A good 20 months have passed since the shareholders of Thames Water declared they wouldn’t be putting another penny into the “uninvestable” company and would rather take a thumping write-off of their investment.
So surely, you’d think, we must be nearing the endgame in the attempt by the creditors – the people who lent money to Thames – to rescue the company via a debt write-down and a recapitalisation with new equity. After all, the 100-odd class A bondholders have been negotiating with Ofwat, the regulator, since June. Indeed, they started work on their proposal six months before that, in case the original preferred bidder, the US private equity group KKR, took fright at the political heat on Thames, which is what happened.
But no, the water torture goes on. “Discussions are taking longer than expected but this is a complex situation and the current phase of the restructuring plan will likely take a number of months to conclude,” Thames said within its half-year numbers on Wednesday. In theory some version of an outline agreement or update is still possible before Christmas, but don’t hold your breath.
What to read into the delay? One hopes it means Ofwat, even as it awaits execution or reinvention under the government’s “reset” of water regulation, is playing hard and tearing chunks out of the creditors’ proposal.
Three areas are critical. First, the terms of the refinancing. Back in October, the creditors tried to present their updated proposed terms as a model of generosity – the write-down on the class A debt would be £4bn, or 25%, rather than the 20% previously suggested. And there would be an injection of £3.15bn in equity. On both scores, you’ll find unattached financiers who think the would-be rescuers aren’t offering nearly enough to ensure a bulletproof balance sheet to attempt a 10-year turnaround of Thames. The debt write-off may need to be bigger (at least 30%) and the creditors may have to dig deeper on equity.
Second, the creditors need to be clearer about how, precisely, they will “reprioritise” the £20bn of spending allowed over the next five years. A perennial problem with the water industry is that the line is blurry between spending on day-to-day operations and capital spending. It all needs to be spelled out in crystal-clear terms. The poor old customers must not be forced by stealth to finance project improvements they have already paid for.
Third, the performance conditions – the even blurrier element in the package. The creditors argue that Thames needs leniency on fines to avoid a doom loop and requires targets on spillages and leaks that it has a chance of achieving. Maybe, but Ofwat – or its successor body – will still need stiff powers to fine Thames for underperformance: the company cannot be granted a free pass on fines. And it would be an outrage if Thames’s customers could be charged more via “outcome delivery incentives”, in regulatory-speak, if their supplier outperforms lowered standards it should have met years ago.
Ofwat’s negotiating hand is not strong because the government clearly prefers a “market-led” solution. Ministers, or some of them, are terrified of Thames ending up in special administration, AKA temporary nationalisation (even if they shouldn’t be, in this column’s view).
But ministers and regulators alike will know there is a likelihood that US hedge funds, led by Elliott Management, would emerge as the biggest shareholders in Thames if the restructuring goes through. They are the opportunistic crew who bought into the debt at distressed prices. It won’t be cuddly UK pension funds, investing via bond-only funds, who emerge at the top of the pile in the internal shuffle between creditors.
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The terms of any deal blessed by the regulator and government must be seen to be severe. The creditors’ October proposal, like June’s, looked too greedy. If the latest delay means Ofwat is insisting on tougher terms, so it should. Even at this late stage, do not go soft. And remember, you are free to recommend special administration.