WSubsequent banknotes in England and Wales were always to be significantly increased in value. The problem was the degree. Ofwat has come up with a figure that roughly represents the amount of money that around three-quarters of businesses need to fund their regular operations and build new projects.
The stock price reactions of the few remaining companies on the stock market always provide the best immediate guide to this hellishly complex five-yearly regulatory decision. Despite a bad day for the market as a whole, Severn Trent and United Utilities were the two best performing companies in the FTSE 100 index. Mr Pennon, owner of South West Water, also joined the FTSE250.
That reaction is understandable, given how much the economic regulator has changed between its July draft and Thursday's final version. The total spending allowance for the sector, to be funded from notes, has increased from £88bn to £104bn over the next five years.
Around £7bn of the difference was explained by requests from the Environment Agency since May to add certain additional projects, and Ofwat had no choice but to grant funding for them. The rest relate to judgment issues, for example around a company's cost of capital, which Ofwat said has been revised upwards to be “in line with market expectations”. This is a “positive” result for the listed trio, agrees analysts at Barclays and Jefferies.
Some believe the government will be overjoyed. For most water companies, including most of the companies not cited, there is no question mark over “investability,” a term industry lobbyists use to scare ministers and regulators. Bondholders and shareholders should run for the hills, like United Utilities, which asked for a 36% increase in the amount of its bills and got 32%, and Yorkshire, which asked for 46% and got 41%. Probably not. The magnitude of this correction is normal for such price movements.
But then along came Southern Water and Thames Water, two representatives of the sector. The former, which currently leaves tens of thousands of customers in Hampshire suffering from power outages, wants to see their ridiculous pre-inflation bills rise by 83% over five years, and won 53%. Thames claimed 53% and won 35% at the same time as being fined £18m for outrageous disregard for dividend payment rules. In either case, the final bill increase may be slightly higher, but it is clear that Ofwat has little faith in a company's ability to actually build a particular project, so they are not willing to spend the associated funds upfront. It is clear that it was not granted.
Thames and Southern Rivers, like everyone else, are free to go to the Competition and Markets Authority to challenge Ofwat's calculations. But both debt-ridden outliers would do well to think twice. From a sector-wide perspective, beleaguered Ofwat has set its bills at a level that allows the average company to spend more on things like storm flooding. Investors will face further pain if the Southern and Thames Rivers fail to meet average expectations.
In the case of Thames, we are talking about the scale of the haircut for bondholders, as current shareholders have already been wiped out. Smaller 'B' classes trade for pennies in the pound. The 'A' class represents approximately £15bn of debt, or approximately 70p in pounds. If you crunch the numbers, you'll end up with a write-down of around £5bn. If that is not enough to raise more than £3bn of new equity capital, bondholders will have to take an even bigger hit. If Thames were still a listed company, the market would have forced a financial restructuring years ago.
None of Thursday's compressed numbers will satisfy lobby groups that want the entire sector to be renationalized. But the government has no appetite for such a venture, and is even afraid of putting the River into special management, otherwise known as temporary public ownership. So the current setup is a dead end for us, at least until Sir John Cunliffe's new Water Commission makes a different recommendation.
But this is perhaps the industry's last chance to regain public trust after years of pollution scandals and hiked dividends. Ofwat did what was politically expedient and pushed the public's tolerance for bill increases to the limit. It's time for the investors behind Southern and Thames Rivers to stop shouting and accept the reality of a haircut and an unusual injection of capital. Please continue.
