The River Thames at Sonning
Thames Water is in big trouble, but its internal problems are secondary right now to the impact its not being able to service its debt has on its shareholders, the largest shareholders of Thames Water include the Ontario Teachers Scheme, the BT Pension Scheme and the University Superannuation Scheme (USS).
USS published a paper on why it increased its stake in Thames Water in December 2021
The paper includes this statement
USS first became an investor in Thames Water in 2017, attracted by the opportunity to support the long-term investment needs of the business. This matches well with the outlook for pension schemes which need to take a long-term investment outlook in order to pay pensions for decades to come.
.At the time of the 2021 top-up acquisition USS claimed
This (Thames Water) will be the largest single investment in the £82.2bn (as at 31 March 2021) portfolio managed by USS’s investment management subsidiary
The valuation of its stake in Thames Water is open to question
Governance as clear as Thames Water.
What puzzles me about Thames Water is that for such a high profile business, it has such a history of poor behavior. The consistent fines the business has picked up for dumping sewage into the Thames impacted the price of its bonds throughout the last decade. As a private entity , it continues to pump sewage into our waterways, as I know only too well.
This is the my perception , but the perception of USS in December 2021 was quite different
With a strengthened board under CEO Sarah Bentley, and a new, experienced executive leadership team in place the company will target reducing leaks, investing in its infrastructure, improving customer service and working towards Net Zero.
Leak detection has already improved after major upgrades but the current five-year regulatory period includes plans for £10.7bn of investment. This covers upgrades to sewage works as well as connecting the network to the Thames Tideway tunnel. Meanwhile, the company has also rolled out a new billing system as well as offered more support to customers with affordability issues.
At the same time, Thames announced a detailed roadmap to achieving Net Zero by 2030 and carbon negative figures by 2040 through a combination of continuing to reduce emissions and increasing the amount of renewable energy it generates. Coupled with this, Thames has also developed resilience plans to help the company cope with the expected impacts of climate change.
The perception of customers is different, this photo was taken at Bourne End in 2013. Thames Water were then fined £120m by the Environment Agency. Not much has changed since then.
Filth in the River Thames at Bourne End – near Marlow.
And just as its environmental credentials are undermined by its poor operational practice, so are its governance credentials.
Thames Water claims “Our external shareholders have not been paid a dividend for the last five years”
But as Hall shows here that really isn’t the full story. Dividends are paid to a holding company that then distributes those to external stakeholders.https://t.co/RNN3ga1LOU pic.twitter.com/MI1eSKafh7
— George Dibb (@GeorgeDibb) June 28, 2023
Thames Water is in a mess , and everything we see about it is a mess. It seems a company that finds it hard to tell the truth. It’s governance is not what we expect from an organisation that sells itself on E, S and G.
The indebtedness of water companies
The attraction of pension schemes owning Thames Water shares is the long term income stream its cashflows produces/
Whether Thames makes outsized returns is difficult to measure. But cash transferred from the operating company to investors via interest payments and dividends over the past decade comes to about £4.1bn, according to S&P data.
A feature of Thames Water’s balance sheet is its indebtedness. It is not alone in this, the FT points out
After being sold with almost no debt at privatisation three decades ago, UK water companies have taken on borrowings of £60.6bn, diverting income from customer bills to pay interest payments.
Thames Water is however unique in the extent of its debt (£14bn). The shareholders get the dividends but three-quarters of that £4.1bn cash flow went as non-taxable interest payments to debtholders.
Customers (like me) pay bills that service debt – but the bills cannot go up as fast as the cost of that debt to Thames, that’s because much of its debt is inflation linked and linked to the wrong kind of inflation – RPI. RPI is at a historically wide premium to CPI inflation, which is used in pricing bills.
Those who play Monopoly know that utilities are extremely boring things to own , but underpin more racy investments. Thames Water has turned itself from a utility into a shonky financial instrument which is looking very high risk. This is a very long way from what USS thought they were buying in 2021..
What this means to pensions
The big fears investors should have about investing into private markets all seem to be crystallising at Thames Water. Here is a highly geared private company with an opaque dividend structure and a valuation that is based more on financial economics than its underlying activities.
The worry is that if the biggest private pension in the company, USS, along with several other large pension funds, could not see this problem coming – investing less than two years ago, what confidence should we have in any other pension scheme?
Those who argue for staying within the tramlines of listed securities will be able to point to Thames Water as an example of the risk of private market investment and with good reason.
It will be interesting to see how, if at all, shareholders are protected by a Government bail out.
Thames Water may be seen as too big to fail for its work to 15m customers. It may also be seen as such for its importance to the 20m workers saving for their retirements.
Want to understand Private markets better?
For those who want to learn more about the risks of investing in private equity, here’s a link to Ludovik’s excellent book.
A question for USS seems appropriate. Presumably, as the CIO Simon Pilcher told us last November, with respect to Thames Water “that has been a really good investment”, that they contributed pro rata (19.7% ca £100 million) to the £500 million of new equity reported to have been raised this year.
Can USS tell us the total amount of funds ‘invested’ in equity Thames Water, as well as whether they own any of the group’s debt instruments?
The failure of Tory privatisations to serve the public good writ large. The debt merchants have done rather well at the expense of the electorate, as per usual.
I think all those involved with pension scheme investment have to consider the possible lessons for infrastructure investments.
To me it appears the main risk highlighted appeared to be unforeseen regulatory changes affecting the assumptions on which the investment was assessed. In 2006, did the then investors correctly assume the requirement to update the capital infrastructure and the consequential need to service additional debt from the regulatory controlled receipts? Was this again correctly assessed by the USS in 2001 or is there just an assumption that infrastructure investment is a “really good investment” without a full assessment of the potential risks?
It may be that they did so and have factored in the additional capital subscription required to meet Thames Water’s future needs.
In either case, the lessons need to be learnt for all future investments.