In water industry circles, the Whitehall codename for the contingency plan for Thames Water’s failure has taken on a new meaning. Project Timber was so-called because of fears that the collapse of Britain’s biggest water company could have far-reaching consequences. But water wags have been humming Monty Python’s Lumberjack song, noting the risk Thames’s predicament poses to the company’s biggest shareholder, the Canadian pensions behemoth Omers.
The fate of Thames, which serves 16 million customers, hangs in the balance. Rishi Sunak has even parachuted in his business aide, the former Morgan Stanley banker Franck Petitgas, to oversee talks between Thames, the regulator, Ofwat, and the environment department, the Financial Times reported.
The immediate threat is a £190m loan owed by the water company’s ultimate parent, Kemble, which has caused its auditors to warn it could run out of money by the end of April, when it is due to be repaid.
Sources close to Thames believe that the loan will probably be reworked to “amend and extend”, giving Kemble a payment holiday in return for higher interest rates long-term. However, investors are pushing Ofwat to allow Thames to pay dividends up to Kemble to service its debts. Meanwhile, Ofwat may decide a £37.5m dividend paid in October was a breach of Thames’s licence and fine it.
Then there is the risk that insurers to Thames’s subcontractors pull their payment protection insurance, meaning those firms may demand cash upfront from Thames – creating a cash crunch.
Here are the main options on the table for the troubled utility company.
Shareholders step in
Kemble, which has an £18bn debt pile, is rumoured to be studying the option to bring in a new shareholder to inject further cash, diluting existing investors but staving off the threat of default. Its current backers include the UK university staff pension scheme, China’s sovereign wealth fund and a subsidiary of the Abu Dhabi sovereign wealth fund.
As Thames’s operating company, Thames Water Utilities, is ringfenced, it could also attempt to find new shareholders if Kemble defaults.
Another option would be for the directors of one of the intermediary companies in Thames’s byzantine structure to seek new investment to ensure that their entity does not go bust, reducing their personal risk of repercussions including becoming banned as a director.
Longer term, shareholders have demanded that Thames is allowed by the regulator, Ofwat, to increase bills by 40% to unlock further investment. The company has asked its backers for £3.25bn. However, it also faces potentially huge fines from Ofwat over its environmental record.
Debt for equity swap
Handing Thames’s bondholders a stake in the company in return for writing off some of their debt – a debt for equity swap – could buy the company some breathing space to operate. It could also mean the company effectively tapping up the same investors, as some of the current shareholders may also hold debt. Given that such a swap would dilute their shareholding, they may not be receptive to this.
Last year, bosses apologised to MPs for confusion over describing a £500m shareholder loan as equity.
If Thames’s credit rating slips even further, then “cash lock-up” conditions will apply – preventing dividends from being paid. If it loses its investment grade (falling below the Baa3/BBB rating) it would breach its licence conditions.
Special administration triggered by a cash crunch
This is the process that allows the state to step in to temporarily renationalise a company, as in the case of the energy provider Bulb, which was eventually sold to the rival supplier Octopus. Sources close to Thames point out it is a very different beast, with a mass of complex infrastructure, from struggling sewage works to a vast network of leaky pipes dating back to the Victorian era.
In infrastructure circles, private investigators have been known to be hired by interested parties to watch the doors of troubled companies to see if qualified administrators are spotted entering. With a Thames administration being widely discussed, it would be no surprise if a there were a few close eyes on its head office (the ironically named Clearwater Court in Reading).
Legislative changes to the water industry special administration regime, which came into force this week, have made it easier to put a large utility company such as Thames through this process while ensuring continuity of service for customers. Crucially, the rules have been rewritten to protect taxpayers, amid fears an administration would cost £5bn to keep the company running. Any state support issued would now need to be repaid, before even secured creditors.
Rapidly selling off Thames’s assets to realise funds would prove tricky. Likewise, selling the company in its entirety could be quite the task with billions of investment and a turnaround in operational performance needed quickly. The sector’s stronger players, such as Severn Trent, may consider reaching outside their monopoly areas. Alternatively an infrastructure investor – tempted by long-term returns as interest rates begin to fall – could step in. A sale closely managed by Ofwat, as it did with Macquarie’s 2021 acquisition of Southern Water, is possible.
Special administration triggered by officials
A remote but potentially explosive possibility exists under water legislation first hastily drafted as Margaret Thatcher privatised the industry in 1989: Thames being forced into administration for poor performance. If the company decides to halt investment to preserve cash, its substandard service could fall further.
Small print states that an administration can be triggered by government, if a company “fails to carry out its statutory functions or licensed activities to such an extent that it is inappropriate for the water industry company to hold its appointment or licence”. This is termed “the ultimate enforcement tool”.
In reality, an effective renationalisation of Britain’s biggest water company may prove too punchy a step for the government in an election year, with stern enforcement notices from Ofwat more likely.
Industry bosses argue a Thames administration would hurt investor confidence in the sector, detractors say any kind of bailout would send a “moral hazard” signal to other companies that the state will simply step in regardless of the risks they take.
‘Mini baby Thames’ – group of smaller mutuals
Campaigners for renationalisation of the water industry may like this idea, which has been floating around as interested watchers try to map out how an administration may shake out. The idea has been dubbed “Mini baby Thames”, taking its name from the Baby Bells – the group of regional telephone companies in the US in the 1980s – formed after AT&T relinquished its monopoly.
Sources studying Thames’s options suggest it could be divided along the lines of the seven existing charging zones across London and the Thames Valley and put into the hands of its customers.
Dieter Helm, a professor of economic policy the University of Oxford, argues that the easiest split is into two separate entities: “London Water” and “Greater Thames Water”. “It is widely recognised that Thames Water is too big to be effectively managed – too big in scale and too big in the multiplicity of functions,” Helm says in his recent analysis of the options.
