Memorandum from T Martin Blaiklock, Consultant,
Infrastructure & Energy Project Finance
INTRODUCTION
The Treasury Committee has requested further
comment with respect to the Inquiry into Private Equity. I am
pleased to provide such comment herewith, particularly with respect
to: (a) transparency"; and (b) "market abuse and conflicts
of interest in private equity transactions".
In the first Part of this Inquiry, I provided
written evidence focussing on the impact of Private Equity on
public services: PFI/PPP and the like. I have noted, however,
that to date your Committee has seemingly not examined this area
of Private Equity activity. My comments herewith, therefore, complement
those made in the context of the Inquiry Part 1.
Over the last 12 months I have be keeping a
particularly close watch on the activities of Thames Water, not
least because I am a Thames Water customer, but also because it
is one example,—and a good example,—of Private Equity
involvement with public services. The case of Thames is significant
as it is the UK's largest privatised water utility, serving the
Capital and 13 million customers, and also a monopoly service
provider!
Given that most, if not all, your Committee
Members use Thames' services at one time or another at Westminster,
they may also be interested in this example of Private Equity
activity!
(A) "TRANSPARENCY"
In December 2006, Thames Water, a direct subsidiary
of RWE, a quoted European utility, was sold to a consortium controlled
by, what can be generically termed, "Private Equity".
Just under 50% of the ownership of Thames now comes from Private
Equity funds (controlled by Macquarie Bank), the balance from
pension funds and the like. Overall, however, Private Equity,
in this case, controls the strategic development and management
of Thames (ref. Appendix, EV165, this Inquiry Part 1).
In the structure shown overleaf [source: OFWAT
Feb 2003 Consultation Doc], Thames Water Utilities Limited (at
the bottom) is the utility licenced by OFWAT. However, Thames
Water Utilities Limited is 5 or 6 times removed from the controlling
investor group (at the top), of whom a number are based offshore
in Luxemburg.
Is this the "transparent" corporate
structure expected of a UK monopoly public service provider??
["MEIF", etc are Macquarie Bank Infrastructure
Funds; "Non-Macquarie Investors" represents offshore
pension funds, etc].
(B) MARKET
ABUSE/CAPITAL
MANIPULATION
— In June 2007, Thames Water reported
(to OFWAT) that in the financial year to 31st March 2007 they
recorded a profit after tax of £190.5 million. This was slightly
less than the previous year, but not far out of line for the industry.
— In June 2007, Thames distributed
dividends of £535.3 million to its shareholders for the financial
year 2006-07.
— The only source of funds to pay such
dividends, apart from after tax profits, is the Balance Sheet
Capital of Thames Water.
— As a result, the recorded reduction
in the Capital of Thames, as per the published Accounts, for this
period was £310 million (£1,628.5 million minus £1,318.6
million). This represents a reduction in the Capital of Thames
of around 20%.
— This reduction in Capital has increased
the leverage, or indebtedness, of Thames Water from 57% to 72%.
— Nevertheless, Thames Water maintains
its "investment grade" rating—and, therefore,
creditworthiness,—albeit that its rating, along with those
of other privatised UK water utilities, has steadily fallen since
the early 1990's, reflecting perceived increased financial risks
in the sector.
— According to recent comment I received
from OFWAT on this issue, the exceptional Thames dividend of £535
million represented "a return of equity to shareholders rather
than a dividend"!!! Is not a "dividend" a return
of shareholders' capital, one might ask?? Such is the world of
the Regulators!!!
— The above events have arisen just
at the time when Thames needs to demonstrate its financial strength,
as it is negotiating the financing of the capital expenditure
relating to the Thames Tideway Tunnel Project (est value = £2
billion).
Finally, I should add that I have good reason
to believe that the same kind of financial operations can be observed
in some, but not necessarily all, of the other UK private water
utilities, which have succumbed to ownership by Private Equity
in recent times.
CONCLUSION
There is no doubt that the introduction of Private
Equity-type investment into to privatised UK public services has
sharpened up the financial management of such enterprises. However,
such Private Equity investment has also:
(a) introduced a lack of transparency in
the control, governance and, therefore, the accounts of such utilities.
Some utilities, such as Thames Water, are effectively owned and
controlled offshore, possibly by companies with limited liability
and domiciled in tax-havens. Corporate information is, not surprisingly,
hard to come by for such Private Equity investments!
Hence, in the event of operational failure by
such utilities, (eg the Seafield spill, Edinburgh, April 2007:
Seafield was owned by Thames) it is quite possible that the controlling
company and its directors cannot be called to account, notwithstanding
OFWAT's Conditions P and F licencing requirements (which in themselves
are not watertight: pardon, the pun!);
(b) increased the leverage and, thereby,
decreased the financial strength of such utilities, at the expense
of customers and the security of service; and
(c) introduced corporate uncertainty. The
investment horizon for Private Equity is traditionally three to
five years, which is short for public service utilities, which
require long-term capital and financial stability. The only balancing
feature has been the increased intervention, as direct investors,
by pension funds and life insurance companies,—as principals,
not clients,— albeit some are offshore owned and controlled.
Such investors have longer time horizons and are ideal investors
for such public service utilities.
Overall, the impact of Private Equity has arguably
not been very beneficial to the (private) public service sector,
and such investor-types have picked off easy targets against a
background of an unsuspecting public. Furthermore, the Regulatory
regime may not, on occasion, be robust enough to cope with such
developments. It remains to be seen what the long-term impact
will be on quality of service, but some other examples, eg BAA,
are not encouraging.
December 2007
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