Thames Water came close to collapse earlier this year as it almost ran out of money. But after agreeing to exclusive takeover talks with the US private equity company KKR, the debt-laden utility was hoping for a quieter period as it sorted out the details.
Those hopes were extinguished on Tuesday after KKR said it waswithdrawing its bid– to the shock of many people in the company and Thames Water’s creditors.
It is those creditors – some of whom bought Thames Water’s debt at a big discount in the hope of a quick profit – who have been left without warning with the responsibility of pulling together billions of pounds to carry out a turnaround that might take 15 years.
Thames Water has been through a tumultuous year already. It had a close shave with bankruptcy, ahigh court battle to secure £3bnin emergency investment, and several testy parliamentary hearings. It must invest £20bn over the next five years to fix leaking pipes and water treatment works, all while trying to fend off public anger over sewage in Britain’s rivers and seas.
KKR balked at the complexity of taking on Thames Water amid so much scrutiny and with multiple stakeholders in play, according to a person close to the talks. Partners at the firm had carried out 10 weeks of intensive due diligence, including several visits to wastewater treatment works, and had relied on a small army of up to 200 advisers to carry out detailed assessments. The state of some of the Thames assets was worse than KKR had initially thought, according to another source.
New York-based KKR, short for Kohlberg, Kravis Roberts, had set 15 members of its European infrastructure team, run by the executive Tara Davies, to work on the Thames bid, with James Gordon serving as the lead partner. (Both formerly worked for Macquarie, the Australian investment bank criticised fortaking dividends from Thames Water while building up debt– although they are not thought to have worked on Thames Water.) Yet over the weekend KKR brought out one of its big guns to try to sweet talk the government: Henry Kravis, one of the co-founders, called up Labour’s business adviser Varun Chandra to discuss the plan. Sky News first reported the call.
KKR has rarely been shy ofpotential controversy, ever since its infamous 1988 buyout of the US conglomerate RJR Nabisco was depicted in the book Barbarians at the Gate. However, several people close to the Thames Water situation have said they believed that KKR also became concerned about the political risks associated with it, such as the possibility of intense public scrutiny leading to a stricter approach from the government on enforcement.
A government spokesperson said that it “makes no apology for tackling the poor behaviour we have seen in the past, where too many people were rewarded for failure”, but added: “We welcome investors who want to work with us to rebuild this vital sector and clean up our rivers, lakes and seas.”
Ofwat, the water regulator for England and Wales, last week laid down the gauntlet to KKR with£123m in new penaltiesmostly related to environmental breaches involving sewage spills.
KKR’s bid hinged on convincing regulators including Ofwat and the Environment Agency to grant it leniency on fines, penalties and other costs amounting to billions of pounds,as revealed by the Guardian.
“There were always going to be three people in the marriage,” wrote Helen Rodriguez, the head of European special situations at CreditSights, a bond rating agency: Thames Water, KKR and the regulator Ofwat. KKR may have been put off by “the inevitable drip of more fines to come”, and decided that it was not worth going through a month of meetings in June to try to reach a compromise, she said.
Thames Water has hired its own army of advisers, including the law firm Linklaters. It is understood that the Linklaters lawyers involved in the discussions on Thames Water have included Alison Saunders, formerly the UK’s director of public prosecutions, and Jonathan Jones, the former head of the government’s legal department. Saunders has previously acted for Southern Water on a criminal investigation, while Jones acted for the energy company Bulb during its own special administration. Linklaters declined to comment.
The prime minister Keir Starmer’s office received a courtesy call from KKR before the announcement but the government is hoping to avoid involvement. Steve Reed, the environment secretary, insisted in parliament on Tuesday: “There remains a market-led solution on the table”, and categorically ruled out a permanent nationalisation.
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However, Reed acknowledged that the government is ready to put Thames Water into a special administration regime – akin to a temporary nationalisation – if it is required.
Yet the “market-led solution” leaves the government with the prospect of the UK’s biggest water company being owned by a group of creditors that includes US hedge funds such as Elliott Investment Management and Silver Point Capital known for controversial tactics, as well as big institutional investors such as Aberdeen, BlackRock, Invesco and M&G. It is an unwieldy group of 100 companies, holding £13bn in Thames Water bonds. The investment bank Jefferies is acting as the group’s main financial adviser.
Despite the financial pressure Thames is under – and the cash burn required to fund its operations – it has covered the costs of as much as £15m for due diligence checks that KKR spent on exploring the state of the vast business. Much of that information has already been shared with the creditor group, and will now be used to inform their talks with Ofwat.
However, the creditors must race to secure a deal as Thames burns through the first £1.5bn of the emergency cash it borrowed to fund its day-to-day operations.
Like KKRbefore it, the creditor group will also try to reach an accommodation with Ofwat that will reduce the scope for big fines that would threaten to wipe out their financial returns. The new owners would look to install a board with more water industry experience. The position of the Thames Water chief executive, Chris Weston, is unclear.
“The creditors believe that Thames Water requires an urgent and fundamental reset and there is a very short and closing window in which a market-led solution can succeed,” a spokesperson for the lenders said. “Discussions with Ofwat and the government will be advanced in the coming weeks to reach an agreement and turnaround for the benefit of customers and the environment.”
Even if yet another deal on Thames Water can be reached, people involved in the crisis noted the irony of the timing of KKR’s decision: it was announced just as an interim government review highlighted“deep-rooted, systemic” problemsin England and Wales’s privatised water industry.