Some things never change: in spite of torrential autumn rain, seven water firms have yet to lift the hosepipe bans they set in place earlier this year. Yet despite this seeming inability to fulfill their only real function (supplying Britain with the water it wants), water companies are hot property.
Thames, the UK’s biggest water firm, has just been bought for £8bn by Australian bank Macquarie, amid competition from rival Australian group Alinta, Guy Hands’ private-equity firm Terra Firma and the Qatar Investment Authority. It seems Australia has a thirst for UK water. For regulatory reasons, Macquarie has just sold South East Water to Westpac, the Australian bank that already owns Mid Kent Water. Earlier this month, AWG (owner of Anglian Water) announced its sale to Osprey, a consortium led by Colonial First State, the asset management arm of Commonwealth Bank of Australia, and a group of other investors, including the UK’s 3i Group.
Overall, the “scramble for water assets” has now seen bidders put almost £12bn on the table, says The Daily Telegraph. But the buying frenzy isn’t over yet. The losers in these auctions may well be tempted to bid for one of the several other UK water companies, which are “ripe for takeover”. United Utilities, Severn Trent, Northumbrian Water, Kelda – the former Yorkshire Water – and Pennon, the owner of South West Water, are all seen as potential targets. As a result, their shares have soared by up to 50% over the past year. Expect to see “aggressive bids”, says James Harding in The Times: the fact that so many of the Thames bidders ended up frustrated “only increases” the possibility that there will soon be no quoted water assets left in the UK.
So what makes utilities look so good to bidders? The reliability of the returns they offer. The system of economic regulation imposed by Ofwat offers known rates of return over five-year pricing cycles, which is attractive to private equity and infrastructure funds. Their bids, says Nils Pratley in The Guardian, rest on hopes of financial engineering: the idea is to “load these water companies with debt and bank the difference between cheap money and allowed regulatory returns”.
The problem here is that this is just about the only thing that makes the water utilities attractive and bidding presupposes that Ofwat keeps playing along. The latest water price review, lasting until 2009/2010, was criticised for being too lenient, offering an after-tax return of 5.1%, says Sylvia Pfeifer in The Sunday Telegraph. One of the results of all this acquisition might be that it sets the next review lower. If so, the new water owners might “face a tough time making their figures add up”. And when they do, they may not find it that easy to unload their purchases. Ofwat discourages consolidation, says Angela Jameson in The Times, because of the need to maintain a number of independent firms “that can be benchmarked” to each other so the water companies can’t buy each other. And while energy firms used to be keen to buy into the sector, the model has proved unsuccessful, with few synergies available (hence the sale of Thames by German energy group, RWE) – so they won’t be stepping into the breach either. There may be more risk in the sector than bidders like to think.
There’s probably also risk in it for retail investors. All the good news about mergers is clearly reflected in water company share prices and that means there’s little money left to be made.