As UK and European assets are being snapped up by cash-rich foreign investors, the water sector has seen its bit of the action over the last couple of years.
“The UK water companies are seen as very attractive assets,” says Sakshi Sharma, who covers the water sector for Infrastructure Journal. Many foreign buyers are looking to get into the market, she says, exemplified by last year’s three major project finance water deals in the UK. The biggest, the acquisition of Northumbrian Water in August, saw a Chinese fund, CKI, pay 30% over the odds to gain access to the proceeds from selling water to 4.4m Brits.
Project finance is a popular way of financing major infrastructure constructions or acquisitions. This type of financing requires a large investment up front which is repaid through the proceeds from the structure the money is financing. Toll motorways, oil refineries and desalination plants are often built through this kind of financing, and utilities are using it too.
It used to be banks, which did the most project financing, as it requires a lot of cheap money to invest. Money which a bank like Royal Bank of Scotland (RBS) used to be able to access through its retail division. These days, the part of RBS which is still free to invest does not have access to such funds and has to rely on money raised in the market for its investments.
The new investors are a diverse bunch, according to ms Sharma. Pensionsfunds. Insurers and foreign investors are filling the gap left by the ailing UK and European banks. Chinese, Japanese and Hong Kong investors in particular. The investment by a Chinese sovereign wealth fund in Thames Water earlier this year was no one-off.
The important thing to consider in project finance is whether the asset will provide a reliable income stream. This reliability does not only rely on the projected availability of customers but also on the political climate and to what extent regulations can be relied upon not to change. Any decrease in the perceived reliability will cost in terms of market interest.
At this moment in time, the project finance model is losing a little steam as many banks are still looking to curb lending and strengthen their balance sheets. In addition, ms Sharma warns that the introduction of new regulations is spooking the UK market: A Department for Environment Food and Rural Affairs (Defra) white paper is doing the rounds and the outcome of these consultations will not be known for a while. ”Until more is known about the outcome, investors are wary”, she says.
Key to the white paper is considerations of sustainability in the light of ever-increasing demand for water, but in the future it may also be easier to gain entry to the market and to merge companies more easily. New pricing structures are also in play.
The ratings agency Moody’s is already considering the consequences for the water company credit risk and announced two months ago that Ofwat’s Future Price Limits and White Paper Increase UK Water Sector’s Credit Risk.
Neil Griffiths-Lambeth, a Moody’s VP Senior Credit Officer and author of the report, is worried that the proposed reforms contain elements which could be credit negative for the sector, in particular for companies that are unable to adapt and/or are weakly positioned in their rating categories.
A poorer credit rating would make all finance raised in the markets more expensive to come by for these utilities, and would be a destabilising influence on the revenue streams.
Defra hopes to introduce the Water Bill as soon as possible.
The future of British water is being decided and the market is holding its breath.