Is it really possible to sell Britain's most hated company? You bet
it is
By Saeed Shah
Published: 16 August 2006
Rarely can a company that is up for sale have faced such a tidal wave
of bad publicity, fines from regulators and customers in uproar. But
its German owners RWE are pressing ahead with the sale of Thames
Water and they appear to be right to do so.
Yesterday, three private-equity consortia were believed to have
tabled offers of a mouth-watering £7bn for Thames, in the first round
of the auction. If RWE does not like the bids, it retains the option
of listing the business.
It seems that no matter how woefully Thames has performed despite its
huge investment requirements, it is a very attractive business from a
financial viewpoint, either for private-equity players or City fund
managers. Rather than make the company unsellable, Thames's
shortcomings appear to show why new ownership could provide a big
upside.
It is thought that bids were put in by Guy Hands' Terra Firma
vehicle, the Qatar state pension fund in partnership with UBS, and
Australia's aggressive Macquarie Bank.
Macquarie is also trying to sell or warehouse its South East Water
business as it tries to avoid regulatory hurdles that would stop it
buying Thames, according to reports.
The buyout group 3i and Canada's Borealis Infrastructure fund, which
had considered making a joint bid for the water company, are not
thought to have made it, but it may join one of the other consortia,
as may the Australian infrastructure investor, Alinta.
Part of the attraction of Thames is simply its rarity value - it is
easily the biggest water company - and the steady cashflow that a
utility can supply in a business world where certainty is
increasingly hard to find. Thames customers can turn to to no other
company for their water and sewage needs.
For private equity, a company with these reliable cashflow
characteristics and a huge asset base can be used to borrow heavily,
allowing them to leverage the business up and take out cash. The
model is already established with some much smaller water businesses,
including the Welsh Water business (now a not-for-profit entity) and
Southern Water, which is owned by Royal Bank of Scotland.
Henk Potts, of Barclays Stockbrokers, says: "The very steady earnings
stream means you can borrow heavily against it. That leverage makes
water businesses much more attractive to private equity than
shareholders."
Tim Steer, a fund manager at New Star, said if a highly rated
chairman and chief executive were put in place at Thames, it could
float successfully on the London stock market.
Undoubtedly another key reason for wanting to buy Thames is the
likelihood that anyone but RWE could do a better job of it. RWE is a
European utility giant with many other interests and demands on its
attention and money. In Britain, the company has a large energy
supply business, which also has huge investment requirements in the
coming decade.
One banker close to the auction of Thames says: "Thames is the
forgotten child of RWE. They [RWE] have not run it hard. It has the
feel of a government department. Any buyer would shake it up and cost-
cut like mad."
Financiers said the levels of returns allowed on water assets have
been set by the regulator Ofwat at a level that is tempting: 5.1 per
cent is allowed after tax for the current five-year period, which
runs from 2005 to 2010.
Under the rules, any investment agreed with the water regulator and
conducted by a water company is added to its regulated asset base. A
return of 5.1 per cent is allowed on the investment but the actual
cost of capital is significantly less, leaving an attractive margin
for the company. Over the five years to 2010 alone, Thames is
committed to invest £3.1bn in its creaking network.
Thames has to maintain 31,000 kilometres (19,300 miles) of water
mains and 66,000 kilometres of sewers, 100 water treatment works and
351 sewage treatment works, including the UK's largest at Beckton in
east London. The network is old and very difficult to maintain. It
has 13 million customers across London and the south-east of England.
Clive Roberts, an analyst at the broker Charles Stanley, says: "They
serve a tight-knit community in the Thames region. It is a highly
urbanised area. Customers are not spread out, as they are for other
water businesses, which makes Thames quite profitable per customer.
Also, should they want to cross-sell other products, it is a high-
income per-capita customer base."
Thames appears to hold the current crown for Britain's most hated
utility. It has missed the leakage targets for the third year in a
row. It is losing enough water every day - 894 million litres - to
fill 700 swimming pools.
The regulator Ofwat is so exasperated that it has ordered Thames to
spend an extra £150m of shareholders' money, so it will not be added
to the regulated asset base, to tackle the issue. That is more than
double the maximum possible fine which the regulator could have
imposed.
The extra expenditure will replace at least 368 kilometres of extra
mains in addition to the 1,235 kilometres which Thames is already
replacing in London, between 2005 and 2010. Ofwat is also poised to
impose a massive fine - of up to £140m - on Thames for failing to
meet customer service targets. The standards that Thames has missed
are understood to relate to guaranteed response times to complaints
and billing enquiries, the keeping of appointments, interruptions to
supply and sewer flooding. At the same time as being castigated for
poor performance, Thames has imposed a hosepipe ban on customers and
applied for a drought order. All this when it has just reported a 31
per cent jump in profits and is putting through a 24 per cent
increase in prices over 2005 to 2010 (excluding inflation). No wonder
customers are in uproar.
Ofwat said in June: "Given its current leakage performance, we are
concerned that the company may not meet future leakage targets or its
security of supply commitments ... poor leakage performance is not
only inefficient, it is also contributing to water shortages that
have led Thames Water to impose a hosepipe ban and seek a drought
order."
Of course, Thames has had to contend with very low rainfall for two
consecutive winters, but customers and the regulator see management
failings. For RWE, Thames has become a PR nightmare, but it has done
very well out of the business. It bought Thames for £4.3bn in 2000
and during its ownership it has taken out roughly £1bn in dividends.
It now looks set to bag £7bn from the sale of Thames, giving RWE a
great return on its ownership of the business. The fines, as large as
they are, are not going to make a lot of difference to the valuation
of the business.
RWE and its financial advisers, Goldman Sachs and Deutsche Bank, will
decide over the next couple of weeks about whether to go for a
listing or take one of the offers. Selling to private equity would
provide a quick, clean exit for the German utility.
Thames may have failed its customers spectacularly, but for RWE it is
about to provide a flood of cash.
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