Water - where the money is

Historically, investment in the water industry was considered a bit dull but safe with low returns. That view has changed. There is now a growing understanding of the potential for profits, writes Sally Nash.

UK water companies are perceived as low-risk, regulated and nicely profitable. It is no surprise then that UK water is currently hot news with bidders fighting to buy. There is no shortage of eager investors, and most are foreign.

This year, foreign investment in the UK water industry has intensified following Aquas de Barcelona's move to snap up Bristol Water in the spring for £165M.

After that, the floodgates opened. Thames Water's German parent, RWE, accepted an £8B bid for the utility from highly acquisitive Australian bank Macquarie (in what would be known as another "macquisition"). And AWG, parent of Anglian Water, is recommending its shareholders accept a £2.2B bid from Osprey, owned by Canadian and Australian pension funds.

Potential buyers for British water assets are Alinta, an Australian energy group; Terra Firma, a private equity firm; Qatar Investment Authority; and GIC, a Singaporean investment group.

Who are the potential targets? Well, London brokerage firm Arc Securities believes that Terra Firma, having lost on the Thames deal, could switch its attentions to Severn Trent Water. At the same time, Dresdner Kleinwort has stated publicly that "any of the UK water (companies) could be targets for financial buyers". United Utilities, for example, could be a potential target. Others include Kelda, which owns Yorkshire Water; Pennon, owner of South West Water; Southern Water and Northumbrian Water Group.

It is clear from the pattern
of interest so far this year that private equity groups and pension funds, particularly from Australia and Canada, have been showing the most interest.

But, of course, contractors are getting in on the act, too. Black & Veatch (BV) has just bought MJ Gleeson's engineering division (WET News, November 2006). The acquisition has resulted in BV gaining £170M worth of new UK water business, having paid just £36M for the division.

So what is it about the nature of the UK water industry that makes it so attractive to investors? Macquarie's chief executive, Alan Moss, recently stated that part of the attraction was that the utilities sector is "safe" with "growing profits".

Water UK's director of communications, Barrie Clarke, told WET News that there were several key reasons as to why UK water firms were so appealing.

The first is that they are perceived as relatively low-risk. So steady returns - returns on water assets tend to be around 5-6% - and the ability to produce consistent results along with steady advancements on behalf of the customer contribute to the overall view that UK water firms are a sound investment, says Clarke.

Another factor is the current availability of funds at low rates in the capital market. And investors such as pension funds see ongoing returns into the future.

Capital programmes
While, historically, water was considered a bit dull but safe with low returns, that view has been reassessed. And there is an appreciation and growing awareness that a business of this kind has a long-term value and potential for delivering good returns, adds Clarke.

Black & Veatch's John Wild, who has been involved in offering technical due diligence services to clients involved in water utility acquisitions, says: "The main attraction of the UK water industry to investors is the guaranteed income stream from the regulated side of the business, coupled with a substantial programme of capital investment."

Although the industry is heavily regulated, it is essentially a low-risk investment. History suggests that water utilities will find ways of out-performing the challenging targets set by Ofwat for AMP4, and that there will continue to be substantial capital programmes in AMP5 and beyond. Investors are interested in the medium- to long-term and are not "in it to make a quick profit".

The industry is well placed to meet the future demands of a growing population and a changing climate, adds Wild. "Opportunities for B&V will continue to arise from the ongoing need for investment both in new technology and in capital maintenance.

"New ownership of utilities will have little impact on these requirements other than through the continuous drive to more efficient procurement and delivery of services."

However, Water UK's Clarke questions whether investing companies are only in it to make a quick buck or if they are willing to invest in the industry. The short-term problems with things such as leaks are well documented. But will these companies invest in researching and developing technology that will meet the future demand of a growing population and a changing climate?

"There is no simple answer to that," admits Clarke. "Business is business after all and the role of investing companies is to look for good returns. They will want to make sure the companies continue to be well run and financed and that they are delivering on the requirements so it is back to the regulatory system."

Customer needs
Clarke believes that as well as regulation, investing companies will have to pay attention to the needs of customers, who will continue to demand good service.
John Aldridge, from trade association British Water, is not sure about the motives of the investing companies. "They have to invest a certain amount because of the regulator but will they go beyond that? Will they be willing to invest or do they simply want a regular yield of say 4%? I don't know."

Likewise, would Osprey, which is buying Anglia, be willing to invest in the UK or just take its 4% a year?

Aldridge points to what has already been happening in water company acquisitions. RWE, says Aldridge, did not invest greatly in Thames Water and "probably stripped quite a lot out".

So UK water companies are attractive, particularly to foreign investors and we can expect more acquisitions and takeovers to take place in the industry.

Susanna Trostdorf, a senior credit analyst at Henderson Global Investors, says that it is looking at "what other deals could occur and which companies would be a target, given the interest for private equity sponsors to buy water companies".

But what, if any, is the impact on contractors? According to the 2003 Black & Veatch Round Table - Water Company Ownership: Does it affect asset delivery and customer service? - the debate concluded that ownership did not affect asset delivery and customer experience because the protection offered by a robust system of regulation means water businesses are able to deliver their statutory goals regardless of ownership model or change of ownership.

From the contractor's
point of view, however, it was noted that during a change of ownership, water company resources may become distracted from capital programmes, which may temporarily affect projects - but ultimately not the delivery of regulatory goals.

Carol Hickman, executive director at the Society of British Water & Wastewater Industries, says that consolidation seems to be an inevitable part of life in the construction industry and offers both opportunities and threats. "The difference in the water sector though, is the role of Ofwat, who may see particular consolidations as undesirable - they would certainly reduce competition even further. Whether we benefit or lost out because of consolidation, we are relatively powerless in influencing it."

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