Macquarie looks at second water business

In what could be Germany’s first hostile public to private Macquarie, the Australian infrastructure group, has offered €1.1bn for Techem the German listed water and energy services provider.

The unsolicited offer has been made directly to shareholders, but it will not be officially ‘hostile’ until the management has rejected it.

This approach comes shortly after German utility group RWE has agreed to sell the British provider Thames Water Holdings to Kemble Water in a deal worth £8bn (US$14.9bn).

Kemble Water is a consortium led by Macquarie´s European Infrastructure Funds which includes Alberta Pension Fund of Canada and the Netherlands-based pension fund ABP. The purchase price includes assumed debt of £3.2bn.

The transaction was approved last week by the management board of RWE and remains

subject to approval by the supervisory board of RWE and by the relevant antitrust authorities. RWE expects this transaction to result in a book gain of at least in the mid hundreds of millions of Euros.

Macquarie´s Kemble Water is understood to have outbid a host of rival bidders including Australian energy company Alinta and a consortium led by the Qatar Investment Office, a government investment fund that has joined forces with UBS’s Global Infrastructure fund; the buyout firm Terra Firma is also believed to have submitted an unsuccessful bid.

The sale of Thames Water is a milestone in RWE’s announced retreat from water utilities. The company has yet to dispose of its US unit American Water, which is expected to list on a US stock exchange in 2007 instead of being sold to an investor.

In 2000, RWE acquired Thames Water for €7.1bn (US$6.26), but the total value of the transaction including debt was recorded as US$8.9bn, partly due to the subsequent combination of Thames Water with RWE’s existing water activities.

The current sale of Thames Water to the Macquarie-led group is the most potent sign yet that the UK water industry can do little wrong in the eyes of investors.

While in percentage terms, the winning bid may not represent the highest premium to a company’s regulated capital value (RCV) that has been paid in the sector, it certainly is in absolute cash terms – more than £2bn more than Thames’ expected RCV of £5.72m by March next year.

This must represent a considerable investment risk. Thames – despite reporting a 31% increase in pre-tax profits to £345m for the year to 31 March – is facing serious regulatory threats to its revenues over the remainder of the current five-year review period up to 2010.

Not only is the regulator Ofwat certain to fine it heavily for any further failures to meet leakage targets (and the fact that it has not met such a target in four years can hardly inspire confidence) but will also come down heavily on any more shortcomings in standards of customer service. The penalties could well exceed £100m in a single year.

Furthermore, the new owners’ ability to boost their returns by increasing the company’s gearing may prove extremely limited. Given Thames’ colossal investment programme (about £1.5bn up to 2010), Ofwat looks set to ring-fence the revenues of the regulated water business more tightly to safeguard customer interests.

The losing bidders in the Thames auction, who now seem likely to pursue other targets in the sector such as Anglian, Northumbrian, and Kelda, may well have cause to be grateful in three years’ time.