Analysts say the amalgamation of smaller water firms would save in operating costs, meaning cheaper bills for consumers and, since the water regulator Ofwat signalled a shift in stance towards mergers and acquisitions (M&A) back in March 2015, the floodgates may well have opened for numerous deals between water firms.
Utilities analyst at Whitman Howard, Angelos Anastasiou, tells Utility Week further consolidation is “certainly feasible”.
“It will probably be another WASC taking over a WOC, as with SWW and Bournemouth,” he says. “Although Ofwat has indicated (vaguely) that it would perhaps be more open to WASC/WASC mergers if there were benefits for customers.”
There are currently 12 WOCs, five of which are owned by WASCs “or similar”, he adds. Bristol Water is owned by Spanish water firm, Aguas de Barcelona; Hartlepool Water (owned by Anglian Water); Bournemouth (Pennon Group); Essex and Suffolk Water (Northumbrian Water); and Cambridge Water (South Staffordshire Water).
Anastasiou believes moves among the remaining seven are the most likely. Additionally, an alternative form of M&A could crop-up with the advent of competition. “Here, there could be aggregation of activities, with some companies deciding that they just want to stay in the wholesale market, while others want to grow their retail supply activities through acquisition, as well as organically,” he says.
The Bournemouth/South West Water merger was given the final go-ahead by the Competition and Markets Authority (CMA) last November amid concerns raised by Ofwat that it could cost the sector’s efficiency drive £119 million by 2025.
The regulator has been criticised in the past for sending out “mixed signals” about its position on M&A and dissuading investors from potential deals. However, it is quick to point out that it “did not oppose the [Bournemouth/SWW] deal”, stating its priority was to ensure current and future customers in England and Wales remain “properly protected”.
The Consumer Council for Water (CCWater) said at the time that the loss of Bournemouth Water could impact Ofwat’s ability to compare performance and set future price controls. These concerns, however, were quashed by Pennon, which confirmed it will continue separate regulatory reporting for Bournemouth until at least 2020 to “aid Ofwat with comparisons between companies”.
The merger resulted in an increase in EBITDA for Pennon for the first half of this financial year despite tighter price controls, with Bournemouth adding £8.6 million.
Pennon group chief executive Chris Loughlin (formerly chief executive of SWW) said that the firm was pleased to receive the CMA clearance of the acquisition of Bournemouth Water. “Pennon is now integrating Bournemouth Water into South West Water delivering significant benefits to customers and shareholders. The combined business is aiming to set the benchmark for efficiency at the next price review,” he added.
Since privatisation in 1989, mergers involving water companies with a turnover of more than £10 million have automatically been referred for an in-depth investigation to the CMA, which decides whether the deal will make it harder for Ofwat to compare companies’ performance.
However, the regulator is considering fresh rules to reduce the barriers to water companies merging, as long as it is to the benefit of customers, by eliminating the need for a full review from the CMA. The move was welcomed by investors who are increasingly focused on M&A in the water sector following the conclusion of the PR14 regulatory determinations. “Any softening of its stance to mergers has to be seen as a positive for a sector where M&A remains a key theme,” said an investor note from RBC Capital.
As Australia’s sovereign wealth Future Fund prepares to sell its 23 per cent stake in Southern Water, in what would be the first significant transfer of equity in the water sector since the significantly tougher PR14 came into effect last April, and with large stakes in other WASCs such as Yorkshire Water coming up for sale in the not-too-distant future, infrastructure fund money that is likely to be spent on the UK water sector could be spent on buying stakes in WASCs rather than purchasing WOCs.
But with the regulator seemingly all for M&A, and with competition in the non-household market just around the corner, the sector is on the cusp of change, and analysts believe the WOCs will begin to go. So which will be the next to be swallowed up?
“We will see,” says Anastasiou.