Banks and financial institutions have always been important players in funding the capital intensive water sector. But of late they have begun to occupy a new role – as direct owners of water utilities. In the UK, 4m customers currently receive water, and 4.5m wastewater, services from a mix of British, Australian and German financial bodies, and the trend is not confined to the UK.  How far can this go, and does it mean a fundamental shift in the way the sector is managed and valued?

Firstly, geography: we believe that the phenomenon will be limited. These institutions have a low risk mentality, and are focusing on the regulated, transparent parts of the water sector.  These happen to be where there is also a growing need for investment capital as legislation and/or climate change kick in. It's no coincidence that the only recent asset acquisitions by financial institutions have been in the UK (Mid Kent, South East, Sutton, Southern) the US (Aquarion) and Chile (Essbio), countries with sophisticated regulatory systems.

Secondly, price: UK water utility acquisition multiples in 2004-5 have been high, but this has always happened in the immediate aftermath of a price review, when the defined forward revenue profile is at its longest.  Multiples (and acquisitions) will tail off as 2009 nears (just as they were modest in 2002-3). In regulated sectors without such a cycle (eg the US and Chile) acquisitions by banks have been opportunistic and multiples low at any time. The banks are interested, but they're not daft.

It's also notable that multiples on acquisitions by non-banks (eg Enron buying Wessex, RWE buying Thames, right up to Agbar buying Bristol this year) tend to be more exciting, because they factor in the non-regulated or strategic value – not part of a bank’s rationale for investing.

Lastly - size.  All but one of these acquisitions (Aquarion by Macquarie) have been under $500m. This is about the "sweet spot" for a P/E firm. Anything significantly bigger might take a consortium of buyers - and then it starts getting complicated. Even Goldman Sachs reportedly only has $3bn in its global infrastructure fund.

Nevertheless, the size threshold could rise as developments continue to make the sector ever more attractive to infrastructure investors. Water companies are falling over themselves to shed their non-regulated activities and become even safer “pure play” businesses, while consumer tariffs are growing significantly on both sides of the Atlantic.   The question is, will some sort of Heisenberg Principle begin to play out here? - ie banks invest because the sector is low risk, but the very entry of such arguably short-term owners may actually raise the risk profile in the sector! This may start to bother the regulator.

Interested in discussing these ideas further?  Contact us…