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16 | 25TH NOVEMBER - 1ST DECEMBER 2016 | UTILITY WEEK Finance & Investment Analysis A great deal has happened in the water sector over the past year and, as mar- ket opening approaches, merger and acquisition activity looks set to increase. Frost & Sullivan vice president for environ- ment and water Fredrick Royan says retail market opening "presents an opportunity" for water and wastewater service companies, such as Severn Trent, to explore opportuni- ties for consolidation – and water-only com- panies in neighbouring regions are of high interest and prospect. In other words, this is not the first occur- rence of consolidation in the water market, and it is unlikely to be the last. In 2015, South West Water (SWW) parent company Pennon announced plans to acquire Bournemouth Water for £100.3 million. This, Royan says, allowed SWW to consolidate its stature in the region and integrate its assets and resources to exploit efficiency gains. He adds: "The number of water-only com- panies has already decreased from 10 to 8 over the past couple of years, with the pur- chase of Bournemouth Water by South West Water and Severn Trent purchasing Dee Val- ley. We expect this trend to continue as there still exist opportunities for consolidation in the UK water utility industry." As part of the Severn Trent-Dee Valley acquisition, Severn Trent will maintain a separate Welsh licence for Dee Valley and intends that the whole of its business in Wales will be regulated under Welsh gov- ernment policy. It will also keep the existing brand for Dee Valley's 258,000 customers in Chester and northeast Wales and northwest England. This is all subject to regulatory approval. Commenting on the acquisition, Severn Trent chief executive Liv Garfield said: "We intend to bring real benefits to Dee Valley's operations and customers by bringing best practice and investment to support and enhance the service the company provides and by sharing the savings we can generate. We are looking forward to engaging with the customers and Welsh regulators and bring- ing our skills in water services to Dee Valley." UK water sector leader at consultancy PwC, Richard Laikin, tells Utility Week "it is not surprising that Dee Valley has found itself being acquired". The water-only com- pany had a particularly challenging PR14 settlement from a cost perspective and it has a high cost of capital, he says. In its financial report for 2015/16, the firm reported reduced revenue, down £1.5 million to £23.1 million. It put this down to a reduction in prices at the PR14 final determination. On the morning of the announcement – Wednesday 16 November – shares in Dee Valley soared, from 1,530 pence the previous close to 1,684 pence. The deal also helped Severn Trent buck the trend of the FTSE 100, which was down overall on that day. Laikin suggests that one of the more inter- esting points in the offer is that Severn Trent intends to maintain a separate Welsh licence for Dee Valley, and that the whole of its busi- ness in Wales will be regulated under Welsh government policy. The implication of this, he says, is that there will be a more "sensible alignment" of the administrative borders for regulatory and policy oversight of the sector. "Plus it potentially de-risks part of Severn Trent's business, as the Welsh government's current water sector policy is less pro- competition than the English government." With the consensus being that further mergers and acquisitions are on the cards, who could be next? Laikin says: "The fact that the last two whole-business transactions in the sector have been consolidation plays as opposed to sales of partial stakes among investors may embolden other companies to attempt mergers. The obvious geographical area for this continues to be the patchwork quilt of companies in the south of England." Severn snaps up Dee Valley Severn Trent has bought rival water company Dee Valley Water in a takeover deal worth £78.5 million. Lois Vallely looks at what it means for the companies involved and for the wider market. Ones to watch Thames Water and Affinity/Sutton and East Surrey/South East – Thames Water is the largest of the UK water companies in terms of customer base, and shares a supply area with Affinity Water, Sutton and East Surrey Water and South East Water, any of which could be an acquisition target as a result. Southern Water and Portsmouth/South East/Affinity – Southern Water is another large southern water and wastewater company. It also shares a supply area with Affinity Water and South East Water, as well as Portsmouth Water – any of which could be an acquisition target. Wessex Water and Bristol Water – there has been a great deal of speculation that Bristol Water could be sold. Considering the companies already share a business retail brand, and a supply area, Wessex Water is a feasible buyer. SUPPLY AREAS SEVERN TRENT SHARE PRICE, FIVE DAY DEE VALLEY SHARE PRICE, FIVE DAY Dee Valley Severn Trent 1,800 1,700 1,600 1,500 16 Nov 17 Nov 19 Nov 21 Nov 2,250 2,200 2,150 2,100 pence 16 Nov 17 Nov 19 Nov 21 Nov pence