Waste disposal gives Severn shareholders a £600m boost

Water giant to pass on benefits of Biffa spin-off

Severn Trent is planning to return at least £600m to shareholders when it spins off its Biffa waste business.

The utility group, owner of Severn Trent Water, will notify shareholders of its plans to restructure later this month.

Chief executive Colin Matthews announced in April that Biffa would be spun off as a separate, publicly quoted company. This will happen by the end of October. Existing Severn Trent shareholders will be given new Biffa shares.

The group will now take the opportunity to increase the debt levels of Severn Trent Water. This will be its only significant asset after the demerger of Biffa, which is expected to float with a market value of some £700m, making it Europe's largest publicly quoted waste group.

Water companies are traditionally highly geared because their revenues are very predictable and virtually guaranteed. But because Severn Trent was not a "pure" water company, due to its ownership of Biffa, the business currently carries less debt than other owners of water operations.

Robert Miller-Bakewell, a Merrill Lynch analyst, estimates that Severn Trent will increase its debt by around £850m. Of that, around £175m would be used to invest in Severn Trent Water's infrastructure, with a minimum of £600m returned to shareholders. The cash could be returned either through a share buyback or a special dividend.

The remainder of the cash raised could be used to pay any fines resulting from an investigation by the Serious Fraud Office into allegations that the company falsified data that it gave to water regulator Ofwat.

Waste businesses are becoming more lucrative as landfill costs rise, partly driven by tighter environmental regulations.

Around five years ago, owners of UK water companies tried to expand into new areas such as waste disposal to increase profits beyond their heavily regulated water businesses. But the cycle is being reversed as pension fund investors seek stable, low-risk returns which are offered by owning shares in water-only companies. This has encouraged owners of water companies to dispose of these other businesses.

Pennon, which owns South West Water, could also sell its Viridor waste business. This could raise up to £1bn.

Bankers say that the £595m sale of Cleanaway, the waste management unit of Australian services company Brambles, in June to French utility Veolia will speed up consolidation. The sale attracted interest from several other bidders, including Suez and private equity firms BC Partners and PAI.