In late 1989, the two heavyweights of water privatisation – Thames and Severn Trent – were floated, along with the other eight water companies. Twenty-eight years on, it is pertinent to consider how their fortunes have diverged over the intervening period, despite their prospectuses setting out similar aims.
Prior to flotation, Thames’ leading lights certainly did not lack in modesty as they sought to position the company as the water equivalent of the then-soaring British Airways. Severn Trent, by contrast, was portrayed by some as one of the remaining nine country cousins.
Not surprisingly, Thames was allocated the lowest yield – at what is now a thumping 8.1 per cent – as the government concluded that it would be the easiest to sell: Severn Trent’s opening yield was 8.25 per cent.
Both companies now recognise the paramountcy of their core business – which, after all, pays not only the bills but also the dividends. Consequently, the regulatory process is crucial. Every water company, bar none, is totally focussed on the 2019 periodic review whose impact will first kick in during April 2020.
Nonetheless, at flotation, most water companies expressed hopes that they would be able to build up substantial non-core earnings. In fact, only South West Water – now a Pennon division – achieved that aim: the 2017/18 interim results from Viridor, its waste subsidiary, were impressive.
Back in 1989, no water company was more upbeat about its non-core potential than Thames, whose underlying ambition was to become a global water company.
It was already in the process of acquiring the water treatment business of Portals. In subsequent years, this aspiration died as a series of overseas problems, notably in Egypt, produced heavy write-downs.
Severn Trent, for its part, acquired Biffa, a high-quality waste company, that recently returned to the stock market. Initially, Biffa prospered under Severn Trent, despite its heavy financing cost. Subsequently, Severn Trent demerged the business, which has faced real challenges in recent years.
Chunky dividends
Given a series of non-core mishaps in the water sector, it was hardly surprising that institutional shareholders insisted that the companies focused on their core businesses. This policy was accentuated when several water companies were taken over by private equity undertakings, which sought both operational cost as well as financial savings.
The private equity model entailed substantial gearing-up, which minimised corporation tax payments. In Severn Trent’s case, along with United Utilities – now effectively North West – and Pennon, it has remained publicly-quoted since 1989.
Severn Trent was upbeat at its recent results meeting and has performed strongly on the key issues identified by Ofwat. It seems a decent bet to be the only water company to be awarded Ofwat’s exalted “exceptional” status.
Thames’ situation is rather different. It was acquired by top German energy company RWE in 2001 – a deal that never really worked out. Subsequently, it was bought by a private equity consortium, led by Australia’s Macquarie.
Over the next decade, the high-debt – now circa £11 billion – and low-tax model was controversially adopted: very substantial amounts of excess capital were returned to the consortium’s shareholders. And even former water regulator Sir Ian Byatt felt moved to convey, in public, his deep regret that Thames has been unable to finance, in full, the £4.2 billion Thames Tideway Tunnel scheme, whilst paying very chunky dividends to its private equity shareholders.
Thames’ recent performance has also caused concern at Ofwat. Last month, it admitted that its leakage targets would not be met until 2020. And it has been the subject of several £millions of fines for failing to meet certain requirements.
Big gainers
Ofwat’s deep concern led to a recent “fishing expedition” under chairman, Jonson Cox, into Thames; it focussed specifically on its finances. What evidence it flushed out is unclear. Nonetheless, Thames has responded by announcing the planned closure of its controversial Cayman Islands companies. It has also confirmed the key appointment, as chairman, of Ian Marchant, the former SSE chief executive and a widely respected expert on utility finances dating right back to the 1980s.
Thames must be approaching the next periodic review with some sense of foreboding. Its most realistic hope is inclusion in Ofwat’s “slow-track” category unless Marchant can turn around its reputation in coming months.
For shareholders, Severn Trent has done them proud – apart from paying impressive dividends, the share price has risen around eight-fold from £2.40 in 1989 to circa £20.40 today.
Unquestionably, the big gainers from Thames have been its private equity investors led by Macquarie who sold out earlier this year.
Consumers in both companies’ areas, as indeed elsewhere, have faced sharp price increases since 1989 as the investment back-log has been tackled and, in Thames’ case particularly, remains unfinished.
For the two sector heavyweights, it has been 28 years of contrasting fortunes.