Is it good or bad news that hedge funds are having a punt in the debt of Thames Water? The speculators include Elliott Management, a firm with a reputation for being New York’s finest financial bruiser. It is reported to have bought £1bn-worth of Thames’s bonds at steep discounts to face value, effectively betting that writedowns will turn out to be less severe than market prices currently imply.
On balance, the development sounds welcome. First, it suggests hard-nosed investors realise that bondholders will not escape the Thames disaster zone intact. That acceptance of financial reality stands in contrast with the victim mentality being displayed by the Thames chairman, Sir Adrian Montague, who is still whistling the impossible line that the company’s troubles would evaporate if only the regulator, Ofwat, would capitulate and inflate customers’ bills by almost two-thirds.
Second, it indicates that the threat of special administration for Thames, aka temporary nationalisation, is concentrating minds. One can think that the likes of Elliott have worked out that a voluntary debt-for-equity swap would yield a better outcome for bondholders than an untested process in which a government-appointed administrator runs up a pile of expenses as a preferred creditor and then imposes a financial solution on everybody else.
Third, a voluntary debt-for-equity swap, if that’s the way the plot is heading, raises the hope that a financial restructuring of Thames, which has looked inevitable since the shareholders refused to inject the sums they had promised, could happen by, say, the first few months of 2025. The formation of negotiating committees and so on is a necessary first step.
There is, of course, no guarantee that the bondholders will be able to come up with a voluntary plan. But the credit rating agencies’ analyses hint at where losses might settle. The shareholders and bondholders of Kemble, Thames’s parent company, would be wiped out, obviously. But Standard & Poor’s update a few weeks ago also spoke about “negligible recovery prospects” in the event of a default for holders of “B” class debt with formal claims of about £1.4bn. As for the £15.3bn of the more senior “A” debt, S&P expected a recovery rate of 70%-ish.
Add up those possible haircuts and you have a sketch of how debts within Thames’s regulated entity could be reduced by £5bn-ish, with bondholders being rolled over into equity in a New Thames. Elliott & co will obviously hope the recovery rate in the “A” debt will be higher than 70%. The point, though, is that the chances of thrashing out a creditor-led deal should improve if a portion of those creditors have bought as low as, say, 60p in the pound.
A financial restructuring still looks hellishly complicated because nothing is straightforward here. There are obvious tensions between the “A” and “B” classes of debtholder (and some funds will be in both, adding further complications). Other considerations include two ideas previously aired by Ofwat – whether to split Thames in two, and how to encourage a restructured entity back to the stock market.
But, in the government’s shoes at this point, you’d do two things. First, make it clear that you won’t be bullied into leaning on Ofwat to go soft on Thames; the regulator’s determinations on bills have to be seen to be independent. Second, send a parallel message to the likes of Elliott that, if bondholders can’t agree debt writedowns between themselves, then special administration is still on the table.