Thames Water’s ‘difficult choices’ must include pain for bondholders | Nils Pratley

Is the board of Thames Water having a laugh? Having been told last month by regulator Ofwat that a plan to hike customers’ bills by 40% over five years was unacceptable, and that 23% would be nearer the mark, the company has returned with a counter-proposal : how about 52%, or 59% if one throws in conditional spending on big projects?

Since these figures don’t include inflation, one can add a few quid to projected average bills of £666 or £696 in 2030, versus £436 today. It would be a miracle if Ofwat, which was talking about £535 before inflation , agreed to anything like that. The August to December consultation period allows for revisions, but regulator and company look to be oceans apart.

Thames’ main argument for its shift from 40% is that it overestimated the rate of population growth on its patch – ie there won’t be as many extra billpayers as it thought in April. But in other respects the song remains the same: the boardroom view is that Ofwat is underestimating the true cost of running the company and upgrading its sewers, storm overflows, wastewater plants and so on. The regulator’s draft stance makes the business plan “neither financeable nor investible and therefore not deliverable”, said chief executive Chris Weston, repeating the now familiar line that “structural underfunding” was imposed on Thames from outside.

Sorry, but the backward-looking stuff is simply unconvincing. Whatever faults can be laid at the regulator’s door (and there are many), the greater portion of Thames’ woes are self-inflicted. The company was soaked by financial engineers and then the current owners failed to grasp the size of the operational headaches. The detail behind last month’s provisional £104m penalty for failings at sewage plants revealed a catalogue of broken promises to clean up its environmental act.

Today’s bull-headed stance on the business plan at least offered clarity on one point: barring an astonishing U-turn at Ofwat, Thames’ struggle to attract £3.3bn in equity from new investors is doomed. Nobody is going to invest in a company whose own management advises against investment.

So the most likely next plotline remains a financial restructuring. Shareholders have already accepted that they’re wiped out, so the next in line to fill a multibillion pound funding gap should be the bondholders. Borrowings within the regulated entity are an unsustainable £15bn. A debt write-down could be executed via the special administration regime, or by a semi-voluntary debt-for-equity swap, but the effect would be the same: haircuts for lenders. At that point, Thames could emerge with the necessary financial breathing space for its management to attempt a turnaround.

In that context, chairman Sir Adrian Montague’s comments were intriguing. “It’s the responsibility of the company, our regulators and the government to seek solutions in the best interests of customers and the environment,” he said. Well, yes, but the missing party in that little list of people who must face up to “difficult choices” is the bondholders.

Come on, Sir Adrian, your customers aren’t fools – they can see that bills will have to rise to fund extra investment, just as they will at all water companies in England and Wales. But the size of the increase is the argument. Billpayers also know that, by rights, bondholders should take a whack here, just as they would at a conventional company that have overextended itself financially. If it is “difficult” to explain to international investors that it is possible to lose money by lending to a regulated UK utility, you need to get over it. The world will move on.