Thames Water - How we are considering taking a position.
Dear All,
Please find Thames Water updated model here.
The fight over Thames water has recently taken shape as the company plan works better for the Class A creditors than it does for the Class B. As Class B creditors are gearing up to fight their position over the coming month, we expect newsflow to peak in November. We are not keen on buying into this newsflow but are keeping an open mind into the end of the year.
Investment Considerations:
- We are preparing to take a position in the TW structure but will wait until any bad press associated with the UK RP subsides over the coming month. We are leaning towards a position in the Class A bonds, not so much for their own sake alone, but in combination with providing fresh cash along the lines proposed last week. On our math, we would earn a combined 15% return on our investment - subject to significant uncertainties.
- While Class A recoveries are driven by TW's fundamental value (which is elusive at this juncture), the Class B recoveries are governed by how much of a nuisance they can create in and out of the UK RP.
- We view the Class A bonds as trading very much on top of recoveries through a second restructuring in 2026. While the Class B bonds may have nuisance value, absent a successful valuation fight, we see them as too expensive for pure optionality.
- Ahead of the Convening Hearing on 17 Dec 24, we expect the Class Bs to take to the press and undermine (not without reason) the current process. Thus, there should be better moments to buy into the structure.
- The New Money in the Class A proposal looks very interesting with a return promising just shy of 20% into the maturity of the Class B RCF in 2026, due to its makewhole language. However, if the Class A's plan is to wipe out the Class B, then safe for the fees this looks on the face of it like a left-pocket / right-pocket earning as the existing holdings would pay for the damage. However, not all the As and Bs will participate, handing those who do a healthy net return.
Key Value Drivers:
- Price rises allowed over the coming AMP8 5-year period to 2030, vs CapEx / ToTex required over the same period. Ofwat had expected price rises in the 20-25% range, while the company and some other water utilities had been requesting over 50%. This is a political calculation, but will be the prime determinant of EV of TW.
- Normalisation of the situation and consequently a reduction of the cost of capital. Thames Water is meant to return to its status as dull utility with yields that should be priced slivers over the sovereign.
Key Risks:
- Failure of negotiations followed by a Special Administration Regime (SAR), which can be thought of as a regular Administration under the 1986 Insolvency Act, except that during the process the government takes control of the company to ensure performance of its duties. While administration is a known quantity, the risk is significant. Creditors would lose control of the process and, without fixed charges over the assets, would be reliant on any proceeds from the sale of assets into a newco and then from the sale of that newco to any bidder. GBP financing of that magnitude should be hard to find in such a situation, curtailing the ultimate price achieved.
- Administrators may recommend breaking up TW, selling piecemeal. The UK Courts have significant discretion and will act in the company's and public's interest first. For the public, administrators might consider that a breakup could be the best way to fix the UK water and wastewater sectors, however, the Labour government wants to avoid this route because certain backbenchers will use it to push for full nationalization.
- Second Restructuring: Chances are that we are unable to restructure the TW balance sheet this time round because the parties are still lacking agreed economics from Ofwat. There is therefore a good chance that - as can be seen in the current Class A led proposal - the fresh cash is injected super sr. but that no other solution is offered for the balance sheet until TW run into maturities in 18 months time. By then Ofwat should have decided what economics it can afford Thames Water and the balance sheet can be restructured / the ownership transferred. However, this would take another 18 months and introduce further uncertainties.
Summary:
Earlier this year we’ve been long the Bs on the chance that the shareholders would support the business and that the situation might be resolved before elections - above securitisation level. We unwound that position when shareholders took too long to respond.
Since then, the situation has deteriorated with the public eye scrutinising every spillage and demanding even greater investment in its Victorian infrastructure. At the same time, the company’s liquidity is eroding and its demands (along with the industry) to raise water prices by a necessary 40-60% over the next five years have run into political headwinds. Ofwat, who have failed to adequately contain the situation, are being reviewed by an independent commission appointed by the Labour government. Possibly, the government has realized that price increases and distressed investors are a part of the solution, but seeks to blame the past government for the sector’s ills.
In terms of process, the ultimate back-drop solution would be the Special Administration Regime (SAR) which could easily become a precursor to full nationalisation. The government wants desperately to avoid nationalization. Likewise, creditors are incentivised to supply the required fresh cash and thereby avoid an uncontrolled process. We therefore expect the ultimate solution to be implemented via a UK Restructuring Plan (Part26a)
- Having initially worked together, the Class A steerco have recently taken matters into their own hand and have negotiated a deal with the company that would leave the Class B creditors vulnerable to a wipeout when the Class B RCF expires in 2026. The company has announced the deal only one week later and is pressing for a December 17th convening hearing, giving Class B creditors little time to table an alternative. They have signalled that it's coming, but there remains a lot of work to do. During November, the Class B creditors are planning to bombard the deal as egregious in the public media ahead of any implementation.
- Class A is mostly composed of RM holders, but HFs are dominating the steerco. Specifically, Elliot and Silverpoint leading with a blocking minority of 25% could technically turn down any deal but their own (75% is the voting threshold per class and there is no numerosity test). Class B is also dominated by RM holders, but we understand has seen recent entries by Arini, Alinor and Polus. From today’s perspective, the Class B is out of the money and even though the Class A proposal is available pro-rata to B holders as well, they won’t weigh heavily enough to block a second restructuring when even with the substantial £3.3bn of fresh cash, the company will run into excessive maturities in 18 months time. Given the UK RP was designed to cram down dissenting classes, and the Company plans to use it, we see the Bs primarily carrying nuisance value.
Happy to discuss,
Glenn
T: +44 203 103 7965
www.sarria.co.uk