Thames Water - the leak is getting bigger
Dear All,
Please find our updated analysis on Thames Water here, which now includes a more detailed legal section.
The new development that emerged last week was the existing shareholder’s reluctance to inject the first £500 million of new equity by the end of March 2024 due to the “uninvestible” nature of the new PR24 plan. While the regulated entity has liquidity until May 2025 - so well beyond elections and the next plan a strategy needs to be decided by 2024. This makes a restructuring and equitisation of the debt at the Kemble entity inevitable. Kemble can pursue a debt-to-equity swap until then or, better, just amend and extend so as to undergo only one restructuring and on the basis of more certainty. The main Kemble creditors are Continental European and Chinese lenders with no attachment to the UK and hence would not meet the basic criteria for holding Thames Water.
Investment Considerations
- As per previous comment, we sold our 1% of NAV position in the Class B notes last week. Better lucky than good? We have decided to remain on the sidelines until we have more visibility on whether or not Thames Water will also have to be restructured.
- That will depend on the stance the new government prescribes to Ofwat, who will translate it into the AMP8 plan next year and thereby decides the value of Thames Water - if any. Nothing is going to happen at the securitised level before then, unless Keir Starmer makes a negative comment that unravels the company ahead of time.
Likelihod of survival of the WBS:
- There is enough liquidity in the WBS to spare the Sunak government embarrassment and instead let Labour deal with it early next year.
- If Labour is elected, the Starmer government needs to decide if it wants to nationalise the company to subsidise water in glitzy London with money from hard-working taxpayers in the north - we imagine this could be difficult to sell to voters - or let Londoners pay themselves for their water and hike bills by 40% in the next five years.
- London should be a relatively safe seat for Labour anyway and the current budget constraints on the UK government suggest to us that the government will neither want to add £3bn in expenses, nor pick up all of that debt. The Tories won’t campaign for nationalisation, so Labour don’t have to either.
- So no appetite for nationalisation. Queue Starmer/Kahn to start blaming the Tories for settling Londoners with such sudden bills - not for settling the tax payer with debt and expenses, although the latter may be good election chatter anyway.
- The new AMP8 plan could play to London citizens and try to provision only just enough bill rises to attract new cash investors, but not enough to save the WBS debt. However, that would deal a major blow to Britain’s bankability. TW pay £200m in annual interest - a bit more than a drop in the river compared to its TOTEX and which is set to rise. But over the next five years, that amounts to less than 1/3 of the investment sought and whether the UK are looking for £2bn or £3bn won’t matter in the public eye. The decapitation at Kemble level may be enough to please the crowds. Going further than that will present a political broadside to the Tories.
- If, despite the above, Labour do decide this is politically inopportune to raise water bills in the capital as fast as that and instead prefers to subsidise the water, it’s Special Administration tool will break up the WBS. The government - through Ofwat’s AMP8 plan - can then decide freely what value it wishes to “pay" for TW and how that payment would be made and over what time frame.
- For the above reasons we think the path of least resistance lies in grudgingly raising the London water bills, not in making a big incision and elevating the issue to national level.
Special Administration Scenario:
- We don’t think the government will want to exercise its rights under this legislation if the likely aim is to find outside investors.
- Third-party investors will be subtracting their investment in the business from EV to determine the remaining capital structure. The recovery to the Class A and Class B debt would therefore be reduced by that amount.
WBS Restructuring Scenario (outside of Special Administration):
- In the event that raising water bills is politically not possible, the company could launch a restructuring plan to compromise the securitisation debt and offer existing Class A and Class B creditors new (lower) instruments, potentially including equity so as to make space / create value for a potential investor.
Housekeeping:
The next catalyst on this name will be a restructuring proposal from Kemble management to the existing creditors of Kemble along with some or any counter proposal from Ofwat after the reaction of shareholders.
Saahil
T: +44 203 192 0200
www.sarria.co.uk