Utility Week

UTILITY WEEK | 9TH - 15TH FEBRUARY 2018 | 19 Finance & Investment Analysis S ince the privatisation of the water industry, the number of water-only companies (WOCs) has been on a gradual decline. Even of those whose names have remained, several – such as Hartlepool Water and Essex and Suffolk Water – are now owned by larger water and sewerage compa- nies (Wascs). And life in the water sector is set to get a great deal tougher with Ofwat's forthcoming price review, PR19, which could see more WOCs get swallowed up. With companies in the throes of prepar- ing their business plans for the 3 September deadline, the sector may look to consolidate further as it searches for greater efficiency and cost savings. This is made more likely considering the regulator is setting a record- low weighted average cost of capital (Wacc) and companies are expecting to see revenues drop from 2020. PR19 has been billed as a challenging price review, with many companies expected to have their business plans slow-tracked or subject to significant scrutiny. WOCs could find themselves under especially intense pressure in PR19, as they have gener- ally higher costs of capital. This could prove particularly challenging given the uncompromising tone Ofwat has struck over the availability of derogations via the small company premium. All of this taken into account, it would be no surprise if a smaller com- pany welcomed the chance for a larger one to take the pressure off by buying it. PwC water sector leader Richard Laikin says: "Water-only companies had an issue during the last few price reviews for multiple rea- sons. But some are cheaper and more efficient than bigger companies." Referring to Severn Trent's acquisition of Dee Valley and Bournemouth Water's integration within South West Water, he suggests there is no reason why the "trend of mergers and acquisitions won't continue". "WOCs still have to produce a business plan, the same as the Wascs, but they have fewer people to do it with. PR19 will be tough for them as it will for everyone else. Inevitably there will be further acquisitions. "Some WOCs will argue they are closer to customers but the general trend is it's hard, and one or two will be acquired," he adds. However, striking a new deal within a periodic review could prove a risk too far. Utilities analyst Nigel Hawkins says: "At the time of privatisation in 1989 there were around 30 water companies. There aren't many le now in 2018." Although he acknowledges legislation has made it easier for acquisitions, he reckons it is "unlikely" we will see many of them this year, as it could be a "risky time" for the sector. But he suggests "every investor has a price at which they will sell". Hawkins also explains tough regulation has been affecting the share prices of the large listed companies, and that takeover activity in the water sector will be "curbed by the ongoing price review and Labour's dire threats to nationalise the water sector". "For water-only companies the periodic review remains para- mount. However, some funds may decide to reshuffle utility investments during 2018." Mel Karam, chief execu- tive of one of the UK's oldest water companies – Bristol Water – insists smaller firms are "the future". He tells Utility Week: "Smaller water-only com- panies are closer to the customers and communi- ties they serve. The proof is in the recently published UK Customer Satisfaction Index showing Bristol Water has legitimacy with its customers." He adds: "As long as there is a level play- ing field in the price review process, there is no reason why WOCs cannot perform successfully. Our agility and closeness to customers and our creative culture is a very strong competitive advantage." The largest water-only supplier in the UK – Affinity Water – says it is "committed to delivering a high-quality water service to its customers". The company prides itself on its community focus, having divided its supply area into eight different communities, "allow- ing it to service customers at a local level". For now, at least, it is business as usual for the water-only companies. Well, perhaps a bit busier than usual. Can WOCs survive past PR19? Will a tough PR19 price review period, planning for a record-low weighted average cost of capital, be the trigger for the water-only companies to be swallowed up? Katey Pigden investigates. Previous M&A activity Severn Trent and Dee Valley In February last year, the water sector saw Dee Valley become part of Severn Trent. The £84 million deal wasn't trouble-free, having faced opposition from some shareholders and a series of court hearings. But full clearance was given by the High Court on 13 February 2017 and, on completion of the deal, Severn Trent chief executive Liv Garfield said: "This is all about working together for the benefit of Dee Valley's customers." Bournemouth and South West In November 2015, the Competition and Markets Authority (CMA) unconditionally cleared the acquisition of Bournemouth Water by Pennon Group, and the subsequent merger of Bournemouth with South West Water. Pennon completed the £100.3 million takeover of Bournemouth in April 2015 and the deal was automatically referred to the CMA for an in-depth investigation in June that year. Pennon chief executive Chris Loughlin said at the time the combined business would provide "an enhanced platform for innovation and growth" ahead of market liberalisation in 2017 and "deliver tangible benefits to customers and shareholders". 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