A flood of cash to buy up the water companies

There's a growing list of potential bidders – but are they tapping into too much risk? Mark Leftly reports

If City analysts are right, Severn Trent chief executive Tony Wray should be celebrating his final annual figures at the helm with a glass of champagne rather than the tap water the listed utility supplies to 3.7m homes and businesses. Scribblers at Société Générale have forecast another bumper year, with revenue up to £1.84bn and a pre-tax and interest profit of £501m – a margin that is, once again, well over 25 per cent.

But Thursday's results will be drowned out by chatter over one issue: the approach to buy out Severn Trent for £5.3bn, which the board rejected earlier this month as substantially undervaluing the utility. A consortium of the Kuwait Investment Office, Canada's Borealis and British pension fund the Universities Superannuation Scheme (USS) has been set a deadline of 11 June to come back with another offer.

With the biggest listed water company, United Utilities, constantly named as a takeover target – to the extent that it recently bumped up its advisory team by drafting in Goldman Sachs – the water industry is simmering with interest. What has some investors wondering, though, is why this is the time that the sector is coming to the boil.

As one City watcher puts it: "These types of consortiums usually don't go in with a final bid straightaway – they're not some sort of chancer private equity group. They usually leave something in the back pocket to come back with. But what's strange is that they've come in ahead of a review: this kind of bid usually happens afterwards."

Water is regulated in five-year cycles. Utilities are currently going through negotiations with Ofwat over what they will be able to charge bill-payers and spend on their pipes and infrastructure for 2015-20.

This means there is a risk Severn Trent will not be able to make as much money as it does in the current price control period. There is a chance that any bidder going for a water company now could find that they pay too much in the light of these changes.

However, the consortium might have thought that it could exploit this uncertainty as it would allow it to argue that what appears to be a slightly stingy offer is therefore justified. The three parties might also be exploiting a chance to pounce on Severn Trent while there is uncertainty over who will replace Wray, pictured.

They might also have calculated that this is a time when a rival bidder is less likely to emerge. British utilities are hugely admired by overseas investors – 12 out of 23 water companies are in foreign hands – as they offer inflation proof, guaranteed returns over a long period of ownership.

Francis Yeoh, managing director at Wessex Water owner YTL, says the way Britain regulates its utilities provides an "incredible environment" for investors. What surprises him is that it took British pension funds until now – in the shapes of USS and the BT scheme's 13 per cent in Thames Water – so long to invest in a sector that will help them generate the safe returns they need to pay the growing legion of retirees.

The sense, then, is that this consortium is willing to risk the regulatory uncertainty for the guarantee of a safe asset that everyone needs and come back with a better bid. Water is always needed; what's different now is that it is also in fashion.

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