Utility Week

12 | 15TH - 21ST DECEMBER 2017 | UTILITY WEEK Policy & Regulation Analysis I n 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. Before 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 Air- ways. Severn Trent, by contrast, was por- trayed 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 para- mountcy of their core business – which, aer all, pays not only the bills but also the divi- dends. Consequently, the regulatory process is crucial. Every water company bar none is totally focused on the 2019 periodic review, the impact of which 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 – its underlying ambition was to become a global water company. It was already in the process of acquir- ing 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. 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 sub- stantial gearing up, which minimised corpo- ration 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 com- pany to be awarded Ofwat's exalted "excep- tional" status. Thames' situation is rather different. It was acquired by top German energy com- pany RWE in 2001 – a deal that never really worked out. Subsequently, it was bought by a private equity consortium led by Austral- ia's Macquarie. Over the next decade, the high-debt – now about £11 billion – and low-tax model A tale of two water companies Twenty-eight years after the privatisation of the water industry, Nigel Hawkins looks at how Thames Water and Severn Trent have gone in different directions. was controversially adopted. 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, while 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 sub- ject of several million pounds-worth of fines for failing to meet certain requirements. Ofwat's deep concern led to a recent "fishing expedition" under chairman Jonson Cox into Thames, focusing specifically on the company's 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 back to the 1980s. Thames must be approaching the next periodic review with a sense of forebod- ing. Its most realistic hope is that it will be included in Ofwat's "slow-track" category – unless Marchant can turn around its reputa- tion 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 £20.40 today. Unquestionably, the big gainers from Thames have been its private equity inves- tors led by Macquarie – which sold out ear- lier this year. Consumers in both companies' areas, and elsewhere, have faced sharp price increases since 1989 as the investment backlog has been tackled. In Thames' case in particular, that task remains unfinished. For the two sector heavyweights, it has been 28 years of contrasting fortunes. Nigel Hawkins, director, Nigel Hawkins Associates

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