Thames Water - Valuation Framework
Dear all,
Please find our updated model including valuation analysis of Thames Water here.
Kemble is now in default and Thames Water bondholders have started to organise in anticipation of either a market-led restructuring of the whole business securitisation or a special administration. The company has finalised a new business plan which involves increasing totex to £19.8 billion which has been submitted to Ofwat. The next deadline or catalyst would be to reach an agreement and a decision from Ofwat by the 12th June 2024. In the meantime, the company has £2.4 billion of liquidity for the next 15 months until a resolution is made but the clock is ticking….
Investment Considerations
- As per our previous comment, we sold our 1% of NAV position in the Class B notes recently. 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 which decides the value of Thames Water. 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.
- No restructuring & break-up of securitisation structure: In this scenario, we see no material upside to the current trading price in the 60s unless interest rates start falling again as they have a greater impact than if Thames Water remains an ongoing concern. The Class A notes (especially the long-dated, lower coupon inflation-linked notes) currently trade at a slight premium to UK gilts of comparable maturity. There is also limited downside so the Class A notes would trade in a range of 10 points of upside and downside.
- Restructuring & break-up of securitisation structure: In this scenario all the claims of the Class A and Class B creditors (irrespective of coupon, inflation indexation and maturity) are treated in the same manner according to their ranking. Depending on the restructuring proposal and the size and structure of the new money need, we see a great variance in the recoveries of the Class A and Class B notes. On the upside, if the Class A and Class B notes get equity in the new Thames Water in return for a haircut of their notional claims, recoveries over an extended period till 2030 could be above par (depending on at what value Thames Water is sold). On the downside, a greater than expected new money need and if provided by a third party could lead to a steep drop in the price and limited upside to recoveries.
Thames Water Valuation Scenarios
The missing piece in the puzzle besides a new business plan and projections is a valuation of Thames which would drive the future recoveries for bond holders. We have used three different approaches to get a view on the enterprise value of Thames Water which are detailed below: -
- Discounted Regulatory Capital Value (RCV) / Book Value Approach
- Discounted Cashflow Approach
- Implied PV on 2030 multiple
Valuation Ranges (as shown below)
- On the upper end: Using the Implied PV on 2030 multiple, we are getting a Thames Water enterprise value of £32 billion (using a multiple of 21x and a 2030 EBITDA of £2.19 billion discounted at 6%). However Thames Water’s network will remain of Victorian construction and difficult and expensive to maintain and therefore this is a largely theoretical “blue sky” valuation scenario. In this case, the Class A and Class B debt would be covered.
- On the lower end: Using a Discounted Cashflow approach, we are getting a Thames Water enterprise value of £15 billion (We have assumed revenues to grow by 40% in the AMP8 period. We have also modelled opex to grow by volumes and inflation. The key driver of the DCF is our capex assumption which combined with opex add up to totex of £19.8 billion. We have used a discount rate of 6%). In this scenario, the recovery rate for the Class A debt would be in the low 80s. A restructuring scenario would boost the long end of the curve and lead to a decline in the short end of the curve.
- Deducting a £3.8 billion new money injection from the enterprise value would give you the recovery values for the Class A notes under the above scenarios.
Housekeeping
The next catalyst on this name will be the approval of Ofwat of the business plan on the 12th June 2024. In the meantime, market participants continue to be amused by the daily headlines, posturing by various stakeholders and the government on this situation.
Happy to discuss over a call at your convenience.
Saahil
T: +44 203 192 0200
www.sarria.co.uk