Outlook: It's your call Mr Fletcher, as water companies go for gold

Collins Stewart; WH Smith
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The Independent Online

How much of a push over is Philip Fletcher, director-general of Ofwat? We'll find out next year, when Mr Fletcher conducts his five-year review of water charges. Hopes are already high in the industry that he'll prove a good deal more sympathetic than his predecessor, who at the time of the last review imposed a swinging one-off cut and severely limited yearly increases thereafter. Certainly that's the mood music coming out of Ofwat, which has already conceded that water bills will need to rise to meet ever tougher standards on clean water.

But whether he's prepared to tolerate an average real increase in water charges of nearly a third over five years (that's on top of inflation), which is what the water companies asked him for yesterday, is another thing. Like union negotiators, the water companies have presumably gone in with an exaggerated claim which they eventually expect to be pared down to something more realistic.

One or two of them are already in concessionary mood, and that's before the formal proceedings have even begun. For instance, the process has necessarily obliged the water companies to use past assumptions about the cost of debt, which is now much lower than it was. Factor in this change and already there's room for movement.

All the same, it's hard to see how Mr Fletcher can allow increases in charges of anything like the ones being asked for. The water companies reckon they need to raise capital spending in the industry by a quarter over the next five years. In itself this is open to question. The water companies are allowed to earn a rate of return on whatever they spend, so there is a positive incentive to gold plate all investment plans.

In the past, water companies have been able to finance ever higher levels of investment from improved operational and balance sheet efficiencies. All the low hanging fruit has now been plucked, they claim, making it hard to achieve significant further cost cuts without endangering public health. What's more, the regulator has made plain his distaste for high levels of debt leverage in the industry, so the buffers have also been hit in the quest for ever lower capital costs.

Ergo, the customer must take the strain of financing the higher environmental and clean water standards that regulators demand. Well maybe, but politically this won't be easy to sell. After the fat cat rows of the early 1990s, the water industry has made a big effort to clean up its act, and in point of fact, though the increases being asked for look big, in nominal terms, they are tiny - just 86p a week more for an average household than what they paid in 1999/2000. Even so, I doubt very much that Mr Fletcher will prove as compliant as the industry would like.

Collins Stewart

Investment banks live in fear of the sort of thing that's now happening to Collins Stewart Tullett, which is why so many of them are willing to pay off their disaffected employees with shut up money before they can go public. In some cases the grievances are well founded. In others, they are completely groundless. Yet even in the unjustified cases, the damage to reputation as claim is traded with counterclaim, with every salacious detail crawled over by the press, can be profound.

In a business which is meant to be as squeaky clean as wholesale financial services, even so much as a hint of scandal is going to inflict some sort of damage. In the worst cases there will be a mass exodus of clients, deterred by the better safe than sorry principle. In the City, there is no such thing as innocent until proven guilty. No one will admit it, but most City firms therefore take the view that it is better to settle, whatever the cost, than have their dirty linen washed in public. Not so Terry Smith, a combative chief executive who loves a fight. Mr Smith has built his whole reputation on straight talking, integrity and truth. To have that questioned by one of his junior analysts made him see red. As it happens, one of the allegations made against Collins Stewart is that hush money was indeed offered. Like all the others, it is hotly disputed. In any case, having with characteristic bravado challenged his disaffected employee to do his worst, Mr Smith has only succeeded in landing himself with a mega damage limitation exercise. It has to be said that so far he hasn't handled it terribly well. The more angry he gets, the more the crowd jeer. He's become like a baited bear.

The press is having a field day and as for his competitors, the champagne corks are positively popping. That this successful little independent investment bank will survive the storm is not in doubt. If Cazenove can live to prosper again after something as momentous as the Guinness scandal, then there is no doubt that Collins Stewart will weather this rather more mundane set of allegations.

Yet whether there is anything in them or not, it's a black mark for Mr Smith and many in the City are already starting to wonder whether he personally will survive it. It will be months before the case comes to court and Mr Smith gets a proper chance to clear the air. In the meantime the share price continues to plummet. It's an awful thing to say, but it would have been cheaper to pay the hush money.

WH Smith

No chief executive likes to bow out with a profits warning, yet that is the fate that has befallen Richard Handover at WH Smith. All in all, it's been an extraordinarily unremarkable reign, so in a sense, this seems an appropriate end. Strategies have been and gone, but nothing much has ever come of them. First there was the "clicks and bricks" initiative, the mere suggestion of which during the heady days of the dot.com boom was enough to drive the share price up to a record high of £7.

Yet it always was a somewhat confused response to the challenge of the internet age, and it wasn't hard to forget that this staid old high street retailer had an online strategy at all once the excitement of the e-commerce revolution began to wane. Then there was the attempt to sell the newspaper distribution business, which seemed logical enough but fell by the wayside when the company failed to fetch the reserve price. The expansion into hotel and airport lounges in the US has been a largely predictable failure, with September 11 and SARs providing the final coup de grace.

The one saving grace has been the core UK retailing business, where perhaps remarkably, profits have been on a rising trend. Now this business too seems to be turning sour. Mr Handover blames the entertainment industry for falling margins and the hot weather in combination with intense competition for flat sales, but neither of these excuses address the key question about WH Smith, which is what is it really for?

WH Smith lost its raison d'être as a pure newsagent long ago, and though somewhat surprisingly it has made a reasonable success as a general retailer of stationary, music, books, novelties and educational material, its position in these markets was always bound to be precarious, caught between the pincer movement of the internet on the one hand and the big supermarket groups on the other.

Again, WH Smith has achieved some success in laying claim to the growing market in exam revision and other educational products, but the brand is still not yet wholly associated with these markets in the same way, say, as Boots is with health, and anyway it seems doubtful educational sales would be large enough of themselves to support a high street infrastructure as big as WH Smith's.

There's a new chief executive starting shortly - Kate Swann, one of the rising stars at Argos. WH Smith needs fresh thinking, and hopefully she'll provide it. A slight disadvantage is that Mr Handover isn't entirely going. He remains as chairman, at least for the next 18 months. WH Smith isn't yet a company in crisis, not withstanding the profits warning, but Ms Swann needs a free hand if she's to prevent it becoming so.

jeremy.warner@independent.co.uk

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