The depth of competition for the arranging mandate – won by BNP Paribas – on the debt financing backing the sale of French water group Saur, the fact that Saur is being sold for around Eu700 million more than it was bought for in 2004, and that both buyers and sellers are private equity groups all demonstrate the growing appetite for European water.

SUEZ Group, La Caixa and HISUSA (which is itself controlled 51% by SUEZ Environment and 49% by Caixa Holding) have also announced that they are launching a public tender offer for the shares that they do not already own in Spanish utility Sociedad General de Aguas de Barcelona (AGBAR). The group of shareholders already jointly own 49.7% of AGBAR, and their intention is to strengthen their control of the company while leaving a free float of around 30% to 33% on the Spanish stock exchange.

The trend is a bitter-sweet irony for those fund managers and bankers that were pressured by their institutions into not looking at utilities during the telco/dotcom boom. Furthermore, the growth in water investment is not just a symptom of asset speculation and high liquidity – the growth in water investment is driven by the desire for long-term steady income streams and ultimately end-user demand.

Major funding required

Improving the quality of drinking water, and the environmental efficiency of wastewater treatment, will requiring major capital expenditure across the European Union in the coming five years. Over the past five years the European Investment Bank (EIB) alone has committed Eu7.7 billion in support of projects in the EU aimed at improving water quality (catchment, treatment and supply), waste management and treatment.

For commercial bank lenders, the most lucrative work is likely to involve public private partnerships (PPPs), which are playing an increasingly important role, though municipal or regional ownership of water companies remains common and many projects will be financed on balance sheet or through municipal/project debt hybrids.

The wave of merger and acquisition activity within the European water sector, has also become a big fee earner for banks which often use their project financing expertise to make asset valuations and get involved in providing acquisition finance facilities.

More funding sophistication

With that involvement has come increasing levels of funding sophistication with securitization – a longstanding favourite in the UK water market – making even bigger inroads.

Having bought Thames Water in 2006, Macquarie now plans to use Thames Water revenues for a securitised take-out of some of the acquisition facilities. Colonial First State is also expected to use securitisation as a source of refinancing for its Anglian Water buy-out.

On the bank debt side there is also strong appetite for water acquisition facilities. The Eu1.5 billion acquisition debt to be raised by CDC, Seche Environnement and Axa Private Equity for their Eu1.72 billion buy-out of Saur from PAI Partners is also unlikely to have little difficulty finding takers despite bank reservations at the infra flavour margins on the deal – rumoured to be 110bp over Euribor. some claim Saur is not an infrastructure credit because of its medium term (12-year) contracts.

Despite the vast debt being raised for acquisitions, bankers do not see any shortage of funding for single water projects, and say that capacity constraints for bank lending into the water sector are still a long way off: Lenders regard the water sector as an area of great potential, especially given the EU directives and the growing level of interest in global environmental challenges.

PPP development

Much of that debt is being lent to PPPs with a number of new European markets opening up to the concept – albeit with either legal complications or often, low margins.

For example, last year's project financing for Aquiris – the first PPP water concession in the Belgian water sector – was a complex and low-priced deal.

Aquiris, which is 97% owned by Veolia, holds a 20-year concession from the Brussels-Capital-Region to provide waste water treatment for around 1.1 million people.

The Eu300 million BOOT project was awarded back in 2001 but the complexity of the financing requirements, and legal challenges that had to be met, led to long delays in putting non-recourse financing in place. As a result, the financing reached close at the end of the construction period, thus removing construction risk from the equation and getting debt pricing ranging from 35bp-50bp. As a result, Aquiris is seen as innovative, but more of a one-off than a template for future European deals.

Lead arranger Calyon split the Eu167 million of commercial project debt with three of its group banks – Caisse du Nord France, Caisse du Nord Ouest, and Credit Agricole Belgium – while the EIB provided a direct loan of Eu100 million.

"The legal framework for concessions in Belgium was a challenge for lenders on the Aquiris deal for a number of reasons," explains Charles Antoine Leunen, member of the finance practice group at Freshfields in Brussels, which acted as legal counsel to the lenders. "Some of its provisions are difficult from a bankability perspective, such as the provisions on compensation upon termination, or the unilateral rights of the authority."

"Considering its shortcomings from a bankability point of view, it is unlikely that, in the current state of the legislation, the concession for public works will be used for future infrastructure projects in Belgium," says Leunen. "The projects currently in tender, in particular the Oosterweel link road and the Liefkenshoek rail connection, have been structured differently."

In the meantime, some other Belgian public water companies are upgrading via borrowing on balance sheet rather than going the PPP route. Last December the EIB signed a Eu125 million loan with Societe Wallonne des Eaux (SWDE) for its 2006-2008 works programme. The total investment for the period is Eu265 million.

Project Omega

A more user-friendly template for European water deals is the Project Omega waste water treatment PPP which recently reached financial close in Northern Ireland.

The sponsor is Glen Water, which is a joint venture between Thames Water and Laing O'Rourke. The project involves the expansion of existing facilities, plus the construction of two new plants. Together they are responsible for 20% of Northern Ireland's wastewater treatment capacity.

The first new plant, the new North Down/Ards wastewater treatment facility, is already under construction, while the sewage treatment and disposal facility at Duncrue Street in Belfast will see construction getting underway soon. Construction costs total £117 million, with another £550 million of services being provided over the life of the PPP contract.

The loan package, which was signed in March, comprises a 14-year £136 million senior loan priced at 100bp, with step up provisions, plus a two-year £14.8 million equity bridge. The debt has been entirely provided by Depfa and Bank of Ireland while financial advisor to Glen Water was Royal Bank of Scotland.

"Project Omega is a complex project which uses a typical DBFO PFI structure, with the Northern Ireland Water Service transferring the risk to the private sector," says John Kirwan, Managing Director & Head of PFI at Depfa Bank in Dublin. "The concessionaire, Glen Water, takes all the risk of delivering the facilities on time and on budget, in addition to the risk of operating the facilities subject to predetermined standards."

"In the Republic of Ireland we have not, so far, seen waste water projects of a large enough scale to benefit from using a PPP framework, where typically in our experience you need a capital value of at least Eu30 million to make the project efficient from a PPP point of view," he adds.

"As a result of the EU urban wastewater directive there will be an increasing need to roll out waste-water projects not only in the Republic of Ireland in the coming years, but also elsewhere in Europe, though whether they will be traditionally procured or PPP has yet to be determined," says Kirwan. "But Project Omega is a good example of the successful use of the PPP model."

The EU country with the largest number of new water projects planned is Italy, which is investing large amounts in upgrading its drinking water and sewage treatment systems. Projects are run at local level by the relevant Ambito Territoriale Ottimale (ATO) catchment area.

Here too a number of new benchmarks have been set. The recent long term debt facility for the Eu255 million Acque Pisa project was the largest ever water financing closed in Italy. A significant portion of the 15-year project loan was held by Depfa, with pre-syndication of the rest to a group of Italian banks.

Depfa is also arranging financing on the Latina project in Lazio. In 2001, following an international call for tender, Veolia Water was chosen by Ambito Territoriale Ottimale de Latina to manage for 30 years the outsourced water and waste water services for the public authority.