Macquarie’s return to UK water is a significant litmus test

Two weeks after Macquarie Asset Management sold its 26.3 percent stake in Thames Water to OMERS Infrastructure and Wren House Infrastructure in March 2017, the utility was slapped with a £20 million ($27.7 million; €23.6 million) penalty. The judge who handed it down called it a “record-breaking fine for record-breaking offending”, in reference to Thames Water repeatedly dumping sewage into the River Thames in London.

This week, Macquarie’s £1 billion acquisition of a majority stake in Southern Water sees it take control roughly a month after the utility was handed a £90 million fine by the UK courts, following a case brought by the Environment Agency for the deliberate discharge of sewage into rivers and seas between 2010 and 2015. This was in addition to the £126 million fine that regulator Ofwat imposed on Southern Water for similar offences in 2019.

Again, record-breaking fines for record-breaking offending.

Macquarie is well-aware of what it’s wading into. Leigh Harrison, head of Macquarie Infrastructure and Real Assets, wrote to Ofwat chair Jonson Cox that Southern Water’s “unauthorised activities and their impact on customers and the environment do not reflect our goals or values, nor are they consistent with any company entrusted with public and environmental responsibilities”. It’s hard to disagree, although cynics might point out that Harrison’s statement is lacking a certain amount of self-awareness – or is perhaps too eager to let bygones be bygones.

Macquarie has also pledged to support Southern Water’s previously agreed £2 billion investment plan with Ofwat, pledging to contribute £230 million to improve the utility’s infrastructure. Cox also noted Macquarie’s commitment to “distributions during [2020-25] below a 4 percent return on actual equity” and that it will only accept dividends during this period when the utility is delivering on its turnaround plan.

So, have lessons been learned from Macquarie’s track record in this sector? “We made important inroads during our period of investment and, despite the challenges Thames Water encountered when managing and upgrading an ageing network, we fundamentally believe Thames Water was a more resilient utility company at the end of our ownership period,” Harrison told us in an emailed statement. He pointed out “a record £12 billion” was invested during Macquarie’s ownership period, which helped cut leakage by a class-leading 22 percent while keeping “customer bills amongst the lowest in the country”. Additionally, Thames Water oversaw procurement of the Thames Tideway Tunnel ‘super-sewer’ project.

Ofwat gave a cautious welcome to Southern Water’s new owner and Cox, responding to Harrison, welcomed Macquarie’s “support for the removal of intercompany loans”, another bone of contention with the prior management of Thames Water.

Might Macquarie’s new approach make a difference? The deal is believed to be funded via its 25-year Super Core Infrastructure Fund, rather than the 12-year approach it took with Thames via its European Infrastructure Fund 2. In the latter case, the drive for higher returns and focus on exit could be said to have clouded long-term performance and behaviour.

However, that open-end or long-term approach has been applied by some of Southern Water’s other shareholders, including JP Morgan Asset Management, Federated Hermes and Whitehelm Capital, which are believed to be diluting their stakes. They were still accused by previous Ofwat chief executive Rachel Fletcher of showing “scant regard for [their] responsibilities to society and the environment”.

Will Macquarie be a better steward than last time and will the supposedly tougher regulatory stance enforce this? “We know our stewardship will ultimately be judged by Southern Water’s performance, and that its transformation will take time given the upgrades required,” Harrison told us, so he’s aware of the stakes.

In that sense, Macquarie’s return to UK water might well turn out to be a litmus test for both the sector and the infrastructure investment market.