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Infrastructure assets under private management top $1tn mark
Macquarie’s income, as the manager of the funds invested in various assets, comes from management and performance fees tied to the fund’s returns. After acquisition, the stable cash flows generated by the asset provide the security for further borrowing, allowing Macquarie to significantly increase the indebtedness of the acquired company.
This provides funding which can either be used to invest in the business or to enhance investor returns through dividend payments and early repayment of the loans made by investors as part of the initial deal.
Folkman, who is himself a private equity investor, points out the risk: “Given the incentives and investor objectives they choose to take the money out rather than reinvesting in the business.” The result, Folkman says, can be ageing assets loaded with debt.
But Paul Jarvis, managing editor at Partnerships Bulletin, which reports on public-private partnerships, defends the industry: “Obviously it is more expensive to raise private finance than for the government to pay for infrastructure directly, but the fact is that states aren’t going to put all these projects on their balance sheets.
“And although a lot of fuss is made about the negative cases, the majority of projects are running as originally planned and are delivering the services as needed.”
Troubled waters
Macquarie first dipped its toe into the UK’s waters in 2003, with its shortlived acquisition of South East Water.
After buying the company for £386mn from the French conglomerate Bouygues, Macquarie sold its final stake three years later for £665mn. During that period, debt — some of which was raised via a Cayman Islands subsidiary — increased more than fourfold from £87mn to £458mn.
The increase in borrowing was used to pay investors more than £60mn in dividends as well as to pay off most of the costs of acquiring the company so that the final sales price was mostly profit.
Although this was a win for investors in Macquarie’s funds, which benefited from the returns guaranteed from providing an essential daily service, it was a loss for customers because a greater proportion of their bills — up from 8.7 per cent of turnover in 2002 to 14 per cent in 2006 — began to go towards paying the interest on debt.
“This is part of a pattern for investors,” says Kate Bayliss, an infrastructure finance expert from Soas, University of London. “Macquarie [and other private equity investors] move in and change the corporate structure. They refinance the assets, hiking up the debt and reducing the equity investment. Sometimes part of the acquisition cost is allocated to the company purchased.”
Protesters gather on Tankerton beach in Kent to demonstrate against Southern Water’s discharges of untreated sewage
Protesters on Tankerton beach in Kent demonstrate against Southern Water’s sewage discharges. The pollution of rivers and seas has led to a backlash against the privatisation of utilities © Chris J Ratcliffe/Getty Images
Macquarie repeated exactly the same strategy, but for bigger stakes, when it and its co-investors acquired Thames Water, which now has 15mn customers in London and the Thames Valley, from German utility RWE for £4.8bn in 2006.
One of the Macquarie consortium’s first acts was to arrange for Thames Water to pay a £656mn dividend in a year in which profits were just £241mn. Within six years, the group of companies managed by Macquarie had recovered all the money it and co-investors had spent on the acquisition, by borrowing against its assets and paying out dividends.
By the time Macquarie sold its final stake in Thames Water in 2017, the company had spent £11bn from customer bills on infrastructure. But far from injecting any new capital in the business — one of the original justifications for privatisation — £2.7bn had been taken out in dividends and £2.2bn in loans.
Meanwhile, the pension deficit grew from £18mn in 2006 to £380mn in 2017. Thames Water’s debt also increased steeply from £3.4bn in 2007 to £10.8bn at the point of sale, a sum still being paid off with interest by customers long after Macquarie has moved on. Just weeks after Macquarie sold its final stake in the business in 2017, Thames Water received a £20mn fine for river pollution.
Bayliss compares this to buying a house, where the stability of the revenue flow from customer bills enables the financiers to purchase the company and take a mortgage against it. “The difference is that unlike homebuyers who pay the mortgage, they transfer the mortgage back to the company so it’s the customers who pay the interest.”
Such practices are common to private equity structures, but when the underlying companies are utilities there is an added tension: the decision over how much they can charge customers to pay for investment — both for day-to-day running and improvements — is made by the regulators who oversee monopolies. With demanding shareholders on one side and price restrictions on the other, it is the investment in the underlying infrastructure that is often sacrificed.
“Let’s be clear,” says Folkman, of Alliance Manchester Business School. “If my financial incentive is that I will be paid if I satisfy my investors, then I will do things that will satisfy my investors?.?.?.?and that’s the problem. It’s not that you’re wicked, it’s what you’re paid to do.”
Macquarie’s decision to take over Southern Water — another UK water utility facing huge investment challenges — as it teetered on the brink of bankruptcy in 2021 was welcomed by the water regulator Ofwat.
Growth in infrastructure as an asset class
Earlier that year, Southern Water had been fined £90mn for deliberately dumping billions of litres of untreated sewage into the sea between 2010 and 2015. Since taking over as the majority investor from a consortium including JPMorgan Asset Management and UBS Asset Management, Macquarie has pledged to raise transparency, close Cayman Islands subsidiaries at the company and to significantly increase investment in sewage treatment works.
Macquarie says it is a responsible investor. “As custodians of vital businesses which touch every aspect of people’s daily lives, we have both a responsibility and an opportunity to ensure that we are actively driving positive change,” reads a statement on its website.
But the pollution and water leaks across the sector have given ammunition to critics from all sides of the political and economic spectrum who are concerned over private ownership of crucial public infrastructure, where the government — and taxpayers — would be forced to take over in the event of any financial or environmental catastrophe.
Now, more than three decades after the regional water authorities were sold off with no debt, the privately owned monopolies are saddled with £62bn in borrowings and regulator Ofwat has raised concerns over their financial stability.
Sir Dieter Helm, a former UK government adviser and professor of economics at Oxford university, warns that instead of privatisation being used as intended, to finance investment and spread the cost long-term, “regulators have allowed [it] to be subverted by widespread financial engineering”.
“Now the balance sheets of these big utilities are largely exhausted, and without gaining the benefit of the really good infrastructure that privatisation promised,” he adds. “On the contrary, recent evidence from both water and electricity distribution suggests that in some cases not even the necessary capital maintenance has been done.”