Since privatisation water companies have paid over £85bn in dividends.
Prem Sikka is an Emeritus Professor of Accounting at the University of Essex and the University of Sheffield, a Labour member of the House of Lords, and Contributing Editor at Left Foot Forward.
Thames Water, the poster-child of predatory capitalism, has long been on the road to financial, environmental and moral bankruptcy. It has been kept in business by the benevolence of the state wedded to privatisation of public monopolies. Are things about to change?
Following public anger Thames has been placed under a “Turnaround Oversight Regime” and subjected to additional monitoring of its performance and finances by Ofwat, England’s water regulator. This step has been taken as Thames once again failed to meet a raft of regulatory targets relating to water supply, sewage disposal and customer service.
The regulatory bark makes press headlines but lacks bite. Indeed, Ofwat has tacitly approved anti-social practices with puny penalties. Since 2010, Thames has been sanctioned at least 99 times and fined £179m. No action is taken against directors who boost profits and executive pay through unplugged leaks and by dumping sewage in rivers and seas. There were 16,990 sewage discharges last year by Thames compared to 8,015 in 2022 while serious pollution incidents arising from sewage dumping rose from 331 to 350.
Thames Water provides water and sewerage services to around 16m of the population in England. It has a state guaranteed monopoly. Captive customers have no choice and no recourse against the company and/or its executives. They simply pay-up and boost profits. For the year to 31 March 2024 Thames Water had underlying sales revenues of £2.401bn, a 10% increase compared to £2.181bn a year earlier. Customer bills are virtually the only source of its income. It reported earnings before interest taxes depreciation and amortisation (EBITDA) of £1.208bn and operating profit of £445m. Rising revenues and profits are not surprising as Ofwat’s pricing formula guarantees real returns to water companies regardless of the failures and social costs.
Since 1989, the company has failed to build any new reservoirs; shareholders have provided little new finance and the company has borrowed money to pay dividends. Thames reported debt of around £16bn for 2024, compared to £14.7bn a year earlier. All of the debt has been acquired since privatisation as shareholders have been reluctant to invest. Most of its infrastructure is over 79 years old. The company does not have a complete map of its sewage network.
High debt means that more of its income is swallowed by higher interest payments. It incurred some £906m finance expense to service its debt, which is nearly 38% of its underlying revenue. The regulator permits the company to pass interest payments on to customers in the form of higher bills. The company’s financial position has become more precarious as its net cash flow declined from £1.83bn to £1.154bn. It has fully used up £2.2bn revolving credit facilities and term loans. Debt repayments loom.
Executives are rewarded for abusing the public and financial mismanagement. Thames’ chief executive collected £437,000 for just three months work, including a bonus of £195,000 though there is no evidence of any extraordinary performance. The previous CEO collected £1.33m, including £446000 bonus, for the year. The company’s non-executive directors have failed to check predatory practices. The entire board collected £3.3m in pay and bonuses.
The company’s PR machine soothes public anxieties by claiming that it invested nearly £2.084bn in infrastructure during the year. However, this isn’t quite true as numbers are inflated by financial engineering. For example, the company claims that some of the interest payments on debt are an infrastructure investment rather than an expense. It capitalised £159.4m of interest payments, compared to £215.2m for the previous year. The amount of interest capitalised since privatisation in 1989 must run into billions of pounds.
Contemporary accounting standards permit capitalisation of interest payments under certain circumstances. These are formulated by big corporations and accounting firms. However, the practice is imprudent because it inflates the alleged investment and distributable profits, enabling companies to pay higher dividends. Thames does not disclose its distributable profits. The folly of capitalising interest payments was highlighted by the 2018 collapse of Carillion.
The amounts attributed to investment are also inflated by treating part of repair and maintenance costs as investment. The amounts involved are not known. Page 121 of the accounts sates that the company:
“capitalises expenditure relating to water and wastewater infrastructure where such expenditure enhances assets or increases the capacity of the network. Maintenance expenditure is taken to the income statement in the period in which it is incurred. Differentiating between enhancement and maintenance works is subjective, particularly in the instances where a single project may include a combination of both types of activities”.
This is a highly imprudent accounting policy. None of the repair/maintenance costs treated as investment can be independently corroborated from any market mechanism.
By inflating its distributable reserves Thames continues to pay high dividends, mostly funded by more borrowing. Earlier this year, Thames’s shareholders pulled the plug on the promised £500m of emergency funding but the company still paid £195.8m in dividends during the year. This is despite the publicity stunt claiming that the regulator will constrain dividend payments.
The company is teetering but Ofwat disarms critics. Financial resilience is often highlighted by the gearing (also known as leverage) ratio. The traditional calculation compares funds provided by shareholders (equity) with those provided by lenders (debt). High levels of debt can be viewed as having higher financial risk as the inability to service raises risk of default and bankruptcy. Conversely, payments of dividends to shareholders are at the discretion of directors and do not have to be made. Gearing ratios are used by credit rating agencies to estimate financial risks.
Ofwat does not use the traditional measure of gearing. Instead, it uses assets/debt ratio to calculate gearing which understates the extent of financial risks. It is worth noting that the amounts attributed to assets are inflated by financial engineering (see above). Thames gearing based on the asset/debt ratio is 80.6% against the Ofwat target of 55% – 60%. One study estimated that on the basis of traditional equity/debt measure, Thames gearing ratio is over 1,000%. It survives because it is able to milk customers.
There is no relief in sight for households. Ofwat has permitted water and wastewater companies to hike customer bills by an average of 21% for the five years from 1st April 2025. The company will effectively continue to raise capital from customers whilst shareholders continue to extract returns.
Thames’ biggest shareholders consider their investment to be almost worthless and are unwilling to provide new finance without bigger hike in customer bills and government funding. Its corporate bonds are trading at just 5.8 pence in the pound. New money would be hard to find and bankruptcy looms.
The newly elected Labour government, just like the Tory government preceding it, does not want to nationalise Thames and other water companies. It is desperately looking at regulatory measures such as closer monitoring of sewage dumping, restraints on executive pay and dividends, and criminal charges against companies for sewage dumping. Will this encourage new investment and lower customer bills?
The government may place Thames and other ailing water companies into special administration, which is different from the “Turnaround Oversight Regime” initiated by Ofwat. Special administration is a form of temporary nationalisation which enables an insolvency practitioner to run the company whilst offering normal services in the hope that company’s finances can be restructured to persuade investors to buy the business. Current creditors will face big losses and shareholders will almost certainly be wiped out. This arrangement will not add anything to the government debt.
Even if new buyers can be found, leaving water in private hands won’t address the real issues because new owners would still want a return on capital, which is the root cause of customer exploitation, unplugged leaks and sewage dumping. That leaves public ownership as the only viable alternative. This can be in the form of a not-for-profit organisation, a co-operative or other entity. The government can buy water companies at knockdown prices and the resulting debt does not have to be added to public finances. It can be loaded onto the companies themselves, as private equity has so frequently done. Public ownership would remove the profit motive and dividends would not be paid. Since privatisation water companies have paid over £85bn in dividends. Under public ownership, that amount would have gone into infrastructure investment. Such choices will need to be made soon.
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