Today’s fall in the weighted average cost of capital (WACC) was always a possibility but remains rather surprising given the operational and financing challenges ahead for many of the industry players. It could have a significant impact on the appetite of those already invested in the sector and will lower returns be attractive enough to stay? It may also cause potential new investors to look elsewhere for better returns on their capital.
Unlike previous regulatory cycles, which have tended to trigger transactions within 18 months of the final determination, we are likely to see a more prolonged momentum behind deal activity this time round. Investors will need more time to digest the full implications of the new regulatory emphasis.
On acquisitions, we are likely to see equity stakes of up to 15 per cent changing hands, rather than 100 per cent or majority exits, at least at the start of the Asset Management Programme (AMP6). There will be many factors for acquirers to consider, some of whom may be new to the industry, not least the management’s ability to position themselves well for the medium term, given more changes are likely to be in store down the track.
There is also continued speculation in the market in relation to potential mergers, between both water and sewage companies, and Water-only companies; and we could see consolidation in the regions.
For many of the water companies the final determination is likely to be stretching, with management’s ability to outperform on financing, or the weighted average cost of capital, reduced. Therefore much of the emphasis will be on placed on operational outperformance and any new investors will want to see an AMP6 track record, before diving in.
There will also be a greater emphasis on diligence, in order to deliver on shareholder commitments; in terms of managing costs, incentives, rewards and sustainable performance. This could all lead to us seeing macro-economic or financing risks paling in comparison.