London & Valley Water ups equity for Thames but pursues concessions

(by Verity Mitchell)

London & Valley Water (L&VW) has published its latest proposals for recapitalising Thames Water. It stressed that these are non-binding and still under discussion between Ofwat, Thames Water itself and other regulators.

L&VW has increased the amount of equity it proposes to provide to Thames Water to £3.35bn from £3.15bn. It would obtain up to £6.55bn of new debt: a mix of an initial £3.25bn, and a further committed facility of up to £3.3bn. It proposed a Performance Improvement and Turnaround Plan for the entirety of AMP8 (2025-2030) which would allow it to deliver the £20.4bn of totex proposed by Ofwat in its final determination. 

However, the plan contains a smorgasbord of allowances, some more favourable than those offered to Thames’ peers. The plan assumes that Thames can access the higher allowed return proposed by the Competition and Markets Authority (CMA) for companies that requested a redetermination.

Whilst Thames is offering to pay all outstanding fines, with L&VW making a significant up-front and ring-fenced investor and redress commitment (without recovery from customers), L&VW rejected the use of the Outcome Delivery Incentive mechanism which would open it to significant future penalties during AMP8. This is one of the key levers Ofwat uses for judging regulatory compliance and ambition. L&VW is also asking for more favourable Price Control Deliverables and agreed gating and delivery mechanisms. 

L&VW's funding depends on further engagement with regulators on enforcement matters. This seems to imply that more concessions would need to be extracted from Ofwat. 

An independent Thames Water Community Benefit Trust would also be established and initially funded by L&VW with £25m in cash to invest in local benefit schemes and projects, including environmental and wildlife support.

The eventual outcome remains a sale to new owners which might mean a stock exchange listing. L&VW would commit to an excess value share mechanism from the proceeds of any eventual sale of the business above agreed levels, which would see certain benefits of the turnaround shared with customers. In addition, under the L&VW proposals, there would be an enhanced asymmetric aggregate sharing mechanism with reduced thresholds.

The L&VW proposal would see commitments from its largest shareholders to lock-up (not sell) a significant proportion of their equity investment during AMP8. In conjunction with this promise, it would provide other undertakings including a commitment to review (and regularly refresh) strategic options for Thames. Under the proposal, Thames Water would not pay a dividend to shareholders before 1 April 2035 or until Thames is returned to the listed markets, to ensure cash is re-invested in improving the business in support of the turnaround.

The L&VW proposal is based on a recapitalisation predicated on a 30% write-off of Class A Debt, and full write-off of the Class B Debt and any subordinated debt or equity held by existing shareholders. This is an increase from the 25% previously offered. Thames will then have net leverage of 52%, the lowest in the sector. L&VW hopes that the newly constituted Class A debt and wider package would provide the foundation for a return to an investment grade credit rating. Discussions with financial stakeholders in relation to the terms of the recapitalisation are expected to take place in the coming weeks.

This proposal remains non-binding. As engagement remains ongoing, there is no certainty that the L&VW proposal will be accepted or that it will be finalised in its current form. No decision has been made by any party to accept the L&VW proposal. Importantly for current liquidity considerations, implementation of the L&VW proposal depends on Thames continuing to access funding under its existing accordion facility.