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One test in journalism is whether you can successfully explain the story you are writing to your mother. In business leadership, it is whether you stand a chance of explaining yourself to a parliamentary committee who are out for blood.
Good luck to Thames Water, then. The debt-laden utility will this week face MPs to explain why a £500mn equity investment from shareholders came into the group in the form of a convertible loan, paying 8 per cent interest.
The answer — which judging by Thames Water’s recent letter to the select committee seems to be: our private equity owners prefer to put in equity in the form of loans and, actually, it doesn’t matter anyway — may meet with some scepticism. The hearing will also look at the recent payment of £37.5mn in dividends from the water company’s regulated operating company up into the upper reaches of its convoluted financing structure. This is particularly important to the future of a company that increasingly looks to be in a downward spiral.
The company has a point on the funding. Despite the fact that the shareholder loan is clearly a liability in the top holding company accounts, and enters the Thames Water operating company as a repayment of an “intra ringfenced group loan”, it is equity where it matters — at the operating level. It is treated as such by credit rating agencies. Private equity likes to make everything as complicated as possible, often for tax reasons. In this case, some tiny sliver of seniority may have appealed given Thames’s dire straits.
Investors in Thames’s long-term debt at the operating level, like pension funds, are unlikely to have concerns: investors in the ringfenced entities that make up the operating group are protected from whatever shenanigans go on above in the holding companies. None of this really makes it easier to explain to politicians or the public, however — which is an issue when you’re a huge utility supplying a basic human resource.
More importantly, you can’t detach Thames’s unwieldy corporate structure from the company’s predicament and the regulatory failures that got it here. The convoluted set-up is a legacy of former owner Macquarie and other ex shareholders’ extraction of value using debt raised from the holding companies. That debt, mostly at what is called Kemble Water Finance, is serviced using dividends sent up from the regulated operating company, hence the £37.5mn.
Thames Water points out that its current owners haven’t received an external dividend for several years (or interest payments on their shareholder loans). The owners don’t plan to receive dividends or similar payments until at least 2030.
But just as equity into the operating group is arguably equity regardless of its origin, dividends are sucking cash out of the utility regardless of where it ends up. KWF does have a working capital facility but, essentially, the flow of dividends up from the operating company to pay its debts is what is keeping the show on the road. And that is getting harder.
This certainly demonstrates the nonsense of a regulatory approach that focused solely on the operating company and didn’t look further up the chain at financing, debt, and structure. As Ofwat belatedly gets tougher, these are in ever-greater conflict.
New licence conditions require companies to consider customers and the environment before paying dividends. From April 2025, the start of the new five-year regulatory period, the credit-rating trigger that can lock up cash in the operating entities will be tightened, raising the risk that Thames’s holding companies won’t be able to service their debts.
Shareholders have made further equity injections conditional on that next regulatory framework. Thames has asked to increase customers’ bills by 40 per cent, is grappling with rising costs and mounting penalties (which it wants capped), as well as facing huge investment needs and being lumbered with an increasingly unsustainable financial structure.
Consider this: in its business plan, Thames expects “cash inflow from equity financing” of £3.22bn over five years. Given that only £2.5bn is assumed to come from its shareholders, points out Martin Young at Investec, the remainder (which the company says is “purely indicative”) comes from additional debt sold by Kemble Water Finance.
That Kemble debt will incur interest, which means extracting more in dividends from the operating company. Indeed, in the business plan, dividends rise from £45mn in the 2022/23 year to £230mn annually by 2029/30. Over the course of the five years, dividends total £936mn in a period where the company has scaled back its plans to invest in ageing assets and stem pollution thanks to “financeability constraints”.
Call it what you want. That would seem to be a problem.
helen.thomas@ft.com