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