A newspaper piece two months back, in the Monday 13 June print edition of the Financial Times (the online version is here) optimistically proclaimed ‘hopes rise for end to water deal dry spell’. I was immediately struck by this article about water company mergers in the UK. Do people really think this is something to get excited about?
The FT article was prompted by Agbar’s apparent intention to sell its holding in Bristol Water – which Agbar bought back in May 2006 and, at the time of writing, still owns. The article talked about barriers to mergers due to Ofwat’s desire to retain as many separate and independent, privatised water companies in England and Wales as possible. It does this to benchmark more robustly the performance of each against the others.
Opposing this stance, Colin Skellet, executive chairman of Wessex Water was quoted as saying, ‘What benefits customers in the long run is efficiency. There’s absolutely no doubt that if you made some sensible combinations [between companies] you would get efficiencies.’ Severn Trent’s chief exec, Tony Wray, also reportedly believes in ‘potential economies of scale’ from sharing administrative functions across newly merged companies.
Some scepticism was noted by an analyst at RBS, who commented that large water mergers would be ‘very hard to justify‘. Colin Skellet was also quoted as noting that large sums have been paid in the past for water companies, and already ‘one wonders how people are going to get a return on that.’
Nevertheless, nowhere in the FT article did it point out that generally speaking most mergers and acquisitions fail. Very few generate truly positive outcomes. Research on the UK water sector specifically, covering data available for the period 1985 to 2000 (by Saul, Parker and Weyman-Jones) has shown very uneven – and overall negative – efficiency ‘gains’ from scale for the England and Wales water companies. So why all the excitement and enthusiasm? It beats me.
Even this month, in The Independent on 3 August, news of the purchase of Northumbrian Water by ‘Hong Kong billionaire Li Ka-Shing’s Cheung Kong Infrastructure (CKI)‘ and the consequent sale to HSBC of Cambridge Water (that CKI had originally bought in 2004) to satisfy anti-competition conditions, has led to increased fervour about the prospect of ‘more takeovers in the water works.’
Earlier this year, Utility Week had talked about an approaching era of ‘merger movement’ (back in February). That piece led with how the Cave Review recommendations might affect Ofwat’s ‘anti-consolidation stance’ – perhaps leading to more developments in the wake of the acquisition (in 2010) of the American owner of Bournemouth & West Hampshire by Singapore-listed Sembcorp Utilities, and the transfer of Bristol Water’s owner Agbar to sole control by the French Suez Environnement.
The UW piece asserted ‘a more rational geographical grouping‘ of consolidated UK water companies would take out ‘significant costs, starting with half a dozen boards of directors, human resources functions, billing systems and regulation departments‘ and lead to ‘a lower cost of capital‘ in the long-term – wryly noting this might even ‘warm the cold economic cockles of Ofwat’s heart‘. There would also be strategic benefits for dealing with climate change and predicted water shortage in the South East of England, the UW article claimed. Given the points I’ve already noted above, let’s just say I remain to be convinced.
One interesting thing the UW piece did note was the influence of the ownership patterns of the water companies. Only four of the big ones (Northumbrian, Severn Trent, South West and United Utilities) are publicly quoted. The rest are owned privately, by private equity, by pension funds, by a mutual or combined companies, or by overseas utilities. This state of play, allied to the water companies’ long-term covenants and highly geared financing arrangements, count heavily against mergers and consolidation. The Government’s water White Paper – now due in November or December this year – is an apparent barrier too, due to risk and uncertainty about its, as yet unrevealed, regulatory changes for the UK water sector.
All in all, given the largely questionable benefits of water mergers though, I’m surprised at the current climate of general positivity about them. I also find it bizarre how eager industry insiders are for them, and how excited outside commentators and speculators get. These are risky, low to negative benefit options we’re talking about.
Now, if we could only get the same kind of buzz around increased innovation in the sector, who knows? In the long run we might actually get far more sustainable, long-term outcomes from this water industry…