Published on the day the FT broke the story that USS had written down £600m of its investment in Thames Water, EDHEC point to what went wrong and how it could have been avoided by better analysis of available data.

Presented as a large utility epitomising the “stable and predictable” cash flows of the infrastructure asset class, the investment in Thames Water was impaired by almost 30% in December, an abrupt and unexpected loss of approximately GBP1.5bn for investors including UK, Japanese and Canadian pension plans. Only nine months earlier, in March 2022, some investors were still increasing the valuations, but for such a large water utility to lose so much value so fast, the investment must in fact have been mispriced for several years.

The research shows that a straightforward comparative analysis reveals the emergence of a high-risk, low-return profile that should have raised at least three red flags:

• Red flag #1: The company should have been expected to take on too much risk as it faced ‘twisted’ incentives in the shape of an extremely low weighted average cost of capital imposed by the regulator.
• Red flag #2: The company created not only a structure to extract a lot of cash but also a huge debt pile – it should have been clear from 2016 onwards that there will be no payout for many years.
• Red flag #3: Thames Water’s exposure to key risk factors was always high compared to its peers and increased over time: this implied a much higher discount rate and lower value than what was reported until the company’s value was brutally reduced by 30% last year.

The research shows that benchmarking the key characteristics of the asset would have provided a much better understanding of its risk profile. Using a comparable set of what a typical company with the same characteristics as Thames Water is like in terms of risk factor exposure, duration and likelihood of dividend payouts, the paper shows that that the firm is likely to have lost between 30 and 50% of its value over the past decade.

Commenting on the paper, Tim Whittaker, Research Director at the EDHEC Infrastructure Institute and Head of Data Collection said:

“This case study underscores the importance of a relative/comparative view in assessing asset valuation and risk. Investors in Thames/Kemble Water, rather than isolating their focus, could have benefited from a comparative approach. Identifying red flags sooner and achieving a better assessment of the risks involved would have been possible through a broader comparative view.”

A copy of the research publication can be downloaded via the following link:

Low Tide: Benchmarking Risks in Infrastructure Investments: What the data showed about Thames Water.