Macquarie's successful £8 billion bid for Thames Water was something of a surprise: the valuation came in at the top of analysts expectations, and Macquarie beat out the assumed frontrunner the Qatar Investment Authority/UBS consortium.

Macquarie is one of the canniest (and most prolific) infrastructure investors and follows a well-trodden path of leveraging its equity in acquisition, injecting management expertise and later refinancing if performance and valuations permit. The purchase of Thames Water is no different.

Macquarie, via its bidding vehicle Kemble Water Limited, has paid a purchase price of £4.8 billion and is taking on Thames Water's pro forma debt of £3.2 billion, giving an implied enterprise value of £8 billion. Most of Thames' debt comprises Baa1 bonds issued from a financing vehicle subsidiary of the holding company.

Thames Water is the UK's largest water and wastewater service, providing drinking water to 8 million people and sewerage services to 13 million customers. The company has been much maligned for failing to adequately tackle leaks and meet UK water regulator Ofwat's consumer performance targets. Macquarie has assured Ofwat that it will follow through with the £3.1 billion investment programme agreed with the previous management, including the £150 million pledged out of shareholders pockets to replace the Victorian-era mains network.

In preparation for the sale, Thames Water underwent a restructuring that was granted permission by Ofwat, with the proposals getting ratings of BBB+ from S&P and Baa1 from Moody's. At the same time, Thames extended the ring fencing of its regulated business by including a 'cash lock up' provision, whereby cash or assets would not be permitted to transfer out of the regulated business to a parent if a regulated company's investment grade credit rating was threatened. This provision, used in the energy sector, is now being introduced across all water licenses.

The ring-fencing provisions are in place to protect customers. This effectively means that water companies' that wish to leverage their balance sheets and keep on the right side of Ofwat should concentrate credit quality on its regulated assets, with lower rated debt at the holding company level and a whole-of-business rating of at least Baa1. (Although investment grade is explicitly a requisite of the regulator, Suez's partial divestment of Northumberland Water set a precedent for Ofwat's displeasure of any company below Baa1).

The Thames acquisition package was lead arranged by Barclays Capital, Dresdner Kleinwort, HSBC and RBC. It uses three levels of acquisition debt and is tranched to lower the regulatory risk with rated, quasi-investment grade, and unrated facilities. The deal is less leveraged than the comparable Anglian and Southern water deals which were banked at around 85% debt to regulated asset value (RAV).

The debt was offered to sub-underwriters on a £250 million blended ticket (£200 million of senior debt and £50 million of sub-debt).

A £1.6 billion 18-month tranche is raised against the bidding vehicle at the utility level, Bid Co, which pays 50bp over Libor in the first year then 60bp. The Bid Co has a debt to RAV of 75%, which gives a lower regulatory risk than the 85% of previous deals.

Above the bidding company, a £625 million senior holding company tranche with a five year tenor pays across a ratings grid. The senior holding company debt is secured against 10% of RAV (bringing the debt-to-RAV to 85%). Effectively this tranche is the cross-over between investment and non-investment grade.

Between years one and three the tranche pays between 110bp and 125bp – as the company is unrated the debt will pay 125bp to begin with. In year four the margin increases to 120bp-140bp and in year five, 130bp-160bp over. The margins will be paid according to the company's rating, between BBB- and BBB+, to incentivise the management.

The new management team is headed up by David Owens who has taken over as CEO and former Amec boss Sir Peter Mason, the company's new non-executive chairman. They face the challenging task of turning the company around after a morale sapping 25% reduction in staff, some 1,200 jobs, announced in the restructuring in the summer. And the recent announcement of a 17% drop in six-monthly profits due to low rainfall and infrastructure costs.

Bringing the debt to RAV from 85% to 95%, a £835 million seven year junior holding company piece will pay 375bp over Libor in years one to three, 400bp between years four and five, and 500bp in the last two years.

The package also features two senior operating company tranches – a £700 million 18-month capex facility paying 40bp over Libor and rising to 45bp after one year, and a £200 million 18-month working capital tranche priced the same.

There is also a three-year non-regulated facility of £270 million which will be held by the arrangers and not sold down. Thames Water's unregulated business includes its property and commercial businesses, a 20% stake in Metronet and international interests in Puerto Rico, Indonesia and Turkey.

The senior operating company sub-underwriters have been offered fees of 7.5bp for underwriting, and 12.5bp as a final hold fee. The senior bidding company lead arrangers will be paid 10bp and 15bp respectively and the senior holding company parties, 20bp and 35bp.

Thames Water acquisition finance
Status: Underwritten with first drawdown on 1 December 2006, sub-underwriting to be finalised by New Year
Description: £3.9 billion debt backing Macquarie's £8 billion purchase of Thames Water from RWE
Borrower: Kemble Water Limited (a consortium led by Macquarie European Infrastructure Fund)
Underwriters: Barclays Capital, Dresdner Kleinwort, HSBC and RBC
Financial adviser to Thames Water Board: BNP Paribas
Legal counsel to borrower: Allen & Overy
Legal counsel to RWE: Slaughter & May
Legal counsel to Thames Water board: Berwin Leighton Paisner