Thames Water (Kemble): Uncharted Waters

Negotiations to smooth the injection of a touted £500 mn equity injection, the first step in a more comprehensive funding package for the Thames Water long term business plan, have broken down. Whether this impasse is a hard stop or simply another round in protracted negotiations is an open question, but we do expect the talking to resume given the high stakes involved. Pushback from the regulator Ofwat on the terms of the business plan seems to have been the major hurdle; the stumbling blocks boil down to an increased contribution from the public (bills up) and a generous interpretation of regulatory standards (quality down) to afford Thames some breathing space. Ofwat is obviously not operating in a vacuum on this one: public scrutiny on environmental standards is increasing, and public distaste for the profligacy of former shareholders is also an issue. Ofwat appears intent on holding its line, for now at least. The government is involved, in the shape of Rishi Sunak’s business and investment advisor Franck Petitgas, brought in to mediate between Thames, the regulator and Defra. However, with the parties now involved in a public stand-off, a period of uncertainty begins until the parties can be brought back to the negotiating table and a compromise agreed.

The shareholders are pointing the finger squarely at the regulator for the impasse. “Shareholders will work constructively with Thames Water, Ofwat and Government on how to address the consequences of Ofwat’s decision.” In accordance with the commitment made by shareholders in June 2022, £500 mn of new funding was drawn by Kemble Water Holdings Limited on 30 March 2023. The shareholders had committed to provide a further £750 mn of equity contributions in the period to March 2025 on certain conditions with a first slug pencilled in by March 2024. These conditions included the preparation of a new business plan within its subsidiary Thames Water Utilities Limited that underpinned a more focused turnaround that delivers targeted performance improvements for customers, the environment and other stakeholders over the next three years – and crucially – that was supported by ‘appropriate’ regulatory arrangements.

Away from the public debate, privately, we assume negotiations are ongoing at the Kemble level. It goes without saying that there is a lot riding on a solution to maturing debt at Kemble, however temporary, in order to maintain the equity chain at Thames intact. No public statements have been made on what level of requisite progress has been achieved on the terming out of a £190 mn loan facility that matures on 30 April 2024. The possibility of a default at the Kemble Holdco level adds a further level of complexity; it would seem reasonable that shareholders would be reticent to throw more money at the situation unless the term loan is extended. Recall that Kemble sits between the Thames Opco and its shareholders.

Except the public Thames bond of 2026, little is known on the public side about the terms and conditions of the other facilities at Kemble including the £190 mn loan in question. Critical for calculating recovery at Thames, would be to know the specifics around their ranking and claim on the share pledge that Kemble bonds enjoy.

Recall, debt at Kemble includes the £400 mn Senior Secured bonds out of the Thames Water (Kemble) Finance Plc and the ~£950 mn Senior Secured TLs at Kemble Water Finance Limited. The bonds are unconditionally and irrevocably guaranteed by Kemble Water Finance Limited. Security for the bonds comprises:

• granted by the guarantor:
  • fixed security over all its shares in the Issuer and Thames Water Limited and all its real property, book debts and bank accounts, present and future (granted by guarantor);
  • an assignment of its rights in respect of the Transaction Documents;
  • a floating charge over all of its property, undertaking and assets;
• granted by the issuer:
  • an assignment of its rights in respect of the Transaction Documents;
  • a fixed charge over all its book debts, bank accounts and investments, present and future;
  • and a floating charge over all of its property, undertaking and assets

Even if, as seems likely, the regulatory stance is forced to soften, Kemble remains a thorn in Thames’ side. The Kemble Water Finance Limited statement today reads “Absent an investible proposition for the Shareholders to provide new equity, Kemble Water Finance Limited (KWF) considers at the current time that it will not be possible to pay further interest payments and, unless an extension to the maturity of the facility is granted by lenders, it will not be able to refinance or repay a £190 million facility which matures on 30 April 2024.”

It goes on that discussions amongst Kemble creditors will begin and that KWF and Thames Water (Kemble) Finance Plc have appointed Alvarez & Marsal to advise and assist them with their lender and noteholder engagement.

Discussions will doubtless centre on the enforceability of the Kemble share pledge over Thames Water Limited and what legal protections exist against the possibility that the government intervenes.

Opco bonds are down around two points, and we see the Opco curve moving wider unless and until a resolution to the current impasse can be announced. Even then, there also needs to be a solution at Kemble to keep that situation under control. We expect the rating agencies will have their say. Moody’s include in their ‘Factors that could lead to a downgrade’: the ratings could be downgraded if “(2) the anticipated equity increase to support additional investment was not forthcoming as planned.”

Kemble bonds have taken a leg down to ~19 and we see bifurcated outcomes here. Even in a situation whether the government steps in to protect the Opco from credit issues at Kemble, the bonds have a legal claim and either a judicial or negotiated settlement can be sought. Doubtless this would be a lengthy process, but redress could be sought.