Ofwat opens arms to Macquarie return as majority owner of Southern Water

Macquarie Asset Management, on behalf of the long term investors including pension funds and insurance companies in its Macquarie Super Core Infrastructure Fund, has reached agreement to acquire a majority interest in Southern Water's ultimate holding company, Greensands Holdings.

Macquarie will contribute £1.037bn of primary equity of which £543m will be new equity in Southern Water, with aims including to recapitalise the business, implement a more sustainable financing strategy, and significantly upgrade Southern’s network and operating performance.

Head of Macquarie Infrastructure and Real Assets, Leigh Harrison, said: “This major £1bn equity investment by one of our long-term infrastructure funds will help put Southern Water back on a stable footing and enable an ambitious multi-year transformation plan to make essential water and wastewater services in the South East of England more sustainable and resilient.

“While we expect Southern Water will have made substantial progress in addressing its issues by the end of 2025, we acknowledge the business’ transformation will take time and that is why we intend to own our stake in Southern Water over multiple regulatory periods.”

Harrison set out Macquarie’s intentions for and commitments to Southern for AMP7 in a letter to Ofwat chair Jonson Cox following extensive consultation with the regulator. These included to:

• strengthen a zero-tolerance mindset to environmental pollution, in recognition that Southern is “one of the worst performing in the UK water sector” – the company is implementing plans to reduce pollution incidents by more than 50% (compared with 2019) over the next four years;

• reducing leaks to move closer to the PR19 ambition. The investment programme includes £230m of funding on top of regulatory allowances to upgrade Southern Water’s infrastructure, “which management believes is critical to improving the quality and resilience of water and wastewater services, including to both minimise and manage pollution incidents more effectively”;

• ensuring bills do not rise by more than inflation to 2025, and honouring the £123m customer rebate due to historical pollutions; and

• improving customer service from second worst in the sector by addressing the root causes of complaints and enhancing Southern Water’s capacity to handle them more effectively.

Harrison also committed to: good leadership and governance principles; executive pay in line with regulatory expectations; to honour existing agreements on pension deficit funding; and to “a conservative distribution policy” while the transformation is taking effect with shareholder distributions below a 4% yield in each year to March 2025.

Responding by letter, Cox welcomed Macquarie’s commitments and investments. He said: “While Ofwat doesn’t approve or endorse individual initiatives, we are supportive of the direction of travel of the actions you are proposing. We would like to see more ambition in all the targets, in particular on environmental performance and we expect to review these with you within six months, post-completion, when you will be in a position to firm up what is attainable.”

Cox also pointed to Macquarie’s past and future responsibilities as new owner, including that “it is important to recognise that companies have been funded through successive price reviews to meet their statutory and regulatory obligations, including to maintain and improve their infrastructure. Where companies have fallen behind, they remain accountable for catching up. PR24 will address the new forward-looking challenges facing the sector.”

Southern’s chief executive, Ian McAulay, called the development “good news for our customers, the local environment, and the regional economy” and pointed to the creation of 1,000 jobs, and its chair Keith Lough also wholeheartedly welcomed the move.

RBC Capital Markets said the deal highlighted the ongoing investor appetite for water: “The exact stake that Macquarie has acquired is not disclosed, however Southern Water has an RCV of ~£5.1bn as of March 2021 and a reported net debt of ~£5.2bn. Given the lack of detail, the implied premium is difficult to calculate but on a range of stakes between 50-75% the implied premium on acquisition would be 20-40%. The market for UK water M&A remains highly active.”

On the back of the deal and the Environment Agency’s recent £90m fine on Southern for historic sewage discharge breaches, Moody’s affirmed the Baa3 senior secured debt ratings of Southern Water Services (Finance) Limited, whose issuance is guaranteed by Southern Water, and said the outlook is stable. The fine and associated costs will be funded by Macquarie's investment.

Moody’s said the acquisition and equity injection are expected to be completed in September, and will significantly reduce the net leverage of both Southern Water and its holding companies.

Macquarie gained notoriety in the water sector after its track record as owner of Thames Water until 2017 was often cited as one of the key triggers for Labour’s public ownership manifesto pledge in the 2019 election, and Ofwat’s deeper excursions into board leadership and governance. There was outcry after Macquarie earned billions from Thames through dividends and paid little corporation tax.