Thames turmoil threatens to engulf the sector

The dramatic departure of Thames Water’s CEO, followed by speculation about the company's very survival, have shocked the sector. Utility Week examines what it means for the company and how far the ripples could spread across the wider industry.

When Thames Water managers joined an internal call last Tuesday morning (27 June) it was clear from one look at Sarah Bentley that this was anything but business as usual.

The clearly shaken chief executive delivered the news that she was stepping down from her position – an announcement that was to send shockwaves across the utilities sector when it came out a few hours later.

The abrupt departure of a leader not even mid-way through her transformation plan spiralled into fevered speculation about the state of Thames’ finances. While the talks between Ofwat and the government over the potential use of the special administration regime were presented by national press as an emergency reaction, they had in fact been going on in the background for some time. However, it is clear that if investors do not agree to inject fresh funds into the business soon, the

possibility of a temporary nationalisation will take an alarming step towards reality. Over the past week Utility Week has gauged the views of experts on how problems at Thames were able to mount to this level as well as what is likely to happen next.

But we have also spoken to the staff at a company which has never been far away from controversy. They describe a new low in the morale of the workforce, fueled by uncertainty about the direction of the company but also the reaction the Thames high viz jacket is having on the streets. They talk of rising incidents of abuse directed at Thames workers out in the field over the past few months, which they only expect to get worse.

Meanwhile, the tone of the speculation has led to an influx of calls from customers asking about the possibility of the taps running dry and if appointments will be fulfilled.

Within the industry there has been genuine compassion for the staff at Thames. When the company won the water efficiency project of the year at last week’s Water Industry Awards, the ovation was lengthy and heartfelt.

However, one Thames employee talked about a general sense of hopelessness over the past week, saying: “Clearly the turnaround plan wasn’t going well but at least there was one. It’s difficult to see what’s next.”

“Clearly the turnaround plan wasn’t going well but at least there was one. It’s difficult to see what’s next.”

Where are we?

It is fair to say that at present there are more questions than answers about the situation at Thames. Bentley herself had been clear that the turnaround plan was behind schedule and that she would need “every single day” of the eight year plan to deliver on her promises. Sadly, this was not to be.

The outcries about the company’s financial position are also nothing new. As Utility Week’s in-depth analysis of debt levels in the water sector laid bare earlier this year, Thames’ gearing ratio of 80.6% had long been a source of concern. While its latest cohort of investors have pumped in fresh equity, it had long been clear that much more was needed to service the company’s £14 billion debt pile and invest in future-proofing the network.

Specifically, the consortium of investors backing Thames need to fulfill their promise to invest the final £1 billion of the £1.5 billion pledged by 2025.

Bentley made reference in her interview with Utility Week to the “combination of poor management decisions, aggressive cost cutting and simply decades of underinvestment” that had preceded her time. She used the term “hollowed out”, even stressing that the phrase was chosen “consciously and accurately”.

It appears these comments and the even more forthright ones she used internally were part of the eventual rift that led to her departure. Even as external consultants were brought in to work on the turnaround plan, Bentley continued to stress that real progress would only be possible with a commensurate level of investment.

With Cathryn Ross, the former Ofwat boss and the company’s strategy and regulation director, and chief financial officer Alistair Cochran now installed as interim joint-CEOs and City troubleshooter Sir Adrian Montague incoming as chair, the priority will be securing support from investors.

Insiders say they still expect a deal to be reached with current shareholders that would avert any imminent use of the special administration regime.

Universities Superannuation Service (USS), the company’s second-largest shareholder has publicly backed the new team and indicated funds will be made available. It is hoped the group’s position, first revealed by Utility Week, will encourage other major shareholders to come out in support. However, all eyes remain on Ontario Municipal Employees Retirement System (OMERS), which is believed to be more nervous about committing to further outlay.

As an investor source told Utility Week: “If the Canadians back the extra investment then I think everything else will fall into place and all investors will follow suit. While they are not a majority shareholder they are the biggest investor and therefore have the most to lose, or gain."

Wider impacts

A key task for the new-look executive team is to not allow the current uncertainty to lead to further delay in Thames’ key goals.

At the end of its week from hell, the company began its search for consultants to join its £300 million technical partners framework.

While senior consultancy managers told Utility Week it would be "ridiculous” not to bid at this early stage of procurement, there was an evident caution about entering into contractual agreements without assurances about Thames’ future.

The uncertainty around Thames has also spooked credit rating agency S&P, which has placed Thames onto CreditWatch. The company maintains its BBB and BB+ issue ratings on its class A and class B debt, but S&P warned it could slide amid uncertainty.

It said the company’s turnaround plan could be hindered by lack of clarity on management and timings of equity injections. Ratings could be downgraded one notch in the coming three to six months, S&P said.

In March Ofwat updated licence conditions to formalise that all water companies must maintain at least two investment grade issuer credit ratings and from 2025, it will be able to block dividend payments if the company loses its strong credit rating. Companies are currently required to have a credit rating that demonstrates the business is financially resilient. The code modification would increase the threshold at which dividends could be restricted.

Who might be next?

Debt

The inevitable – and unwelcome – question for the wider sector is whether the troubles at Thames could start a domino effect across the industry.

The sector has combined debts of c£60 billion, equivalent to nearly 70% of its regulatory asset value. However the gearing levels across the sector do vary significantly, with Hafren Dyfrdwy’s level of 39.7% (as of March 2022) half that of Thames.

Despite its lower gearing, even Hafren is not immune to the pressures currently facing the sector, given it has the highest ratio of debt linked to inflation – at around 90%, according to Moody’s research last year.

This also showed the proportion of debt needing to be refinanced over the following four years ranged from a few per cent for Affinity to almost 30% for Portsmouth.

Companies’ exposure to floating rate debt was generally limited but also varied significantly. The companies with the greatest exposure were Bristol and SES at over 20%. South Staffs, Affinity and Southern all had no exposure, while Yorkshire was slightly overhedged against rising interest rates.

Last week saw Yorkshire raise £500 million equity from its investors. Despite the timing of the announcement, this was actually part of a plan first set out last year which will see almost £1 billion of equity injected into the firm over the next five years.

While it remains very difficult to defend the historic balance between investment and dividends, the sector can point to investors increasingly backing their commitments with cash.

It is surprising that Macquarie’s continued involvement in the water sector hasn’t been the source of more comment over the past week, given its central role in ramping up Thames’ gearing. Perhaps that’s because its immediate pledge to invest £1 billion when it took a stake in Southern Water in 2021 doesn’t fit with the default “Vampire Kangaroo” portrayal. The group also agreed a £120 million debt investment in Anglian’s holding company the same year.

Despite these examples, there is a clear and urgent need for shareholders to deliver further fresh funds to their water investments – both to shore up their financial positions and to legitimise the promise to spend £10 billion on reducing the impact of pollution on waterways.

It was interesting to note the caveat in USS’s commitment to back Thames financially that the water sector would only align with the objectives of its pension fund members under the “appropriate regulatory environment”.

A cynic could read this as a demand that billpayers bear the brunt of the responsibility for fixing the water sector.

If that is the case, then USS and other investors should be warned that it will not go unnoticed or unchallenged. The Thames crisis represents a nadir in the public’s perception of water privitisation and the message is clear – “this is your mess, you fix it”.

And for Thames itself, the search for a white knight begins again. However, the absence of any real speculation about who could be in the frame is very telling. For a corporate titan with a big ego, this could be a task to relish. However, with such sensitivity over remuneration and the sheer scale of the task to hand, who could be persuaded to take the risk?