European Water Deal of the Year 2001-Glas Cymru
Whole business securitisations were meant to be the flavour of the
year, especially in industries like utilities and telecoms. But
received wisdom in the water industry was that the UK regulatory
regime, enforced by OFWAT, would make the use of the structure on
water assets difficult to enact. Glas, however, unique in the
circumstances of its creation, provides ? for the time being ? a
dazzling exception.
It is now close to orthodoxy that the water business does not generate the kind of reserves that justify a low level of leverage. Given that water bills (the companies' primary source of income) are set by regulators, there is little in the way of sparkling returns that can be presented to equity investors. Moreover, the regulator explicitly sets out what the return on capital should be for companies in the sector. UK water companies that have tried to compensate by turning to foreign markets have often suffered.
The reasoning behind the use of debt-financed ring-fenced vehicles is that predictable cashflows justify a higher level of gearing. The parts of the business that could benefit from avoiding major capital expenditure and the ability to force down overheads ? the management outsourcing ? continue as a familiar PLC-structure with a major equity component. These companies would eventually become the outsourced managers for a number of companies, hopefully reaping further economies of scale.
Several of the Water and Sewage Companies (WaSCs) have floated the proposal to separate the asset side of the business from the management side. Kelda, owner of Yorkshire Water, was among the first but came up against concerns from the regulator about the proposed structure, which envisaged a continuing equity stake in both sides of the business. This smacked of Kelda shunting a raft of liabilities (in the form of future upgrading capex) off its balance sheet and looked politically untenable.
Glas, however, grew out of a unique set of corporate and political conditions, chief amongst which was the distress of its erstwhile owner, Hyder. Hyder had diversified from its original Welsh Water base into electricity distribution and PFI investments. After debt levels at the parent became unsustainable the company was taken over by the Mirant/PPL joint venture Western Power Distribution (WPD). WPD had little interest in the water business, however, and Hyder thus became a juicy target for principal finance groups throughout London.
The eventual solution was, however, more elegant and politically astute than a leveraged buyout. Two of Hyder's directors, Nigel Annett and Chris Jones, were looking into a stakeholder structure that fell short of full incorporation ? modelling the proposed business on UK private health provider, BUPA. Until Glas Cymru, BUPA was by far the most prominent example of a company limited by guarantee. This has members rather than shareholders, and has a constitution limiting its activities and promoting best practice in governance through pre-determined performance levels rather than equity performance.
The two most important of these are the maintenance of strong financing ratios and agreed service levels ? goals shared to a large extent by OFWAT and the newly created Welsh Assembly. Glas chimed in nicely with current political rhetoric in the UK which has evidenced a weakening in support for shareholder concerns driving utility service provision.
However, the company's structure has a few obstacles for the senior secured bondholder to grapple with. The most important of these is the role of the special administrator which would step in to ensure uninterrupted supplies in the event of insolvency. This makes enforcing security more difficult than would normally be the case and has led to the incorporation of early triggers within the covenant structure to ensure that remedy can be achieved before a full default.
Glas retains responsibility for the provision of water services, although its staff consists of around 40 individuals concerned with high-level performance monitoring and the implementation of capex plans. The operation of the Welsh Water network is contracted out to United Utilities, whilst Thames Water handles customer service functions. Procurement and new spending is implemented under a partnership programme, which splits cost savings between Glas and its suppliers.
Bookrunners on the deal were Royal Bank of Scotland and Citibank Solomon Smith Barney, who had previously provided a bridge loan to the company to repay the £1.85 billion debt assumed with the £1 purchase of Welsh Water from WPD. WPD settled for 93% of the regulatory asset value of the sale, and chose the mutual-like entity above bids from Nomura and others. The deal features strict covenants on additional indebtedness, EBITDA ratios and ratings maintenance. The latter means that managers are encouraged to keep the cost of capital as low as possible.
The issue featured twelve tranches and one revolving credit issue which was not launched but could be if required. The A tranches were wrapped by MBIA for an AAA/Aaa rating and amounted to £800 million and $286 million. The B tranches of £560 million carried an A-/A3 rating, and the C tranches of £250 million carried a BBB rating. A first-loss D tranche of £100 million was not rated but carried a hefty 550bp over the three-month libor price tag. Maturities ranged within the series between 2006 and 2028 and pricing between 37.5bp over the three-month libor and that of the aforementioned D tranche. Large investors were encouraged to take a vertical slice across all tranches and many did so. All carry a bullet repayment schedule, as befits a permanently debt-financed vehicle.
The deal is not going to be easy to replicate, despite the oft-stated ambition of utilities such as Scottish and Southern and Anglia Water (now branded as AWG) to spin off regulated assets. It has been used on some of the smaller companies including Sutton & East Surrey but few banks say that there are any active proposals in front of the market. Ironically, the one ray of light comes from Wessex Water whose parent, Enron, is in much-publicised distress. Wessex would be a candidate for a whole-business securitisation, although probably not one with the same level of gearing.
It is now close to orthodoxy that the water business does not generate the kind of reserves that justify a low level of leverage. Given that water bills (the companies' primary source of income) are set by regulators, there is little in the way of sparkling returns that can be presented to equity investors. Moreover, the regulator explicitly sets out what the return on capital should be for companies in the sector. UK water companies that have tried to compensate by turning to foreign markets have often suffered.
The reasoning behind the use of debt-financed ring-fenced vehicles is that predictable cashflows justify a higher level of gearing. The parts of the business that could benefit from avoiding major capital expenditure and the ability to force down overheads ? the management outsourcing ? continue as a familiar PLC-structure with a major equity component. These companies would eventually become the outsourced managers for a number of companies, hopefully reaping further economies of scale.
Several of the Water and Sewage Companies (WaSCs) have floated the proposal to separate the asset side of the business from the management side. Kelda, owner of Yorkshire Water, was among the first but came up against concerns from the regulator about the proposed structure, which envisaged a continuing equity stake in both sides of the business. This smacked of Kelda shunting a raft of liabilities (in the form of future upgrading capex) off its balance sheet and looked politically untenable.
Glas, however, grew out of a unique set of corporate and political conditions, chief amongst which was the distress of its erstwhile owner, Hyder. Hyder had diversified from its original Welsh Water base into electricity distribution and PFI investments. After debt levels at the parent became unsustainable the company was taken over by the Mirant/PPL joint venture Western Power Distribution (WPD). WPD had little interest in the water business, however, and Hyder thus became a juicy target for principal finance groups throughout London.
The eventual solution was, however, more elegant and politically astute than a leveraged buyout. Two of Hyder's directors, Nigel Annett and Chris Jones, were looking into a stakeholder structure that fell short of full incorporation ? modelling the proposed business on UK private health provider, BUPA. Until Glas Cymru, BUPA was by far the most prominent example of a company limited by guarantee. This has members rather than shareholders, and has a constitution limiting its activities and promoting best practice in governance through pre-determined performance levels rather than equity performance.
The two most important of these are the maintenance of strong financing ratios and agreed service levels ? goals shared to a large extent by OFWAT and the newly created Welsh Assembly. Glas chimed in nicely with current political rhetoric in the UK which has evidenced a weakening in support for shareholder concerns driving utility service provision.
However, the company's structure has a few obstacles for the senior secured bondholder to grapple with. The most important of these is the role of the special administrator which would step in to ensure uninterrupted supplies in the event of insolvency. This makes enforcing security more difficult than would normally be the case and has led to the incorporation of early triggers within the covenant structure to ensure that remedy can be achieved before a full default.
Glas retains responsibility for the provision of water services, although its staff consists of around 40 individuals concerned with high-level performance monitoring and the implementation of capex plans. The operation of the Welsh Water network is contracted out to United Utilities, whilst Thames Water handles customer service functions. Procurement and new spending is implemented under a partnership programme, which splits cost savings between Glas and its suppliers.
Bookrunners on the deal were Royal Bank of Scotland and Citibank Solomon Smith Barney, who had previously provided a bridge loan to the company to repay the £1.85 billion debt assumed with the £1 purchase of Welsh Water from WPD. WPD settled for 93% of the regulatory asset value of the sale, and chose the mutual-like entity above bids from Nomura and others. The deal features strict covenants on additional indebtedness, EBITDA ratios and ratings maintenance. The latter means that managers are encouraged to keep the cost of capital as low as possible.
The issue featured twelve tranches and one revolving credit issue which was not launched but could be if required. The A tranches were wrapped by MBIA for an AAA/Aaa rating and amounted to £800 million and $286 million. The B tranches of £560 million carried an A-/A3 rating, and the C tranches of £250 million carried a BBB rating. A first-loss D tranche of £100 million was not rated but carried a hefty 550bp over the three-month libor price tag. Maturities ranged within the series between 2006 and 2028 and pricing between 37.5bp over the three-month libor and that of the aforementioned D tranche. Large investors were encouraged to take a vertical slice across all tranches and many did so. All carry a bullet repayment schedule, as befits a permanently debt-financed vehicle.
The deal is not going to be easy to replicate, despite the oft-stated ambition of utilities such as Scottish and Southern and Anglia Water (now branded as AWG) to spin off regulated assets. It has been used on some of the smaller companies including Sutton & East Surrey but few banks say that there are any active proposals in front of the market. Ironically, the one ray of light comes from Wessex Water whose parent, Enron, is in much-publicised distress. Wessex would be a candidate for a whole-business securitisation, although probably not one with the same level of gearing.
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