Water: Made In Europe
With a price tag of £367.9 million ($588.64 million) plus £206.7
million of debt, Thames Water's acquisition of the E'Town water
utility in New Jersey, isn't cheap ? but it is strategic.
The deal marks the next stage of Thames Water's carefully planned expansion into the US water sector, a market in which operation and management (O&M) contracts are expected to grow at a rate of at least 20% a year.
But for a European water company to be taking a stake in the US water sector is nothing new. The UK's Thames Water has already been manufacturing water filtration equipment in the US for over 10 years. And Thames together with companies such as Vivendi, Suez Lyonnais des Eaux, Severn Trent and Yorkshire Water have already established a firm foothold in a market that they consider is on the point of taking off. Since 1997, these companies have announced US water acquisition deals worth more than $15 billion.
According to David Chardavoyne, president of Thames Water in the US, the E'Town purchase is part of the company's five point plan to expand in the US. "What this acquisition does is put Thames Water firmly in the US market. This is a huge market in which O&M contracts and design-build-operate (DBO) are becoming more prevalent. We believe that there are five distinct markets which we can participate in.? These include owning a utility, manufacturing products, providing services, acting as a concessionaire in a DBO or build-own-operate-transfer (Boot) project or participating in an O&M contract.
In essence E'Town will provide Thames Water with the spring board to jump into other water projects. Even before the sale, E'Town had secured two O&M contracts through its subsidiary businesses Edison Water and Liberty Water to manage projects in Pennsylvania, New Jersey and New England.
Assuming it receives approval from the New Jersey Bureau of Public Utilities and it is approved under US law, Thames Water will have to pay for its acquisition. Chardavoyne says that at present there are no plans to use a project finance structure to fund the acquisition but with the market increasingly dominated by European players it seems logical that the techniques used to finance water projects in Europe will be transferred to the US environment.
In the UK, for example, a consortium led by Thames Water has just finalized the £29.6 million second stage of financing for its Stirling Water project in Scotland. Part one of the financing, which was managed by RBC Dominion Securities and SG (co-manager and adviser), raised £79 million through a AAA credit enhanced bond issue.
However, with a privatized English and Welsh water sector and only a limited number of concessions in Scotland, UK companies like their French counterparts have been looking elsewhere.
A quick glance at the bidders on the Tampa water DBO concession in Florida is indicative of the domination by European companies. The five consortia which placed initial bids, although United Water Services has since dropped out, include: Yorkshire Water and Ogden; Azurix; US Filter (owned by Vivendi); United Water Services (owned by Suez Lyonnais des Eaux); and Thames Water.
Suez Lyonnais des Eaux has already established its global credentials as more than just a contractor with a string of project finance deals in Asia and Latin America. And together with Degremont, it issued $100 million in bonds for its Salitre wastewater plant in Colombia in 1997. The Inter-American Development Bank provided a partial risk guarantee on $30 million of the debt, the remainder is uncovered.
A development bank also assisted Vivendi in its Chengdu water project in China earlier in 1999, the first build-operate-transfer water project in the country to reach financial close.
Both Suez Lyonnais des Eaux and Vivendi have established their credentials in the US. In March 1999, Vivendi bought US Filter, the US's largest water and wastewater treatment company, for $6.9 billion.
Suez has also set up joint-venture companies such as United Water which it operates with United Water Resources, and White River Environmental Partnership, which it operates with JMM Operational Services. In 1997, Suez, together with JMM, received its first wastewater service contract for a project in Indianapolis.
This was followed soon after by a 10-year contract with the Milwaukee Metropolitan Sewerage District, under Suez's United Water venture. The $300 million contract involves managing two large wastewater treatment plants, a bio-solids fertilizer plant, a sewerage network, deep tunnel storage and a 30MW power plant. But both contracts are operational contracts and project development is funded by the city through the issue of tax exempt bonds.
In common with the French, Thames and the other water UK companies are trying to secure a stake in the US early. Much of the US water system is still publicly owned. Figures from rating agency Moody's show that 80% of domestic wastewater systems in the US are still either municipally or publicly owned.
However, ?very few municipal governments are willing to sell off their water companies. But more are entering into long-term management contracts with private companies,? says Mary Francoeur, vice-president in the infrastructure department at Moody's in New York.
Municipalities have largely funded the development of the water sector through federal government funding and the issue of tax-exempt municipal bonds. Many water and wastewater systems are now well over 100 years old. The pressure of having to maintain these systems and upgrade them in line with recent minimum drinking water requirements, is placing an increasing pressure on municipalities. Added to that, the level of federal funding has dipped considerably. The US government estimated in 1995 that $138.4 billion will be needed to improve drinking water by 2015 and a further $332 billion will be required to upgrade wastewater facilities. But since 1979, the level of federal funding has dropped from $12 billion to $2 billion. And whereas municipalities averaged $9 billion in investment in the water sector, this figure has more than doubled.
?But there has been an uptide of private activity since Internal Revenue Service (IRS) changes,? says Francoeur. Legislation issued by the US IRS provides safe areas for private companies operating public utilities under long-term management contracts. And until the beginning of 1997, for municipal bond obligations to retain their tax exempt status after the sale of a bond financed facility to a private company, the contract had to be for less than three years.
This did not give private operators enough time to make a return on their investment, in the case of a concession, or make cost savings, in the case of an operating contract. New IRS legislation in 1997, increased the limit to 20 years.
Despite change, the number of Boot or DBO concessions being offered has been low and the majority of deals tend to be offered as management contracts. Says Francoeur: ?What generally happens is that companies pay an up front fee to the municipality but the capital infusion is still the responsibility of the owner."
In 1997, Poseidon Water Resources closed financing for the Cranston Water project on Rhode Island ? the first US water privatization to tap the capital markets. Poseidon holds a lease contract with the city of Cranston. With Banque Paribas as arranger and John Hancock and New York Life managing the bond, the deal set the pace for future project finance deals. But since Cranston there have only been a handful of contracts offered in Oklahoma, Atlanta, Indianapolis and Michigan.
Taking the plunge
For the private operators there are still hurdles to overcome. Private water companies are ready to provide municipalities with their services but privatizing utilities depends on the policy of the city mayor.
In Indianopolis, Mayor Stephen Goldsmith has written an entire book on resurrecting urban areas. In ?The Twenty-first Century City', he says that White River Environmental Partnership promised to cut costs by 40% and save the city $65 million over five years while matching or exceeding the previous environmental performance. But plans to reduce the workforce by 37% were greeted with less enthusiasm. Indianopolis accepted White River's plans but other mayors have been more cautious and have been unwilling to risk losing political points on the water issue.
Jacob Worenklein, global head of project finance at SG in New York says that with many municipal governments facing large funding gaps, the need for additional sources of revenue will become more urgent. "In many ways the market in the US water sector follows what has been happening in the US power sector." He says that as local governments adopt public-private partnership schemes for the water sector as exist in Scotland, there will be greater demand for bank and capital market project financing. ?Banks are now a lot more comfortable financing public-private partnerships. There is no reason why a long-term water contract for a concession such as Tampa in the US could not replicate some of the UK water transactions.?
That has already started happening in Europe with Dutch water operator Delphland appointing East Scotland and PricewaterhouseCoopers ? both advisors on the groundbreaking Stirling Water project bond in the UK ? as advisors to its deal planned for next year.
But whether the US will adopt European deals as templates depends on how politically fragmented the market remains. There is considerable room for development. The Environmental Protection Agency estimates that $100 billion is needed to bring all water and sewer systems in to compliance. In a recent report, Moody's said: "Both the water and wastewater sectors are mature and are very slow to innovate, often relying on traditional designs that have been operationally risk-free and that more easily obtain regulatory approvals.? The report continues: ?Moody's believes a notable risk to these industries is their ability to continue to meet capital investment requirements of the systems as they age. Ageing systems require additional capital and operating support.?
And attitudes are beginning to change. In a recent report carried out by advisers PricewaterhouseCoopers, 75% of utility companies in the US are in favour of deregulation in their sector.
Governments in Seattle, Chicago and Houston are all investigating partial privatization programmes. But O&M contracts continue to be favoured over total sell-offs.
Perhaps the clearest indication that this is a market with big potential comes from Enron. In July 1998, Enron announced the creation of a new water company, Azurix. The business was formed to own and operate water and wastewater assets, develop related infrastructure and "extend critical risk management and finance skills into the international water market?. Enron quickly followed up the launch of Azurix with the acquisition of a UK company, Wessex Water.
Since then, Azurix has won concessions in Argentina and Mexico and has secured management contracts for projects in Glynn County, Georgia and Madera County, California. The message from Enron is: take the plunge now or risk losing out later.
The deal marks the next stage of Thames Water's carefully planned expansion into the US water sector, a market in which operation and management (O&M) contracts are expected to grow at a rate of at least 20% a year.
But for a European water company to be taking a stake in the US water sector is nothing new. The UK's Thames Water has already been manufacturing water filtration equipment in the US for over 10 years. And Thames together with companies such as Vivendi, Suez Lyonnais des Eaux, Severn Trent and Yorkshire Water have already established a firm foothold in a market that they consider is on the point of taking off. Since 1997, these companies have announced US water acquisition deals worth more than $15 billion.
According to David Chardavoyne, president of Thames Water in the US, the E'Town purchase is part of the company's five point plan to expand in the US. "What this acquisition does is put Thames Water firmly in the US market. This is a huge market in which O&M contracts and design-build-operate (DBO) are becoming more prevalent. We believe that there are five distinct markets which we can participate in.? These include owning a utility, manufacturing products, providing services, acting as a concessionaire in a DBO or build-own-operate-transfer (Boot) project or participating in an O&M contract.
In essence E'Town will provide Thames Water with the spring board to jump into other water projects. Even before the sale, E'Town had secured two O&M contracts through its subsidiary businesses Edison Water and Liberty Water to manage projects in Pennsylvania, New Jersey and New England.
Assuming it receives approval from the New Jersey Bureau of Public Utilities and it is approved under US law, Thames Water will have to pay for its acquisition. Chardavoyne says that at present there are no plans to use a project finance structure to fund the acquisition but with the market increasingly dominated by European players it seems logical that the techniques used to finance water projects in Europe will be transferred to the US environment.
In the UK, for example, a consortium led by Thames Water has just finalized the £29.6 million second stage of financing for its Stirling Water project in Scotland. Part one of the financing, which was managed by RBC Dominion Securities and SG (co-manager and adviser), raised £79 million through a AAA credit enhanced bond issue.
However, with a privatized English and Welsh water sector and only a limited number of concessions in Scotland, UK companies like their French counterparts have been looking elsewhere.
A quick glance at the bidders on the Tampa water DBO concession in Florida is indicative of the domination by European companies. The five consortia which placed initial bids, although United Water Services has since dropped out, include: Yorkshire Water and Ogden; Azurix; US Filter (owned by Vivendi); United Water Services (owned by Suez Lyonnais des Eaux); and Thames Water.
Suez Lyonnais des Eaux has already established its global credentials as more than just a contractor with a string of project finance deals in Asia and Latin America. And together with Degremont, it issued $100 million in bonds for its Salitre wastewater plant in Colombia in 1997. The Inter-American Development Bank provided a partial risk guarantee on $30 million of the debt, the remainder is uncovered.
A development bank also assisted Vivendi in its Chengdu water project in China earlier in 1999, the first build-operate-transfer water project in the country to reach financial close.
Both Suez Lyonnais des Eaux and Vivendi have established their credentials in the US. In March 1999, Vivendi bought US Filter, the US's largest water and wastewater treatment company, for $6.9 billion.
Suez has also set up joint-venture companies such as United Water which it operates with United Water Resources, and White River Environmental Partnership, which it operates with JMM Operational Services. In 1997, Suez, together with JMM, received its first wastewater service contract for a project in Indianapolis.
This was followed soon after by a 10-year contract with the Milwaukee Metropolitan Sewerage District, under Suez's United Water venture. The $300 million contract involves managing two large wastewater treatment plants, a bio-solids fertilizer plant, a sewerage network, deep tunnel storage and a 30MW power plant. But both contracts are operational contracts and project development is funded by the city through the issue of tax exempt bonds.
In common with the French, Thames and the other water UK companies are trying to secure a stake in the US early. Much of the US water system is still publicly owned. Figures from rating agency Moody's show that 80% of domestic wastewater systems in the US are still either municipally or publicly owned.
However, ?very few municipal governments are willing to sell off their water companies. But more are entering into long-term management contracts with private companies,? says Mary Francoeur, vice-president in the infrastructure department at Moody's in New York.
Municipalities have largely funded the development of the water sector through federal government funding and the issue of tax-exempt municipal bonds. Many water and wastewater systems are now well over 100 years old. The pressure of having to maintain these systems and upgrade them in line with recent minimum drinking water requirements, is placing an increasing pressure on municipalities. Added to that, the level of federal funding has dipped considerably. The US government estimated in 1995 that $138.4 billion will be needed to improve drinking water by 2015 and a further $332 billion will be required to upgrade wastewater facilities. But since 1979, the level of federal funding has dropped from $12 billion to $2 billion. And whereas municipalities averaged $9 billion in investment in the water sector, this figure has more than doubled.
?But there has been an uptide of private activity since Internal Revenue Service (IRS) changes,? says Francoeur. Legislation issued by the US IRS provides safe areas for private companies operating public utilities under long-term management contracts. And until the beginning of 1997, for municipal bond obligations to retain their tax exempt status after the sale of a bond financed facility to a private company, the contract had to be for less than three years.
This did not give private operators enough time to make a return on their investment, in the case of a concession, or make cost savings, in the case of an operating contract. New IRS legislation in 1997, increased the limit to 20 years.
Despite change, the number of Boot or DBO concessions being offered has been low and the majority of deals tend to be offered as management contracts. Says Francoeur: ?What generally happens is that companies pay an up front fee to the municipality but the capital infusion is still the responsibility of the owner."
In 1997, Poseidon Water Resources closed financing for the Cranston Water project on Rhode Island ? the first US water privatization to tap the capital markets. Poseidon holds a lease contract with the city of Cranston. With Banque Paribas as arranger and John Hancock and New York Life managing the bond, the deal set the pace for future project finance deals. But since Cranston there have only been a handful of contracts offered in Oklahoma, Atlanta, Indianapolis and Michigan.
Taking the plunge
For the private operators there are still hurdles to overcome. Private water companies are ready to provide municipalities with their services but privatizing utilities depends on the policy of the city mayor.
In Indianopolis, Mayor Stephen Goldsmith has written an entire book on resurrecting urban areas. In ?The Twenty-first Century City', he says that White River Environmental Partnership promised to cut costs by 40% and save the city $65 million over five years while matching or exceeding the previous environmental performance. But plans to reduce the workforce by 37% were greeted with less enthusiasm. Indianopolis accepted White River's plans but other mayors have been more cautious and have been unwilling to risk losing political points on the water issue.
Jacob Worenklein, global head of project finance at SG in New York says that with many municipal governments facing large funding gaps, the need for additional sources of revenue will become more urgent. "In many ways the market in the US water sector follows what has been happening in the US power sector." He says that as local governments adopt public-private partnership schemes for the water sector as exist in Scotland, there will be greater demand for bank and capital market project financing. ?Banks are now a lot more comfortable financing public-private partnerships. There is no reason why a long-term water contract for a concession such as Tampa in the US could not replicate some of the UK water transactions.?
That has already started happening in Europe with Dutch water operator Delphland appointing East Scotland and PricewaterhouseCoopers ? both advisors on the groundbreaking Stirling Water project bond in the UK ? as advisors to its deal planned for next year.
But whether the US will adopt European deals as templates depends on how politically fragmented the market remains. There is considerable room for development. The Environmental Protection Agency estimates that $100 billion is needed to bring all water and sewer systems in to compliance. In a recent report, Moody's said: "Both the water and wastewater sectors are mature and are very slow to innovate, often relying on traditional designs that have been operationally risk-free and that more easily obtain regulatory approvals.? The report continues: ?Moody's believes a notable risk to these industries is their ability to continue to meet capital investment requirements of the systems as they age. Ageing systems require additional capital and operating support.?
And attitudes are beginning to change. In a recent report carried out by advisers PricewaterhouseCoopers, 75% of utility companies in the US are in favour of deregulation in their sector.
Governments in Seattle, Chicago and Houston are all investigating partial privatization programmes. But O&M contracts continue to be favoured over total sell-offs.
Perhaps the clearest indication that this is a market with big potential comes from Enron. In July 1998, Enron announced the creation of a new water company, Azurix. The business was formed to own and operate water and wastewater assets, develop related infrastructure and "extend critical risk management and finance skills into the international water market?. Enron quickly followed up the launch of Azurix with the acquisition of a UK company, Wessex Water.
Since then, Azurix has won concessions in Argentina and Mexico and has secured management contracts for projects in Glynn County, Georgia and Madera County, California. The message from Enron is: take the plunge now or risk losing out later.
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