The decision by Agbar to sell Bristol Water has reignited hopes for a series of mergers and acquisitions in the struggling water sector in England. While funding for deals has become more challenging, interest remains from international investors, buoyed by the potential relaxation of merger regulations. However, analysts remain cautious about the financial viability of large transactions in a market where valuations are high compared to historical standards.

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Hopes rise for end to water deal dry spell
By Alistair Gray
Published: June 12 2011 22:27 | Last updated: June 12 2011 23:22
Water company customers in drought-hit areas of England still hope for adequate rainfall, but bankers praying for
an end to the prolonged dealmaking dry spell in the sector have received a trickle of good news.
The decision by Agbar, the French-Spanish owners of Bristol Water, in effect to put the utility up for sale has
sparked hopes that a long-awaited round of deals will come to fruition.
A successful sale of Bristol can act as a “trigger” for other transactions, says Angelos Anastasiou, analyst at
Investec.
Fuelled by cheap debt, a host of international infrastructure and pension funds clamoured to buy England’s water
companies during the previous decade’s credit boom. Although funding may now be harder to come by, the main
reason for the interest of such investors in the industry – predictable cash flows that match their long-term
liabilities – remains intact.
Mergers and acquisitions bulls also point to recent acquisitions in the electricity sector.
PPL, the US power group, snapped up Eon’s UK business, Central Networks, for
£4bn earlier this year. Some analysts believe bidders who missed out are eyeing
some of England’s water companies.
Interested parties included Cheung Kong Infrastructure , the investment vehicle
of Hong Kong billionaire Li Ka-shing, which in July bought EDF’s UK distribution
business for £5.8bn, and MidAmerican Energy Holdings, owned by Warren
Buffett’s Berkshire Hathaway.
Also whetting the appetite of the City is the Potential Bristol buyer
possibility that policymakers and regulators are
preparing to relax stringent merger rules as part A possible takeover of Bristol
Water by Wessex Water would
of the industry’s biggest shake-up since seem an obvious combination,
privatisation in 1989. writes Alistair Gray.
Wessex is the region’s
At present, mooted mergers between existing stalwart, which provides
companies are automatically referred to the sewage services in Bristol’s
Competition Commission; there have only been patch. The two companies
a handful of such deals in recent years. have already formed a joint
venture so that customers in
the area receive a single bill for
When Macquarie won the hotly contested water and sewage.
auction for Thames Water in 2006, it sold its
Although declining to comment
stake in South East Water to overcome the on the Bristol situation, Colin
potential regulatory block to its bid. Skellett, Wessex executive
chairman, said: “We have an
The barriers have been set up mainly because owner who has plenty of
the industry regulator is keen to maximise the capacity to do other things ...
They have a large amount of
number of companies between which it can cash.”
compare performance.
Whether Wessex, which
Malaysian infrastructure group
In an interview with the Financial Times earlier YTL bought from bankrupt
this year, Regina Finn, chief executive of Ofwat, Enron in 2002, would win
said the barriers to mergers could be lifted were regulatory approval for an
the regional monopolies to agree to the acquisition of Bristol is far from!
introduction of competition. certain.
Agbar, owned by France-
Colin Skellett, executive chairman of Wessex based Suez Environnement
and La Caixa, the Catalan
Water, says: “If a water company comes up for
bank, paid £362m for Bristol
sale, it’s far more likely that it will be bought by five years ago – a premium of
an infrastructure investor or a foreign investor.” about 145 per cent regulated
He adds: “What benefits customers in the long asset value, according to
run is efficiency. There’s absolutely no doubt Lakis Athanasiou at Evolution.
that if you made some sensible combinations Last year, Bristol was the first
[between companies] you would get water company since the
efficiencies.” 1990s to appeal against
Ofwat’s latest pricing review.
The regulator had allowed
Much of England is dominated by the industry’s Bristol to increase bills by 7
stalwarts, which provide both water and sewage per cent over five years, but
services. But other areas have a mishmash of a the company claimed Ofwat

2. structure. “seriously underestimated the
costs needed to deliver the
things they want us to do”. The
Proponents of consolidation – who include
Competition Commission
Tony Wray, chief executive of Severn Trent – subsequently allowed Bristol to
point to potential economies of scale in, for lift bills by 15 per cent.
example, sharing back-office functions such as
customer services.
But with the government’s white paper on the future of the industry now delayed until December, rule changes
look some way off – if they are made at all.
Moreover, given that the sector is trading at a premium to its regulatory capital value, several analysts remain
sceptical of the financial benefits that companies would gain from dealmaking.
Iain Turner, analyst at Royal Bank of Scotland, says some “synergistic tidying up” may be sensible, but large
deals will be “very hard to justify”. Shareholders in the listed companies will prefer them to buy back their own
shares than snap up sizeable peers, he adds. “If you look at the prices that have been paid sometimes for water
companies, one wonders quite how people are going to get a return on that,” says Mr Skellett. “So would there be
an appetite [for smaller deals]? I think there would if the prices were sensible.”
For the time being, infrastructure investors are among the most likely candidates. Robert Miller-Bakewell, a
former equity analyst who covered the sector for two decades, says that they have been through a rough patch
but now have a “decent amount of cash to hand”.
Traditionally, deals are more attractive near the start of the regulatory cycle: the longer potential buyers fail to
complete a transaction, the less certain their short-term returns.
With water companies now more than a year into a five-year regulatory regime, Mr Turner says: “If you were
going to do a deal, you may have done it by now.”
For months, speculation has swirled that Ontario Teachers’ Pension Plan is considering a takeover of
Northumbrian Water. And, for months, a deal has failed to materialise. The company has consistently declined to
comment on whether it has been approached.
There is also the added complication of the various government and regulatory reviews, which may scare off
potential buyers.
For all the excitable talk, sceptics point to the high valuations in the sector. Mr Miller-Bakewell says electricity
assets trade on lower multiples than their water counterparts.
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