There is a growing body of opinion among water sector stakeholders that greater efficiencies could be gained if water companies were allowed to consolidate.
It takes only a quick glance at the map of water companies across England and Wales to identify a number of potential opportunities for the integration of head office functions, for more sustainable use of water resources, for improved performance and service levels and for rationalisation of assets, among other potential benefits. The prize is sizeable, but little consolidation has occurred over the past 22 years. This is largely down to water sector merger rules (see box).
The only mergers that have been allowed have been between water-only companies (Wocs) – for example, South East Water and Mid Kent Water in 2007 – or in a small number of cases between a water and sewerage company (WaSC) and a Woc – for example, Northumbrian Water with Essex & Suffolk Water in 2000. There have been no mergers between WaSCs. In 1995, South West Water was a takeover target for both Severn Trent and Wessex Water. Both bids were blocked to preserve the number of comparators.
December’s Water White Paper recognises that mergers and takeovers can be a strong driver for efficiency improvements. It also recognises that the value of Ofwat’s comparative regulation regime is probably diminishing. It therefore announces that government is strongly minded to reform the water sector special merger regime. Subject to consultation, the turnover threshold may be raised to £70 million.
In addition, a future Water Bill is likely to introduce a two-tier referral system. This would enable an acquiring water company to give undertakings to the Office of Fair Trading (OFT) rather than face the expense, delay and uncertainty of a Competition Commission investigation. Such undertakings might include continuing post-merger with separate price controls or divesting part of the business. Ofwat is also likely to be required to publish its methodology on how it values individual comparators in its comparative regulation regime, to help acquiring water companies understand what undertakings may be appropriate when considering whether to make a takeover bid.
Inset appointees will be exempted from the special merger rules, but will continue to be subject (in principle) to the general merger regime. They do not form part of the comparative regulation regime anyway.
Even without any reform, 2011 saw a deluge of ownership changes in the sector as Northumbrian Water, Bristol Water and Cambridge Water all became subject to acquisitions. The takeover by South Staffordshire Water of Cambridge Water has recently been referred to the Competition Commission. In the other cases, the purchaser was external to the sector so a referral was not triggered. In addition, Veolia Water UK announced that it intends to dispose of its three UK water businesses, having first unified the management and licences of the three companies.
This latter proposal is the subject of an informal Ofwat consultation seeking views on any impact that may ensue on the regulator’s ability to regulate effectively. Interestingly, the consultation paper states that Veolia believes that since the three companies are already under common ownership, the proposed unification will not amount to a merger (the merger having occurred previously). Ofwat does not venture an opinion on the merger question, leaving that to the OFT, but does state that the proposed unification would not reduce the number of comparators available, as Ofwat does not treat the three as separate comparators.
If the reforms outlined in the White Paper, or a version of them, are enacted, will this provide a stimulus for water mergers? The current turnover threshold of £10 million for automatic referral to the Competition Commission catches all water companies (except Cholderton and District Water). At £70 million, a further eight Wocs would be excluded, including Cambridge Water, and two of the three Veolia UK water businesses. Accordingly, further Woc mergers would appear feasible.
The introduction of a two-tier referral approach might afford parties to proposed mergers the ability to proceed with greater certainty. The jury is still out on whether this will be sufficient to accommodate the first ever WaSC/WaSC merger, although WaSC consolidation would appear to remain unlikely in the absence of a move away from comparative regulation.
Clive Mottram, head of water regulation at law firm Eversheds
Water’s special merger regime
If a merger of two water undertakings occurs or is proposed and the turnover of each company exceeds £10 million, the Office of Fair Trading (OFT) is under an obligation to refer the merger to the Competition Commission for investigation. The principal question for the commission is whether the merger may be expected to prejudice Ofwat’s ability to make comparisons between water companies. Ofwat’s regime of comparative competition is thus given protected status. This has restricted mergers to the smaller players within the sector, so a sufficient number of larger operators are preserved to keep comparisons meaningful.
In contrast, the general UK merger rules for businesses look at whether the merger has resulted or may result in a substantial lessening of competition. The substantive question to be addressed is therefore quite different. From a jurisdictional perspective, the general rules are also distinct. A “relevant merger” (one which the OFT has the ability to consider for potential reference to the Competition Commission) is one in which the UK turnover of the acquired business exceeds £70 million, or one where the merged entity would have 25 per cent or more share of a relevant market. The OFT can also decide not to refer the merger if it judges the benefits outweigh the negatives.
This article first appeared in Utility Week’s print edition of 16 March 2012.
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