UK’s Southern Water in Talks to Avoid Thames-Like Debt Pain

(Bloomberg) -- Britain’s Southern Water Ltd. is trying to fix its finances in an effort to preserve its investment grade status, safeguard its balance sheet — and avoid the same debt woes as Thames Water.

The utility has entered into talks with its creditors to figure out how to reshape its capital structure, according to people familiar with the matter. The parties are discussing how to accommodate a £900 million ($1.2 billion) equity injection — led by majority shareholder Macquarie Asset Management — and what other tweaks may be necessary to stabilize the company’s finances, the people said, requesting anonymity to discuss private matters. 

A representative for Southern Water declined to comment. A spokesperson for Macquarie also declined to comment.

With around 2.7 million customers, Southern is one of the UK’s largest water companies. The industry has been grappling with a combination of high interest rates, regulatory changes and public outrage over chronic leaks and sewage spills. 

Southern faced particular scrutiny following Moody’s Ratings’ decision to downgrade it to junk status in November. S&P Global Ratings threatened to take similar action unless its liquidity situation improves by the end of March. 

UK water companies need investment grade scores from at least two ratings agencies to keep their operating license, according to industry regulator Ofwat.

To avoid another downgrade, the company is looking for further support from Macquarie. Speaking to the UK parliament in January, Southern’s chief executive officer Lawrence Gosden said that shareholders were “on board to get the company back on track.” In February, the utility said it was expecting to secure commitments for £900 million of fresh equity no later than June 30. 

Following the announcement, Fitch Ratings removed it from its review list for a potential downgrade to junk. 

As such, Southern’s debt talks with creditors should be more optimistic than Thames Water, the UK’s largest water firm. Thames’ shareholders took a step back last year after a spat with Ofwat, declaring the business “uninvestible.” 

At the end of September, Thames had £16 billion of net debt, while Southern had £6.2 billion. Similarly to Thames Water, Southern appealed to the Competition and Markets Authority to examine a recent decision by Ofwat on how much it can charge customers and return to investors.

Thames Water has now obtained the green light from a judge for a £3 billion emergency loan, in anticipation of a more wide-ranging debt restructuring, as reported. 

Support from shareholders will likely be key to a successful restructuring as the water companies as negotiate over their heavy debt piles with their creditors, while trying to meet the regulator’s criteria. 

Capital Structure

Southern Water has debt at three levels. 

Some is at the operating company level, closest to the assets and operations. Then there’s so-called midco-level debt, dependent on distributions received from the operating company. Finally there’s holding company debt, serviced by cash funneled up from the midco. The further away from the core of the business, the riskier the debt. 

The company and its stakeholders have brought on board a slew of advisers. Southern Water is working with bankers at Evercore and law firm Linklaters, according to some of the people familiar with the matter. 

Meanwhile, creditors holding midco debt are advised by law firm Greenberg Traurig and consultants Ankura, while those exposed to holding company debt tapped Kirkland & Ellis and Lazard, the people said. 

A spokesperson for Lazard declined to comment. Representatives for Kirkland & Ellis as well as for Greenberg Traurig and Ankura didn’t immediately respond to requests for comment.

The lender banks are working with Perella Weinberg and Clifford Chance, as Bloomberg News reported last year. 

Southern Water last raised debt in November, in the form of a £300 million private placement. The money came with a hefty price tag. One of the tranches was priced at discount of 90 pence on the pound, meaning a yield of nearly 10% for the debt, Bloomberg calculations show.

(adds details on debt in ninth and last graphs.)

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