Outlook The City's mouth is watering. A takeover bid for Severn Trent from a consortium of pension funds and a sovereign wealth pot is stimulating juices in the Square Mile. Large fees for investment banks and, naturally, profits for speculators are in prospect if the £5bn-odd approach to buy the water company, which unveiled its full-year results yesterday, is successful. The other two other listed water utilities could also soon be in play too, slather the bulls.
But what's in it for customers of these companies? Will any benefits reach them from this change of ownership? Don't expect much trickle down. High returns for the owners of regional monopoly utility firms generally mean high bills for you and me.
The water regulator Ofwat allowed the companies to raise their rates by an average of 3.5 per cent in April. The average Severn Trent customer saw their bills rise by 5.2 per cent to £326 last year. Small wonder pension funds, trying to meet their liabilities in a low interest rate world, want to own a piece of an industry which has a captive market and an apparent green light to raise the price of its product above the price of inflation.
Privatisation of the water companies 20 years ago was presented as a necessary means of attracting investment. In fairness it has delivered on that front, with £20bn spent roughly every five years on fixing pipes, treating sewage and cleaning up pollution. The fact that wildlife is now abundant in our once-dirty rivers is testament to that progress. But it has come at a steep cost in higher bills. Water is about 7 per cent more expensive than it was in 2005 in real terms. Average real incomes, by contrast, are back down to where they were in 2003.
And there could be an still higher social cost lurking below. Jonson Cox, the new chairman of the regulator Ofwat, warned in his maiden speech to the Royal Academy of Engineering in March that the "opaque" financial structures of the water companies' owners (the majority of which are now private-equity firms) can facilitate tax avoidance. Coming from the sector's regulator that's a rather interesting charge, to put it mildly. And as a former chief executive of Anglian Water, Mr Cox knows whereof he speaks.
Mr Cox also pointed out that water companies are more leveraged than they were as managers have sought higher returns on equity. Since 2006 the level of equity funding on the sector's aggregate balance sheet has slipped from 42.5 per cent to 30 per cent. Severn Trent reported yesterday that its net debt pile has increased over the past year by some £300m to £4.3bn. Its equity finances just 10 per cent of the balance sheet.
Those large debt piles are tax efficient, thanks to the tax deductibility of debt interest costs, but they make the water companies vulnerable to a rise in interest rates. When the day comes that rates do rise, the water companies will inevitably face a financial squeeze. And that squeeze could be even greater if the regulator declines to raise the charges they can impose on customers. A review of charging is due in just two years' time.
It's hard to imagine a water company going out of business, of course. Nationalisation would swiftly follow any hint of a financial stumble. No politician is going to allow a massive tranche of the voting public to turn on their taps one day and discover that nothing comes out.
One hopes nationalisation would see equity and debtholders wiped out. But what about the executives who earned multi-million pound pay packages by leveraging up their firms in the good times? There are no clawback provisions for the bonuses splashed around in the water sector. High leverage, outsized executive rewards, monopolistic rent extraction, too-big-to-fail businesses: we've been here before, haven't we?