Speaker 1: Bloomberg Audio Studios, podcasts, radio news. Regulated assets like water,
Speaker 1: airport and energy are held by investors on the basis
Speaker 1: that usually returns are safe and predictable. The owners of
Speaker 1: Thames Water, which serves, by the way, what a quarter
Speaker 1: of the UK population, disproves that and investors are risking everything.
Speaker 1: They're risking losing their investments. They've had to write off
Speaker 1: billions of pounds and now creditors are contemplating or restructuring
Speaker 1: that would possibly impose more losses on them. So if
Speaker 1: you're the new government trying to attract a lot of
Speaker 1: investment into the country, how do you fix Thames Water
Speaker 1: so that creditors don't point to that and say, well,
Speaker 1: the UK is uninvestable. On today's show, we discuss why
Speaker 1: the tale of Thameswater has spooked born investors and what
Speaker 1: the government needs to do to win them back. I'm
Speaker 1: Francin Laqua. This is in the City.
Speaker 2: Welcome to the City of London.
Speaker 3: The City of the City of London.
Speaker 2: We need mind the gap between the and the financial
Speaker 2: hearts of the country, the city, the city.
Speaker 4: Welcome to in the city, clear of the doors.
Speaker 1: So with me today. UK Economy reporter Phil Aldrich and
Speaker 1: corporate finance reporter abinav Ramarayan, thank you both for joining us.
Speaker 1: I mean, this is kind of a crazy story because
Speaker 1: you know, water is meant to be boring, utilities are
Speaker 1: meant to be predictable, and Thames Water was anything but.
Speaker 3: Well, exactly, the old point about the investment class that
Speaker 3: water represents is its stable, regulated monopoly. If you put
Speaker 3: your money in, you're supposed to get guaranteed dividends, it's
Speaker 3: inflation protected. It's not meant to be a roller coaster ride.
Speaker 3: And you know, in this instance, the investors since twenty
Speaker 3: seventeen for Thames Water have not seen a penny dividends
Speaker 3: and now certainly two of them have written off their
Speaker 3: stakes entirely. Basically the company is now in the hands
Speaker 3: of its creditors, so the shoholding is worthless. So it's
Speaker 3: a complete disaster. But there are sort of implications more
Speaker 3: broadly for the UK as a whole as an investment
Speaker 3: destinations because of the simple fact this should not be
Speaker 3: happening to these regulated assets.
Speaker 1: So is this a case study of how not to
Speaker 1: run a water utility? And what exactly happened.
Speaker 4: Well, it all comes back to debt and we've seen
Speaker 4: this across the board in the UK. It's not just Thmeswater.
Speaker 4: We've seen a bunch of private equity owned companies from Morrison's,
Speaker 4: ASDA and so on that have struggled with a debt
Speaker 4: load at a time when interest rates have gone up
Speaker 4: at a rapid base. They're coming back down now, of course,
Speaker 4: but the damage is done. And I think Thames Water
Speaker 4: is another such case where the previous owner mcquarie piled
Speaker 4: a huge amount of debt onto Demeswater's balance sheet, extracted
Speaker 4: some dividends from it, and maybe didn't quite invest as
Speaker 4: much as they should have to keep the pipes from leading.
Speaker 4: I think they have something like a third of the water.
Speaker 4: They have like a leakage of about a third of
Speaker 4: the water that the process. So yeah, it is I
Speaker 4: think it's a case of financial engineering. I think there
Speaker 4: are even some echoes to the national crisis in this
Speaker 4: particular story.
Speaker 3: Thames is was is the extreme example in the water industry.
Speaker 3: You know, you speak to people there and they do
Speaker 3: say there was management failings as well as this massive
Speaker 3: debt load that just parted up on the business.
Speaker 1: Failings because they didn't identify the problem or they just.
Speaker 3: They were just bad managers. They just didn't run the business. Well.
Speaker 3: I mean, you can look at companies like seven Trent
Speaker 3: that operationally they've been done, they've been run effectively that
Speaker 3: it's sorto listed to it never quite had the same
Speaker 3: amount of debt problems. But people just say that Thames
Speaker 3: was just had you know, it's bosses, which is not
Speaker 3: particularly good.
Speaker 1: So what was the exact role of the regulator in this?
Speaker 3: So the head of the regulator is appointed by the
Speaker 3: government and obviously their role is to make sure that
Speaker 3: these privatized monopolies operate as much as if it was
Speaker 3: a comparative market. So their main objective is to balance
Speaker 3: household bill levels against investment levels, and so they have
Speaker 3: to determine how much bills go up or actually in
Speaker 3: previously they've been bringing bills down and as a result
Speaker 3: of bills are falling, then investment levels have been not
Speaker 3: growing as much as the investors wanted. The way the
Speaker 3: water industry works, you have the regulators who are being
Speaker 3: given incentives by government or being effectively told by government
Speaker 3: to keep bills low and that was the priority for them,
Speaker 3: and so as a result, investment levels were cut. So
Speaker 3: you know, in twenty nineteen, for example, when the water
Speaker 3: industry as a whole, we're saying it wanted to invest
Speaker 3: about five billion pounds more than what the regulator let
Speaker 3: them invest. Now what happened after that is we had
Speaker 3: more and more sewage bills, etc. And there was a
Speaker 3: complete national outcry about the situation. And obviously penalties were
Speaker 3: then imposed on these companies. So the companies feel as
Speaker 3: though the regulator is not being fair to them by
Speaker 3: blocking the investment that was required and then penalizing them
Speaker 3: when these problems due to lack of investment arose. And
Speaker 3: obviously the politicians don't want to have the nightmare of
Speaker 3: sewage bills everywhere, but they also don't want households up
Speaker 3: in ours because of rising bills. And so the warner
Speaker 3: industry ended up being sort of trapped in this difficult
Speaker 3: political place. And really it's all kind of broken now.
Speaker 1: But why was it so leveraged? So what did they
Speaker 1: use the debt to finance?
Speaker 4: Well, I mean to some extent investment for some of
Speaker 4: the necessary investment to upgrade the infrastructure, but there was
Speaker 4: a lot of dividends bare out as well, and this
Speaker 4: is one of the reasons why there's a lot of
Speaker 4: customer dissatisfaction. In fact, I think it was a big
Speaker 4: policy issue which led up to the general election earlier
Speaker 4: this year, and I do think the leverage was egregious.
Speaker 4: I think it's definitely over fifteen billion pounds the debt
Speaker 4: on the operating company. Don't remember the exactly god, but
Speaker 4: it is a huge amount of debt for water utility,
Speaker 4: which has a monopoly over one of the biggest cities
Speaker 4: in the world to have.
Speaker 1: So when did the trouble start?
Speaker 4: I don't want to get too nerdy, but like inflation
Speaker 4: is a big part of this because a lot of
Speaker 4: the debt issued by water utilities in the UK, the
Speaker 4: interest payments or the coupons, are linked to inflation, which
Speaker 4: means that a sharp increase in inflation was really troublesome
Speaker 4: for many of these companies. The reason they do that
Speaker 4: is because water bills also rise with inflation. But bizarrely
Speaker 4: they used two different measures of inflation, which meant that
Speaker 4: there was a mismatch between what they were paying out
Speaker 4: in terms of their debt obligations and what they were
Speaker 4: getting in in terms of the water bills that customer's paid.
Speaker 1: And investors have been really badly, badly hurt by this.
Speaker 1: Could the government have handled it better well?
Speaker 3: Obviously the labor governments inherited this problem and they are
Speaker 3: having to deal with it. In terms of sentiment for
Speaker 3: the UK, this is not good. Labor desperately needs huge
Speaker 3: amounts of money to invest with their plans for growth
Speaker 3: are predicated on a lot of private investment. And if
Speaker 3: you've got the safest of safe assets going bust and
Speaker 3: then the regulator afterwards saying that your returns are not
Speaker 3: going to be particularly good when clearly the risk premium
Speaker 3: has gone up, they're worried about what that says about
Speaker 3: the country as a whole, and whether it's investible in
Speaker 3: these particularly safe sectors. And if you're going to be
Speaker 3: doing joint investment with the government effectively, which would be
Speaker 3: the green energy revolution, you know, are they trustworthy? So
Speaker 3: this is a moment Labor has to seize and Labor
Speaker 3: has to sort of reset the trust with these investors
Speaker 3: in some format. So it's a tricky one.
Speaker 1: Because essentially, I mean, things have gotten so badly right
Speaker 1: for Thameswater, which serves, by the way, what a quarter
Speaker 1: of the UK population that they're now talking about these
Speaker 1: special measures, and so they could eventually be broken up
Speaker 1: or nationalized. So if you're an investor, you lose everything absolutely.
Speaker 4: And I was saying earlier that there are shades or
Speaker 4: the financial crisis, and this is where I think, this
Speaker 4: is where I see the similarity, which is where off
Speaker 4: what seems fairly preoccupied I think with what is right
Speaker 4: and what is wrong, as the Bank of England was
Speaker 4: back when two thousand and eight happened. But at that point,
Speaker 4: I think we have reached a point where what is
Speaker 4: right and what is wrong is irrelevant. Now the only
Speaker 4: question is what is best for the country as a whole.
Speaker 4: Maybe mcquarie and the current owners of Thames Water were
Speaker 4: in the wrong, maybe they shouldn't have made all those
Speaker 4: bad management decisions, but that now fails into insignificance compared
Speaker 4: to the bigger picture, which is that labor desperately needs
Speaker 4: investors on board. But of course it's a political it's
Speaker 4: a political mindfield, and.
Speaker 3: Say I'll be talking about the moral hazard that in
Speaker 3: Mervin King, Yeah, brewed up right at the moment where
Speaker 3: you know, we needed to ditch moral hazard to make
Speaker 3: sure that there wasn't a complete social meltdown. In twenty
Speaker 3: seventeen thousand and eight, and obviously the bank changed time
Speaker 3: later on. But absolutely, I mean, these water companies have
Speaker 3: they've got over leverage. They definitely abused what they had
Speaker 3: and took too much in dividends. But you can't change
Speaker 3: the past bygones of bygones now and you've got to
Speaker 3: sort of move on. You can, you can resent what
Speaker 3: has happened. You can forever hold Macquarie to account to
Speaker 3: a degree, but you know, we need the investment.
Speaker 1: But there was a tipping point I think in March,
Speaker 1: and I don't know whether it is useful talk about it,
Speaker 1: where the investors didn't want to put an extra five
Speaker 1: hundred million because they said the regulators were looking at
Speaker 1: it wrong. So how does labor fix this? I mean,
Speaker 1: if you if you want to a blueprint saying come
Speaker 1: and invest in my country, it's safe and we take
Speaker 1: right decisions. Does labor change the regulators? Do they change
Speaker 1: off what the way this industry has looked at or
Speaker 1: do they put five hundred million themselves?
Speaker 4: Everyone needs to share a bit of the pain. I
Speaker 4: think this will be what will what will happen? I
Speaker 4: think creditors will take a bit of pain. There will
Speaker 4: be a hair cut on Themswater debt to bring it
Speaker 4: to a more manageable level. Because right now what off
Speaker 4: what calls gearing, which is then measure of how indebted
Speaker 4: a regulated entity is, is over eighty percent in the
Speaker 4: case of Thames Water, and I think of what recommends
Speaker 4: somewhere between fifty five and sixty five percent. So it's
Speaker 4: immensely indebted. And in order to bring that down, I
Speaker 4: think creators will have to take a hit, but you
Speaker 4: have to walk that fine line where creators take a hit,
Speaker 4: but not such a hit that they run away, and
Speaker 4: then customers will also have to take a hit. Bills
Speaker 4: will have to go up, but not to the extent that,
Speaker 4: you know, you lose the electorate.
Speaker 3: And in that situation, obviously the shareholders are wiped out.
Speaker 3: The creditors are taking a hit. After the shaholders it
Speaker 3: completely wiped out. So I mean there is that in
Speaker 3: the terms example, So there definitely is burden. The shift
Speaker 3: is going to have to be burned sharing and I
Speaker 3: mean for the politicians, the cost is political in that
Speaker 3: they've got to let they'll have to let bill's household
Speaker 3: bills rise. The investment challenge is multi decade, right fix
Speaker 3: the water. You can't fix the water the pipes and
Speaker 3: get everything working in five years, and that's where they
Speaker 3: have these five year investment horizons. And then with Thames,
Speaker 3: if you I mean right now, we need the investment,
Speaker 3: as a were saying, if the government comes in, puts
Speaker 3: the business in special measures, then breaks it up and
Speaker 3: tries to set up new operating companies, and that whole
Speaker 3: process will take a year possibly more before the company
Speaker 3: is up and running properly again, or it's various satellite companies,
Speaker 3: and that's just going to delay the investment process and
Speaker 3: labor are facing in three or four or five years
Speaker 3: time when when the next election is held, they're going
Speaker 3: to be judged not on where the bills came down,
Speaker 3: but on whether the sewage is not being pumped into
Speaker 3: the rivers any longer, right, And so for them, they
Speaker 3: need to show that the investment and has been delivered
Speaker 3: and the infrastructure is being upgraded. And that's what they're
Speaker 3: going to be judged on, and which is very different
Speaker 3: to what the Tories were believe that they were being
Speaker 3: judged on until the last couple of years when the
Speaker 3: when it really blew up and it became a national
Speaker 3: outrage about it. So if you were to say politically,
Speaker 3: what would be the balance to take, you would you
Speaker 3: would presume they would choose rock bills rising over you know,
Speaker 3: another five years of sewage pouring into the rivers.
Speaker 1: But Phil, so this is extremely important because the Labor
Speaker 1: government have been in charge for almost three three months.
Speaker 1: They're trying to attract foreign investment, as you're saying, and
Speaker 1: so this is seen as a kind of critical test, right,
Speaker 1: how do they deal with investors? How do they deal
Speaker 1: with this fallout? And that's kind of what you know,
Speaker 1: investors will judge and decide whether they want to put
Speaker 1: their money in the UK or not.
Speaker 3: Yeah, I mean there's a big it's a big deal.
Speaker 3: I mean there's a group, the Global Investor Forum. Forget,
Speaker 3: there's a group.
Speaker 1: There's always a Global investor.
Speaker 3: Yeah, there's there's a there's a group called the g
Speaker 3: I I A. And and that's this is the issue
Speaker 3: that they're raising, is that the UK is now considered
Speaker 3: to be less investible by these huge global asset managers
Speaker 3: than the whole of Europe and the US. We're right
Speaker 3: at the bottom of the detail. The sentiment in the
Speaker 3: UK is as low as it has been one guys,
Speaker 3: but it too said it was the only time it's
Speaker 3: been lower in their memory was when Jeremy Corbyn was
Speaker 3: standing to be Prime minister and he was going to
Speaker 3: nationalize the nationalized, whilst swathes of the UK private sector.
Speaker 3: So the investor community is definitely concerned about what's happening
Speaker 3: in the UK. The good news is they're feeling a
Speaker 3: lot happier with the conversations they're having with the Labor government,
Speaker 3: so the sentiment is improving, but it's starting from a
Speaker 3: very low place. And you know what happened in the
Speaker 3: regulated as I say, these are supposed to be super safe,
Speaker 3: regulated industries. Nothing you should never get a shock really.
Speaker 3: Obviously this is partly to do with the poor management
Speaker 3: of Thames Water that they got a shock. You can't
Speaker 3: just blame it on the regulator, but certainly the regulator
Speaker 3: has been from what the investors say, has been a
Speaker 3: problem in the water sector. So if you can't get
Speaker 3: the investment in their the sort of trust concern just spreads.
Speaker 1: You say, I mean these are assets, I guess you know, airports, infrastructure,
Speaker 1: what are there are meant to be if not boring. Certainly,
Speaker 1: you know very little last predictable safe.
Speaker 3: And you can go elsewhere in the world and you
Speaker 3: can find those assets with good returns and they and
Speaker 3: they're not they're not collapsing into administration like terms.
Speaker 4: Absolutely. The good news though for good news good news.
Speaker 4: The good news, I mean, I don't know if it's
Speaker 4: a good news, but it's a comforting thought anyway, is
Speaker 4: that investors have shot memories. I mean, I've seen this
Speaker 4: time and time again in my financial reporting career. I
Speaker 4: don't think it would take a huge amount for investors
Speaker 4: to suddenly look at like a five six percent yield
Speaker 4: from a regulated entity and be like, oh, that looks
Speaker 4: quite good. I mean, there's a lot of anger out
Speaker 4: there right now, but I do think it is fixable.
Speaker 3: Yeah, they say, I mean, you speak to them, they say,
Speaker 3: how do you rebuild trust? And they say, well, you
Speaker 3: can start off by giving us a better return, And
Speaker 3: you know that that's probably that's all that needs to happen,
Speaker 3: give a better return. I think they do want They
Speaker 3: just do want a little bit more around the regulator.
Speaker 3: Fram they do not want to go through these kind
Speaker 3: of absolutely tortuous problems that they've had with off WHATK
Speaker 3: but that is certainly off What is is is the
Speaker 3: core problem here. The other regulators there at the moment,
Speaker 3: they don't have concerns with They'd worried that if what's
Speaker 3: happened in off What spreads to OFF Gym or the
Speaker 3: Civilization Authority and elsewhere, then you know, that could be bad.
Speaker 3: But at the moment they feel it's really just a
Speaker 3: specific off problem, which so it could be resolved. Like
Speaker 3: you say, I've been pretty relatively quickly.
Speaker 1: When more or less could this be resolved or at
Speaker 1: least I mean, you know, investment memories are short. I do,
Speaker 1: but we have a big budget October thirtieth. Like they're
Speaker 1: just also trying to figure out this new government and
Speaker 1: what they believe in fundamentally right the policies.
Speaker 4: I mean, I'm looking at other sort of similar restructuring
Speaker 4: situations and some of them last for years. But I
Speaker 4: suspect that I think by the end of this year,
Speaker 4: when so far we've only had drafted dominations from OFF
Speaker 4: What or just a plan of what they might impause
Speaker 4: on the industry, So by the end of the year
Speaker 4: we'll probably have we'll have a fleshed out plan and
Speaker 4: if that is acceptable to investors, we could see improvements
Speaker 4: by the end of the year. If it's not acceptable
Speaker 4: to investors, then you get like a challenge and it
Speaker 4: might go to the CMA of the Competition Markets Authority,
Speaker 4: or it might become.
Speaker 3: It does feel like December is going to be this
Speaker 3: kind of clinch moment where either the investors are given assurances,
Speaker 3: particularly on the returns that they're going to get, and
Speaker 3: they'll be happy to put their money in, and basically
Speaker 3: the problem will go will slowly go away, and I
Speaker 3: think there's even there talks about maybe reforming off What
Speaker 3: a little bit, but you can see that this issue
Speaker 3: would just retreat. If off What holds its line, then
Speaker 3: the water companies are threatening to take the regulator court
Speaker 3: through another regulator, and then it's begin to be it'll
Speaker 3: blow up into a political issue as well, because that's
Speaker 3: the start of the new five year investment period. So
Speaker 3: that's just that's going to delay the whole process. So
Speaker 3: you know, the end of the year is going to
Speaker 3: be a clinching moment.
Speaker 1: Thank you so much for joining us, phil and Abinov.
Speaker 4: Thanks Vern, it was absolute pleasure. Thank you so much.
Speaker 1: Thanks for listening to this Week's in the City from Bloomberg.
Speaker 1: This episode was hosted by me Francin Laqua and it
Speaker 1: was produced by Summersati. Production support from Isabella Award and
Speaker 1: sound design from Blake Maples. Special thanks to Philip Aldrich
Speaker 1: and Abanov rum n Ryan. Please subscribe, rate, and review
Speaker 1: wherever you listen to podcasts.