“We continue to view Thames Water as a long-term investment,” said the Universities Superannuation Scheme (USS), the £75bn pension fund for UK academics, as it wrote down the value of its stake in the Thames’ parent by nearly two-thirds, or almost £600m. Top marks for cheerfulness, but it’s a line that recalls the old joke about the definition of a long-term investment: a short-term investment gone wrong.
USS and Canadian pension fund Omers, the other late arrival on Thames’ register in 2017 (they replaced the departing Macquarie and its co-travellers), surely cannot have imagined that the long term would stretch quite so far over the horizon. As USS says, it’s taken no dividends so far, and the current business plan imagines no income for shareholders until 2030 at the earliest. That’s a near-eternity in investment terms for utility assets, which are supposedly prized for their ability to generate steady cash.
“What could investors have known beforehand?” asked a paper published on Wednesday by Edhec Infra, a research institute and data provider. Quite a lot, it concludes, noting three “red flags”.
First, what it calls “twisted” regulated incentives encouraged overborrowing. Second, there was so much debt in Thames that it “should have been clear from 2016 onwards” that there would be no payouts for many years. Third, a combination of high debts and underinvestment meant Thames had become more risky than its peers: underperformance, high costs and fines would happen “sooner or later”.
USS and Omers might reasonably argue that Edhec Infra’s analysis is written with the benefit of hindsight. That’s true. And it’s also the case that the regulatory system re-sets every five years, with new allocations made for capital costs, bills, capital expenditure and so on. So any backward-looking analysis uses data that couldn’t have been assumed at the time. And it’s fair to day that higher energy costs and inflation haven’t helped in the past two years.
All the same, the researchers are surely right on the basic point: buying out Macquarie, circa 2017, was a high-risk punt even at the time. Public anger with water companies and the state of the waterways was already intense. The Ofwat chair of the day, Jonson Cox, was venting his feelings by writing open letters calling for “a step change” in the way Thames “operates and behaves”. Regulatory run-ins and court cases were becoming more common, including one where a judge whacked Thames after a major spillage of raw sewage and said: “It should not be cheaper to offend than to take appropriate precautions.” In short, the tide was already turning in 2017.
That is why it is hard to muster any sympathy for the late-arriving shareholders. Yes, a lot of damage was done in the decade of dividend extraction under Macquarie’s ownership, as is widely recognised, but the 2017 vintage entered with their eyes open, or should have done. It looks as if they simply overpaid and underestimated the effort and catch-up investment required. Not every water company is in a Thames-like mess.
One can also speculate, as Edhec Infra’s analysts don’t, as to whether Thames’s fragmented ownership has been a factor. Omers, with 32%, and USS, with 20%, are the biggest shareholders, but the cast also takes in the governments of Abu Dhabi (10%) and China (9%), the manager of BT’s pension fund (9%) and a second Canadian fund (9%).
It makes for a bloated 15-strong board at the level of Kemble Water, the parent. Six of the 15, according to the last accounts, also have “alternative directors to represent them when they are unavailable”. USS itself – on its home patch and more publicly associated with Thames – may be active and engaged. But the structure as a whole smacks of control by investment committees scattered around the globe, which is not obviously a formula for dynamism in a crisis.
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After the writedowns, the next challenge for the investors is whether to commit more capital, a question that will hinge in large part on whether Ofwat will accept a series of exceptional demands in Thames’ proposed business plan, including relief from fines and a 40% hike in customers’ bills. Given the recent history – pre and post-2017 – there is no reason for Ofwat to be generous.
