What did Sarah Bentley, the now ex-chief executive of Thames Water, mean when she warned repeatedly in her final months in the job that England’s largest water and wastewater company had been “hollowed out over decades”?
A benign(ish) interpretation is that she was merely reprising what everybody has known for years: that Thames was rinsed by its former owners, most notably the Australian financial outfit Macquarie, which was the dominant shareholder from 2006 to 2017. That was the period in which the company’s borrowings were increased towards today’s towering level of £14bn and the regulator Ofwat was reduced, more or less, to appealing for Macquarie to get out and make way for more far-sighted owners.
Or was Bentley signalling that the hollowing out was worse than feared and now imperils the eight-year plan that was launched in March 2021 to “transform our company from an underperformer”? Have, for instance, the financial assumptions of two years ago been blown apart so that the newish shareholders – who injected £500m as recently as March – now fear they would be throwing good money after bad if they advance the next £1bn slug?
In the absence of clear messages from the company, its shareholders or Ofwat, one can only make assumptions about how Thames could have deteriorated so suddenly to a point where the Treasury is panicked. Problem No 1 is well known: the inflationary backdrop, which is plainly an issue when the interest on slightly more than half your debt is linked to the RPI measure.
But the less-publicised second problem may be heaping uncertainty upon uncertainty: it is the huge investigation by Ofwat and the Environment Agency to determine whether the industry was not treating as much sewage as it should have been at 2,000-plus treatment plants. Six companies, including Thames, are under specific attention and every legally constrained regulatory hint has suggested a major scandal. “From what we have seen so far, the scale of the issue here is shocking,” Ofwat’s chief executive, David Black, said last summer.
What’s the potential bill for that one? Fines – if they’re what’s coming – may be the lesser part. A bigger headache would arrive if Thames et al are ordered to upgrade their plants to handle the quantities of sewage that they claimed in the first place. That is how the system is meant to work: the cost of new infrastructure is largely funded through water bills, but it’s up to companies to maintain their assets to the required standard.
Thames’s regulatory capital value (RCV), or the value of its assets as agreed with Ofwat, was £16.6bn in its last set of accounts. If, in fact, those assets require repair at the company’s expense, one can see how financial problems could multiply. Both parts of the gearing equation – which Thames likes to present as akin to a mortgage on a house – would be moving in the wrong direction. The assets wouldn’t be worth what was assumed, and the cost of financing would be rising.
A key feature at Thames is that gearing was 80.6% a year ago versus Ofwat’s notional norm of 60% for a resilient company. Thus one can understand why the government feels it has “no true grasp on the costs” and fears a funding shortfall could be as much as £10bn, as reported by the Guardian. Householders threatened with negative equity know the same feeling of despair and uncertainty.
Yet the question of who should pay for any financial reconstruction of Thames is surely simple: shareholders and bondholders are on the hook. Both groups knew the rules, or should have done: in extremis, shareholders get wiped out and bondholders take haircuts.
One can feel a sliver of sympathy for Omers and USS, the cuddly pension fund-types who arrived as shareholders as Macquarie departed and spoke the regulator-pleasing language of long-term investment horizons. They probably rue the day they got involved with Thames.
Ultimately, though, it was up to them to assess the risks in backing a company that had been through the financial wringer for 20-odd years, even before Macquarie’s ill-starred stewardship. As for the lenders, if they wanted true risk-free returns in the UK, they should have bought index-linked gilts. As the admirable Feargal Sharkey says, it would be disgraceful if a penny of public money is spent on bailing out Thames’s financial backers.
Ministers are said to be worried about the effect on foreign investment in UK infrastructure if the worst happens, but need to get a grip quickly. Not every water company is in Thames’s dire condition. Even Yorkshire, also at the aggressive end of the financing spectrum, has been able to raise capital from shareholders. Thames Water’s shareholders and bondholders must divide the financial pain between themselves.
