Waterworld
The first waves of growth and consolidation have been washing over
the global water industry for the last decade, with investment
expected to increase by $100 billion a year to match renewed
demand. Thames Water has launched into some heavy investment over
the last few years.
Yet despite the vast potential, actual overall private sector investment in water projects until now has failed to overwhelm. The reasons behind the unimposing number of existing contracts are not hard to grasp. Says Linda Kemeny, Thames Group Treasurer: ?It's a very slow process to actually conclude private water projects. We are generally dealing with entities which are sub-sovereign in nature, which typically lack their own professional adivsers. Additionally, local currency cashflow problems and various political intricacies obviously tend to delay projects.? Nonetheless, successive governments around the world are embracing privatization in some form or other.
The water business is also a low margin, high risk enterprise. Privatization frequently runs into opposition from public officials unprepared to turn the resource over to profit-hungry private hands. The bidding process for contracts is time-consuming and expensive, with development costs running high.
But Thames has had considerable success in attracting both limited and non-recourse project finance from institutional and commercial lenders alike- a key factor in Thames' international market success.
Now, the task facing Linda Kemeny and the Thames team is to replicate its armory of financing structures in more less developed markets. But, explains Kemeny, ?its very difficult to develop a cookie-cutter approach to financing water projects, since each water project we have looked at is different from the next.?
Until now, project finance in the water sector has been limited to a few Scottish PFI deals, most notably last year's Stirling Water Seafield Finance project .
Although the use of project bonds to fund UK PFI deals has been on the upswing recently, Stirling marks a first. The consortium assembled by Thames Water, MJ Gleeson and Montgomery Watson, used a monoline wrapped bond package that may spell the way most water concessions are funded in the future.
Stirling Seafield finance is the vehicle used to finance the two separately tendered but operationally inter-linked water facilities in the East of Scotland, Almond Valley/Seafield and Esk. Given the thirty year length of the concession, and the boom in the PFI bond market, Stirling opted for a bond issue. MBIA-Ambac insured the bond, guaranteeing its AAA status, after thorough due diligence, which also ensured that the shadow rating was at the required grade. The £79 billion issue was lead managed by the Royal Bank of Canada and launched in March of last year. The same team of managers launched the later Esk-based £29 million bond in December. Financing was also backed by £14.8 million in sub-debt, and £4.95 million in equity.
Opting for a monoline wrap, the sponsors departed somewhat from standard practice: ?We believed that by having the insurance wrap we were achieving a lower margin above the cost of funding than we would otherwise have achieved,? explains Kemeny. ?Also, we felt that the pricing we were offered through the banking market would have been more expensive than the bond route. We examined both options very carefully, and left the choice open to the banking market. Going for monoline was more cost effective than attempting to get the investment grade rating ourselves and then going to the market?.
This form of financing offers a model by which other governments travelling the PPP route can work. Delphland of Holland is one interested party, and Thames hopes that the process can also be applied to its other global springboards. Given the upheaval expected in water industries later this year, the model is likely to pick up momentum.
With the renewed confidence in bond issues, then, the challenge is to replicate the Stirling model elsewhere. Says Kemeny, ?The Stirling model will certainly travel far. It's a developed market model which requires the assurance of investors. We've talked to the monoline insurers about moving into other markets over the next couple of years, particularly in emerging markets with single A ratings at the sovereign level. There is substantial opportunity in Europe, where we may see the type of scenario we've already seen for wrapped bonds for PFI projects in the UK.?
Stirling, Kemeny argues, is a benchmark for developed market projects. ?It succeeded in part because it was carried out in an established market with highly credit worthy clients,? she says. ?We were able to use the capital markets to attract long term finance which was crucial to maintaining the price the water authority wanted to see.?
The Stirling lesson teaches that capital markets can be used in a similar way to a bank facility. Further, Thames' experience demonstrates the willingness of bond investors to participate in the water market.
Asset securitization and separation, which is being considered by other companies in this underperforming sector, is not the course Thames is running at present, though the company continues to examine its opportunities. ?Clearly we're looking at the market with interest,? says Kemeny. ?Thames has identified growing its nonregulated businesses and moving its expertise into the overseas market, as a way to ensure growth for the business a whole, as opposed to breaking up in the way that others are considering.?
But regulatory concerns, the impact on credit ratings and legal issues plainly throw up such methodological concerns. Other companies in the sector are looking at such moves. For example, Aguas Argentinas, partially owned by Thames rival Suez Lyonnaise des Eaux, is carrying out a $100 million securitization based on its water operations on Argentina's capital Buenos Aires. Adds Kemeny, ?clearly we have to consider off balance sheet type structures where we can ? if it makes sense.?
Because of the high costs involved in operating a concession, companies must fund deals on a limited or non-recourse basis. This is not a problem when concessions are operated in capital cities, where the project is backed by the national government, which can provide a sovereign guarantee.
But for water, however, the money is made in providing services for municipalities, which are obviously smaller and less creditworthy than national governments. And project financing is not always cost-effective for doing smaller municipal deals.
Nevertheless, with many municipal governments facing unwieldy funding gaps, the need for additional sources of revenue will become more acute. And as local governments worldwide adopt public-private partnership schemes for the water sector, the demand for bank and capital market project financing is destined to ripen.
Thames, faced with a saturated and increasingly regulated market at home, is now winding its tributaries through more profitable waters by expanding abroad. Its future earnings growth, denied it by regulatory price capping at home, will likely come from its international portfolio. Thames' recent acquisition of the E'Town water utility in New Jersey fetched a price tag of £367.9 million plus £206.7 million of debt, and marks the launch of Thames' proposed American platform.
Indeed, the US water industry is highly fragmented and fit for consolidation. About 55,000 companies provide water services. Only about 300 of those serve populations greater than 100,000. Many are municipally owned and lack the financial strength to finance the high levels of investment required to comply with new environmental standards, replace existing infrastructure and meet increasing demand for clean water and waste services.
US industry estimates suggest that $138 billion will need to be spent on water supply services and another $140 billion on waste water over the next 20 years. Annual industry sales of $60 billion are forecast to grow by a further $10 billion by 2003.
?We see a lot of potential in the States,? Kemeny confirms. ?E'Town is important as a bridge for us to build to other states. It's an important reference base. The idea is to achieve a substantial US business. And we see this as a balance to some other projects we have in the emerging market pipelines.?
Thames is paying for its acquisition in cash. At present there are no plans to use a project finance structure to fund either this purchase or future acquisitions. But, as the big European players stream into the American market, it is reasonable to expect the arrival of structures similar to those used to finance European water projects, such as Stirling. ?The types of structures we use will depend on whether it's a regulated or nonregulated business and also on what are obligations will be to maintain debt-equity ratios. But there will be a lot of flexibility in going forward to restructure corporate ownership of water utilities in the States,? says Kemeny.
However, finding acquisition targets is difficult. Many municipalities are reluctant to relinquish ownership of such vital infrastructure. But the pressure of maintaining ailing systems or upgrading them to meet health and safety requirements is forcing municipalities to look grudgingly to private operators. In these terms, adds Kemeny, ?the US can be plausibly described as an emerging market.?
South of E'Town, Thames is also edging into the Latin American water market. Again, motivated by a need to balance and diversify its global portfolio of operating assets, Thames is focusing enthusiastically on areas such as Chile, Brazil and Peru.
?We see a lot of opportunity in Latin America and we now have an alliance with Electricidade de Portugal, signed last year, to bid on Latin American water projects.? Chile's regulatory regime is possibly the most advanced and is in some respects comparable to the UK. ?We're trying to focus on a number of areas where we feel we can bring in expertise,? says Kemeny.
But the irrefutable improvements brought to customers by private sector operators have usually been accompanied by an increase in charges, which can prove politically unpopular. ?We first have to be very clear that the legal contractual framework is satisfactory,? Kemeny cautions. Moreover, she adds, ?we have to be very clear that the entity we're dealing with can be relied upon to set tariffs appropriately. So we have to ensure that the tariff is affordable from the outset, to guarantee the acceptability of inflation-linked tariff increases.?
The industrial town of Izmit is the locale for Thames' recent inlet into Turkey. And the company's 15 year contract to supply water to the region is slated by some to set a trend for privately run water and sewerage industry in the country.
Thames, together with Turkish and Japanese partners, completed the deal to build the biggest privately financed water plant in Turkey in 1998. The highly complex $900 million financing for the project consisted of 15% equity and 85% loans, lead arranged by Chase Investment Bank, Societe Generale, Sumitomo Bank, Greenwich NatWest and Fuji Bank. A Mitsui-Sumitomo joint venture furnished the equity and supplied invaluable construction materials. Comments Kemeny, ?the Izmit scheme is unique in that it's the largest scheme in the world. It attracted an indirect guarantee from the Republic of Turkey which enabled the consortium to attract substanital foreign investment.?
Yet despite the Izmit achievement, financiers still must become convinced that projects can generate sufficient and dependable revenues to recover investments. Further, public infrastructure deals, such as Izmit, have traditionally been secured by Turkish treasury guarantees, but there is a limit to the number of guarantees Turkey can afford to issue.
Nevertheless, Thames' worldwide operations demonstrate that private water operators can advance the quality and cut the costs of infrastructure traditionally operated by the state.
This axiom is again borne out by Thames' recently renegotiated concession contract with Jakarta. Thames established the consortium PT Thames PAM in 1997 to replace the then public water supply authority in Jakarta on a 25 year concession, covering the eastern half of the city. The company plans to invest $200 million in distribution facilities in the region.
Observe also Thames' recently signed agreement with Multi Vest Resources and Nilaimas Corp to mutually take part in water and sewerage opportunities in Malaysia. The new joint venture, Puas Emas Sdn Bhd, with enough initial paid up capital, is well poised to bid for new projects. Other major projects are ongoing in Puerto Rico, Thailand, China and Australia.
And with the ever-growing global demand for superior water infrastructure, expect Thames to surge.
Yet despite the vast potential, actual overall private sector investment in water projects until now has failed to overwhelm. The reasons behind the unimposing number of existing contracts are not hard to grasp. Says Linda Kemeny, Thames Group Treasurer: ?It's a very slow process to actually conclude private water projects. We are generally dealing with entities which are sub-sovereign in nature, which typically lack their own professional adivsers. Additionally, local currency cashflow problems and various political intricacies obviously tend to delay projects.? Nonetheless, successive governments around the world are embracing privatization in some form or other.
The water business is also a low margin, high risk enterprise. Privatization frequently runs into opposition from public officials unprepared to turn the resource over to profit-hungry private hands. The bidding process for contracts is time-consuming and expensive, with development costs running high.
But Thames has had considerable success in attracting both limited and non-recourse project finance from institutional and commercial lenders alike- a key factor in Thames' international market success.
Now, the task facing Linda Kemeny and the Thames team is to replicate its armory of financing structures in more less developed markets. But, explains Kemeny, ?its very difficult to develop a cookie-cutter approach to financing water projects, since each water project we have looked at is different from the next.?
Until now, project finance in the water sector has been limited to a few Scottish PFI deals, most notably last year's Stirling Water Seafield Finance project .
Although the use of project bonds to fund UK PFI deals has been on the upswing recently, Stirling marks a first. The consortium assembled by Thames Water, MJ Gleeson and Montgomery Watson, used a monoline wrapped bond package that may spell the way most water concessions are funded in the future.
Stirling Seafield finance is the vehicle used to finance the two separately tendered but operationally inter-linked water facilities in the East of Scotland, Almond Valley/Seafield and Esk. Given the thirty year length of the concession, and the boom in the PFI bond market, Stirling opted for a bond issue. MBIA-Ambac insured the bond, guaranteeing its AAA status, after thorough due diligence, which also ensured that the shadow rating was at the required grade. The £79 billion issue was lead managed by the Royal Bank of Canada and launched in March of last year. The same team of managers launched the later Esk-based £29 million bond in December. Financing was also backed by £14.8 million in sub-debt, and £4.95 million in equity.
Opting for a monoline wrap, the sponsors departed somewhat from standard practice: ?We believed that by having the insurance wrap we were achieving a lower margin above the cost of funding than we would otherwise have achieved,? explains Kemeny. ?Also, we felt that the pricing we were offered through the banking market would have been more expensive than the bond route. We examined both options very carefully, and left the choice open to the banking market. Going for monoline was more cost effective than attempting to get the investment grade rating ourselves and then going to the market?.
This form of financing offers a model by which other governments travelling the PPP route can work. Delphland of Holland is one interested party, and Thames hopes that the process can also be applied to its other global springboards. Given the upheaval expected in water industries later this year, the model is likely to pick up momentum.
With the renewed confidence in bond issues, then, the challenge is to replicate the Stirling model elsewhere. Says Kemeny, ?The Stirling model will certainly travel far. It's a developed market model which requires the assurance of investors. We've talked to the monoline insurers about moving into other markets over the next couple of years, particularly in emerging markets with single A ratings at the sovereign level. There is substantial opportunity in Europe, where we may see the type of scenario we've already seen for wrapped bonds for PFI projects in the UK.?
Stirling, Kemeny argues, is a benchmark for developed market projects. ?It succeeded in part because it was carried out in an established market with highly credit worthy clients,? she says. ?We were able to use the capital markets to attract long term finance which was crucial to maintaining the price the water authority wanted to see.?
The Stirling lesson teaches that capital markets can be used in a similar way to a bank facility. Further, Thames' experience demonstrates the willingness of bond investors to participate in the water market.
Asset securitization and separation, which is being considered by other companies in this underperforming sector, is not the course Thames is running at present, though the company continues to examine its opportunities. ?Clearly we're looking at the market with interest,? says Kemeny. ?Thames has identified growing its nonregulated businesses and moving its expertise into the overseas market, as a way to ensure growth for the business a whole, as opposed to breaking up in the way that others are considering.?
But regulatory concerns, the impact on credit ratings and legal issues plainly throw up such methodological concerns. Other companies in the sector are looking at such moves. For example, Aguas Argentinas, partially owned by Thames rival Suez Lyonnaise des Eaux, is carrying out a $100 million securitization based on its water operations on Argentina's capital Buenos Aires. Adds Kemeny, ?clearly we have to consider off balance sheet type structures where we can ? if it makes sense.?
Because of the high costs involved in operating a concession, companies must fund deals on a limited or non-recourse basis. This is not a problem when concessions are operated in capital cities, where the project is backed by the national government, which can provide a sovereign guarantee.
But for water, however, the money is made in providing services for municipalities, which are obviously smaller and less creditworthy than national governments. And project financing is not always cost-effective for doing smaller municipal deals.
Nevertheless, with many municipal governments facing unwieldy funding gaps, the need for additional sources of revenue will become more acute. And as local governments worldwide adopt public-private partnership schemes for the water sector, the demand for bank and capital market project financing is destined to ripen.
Thames, faced with a saturated and increasingly regulated market at home, is now winding its tributaries through more profitable waters by expanding abroad. Its future earnings growth, denied it by regulatory price capping at home, will likely come from its international portfolio. Thames' recent acquisition of the E'Town water utility in New Jersey fetched a price tag of £367.9 million plus £206.7 million of debt, and marks the launch of Thames' proposed American platform.
Indeed, the US water industry is highly fragmented and fit for consolidation. About 55,000 companies provide water services. Only about 300 of those serve populations greater than 100,000. Many are municipally owned and lack the financial strength to finance the high levels of investment required to comply with new environmental standards, replace existing infrastructure and meet increasing demand for clean water and waste services.
US industry estimates suggest that $138 billion will need to be spent on water supply services and another $140 billion on waste water over the next 20 years. Annual industry sales of $60 billion are forecast to grow by a further $10 billion by 2003.
?We see a lot of potential in the States,? Kemeny confirms. ?E'Town is important as a bridge for us to build to other states. It's an important reference base. The idea is to achieve a substantial US business. And we see this as a balance to some other projects we have in the emerging market pipelines.?
Thames is paying for its acquisition in cash. At present there are no plans to use a project finance structure to fund either this purchase or future acquisitions. But, as the big European players stream into the American market, it is reasonable to expect the arrival of structures similar to those used to finance European water projects, such as Stirling. ?The types of structures we use will depend on whether it's a regulated or nonregulated business and also on what are obligations will be to maintain debt-equity ratios. But there will be a lot of flexibility in going forward to restructure corporate ownership of water utilities in the States,? says Kemeny.
However, finding acquisition targets is difficult. Many municipalities are reluctant to relinquish ownership of such vital infrastructure. But the pressure of maintaining ailing systems or upgrading them to meet health and safety requirements is forcing municipalities to look grudgingly to private operators. In these terms, adds Kemeny, ?the US can be plausibly described as an emerging market.?
South of E'Town, Thames is also edging into the Latin American water market. Again, motivated by a need to balance and diversify its global portfolio of operating assets, Thames is focusing enthusiastically on areas such as Chile, Brazil and Peru.
?We see a lot of opportunity in Latin America and we now have an alliance with Electricidade de Portugal, signed last year, to bid on Latin American water projects.? Chile's regulatory regime is possibly the most advanced and is in some respects comparable to the UK. ?We're trying to focus on a number of areas where we feel we can bring in expertise,? says Kemeny.
But the irrefutable improvements brought to customers by private sector operators have usually been accompanied by an increase in charges, which can prove politically unpopular. ?We first have to be very clear that the legal contractual framework is satisfactory,? Kemeny cautions. Moreover, she adds, ?we have to be very clear that the entity we're dealing with can be relied upon to set tariffs appropriately. So we have to ensure that the tariff is affordable from the outset, to guarantee the acceptability of inflation-linked tariff increases.?
The industrial town of Izmit is the locale for Thames' recent inlet into Turkey. And the company's 15 year contract to supply water to the region is slated by some to set a trend for privately run water and sewerage industry in the country.
Thames, together with Turkish and Japanese partners, completed the deal to build the biggest privately financed water plant in Turkey in 1998. The highly complex $900 million financing for the project consisted of 15% equity and 85% loans, lead arranged by Chase Investment Bank, Societe Generale, Sumitomo Bank, Greenwich NatWest and Fuji Bank. A Mitsui-Sumitomo joint venture furnished the equity and supplied invaluable construction materials. Comments Kemeny, ?the Izmit scheme is unique in that it's the largest scheme in the world. It attracted an indirect guarantee from the Republic of Turkey which enabled the consortium to attract substanital foreign investment.?
Yet despite the Izmit achievement, financiers still must become convinced that projects can generate sufficient and dependable revenues to recover investments. Further, public infrastructure deals, such as Izmit, have traditionally been secured by Turkish treasury guarantees, but there is a limit to the number of guarantees Turkey can afford to issue.
Nevertheless, Thames' worldwide operations demonstrate that private water operators can advance the quality and cut the costs of infrastructure traditionally operated by the state.
This axiom is again borne out by Thames' recently renegotiated concession contract with Jakarta. Thames established the consortium PT Thames PAM in 1997 to replace the then public water supply authority in Jakarta on a 25 year concession, covering the eastern half of the city. The company plans to invest $200 million in distribution facilities in the region.
Observe also Thames' recently signed agreement with Multi Vest Resources and Nilaimas Corp to mutually take part in water and sewerage opportunities in Malaysia. The new joint venture, Puas Emas Sdn Bhd, with enough initial paid up capital, is well poised to bid for new projects. Other major projects are ongoing in Puerto Rico, Thailand, China and Australia.
And with the ever-growing global demand for superior water infrastructure, expect Thames to surge.
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