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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is an investor, a former partner at Apollo and the author of ‘Two and Twenty’
The looming prospect of a restructuring. A mountain of distressed and defaulted debt laced with derivatives. Shareholders writing off their stakes after describing a hugely important business as “uninvestable”. Dividends paid out through a complex and opaque corporate structure while the operations fail to serve customers properly.
No, we are not talking about a private equity case study of a risky cyclical business where things went wrong. Rather, this is the bitter reality of what should have been a bulletproof infrastructure investment: Thames Water.
It has been easy to assign blame. Management, investors, regulators and politicians deserve their fair share. The grim future faced by millions of customers was many years in the making — and it was not down to a single issue such as a period of high interest rates.
The potential failure of this investment by the private sector in a natural monopoly providing a critical resource for human life has been hiding in plain sight. A financially disastrous capital structure ensured there might be scant value left for the investors involved and plenty more pain to come for customers with nowhere else to turn to for their water supply.
What is striking is the urgency of the need for the next government to tackle the problem head on. It needs to focus on precisely how much money is really required to upgrade the Victorian-era sewers, fix the pipes and stop the seemingly endless stream of sewage dumping scandals.
This core assumption is perhaps the elephant in the room. And once this number range is checked and bounded with independent verification, the required budget should be made public. Transparency is the least that customers facing escalating water bills deserve: a clear plan absent of financial engineering and legal jargon that lays out the money needed and who will pay for it.
Ownership of UK water companies has long been the preserve of specialist infrastructure investors attracted to stable assets with predictable cash flows that promise a regular cash return. Quite astonishingly, however, it seems that the key ingredient missing in the infrastructure investors’ approach to Thames Water has been to invest enough in the infrastructure.
Similarly, a critical input missing from the regulator’s involvement in overseeing Thames Water to date has been to adequately scrutinise and finalise a realistic budget for capital expenditure and maintenance costs. There needs to be a clearer long-term budget, one that is not a hopelessly moving target. For many years, the discussions between the company and the regulator have looked like a chaotic carousel of underperformance where investment plans are insufficient, service levels disappoint, fines stack up and yet somehow both spills and dividends keep flowing with alarming frequency.
In this context, perhaps the election this week comes at a welcome juncture. Perhaps a comprehensive reset of the situation — from ownership structure to capital structure to regulation — is what Thames Water needs and the public deserves.
The next government will have a natural break point to recognise the problem and take the essential next step. It is likely to require political effort at the centre to find a solution that may involve new private investment or a mix of public and private money.
To somehow maintain a version of the status quo with tweaks around the edges — a new shareholder here or there but with the key issues of insufficient investment and poor service quality effectively kicked down the road — would be a terrible waste of the opportunity presented by this crisis.
A private sector investment in water should not end up with a binary outcome: either win big for decades with double-digit annual returns or slip towards financial administration, with the companies being broken up or sold or nationalised.
And this applies not only for Thames Water but also for other water companies facing escalating interest payments and investment needs. It makes sense for incoming ministers to get this right before the sector faces a kind of contagion in sentiment, if worries over one company spread to another.
When banks or insurers fail, there is no shortage of political interest in a rapid solution to the mess. The potential wipeout of the UK’s largest water company is not something that can be shaken off as simply a problem for its shareholders.