Thames Water – The Straw that broke the UK’s back?

Blain’s Morning Porridge 29th June 2023:  Thames Water – The Straw that broke the UK’s back?

“Socialist governments traditionally do make a financial mess. They always run out of other people’s money.”

The Thames Water debacle is shaping up to be a critical “Judder” moment for the UK. Public utility privatisations decades ago have left a legacy of underinvestment and broken services. The bills will be enormous – and crippling – creating a potential investment crisis.

I don’t like DRAMA early morning.. BUT! the imminent collapse of Thames Water – the UK’s largest water company – is shaping up to become the fundamental crisis point when the UK’s long-saga of economic decline turned critical.

Economic success is all about confidence and common sense. This is not about the collapse of a single company – it’s about how 40 years of miscalculations, mistakes, and the primacy of political will over common sense, have finally come due. Today’s crisis will have massive market, political and economic consequences as the travails of Thames Water ultimately reveal just how disjointed, hollowed-out, ineffective, but most importantly, how bust and broken the last 40 years has left the UK economy. (Sir Keir Starmer is welcome to use this paragraph – but only if he subscribes to The Morning Porridge.)

The implications of Thames Water for future investment into the UK are frankly frightening. It will be a “judder moment” as markets realise what it means. Its more than just the collapse of a poorly run, over-leveraged privatised utility. As a British taxpayer and voter I am a tad peeved. We should have seen this coming – but we didn’t because it all happened in plain sight.

Let’s recap…

On Tuesday the very well-heeled CEO of Thames Water, Sarah Bentley, did a runner. She was paid a £3.1 golden hello to join the firm 3-years ago, received a £2 mm salary and over £727,000 in additional bonus payments last year despite running the worst raw sewage polluter in the UK. Thames Water has paid £1.6 bln in dividends since 2011, but paid zero in corporation taxes in 2021. As she scarpered off with immediate effect yesterday her Chairman wished her “every success for the future”. I shall remember that next time I catch something nasty from the turds that pollute our local river after decades of underinvestment.

I wonder why she ran? (Rhetorical question.)

• Could her departure be anything to do with the company’s impossible position?
• Was it the enormous future investment bills simply to stop its system getting worse?
• Was it the £14 bln plus of outstanding debt about to default?
• Was it the likely reaction to her proposals to fund the debt with a 40% increase on customer bills?
• Was it the realisation the whole game was up?
• Or was it just too difficult to keep all the balls up in the air any longer?

Thames Water was once a modern public utility. Its ancestry includes the modern sewage systems built to solve the Great Stink, cleaned up the Thames, and provided clean sweet water to 27% of England’s population. It can trace its public sector roots back to the 1600s. But it was privatised in 1989, acquired by German energy firm RWE in 2001, who flipped it on to Australia’s more malevolent native version of Goldman Sachs, the Vampire Kangaroo: Macquarie Bank, in 2005.

Now… before everyone blames the banks and investors – that’s what they do. They look to improve shareholder returns. That is their priority – not customers. (That’s the difference between governments and corporates: government’s shareholders and customers are one and the same.)

The Aussie Asset Strippers did rather well out the opportunity. They pushed up the debt by $10bn, paid less than £100k in taxes, while paying themselves £1.2 bln in dividends for doing the square root of didley-squat in terms of real investment into water infrastructure, (while also leaving a hole in the pension fund), before dumping its looted corpse on some pension funds who thought they were buying annuity cashflows for a couple of billion sterling six years ago.

This morning Thames Water bonds are trading sub 50%. I suspect the short-dated TW bonds will be ok – the government will try to delay default till an election next year is out the way. The current equity investors include Canadian Pension funds, Gulf and Chinese sovereign wealth funds, plus some large UK occupational pension schemes including USS and BT. There are calls for the company to be re-nationalised – leaving these shareholders with zero.

That will be a simply “marvellous” signal to send global investors…. (US Readers – Sarcasm Alert) Not only has 40 years of privatisation left the UK’s infrastructure broken, but after zeroing investors, the only alternative is to fund it with government borrowing – which QE and Covid has left at over 100% of GDP – the highest ratio since the 1960s. Hence my concerns for future inwards investment into the UK. There is significant domino risk – Thames Water was the first. Which will be next? What is the ability of the state to absorb the losses? This is going to hurt in UK bond and equity markets.

Let me quickly recap Virtuous Sovereign Trinity theory: if the UK’s bond market comes under further pressure to refinance bust privatised utilities – then it will not only trigger ructions in the stability of sterling, but will further question the political competency of the government. Result? Decreasing global confidence in UK plc…

Global investors looking at the UK today see a nation of decaying infrastructure, a massive bill to rebuild it, a planning process that actively stops anything – and a nation showing little realisation of the crisis. The opportunity to invest has passed – the big returns from privatising the state are gone – Macquarie and others got them.

Hence, I though it apt to start this morning’s comment with a Margaret Thatcher quote on the top line this morning. It’s tempting to suggest we might want to rethink that one: “Conservative governments traditionally do make a mess. They always give away our money to their chums…”

The UK’s infrastructure crisis might be solvable if it was just one water company – but its all of them. And the Railways. And the Roads. And Education. And the NHS. And the power companies. (Let’s not mention the burgeoning costs and planning delays that leave the HS2 Northern Levelling Up Railway and pointless point-to-point from some random place in North-West London to Birmingham.) To cap it all; a few years ago Macquarie was asked by the water regulator, Ofwat, to “rescue” failing Southern Water… I wonder how much they made from that?

I expected better of privatisation – the flagship Tory policy of the Thatcher-Major era. Then we believed in common-sense financial rectitude and sensible budgets. It wasn’t supposed to end like this – the whole idea of privatisations was to take control away from the state which had clearly failed to properly manage state-run industry. The Tories – and lest we forget, voters – took great delight in privatising everything. Royal Mail, Capita, British Aerospace, Cable & Wireless, British Gas, British Telecom, British Steel, BP, Rolls Royce, British Airways, Water Companies, Electricity companies, British Coal, National Power, Powergen, British Rail. There is a degree of commonality in that list. Many, but not all, of these companies are less good today than they were then. Pretty much the same thing happened to every privatisation… new owners came in, levered them up to pay themselves dividends, flogged them on and left them broken. These costs are coming due.

There was a hilarious dark-analysis earlier this week: The Great Railway Disaster – on Channel 5 about the complete clusterf*ck that is UK railways. Comedian Ben Elton summed it up: “We sold off British Rail because the Tories considered it a firm run badly by the UK government. They sold it so it could be run even more badly by rail companies owned by the Italians, German and French.” Yep, nationalised foreign government rail firms – and Yooropeans to boot – own many of the UK failing rail franchises.

Elton’s somewhat left-leaning programme successfully demonstrated British Rail was, in every single respect, a better, more profitable, more reliable firm before privatisation created a quagmire of dodged responsibility and missed opportunities. In real terms today’s privatised UK railways cost more than double the cost of BR in the 1980s in subsidies and support.

The privatisation of utilities in the UK has been an fiscal disaster for the UK.  Now we pay for it.

If I was a lefty – which I acknowledge there is a danger I am morphing back into – I would write something like: “After decades of chronic mismanagement, asset stripping, paying dividends to equity owners by raising debt, and treating customers as marks to be exploited, Privatisation has left the UK with the worst infrastructure in Europe, hopelessly inefficient and overpriced utilities and a sense of national despair.” (Sir Kier can have that one for nothing.)

But… I am a simple, tell it like it is market commentator. No point bleating over what a mistake privatisation proved to be. We have to solve what is solvable. Brexit (which, yes, I voted for – mea culpa) was another massive mistake and equally badly executed – there may be time to rescue something from it.

How do we fix the UK? Cool Heads. Pragmatism. And a clear acknowledgement mistakes were made. Oh, and instead of 18 months of political dither as the current government staggers from mistake to mistake.. maybe time for a change… (Not that I would wish the Gordian Knot of solving the UK’s broken economy and empty wallet on anyone…)

Out of time, no time for 5 things, and back to the day job…

Bill Blain

Strategist – Shard Capital.