(Bloomberg) -- The UK’s biggest water and sewage company could be broken up, listed on the stock exchange, or forced to cap its debt under special measures set out by the regulator on Thursday.
Heavily-indebted Thames Water will be put into a Turnaround Oversight Regime to ensure it can fix chronic leaks and sewage spills, according to the draft ruling. Ofwat also limited the amount Thames can hike annual customer bills to £535 ($688) per household, in line with the average increase for the industry. But it’s well below the £627 proposed by Thames.
The special measures are an attempt by Ofwat to prevent Thames from being temporarily nationalized. The regulator will closely monitor the utility, which is in crisis after shareholders halted new equity injections in March and its parent company defaulted on its debts.
Thames now needs to use the ruling to find new shareholders who are prepared to stump up at least £2.5 billion in equity to secure water supplies and stop chronic leaks and sewage spills across London and Oxfordshire. It’s a tough sell for investors though and analysts said the company may well still end up temporarily in government hands.
If it can’t attract new investors or convince Ofwat to increase returns before its final ruling in December, Britain’s biggest water company will run out of money by the end of May.
Not Enough
The move is unlikely to be enough to prevent a government-led special administration, said Tim Whittaker, research director at the EDHEC Infrastructure & Private Assets Research Institute.
“The special measures regime makes higher prices contingent on performance – which we all know is lacking – I can’t see investors wanting to put more equity into the business as it stands.”
Thames said it’s “taking stock of our turnaround plan under our new leadership and reflecting on our progress to date,” according to a statement.
The company will be in special measures until the board can convince Ofwat it has adequate financial resilience, according to the regulator.
This could mean introducing a limit on the amount of debt the company can take on, a separation of the business into two or more water companies, or looking to a public listing to secure additional equity. An independent monitor could be appointed with full access to company files to report to Ofwat.
Overnight, ratings agency S&P said it would scrutinize Thames Water for a potential downgrade. That would put the utility into the category of “junk”.
Investor Returns
Key to Thames’s chance of survival is the return on equity rate. Ofwat indicated it would allow water companies to pay investors a 4.8% return on equity needed for infrastructure investments. That’s below the 5.7% Thames said it needs to find new sources of cash.
The return on equity is the rate water companies can pay shareholders for infrastructure investments like fixing leaking pipes. Firms like Thames have long argued that investors need a reasonable return to make water an attractive sector. It’s a balancing act for Ofwat, which has to avoid saddling consumers with huge bill increases.
While Ofwat raised the return on equity rate from its earlier view in 2022, it’s a “minor concession”, said Paul Vickars, senior credit analyst at Bloomberg Intelligence. He said the special measures were likely a precursor to special administration.
“This does little to reduce the risk that Thames won’t be able to attract the equity it needs to fund its plan,” he said.
Ofwat specified it’s view that Thames now has “significant funding and the opportunity to turn its performance around”.
The draft ruling was announced among hundreds of pages of documents published on Thursday setting out price controls and performance metrics for all 16 water and sewage companies in England and Wales. The plans are important for all companies but for Thames it’s crucial.
Rising Bills
Under Ofwat’s plans, bills will rise by £19 a year over the next five years, across the industry. That’s a third less than the increases requested by companies.
Thames’ budget was set at £16.9 billion with about 20% conditional on the company demonstrating it has sufficient equity investment available. In total companies will be allowed to spend £88 billion over the next five years, far less than the £104 billion companies had requested.
Ofwat branded Thames’s business plan as “inadequate” and said it would incur a £140 million fine unless it improves. The watchdog criticized Thames for lacking ambition on cutting pollution from storm overflows in the sewage network, sewage spills into people’s homes and stemming chronic leaks.
“Thames’s business plan was late, it was incomplete, it didn’t contain lots of stuff that the Environment Agency said it should have contained,” said Chris Walters, a senior director at Ofwat. “Parts of it certainly did not have the assurance of Thames’s own board and it’s difficult for us to stand behind a plan that a board won’t stand behind.”
Ofwat also said Thames was “unreasonable” in planning to have a gearing ratio of 70.35% in 2030, far higher than the 55% Ofwat demanded. The regulator announced today that companies cannot pay dividends if they have a gearing above 70%.
How Debt and Sewage Pushed Thames Water to the Brink: QuickTake
“Let me be very clear to water companies. We will be closely scrutinizing the delivery of their plans and will hold them to account to deliver real improvements to the environment and for customers and on their investment programs,” said David Black, chief executive officer of Ofwat.
Water company bosses met with Environment Secretary Steve Reed on Thursday and signed up to his plan that aims to to attract more investment, create jobs and clean up the nation’s polluted waterways, according to a statement.
(Updates details of meeting in final paragraph.)
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