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US hedge fund Elliott Management has been buying the bonds of troubled British utility company Thames Water, in a bet that markets have grown too pessimistic over the size of losses that investors may have to take on the debt.
Elliott, which manages about $65bn in assets and is known for its aggressive approach to corporate and sovereign debt restructuring, had built a position in the heavily-indebted water company’s bonds at a discount to face value in recent weeks, according to three people with knowledge of the trade.
Thames Water — which supplies 16mn people in London and the surrounding area, or about a quarter of the population of England and Wales — has suffered a sharp drop in its bond prices after its parent company defaulted on its debt earlier this month.
Elliott’s bet is focused on the top-ranking bonds out of more than £16bn of debt within a so-called regulatory ringfence — which surrounds the core utility and means it has to abide by regulatory conditions. Some of these bonds are trading at little over 70 pence in the pound, as investors have grown more nervous about the potential for deep impairments.
One person with knowledge of the position said these levels were lower than Elliott’s worse-case expectations for these bonds, and the hedge fund firm believes the debt could potentially make it out of Thames Water’s present crisis unscathed. Two of the people said that Elliott’s position was relatively small and it was still evaluating whether to build it to a more material holding.
Elliott declined to comment.
Government contingency plans for a potential nationalisation of Thames Water, which has become a focus for public anger over sewage pollution and mistrust of England’s privatised water system, emerged last week.
They mooted that the £15bn of top-ranking bonds could face losses of 5-10 per cent in the event that the utility has to come back under public control. The £1.3bn of so-called class B debt, which is still inside the ringfence but has a lower-ranking claim on the company’s cash flows, could be hit with even deeper 35-40 per cent impairments.
While Elliott has a long record of distressed debt investing, it is best known in the UK for its activist equity bets, including pushing for change at pharmaceuticals group GSK and more recently at Scottish Mortgage Investment Trust.
Elliott is just one of a number of distressed debt investors that have rushed to buy Thames Water’s bonds in the belief that nervous fund managers are selling them for less than they are worth. The hedge fund has stayed clear of bonds at Thames Water’s holding company Kemble, however, which sit outside the regulatory ringfence and are trading at less than 15 pence.
While Elliott is known for its hardball tactics with creditors — for instance seizing an Argentine naval vessel during a protracted tussle with the Latin American nation — British water company legislation restricts the ability of bondholders to seize assets if Thames Water is unable to service its debts.
Instead, in the event of an insolvency, debt in the securitisation is secured on claims from the proceeds of a sale to a suitable owner. Present shareholders, which include the sovereign wealth funds of China and Abu Dhabi, last month declared Thames Water “uninvestable” and backtracked on plans to inject a further £500mn into the business.
These owners, which also include pension funds Omers of Canada and Britain’s USS universities scheme, are in a stand-off with regulator Ofwat over the amount of shareholder equity needed to support the water company, which requires billions of pounds to overhaul its ageing infrastructure, and the size of increases in customer bills that can be imposed.
Thames Water on Monday updated its business plan to increase the amount it plans to spend on its network to combat environmental issues such as sewage spills by £1.1bn to £19.8bn.
