of the price paid for the 26 per cent stake in Kemble, the rumoured figure is c£1.35 billion, which – if accurate – would suggest a healthy premium over Thames’ Regulatory Capital Value (RCV) of £11.9 billion, once the hefty net debt element has been stripped out.

Furthermore, a smaller Canadian-based investor, Fiera – via its Aquila subsidiary – has also acquired a stake in Kemble; it paid £120 million for a 2.4 per cent shareholding.

Another significant water deal recently concerned Australian-owned Hastings Funds Management, which has now secured full ownership of South East Water, implying a total equity valuation of £400 million for the business.

Of course, in terms of utility RCV premia paid, it is the eye-watering National Grid gas division sale – or at least 61 per cent of it – that implied a stonking premium over the £8.5 billion RCV.

Many analysts were expecting successful bids valuing the business at over £11 billion.

However, the Macquarie-led consortium pushed out the boat and agreed an indicative valuation figure of £13.8 billion; this implied a very aggressive premium to the RCV. The days of a 30 per cent premium for a utility stock being par look numbered.

Assuredly, the Borealis-led consortium will have made various assumptions about how Thames will fare in the next periodic review, which is due to impact in April 2020.

Despite some threatening noises from Ofwat, the reality is that the pivotal Weighted Average Cost of Capital (Wacc) assumption will probably rise in nominal terms at least, on the back of higher global interest rates; as expected, the US Treasury has just confirmed a quarter-point increase.

“We feel privileged to have been associated with Thames Water for such a long period of time and are pleased to have significantly increased investment levels and improved operational performance.”

MIRA global head Martin Stanley

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However, the risks attached to the £4.2 billion Thames Tideway Tunnel (TTT) scheme – previously seen as a heavy liability for Thames – have abated, with Bazalgette Tunnel taking control of the 16-mile super-sewer project.

Whilst increases in Thames’ bills will partly finance this very expensive scheme, the risks attached to its shareholders seem to have been markedly reduced, although the funding arrangements associated with the TTT project are immensely complicated.

Even so, Thames still has an on-going £4.5 billion five-year capital expenditure to deliver by March 2020. Since much of the construction work will take place in very busy and built-up parts of London, this remains a formidable challenge.

More generally, stock markets have boomed following the election of President Trump. Furthermore, the pound sterling, which plunged post the unexpected Brexit result last June, has made UK corporate stocks look comparatively cheap.

This view has been endorsed by the take-over of ARM Holdings and the abortive bid for Unilever, along with corporate activity in the both the oil services and building sectors; in the latter case, there is a scramble to acquire Bovis.

Hence, further activity in the utilities sector should be expected, ranging from outrights bids or the exchange of assets owned by private equity share-holders, such as the recent deal involving Thames.