OMERS Writing Off Stake in Troubled British Utility Thames Water

James Bradshaw of the Globe and Mail reports that OMERS is writing off its take in troubled British utility Thames Water:

The Ontario Municipal Employees Retirement System (OMERS) has written off its entire investment in troubled British utility Thames Water, walking away from a stake once valued at well over $1-billion.

Thames Water has been struggling under the weight of more than £18-billion ($31-billion) of debt that has become more expensive with high interest rates. In late March, its shareholders – of which OMERS is the largest – refused to inject more money into the beleaguered company, casting doubt on its viability.

Before Friday’s write-off, an OMERS subsidiary that holds a roughly one-fifth stake in Thames Water, OMERS Farmoor Singapore PTE Ltd., had filed annual financial statements that show it marked down the value of its assets from £700-million ($1.2-billion) at the end of 2022 to £321-million ($461-million) at the end of last year.

The financial filing also refers to the impasse that shareholders reached with Thames Water and its regulator, Britain’s Water Services Regulation Authority, or Ofwat. The “subsequent financial effect will be a full write down of the investment” and an outstanding loan, the filing says.

As of Dec. 31, 2021, OMERS had valued the part of its stake held through its Singapore subsidiary at £990-million ($1.7-billion).

On Thursday, OMERS also withdrew its representative from Thames Waters’s board of directors when Michael McNicholas, a managing director at OMERS Infrastructure, stepped down.

Shareholders in Thames Water “concluded that the UK regulator, Ofwat, was not prepared to provide the necessary regulatory support for Thames Water to have an investable business plan. Consequently, no shareholders provided further funding to Thames Water and the value of OMERS Thames Water investment has now been written off,” said James Thompson, a spokesperson for OMERS Infrastructure, in an e-mailed statement Friday.

OMERS is one of Canada’s largest pension fund managers, overseeing $129-billion of assets with investments in Canada, the United States, Europe and Asia.

“This diversification, scale and strength of our investments ensure that we can protect our members from these kinds of challenges as they arise,” Mr. Thompson said.

Thames Water serves 16 million customers, mostly in and around London, and investors value such utilities for the steady returns they typically provide. But as problems piled up at Thames, the company’s relationship with its regulator deteriorated.

More than a year of negotiations failed to produce an agreement for shareholders to put up further support. Since then, investors in Thames Water have been bracing for further writedowns, and by the time talks stalled, the estimated value of the utility had already plunged. Faced with a choice between putting more money into the flailing utility or cutting its losses, OMERS has chosen to walk away.

The write-off deals a blow to OMERS’s $28-billion infrastructure portfolio, which has otherwise largely performed well. The unit earned a 5.5-per-cent return in 2023 – dragged down by unrealized losses on a few assets in energy, utilities and transportation – and has returned an average of 10.7 per cent annually over the past decade.

OMERS owns about 32 per cent of Thames Water’s parent company, Kemble Water Finance Ltd., through multiple subsidiaries. But OMERS has partners in its investment, which makes its direct exposure to losses somewhat lower. The pension fund made its initial investment in Thames Water in 2017, in tandem with the infrastructure-investing arm of the Kuwait Investment Authority (KIA). OMERS then boosted its stake to current levels in 2018.

Another major Canadian pension fund, British Columbia Investment Management Corp. (BCI), owns nearly 9 per cent. BCI manages $233-billion in assets.

A spokesperson for BCI could not immediately be reached for comment.

Thames Water was privatized in 1989 and its debt has been piling up as the company borrowed to pay for upgrades to its water and sewage infrastructure. The utility had been looking for a lifeline from nine of its investors that would have provided more than £3-billion ($5.15-billion) in funding over the next five years, with an initial £500-million that was due March 31. But after the investors balked, the likelihood that the British government could have to step in has increased.

At the time, OMERS’s global head of infrastructure, Michael Hill, said that “shareholders can no longer invest money into a business where it has become clear that we will never get it back.”

Mr. Hill had also stressed that writedowns on the OMERS stake will not affect its ability to pay pensions to members.

Abhinav Ramnarayan and Jessica Shankleman of Bloomberg News also report Thames Water Kemble bonds close to worthless as board exits:

The parent company of struggling British water utility Thames Water Ltd. saw its debt hit new lows after a wave of directors quit the board ahead of a crucial June 12 ruling. 

The defaulted bonds of Thames Water Kemble Finance Plc, the holding company of Britain’s largest water utility, dropped as low as 5.8 pence on the pound on Tuesday, according to Bloomberg pricing data, before rising slightly later in the day. 

While the bonds were already trading at extremely low levels after Kemble defaulted on its debt last month, a wave of board resignations has rendered the debt almost worthless. Creditors have appointed Moelis & Co. as their financial adviser as they begin talks with the company, according to people with knowledge of the matter. 

The board clearout began on Monday afternoon and continued into Tuesday. Yesterday, directors resigned from Thames Water (Kemble) Finance and several quit from Kemble Water Finance Ltd, the two units in the company’s holding structure that contain most of the debt. Today, some of those same directors also left Kemble Water Holdings Ltd, the ultimate parent company, along with Kemble Water Eurobond Plc and Kemble Water Finance Ltd.

The resignations raise the risk that Thames Water will need to be temporarily nationalized if it fails to find new investors after June 12. That’s the date when industry regulator Ofwat is due to publish its assessment of Thames’s next big business plan, which runs to 2030. The heavily indebted utility needs more than £2.5 billion ($3.18 billion) to fund itself. The money is unlikely to come from Kemble, which declared the business plan “uninvestible” before defaulting on its debt. 

However, the government and Ofwat have continued to resist pressure to bring Thames into special administration, insisting it has a wide range of options to find new equity. Ofwat last week told Thames that it was minded to take action against Thames for paying dividends to service Kemble debt last year, which could potentially lead to new fines. 

Consultants at restructuring advisory firm Alvarez & Marsal are working with Kemble as the company starts talks with lenders and bondholders over its debt structure.

Alright, it's Tuesday, I trust everyone is well rested after a beautiful long Victoria Day weekend.

I tried to stay up last night to watch the full Game 7 of the Edmonton Oilers vs the Vancouver Canucks but couldn't do it (passed out on my couch after the Oilers took a commanding 3-0 lead and then dragged myself to bed).

Oilers are now truly Canada's team entering the western conference final.

My buds and I love watching them play, they have exceptional talent led by Connor McDavid who along with the Maple Leafs' Auston Matthews, I consider to be the best hockey players in the world (both of them have a sixth sense, they both create opportunities when on the ice).

Anyways, where am I going with this? What does all this hockey talk have to do with Thames Water and OMERS writing off its investment there?

Well nothing, except as much as I love watching good hockey during the playoffs, I loathe Thames Water and always thought it was a bad investment fraught with risks.

I especially hated how the Macquarie boys stripped this asset down and loaded it up with debt in their quest to generate returns.

By the time OMERS and BCI bought their respective majority and minority stake in Thames Water, it was too late, the titanic was leaking and sinking.

I wrote about all this here.

Sometimes private equity funds add value, sometimes they don't. 

I wrote all about this on LinkedIn earlier when I discussed how private equity destroyed Red Lobster so by the time the new inexperienced owners took over, it was too late:

Just keep in mind that sometimes private equity adds value, sometimes it really doesn't.

When you see PE funds stripping assets and loading companies with debt, you know they're being lazy idiots and extracting a pound of flesh.

And sometimes these elite PE firms just don't know what they're doing.

Ever since Brazilian powerhouse 3G Capital took over Tim Hortons, the quality and the service has gone downhill (I'd love to talk to these people because they're sitting on a goldmine and bungling it up).

Thames Water is a utility that needs massive, more like MASSIVE investments, and if the regulators aren't going to budge, then I agree with OMERS, write off your stake and walk away, it's not worth it.

The best analogy I can give you is a stock that keeps heading lower and lower, dragging down your overall portfolio.

You can pray all you want, but if the price keeps heading lower, at one point, you need to make a decision and cut your losses.

Obviously, it's more complicated when you're talking about illiquid investments like infrastructure, real estate and private equity because when there's no bid (nobody willing to buy the asset), you have to write it off. 

In this case, recall, Universities Superannuation Scheme (USS), a UK pension fund which holds almost 20% of Thames Water’s parent entity, Kemble Water, took a 62% writedown in the troubled utility earlier this year.

At the time, I thought that was steep and said OMERS' writedown of 28% seemed more reasonable to me.

It's now clear that USS was right to take such a massive writedown as they saw where this was heading, downhill fast.

From the Bloomberg article above:

The heavily indebted utility needs more than £2.5 billion ($3.18 billion) to fund itself. The money is unlikely to come from Kemble, which declared the business plan “uninvestible” before defaulting on its debt.
At this point, USS, OMERS, BCI and other investors would be nuts and irresponsible to invest another dime in Thames Water unless regulators increase the fees significantly.

So, you bet this asset will be nationalized and massive investments will still be required to bring it back into shape.

And again, as I stated back in January:

I'm not a big fan of Thames Water, think the Macquarie boys made a killing off it by stripping its assets and never reinvesting in it, and OMERS, BCI, USS and other investors need to plow a lot of money in this dead horse to reform it.

Any way you slice it, it's a problem investment, all pension funds run into these problems once in a while which is why they need to be diversified at all times.

This Thames Water fiasco is a textbook case study of how to turn a profitable utility into a national disaster!

So where does this leave OMERS, USS, BCI and other investors?

Well, they resigned from the Board of Kemble Water, the parent holding company and are writing this asset down.

That means their respective infrastructure portfolio will take a hit, OMERS will bear the brunt of the losses as it had the biggest stake (32%).

But it's important to put things into proper context.

A $1.2 billion hit on $129-billion of assets for OMERS isn't the end of the world. 

It has an incredible $28 billion infrastructure portfolio and they will bounce back, just like they did when they got hit hard by two investments during the pandemic.

For BCI with its 9% stake in Kemble Water, it can easily absorb a full writedown and it will be inconsequential to its $233-billion overall portfolio.

I'm not trying to minimize the sting of these losses -- to be sure, they hurt -- but they will move on and invest elsewhere.

It's more important to really learn your lessons here about what went wrong and whether this water utility was worth investing in.

In my opinion, it was a doomed investment a long time ago but maybe OMERS saw real potential here and had a valid turnaround plan.

I don't know, some infrastructure investments carry a lot more risks than others and nobody is immune (OTPP had issues with their Finnish electricity grids last year when regulators changed pricing on them).

Lastly, let me circumvent critics who will scream at me: "You see, Leo, this is just another example of why Canada's large pension funds shouldn't be investing in foreign infrastructure assets."

This is total nonsense, absolute rubbish!

Unless you're investing in GICs taking no risk (and potentially losing on inflation), you're always going to have risks investing in domestic or foreign assets.

We pay pension fund managers big bucks to properly account for all risks and diversify their portfolios across geographies and sectors in illiquid assets.

All this to say stick a fork in Thames Water, it's done but OMERS Infrastructure will carry on!

And I emailed Blake Hutchinson, Jonathan Simmons and Michael Hill on Friday to tell them I wasn't surprised, and upwards and onwards!

You're not going to win them all, you try to make sure you have a lot more winners than losers.

That goes for all of Canada's large pension funds, not just OMERS.

Lastly, OMERS CFO & CSO Jonathan Simmons emailed me this:

Yes. Upwards and onwards indeed!   

In other news, I'm off to a good start fundraising for my MS walk - about half way to my goal of $40,000 which will help me reach $500,000 cumulatively. Its my 25th year!.   

If you feel comfortable giving it a plug and sending a link to fundraising  page in one of your blogs, it would be terrific!

I feel more than comfortable plugging Jonathan's MS Walk on LinkedIn and here.

Please help him attain his $40,000 goal by donating here.

Jonathan is incredible to have raised close to $500,000 cumulatively over the last 25 years for MS research and I cannot thank him enough.

Please help him attain his goal of $40,000 for his walk this Sunday (he's more than halfway there and if all my 28,000 LinkedIn contacts gave just $10, he'd already attain it).

MS is a disease I know all too well, was diagnosed with it 27 years ago, in June 1997 right in the middle of writing my MA thesis in Economics at McGill (got an A after submitting it a few months later than initially planned).

The good news is after many years, the disease eventually plateaus as you're way past the early inflammatory stages and you learn to live with all the visible and invisible symptoms (some are more annoying than others but all are manageable).

To be honest, my back surgeries were tougher and I'll never forget that excruciating nerve pain I had before doing them (crippling pain).

Still recovering from the second back surgery as spinal fusion isn't a joke but I have a beautiful, healthy young baby boy to remind me that I need to forge ahead no matter what and that's what I'll do for his sake.

Life throws you many curveballs, you need to always forge ahead no matter what and be thankful for what you have. There simply is no other choice but if I can do it, anyone can.

Just my little inspirational message after this beautiful Victoria Day weekend.

Below, Britain’s biggest supplier of water is in trouble. The parent company of Thames Water is at risk of running out of money, having been forced to deal with a seemingly endless series of leaks and sewage spills while struggling to adapt to global warming and its effect on London’s future. So how did it get into this big of a mess, and is there a way out? Bloomberg reporter Jess Shankelman joins this week’s In the City with Allegra Stratton and Ailbhe Rea to discuss.

And David Black, the chief executive of Ofwat, is grilled by Labour MP Clive Lewis as he speaks to the Environmental Audit Committee, in a session on water quality and infrastructure. The MP for Norwich South opens by asking Mr Black about the standards of water quality before going on to question him about the funding of Thames Water, remarking:. "After 30 years of privatized water we find ourselves not only swimming in our own excrement ... but drinking it as well."

Well, it's safe to say Thames Water was a sh*tty investment, time to move on!

The last two clips are mainly for me but might also help many of you regardless of whether you have MS or are recovering from back surgery. Just remember, after spinal fusion surgery, no bending or lifting or any exercise or physio for first 12 weeks as your spine needs to fuse properly (just walking and light stretches like knee to chest).

After week 12, you can do more like regular physio and swimming and only do what you can as you do not want to re-injure your back and set your recovery back. Watch the clips and make sure you're doing the bridge as shown (most people get it wrong and over-arch their back; after spine surgery wsit till week 12 to do bridge exercise).

Update: In an interesting twist, a LinkedIn follower pointed out that last month Australia’s Macquarie was among the lenders to Thames Water’s parent company:

The Australian investment bank Macquarie, which has been criticised for its role in the privatisation of England’s water industry, is understood be among lenders to Thames Water’s troubled parent company.

The former Thames Water shareholder could, along with other lenders, play an important role in determining the fate of Britain’s biggest water company, after its parent company Kemble Water Finance defaulted on its debt.

Kemble said on Friday it had requested that its lenders and bondholders take no creditor action, but the development raised the prospect that the utility could face a significant restructure or even ultimately collapse.

Macquarie’s fresh involvement, first reported by the Times, is likely to spark further controversy, after the Australian group came under fire for loading Thames Water with debt and inadequate investment while receiving big dividends during its part-ownership between 2006 and 2017.

Macquarie has defended its stewardship of the utility, arguing that it invested more than £11bn in Thames Water’s network during the period, the highest per customer level of all water companies in England and Wales.

It emerged last week that the group of lenders to Kemble also include the Dutch bank ING, Allied Irish Banks (AIB) and the Chinese state-owned Bank of China and Industrial and Commercial Bank of China (ICBC).

Kemble has a £190m loan that is due to be repaid at the end of this month, but the banks are expected to agree an extension. Late last month Thames Water’s shareholders refused to stump up £500m needed by the end of March, some of which was earmarked to pay the Kemble loan.

Macquarie is thought to have invested £130m in Kemble’s debt in 2018 and 2020, equivalent to about 9% of the company’s debt instruments. This is not part of the £190m due later this month.

A spokesperson for Macquarie said: “We manage debt investments on behalf of long-term institutional investors in a range of infrastructure companies, providing long-term financing for essential infrastructure. Macquarie has not had any control or influence over Thames Water’s operating company since 2017.”

Macquarie sold its remaining stake in Thames Water seven years ago. The utility’s debt jumped from £3.4bn to £10.8bn during the Macquarie consortium-led ownership.

The Australian group is known for buying public infrastructure. It can then charge fees, and receive dividends for its part-ownership, as well as enjoy any increase in the asset price. Estimates have put dividends paid for Thames Water during the Australian bank’s 11-year stewardship at £2.7bn.

Days after Macquarie’s sale of its stake was announced in March 2017, Thames Water was hit with a then record fine of £20.3m linked to huge leaks of untreated sewage for offences in 2013 and 2014.

They can defend their record all they want, every infrastructure expert I spoke to told me Macquarie grossly mismanaged this asset and left it with a pile of debt, which the evidence supports.