Thames Water Marked Down by More Than 60%

The U.K.’s Universities Superannuation Scheme downgraded the value of its holdings in the private utility, putting infrastructure investments under a spotlight.

Multiple investors in the U.K.’s Thames Water Utilities Ltd. have cut the value of their investments over the last year.

Church Water Investment Ltd., part of the Universities Superannuation Scheme, the largest private pension fund in the U.K., cut the value of its holdings by 62% as of March 2023, according to information released in December 2023.

Thames Water is a private utility responsible for water utilities for 16 million people in the greater London area.

The value of the USS stake in Thames Water was written down to 364.4 million pounds ($464.65 million) from 955.8 million pounds ($1.218 billion) last year. Church Water Investment is currently the second-largest shareholder of Thames Water, owning 20% of the shares of the utility’s parent company, Kemble Water Holdings Ltd.

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The company’s largest shareholder, the Ontario Municipal Employees Retirement System, marked down the value of its investment by 30% in 2022 and was in discussions with institutional investors, including Japan’s GPIF, about whether more money should be invested in the struggling utility company. OMERs refused to comment on the latest devaluation by USS.

“The challenges facing Thames Water are the manifestation of historic under-investment over multiple decades and, more recently, the significant financial impact of soaring energy prices and other inflationary cost pressures,” said a spokesperson for USS in a statement provided to CIO. “However, we have given our backing to Thames Water’s latest business plan.”

The Universities Superannuation Scheme manages the retirements of current and retired academic staff from U.K. universities. The fund managed 75.5 billion pounds ($95.87 billion) as of March 31, 2023, and has more than 500,000 members.

Red Flags, Other Thames Issues

In “Low Tide,” a report by the EDHEC Business School’s Infrastructure and Private Assets Research Institute, the institute identified three red flags with investments in Thames Water:

“The utility should not have been expected to behave ‘normally’ as its incentives were twisted by an extremely low regulatory weighted average cost of capital (or WACC) that could only logically push it to take on too much risk to achieve the level of returns required by the market. While this is true of the whole sector, the gap between Thames Water’s market WACC and its regulated version is the largest of all of its peers”;
“As a response, investors in Thames Water created a structure to extract the maximum amount of cash as fast as possible, which also created a huge debt pile, leading to a necessity to conserve capital. It should have been clear from 2016 onwards that there would be no potential for further payouts for many years”; and
“Thames Water’s exposure to key risk factors that have been shown to drive market prices has been high, and rising, for a significant period of time: this leads to a increasingly higher market risk premium and therefore discount rate and a likely loss in value that was not recognized for years.”

According to EDHEC and other reports, many Thames Waters issues come from the age of its infrastructure.

“In some ways, the U.K. water utility sector is hostage to its Victorian-era infrastructure,” said Tom Atkinson, an equity portfolio manager at AXA Investment Managers, in a Morningstar report. “Its age, outdated design and struggle to cope with population growth have led to two major problems in particular—leakage and contamination—which have now come to widespread public attention.”

The Future for Infrastructure Investments?

Infrastructure investments are popular with income investors. These investments generally provide cash dividends to investors, and with interest rates elevated and likely to fall, these investments could perform well, according to Morningstar.

Thames Water issues may be specific to the company, and for pension investors, who make up a majority of Thames’ ownership, such a utility is a poor investment.

“The Thames Water debacle raises questions of the suitability of this kind of private market investment for pension funds,” wrote Keith Ambachtsheer, director emeritus of the International Centre for Pension Management, in an op-ed for the Canadian newspaper Globe and Mail. “In principle, as an asset securing future pension payment obligations, infrastructure should make for an ideal pension fund investment. But the case of Thames Water shows that is not always the case in practice.”

Another issue with Thames Water is that the company has not paid out any dividends since 2017, and there are concerns among some investors regarding investments in aged infrastructure. Some of London’s water pipes are more than 150 years old.

There are other opportunities in water infrastructure investments, according to Atkinson in the Morningstar note. Atkinson’s ideas include companies that offer services in water testing and processing, irrigation and land reclamation.

According to the 2024 outlook of Macquarie Asset Management, the prior owner of Thames Water, “not only does infrastructure have a well-established, attractive risk-return profile, it also has strong defensive characteristics, a trait that is likely to serve the asset class well in 2024. Deal volumes were weak globally in 2023 but should pick up over the course of the year.”

Macquarie also noted parallels between investments in infrastructure and the energy transition, with the latter driving the former.

Despite ongoing issues at Thames Water, USS expressed its commitment to further investments in the struggling utility.

“As a long-term investor, we can provide patient capital and be an active, responsible steward of the company,” a USS spokesperson told CIO. “While the value we place on our Thames investment may go up or down as part of our regular revaluations, we continue to view this as a long-term investment, in line with the long-term needs of the scheme. That is why we were willing to commit additional funds to the business in March 2023 and have shown willingness to commit more in the future.”

In its report, EDHEC noted that Thames Waters’ allowed revenues were too low, its dividend payments would cease and the utility’s exposure to negative risk factors would increase. The report alleged that investors did not compare Thames Water to its peers; if they had, the company’s flaws would be apparent.