The cost of nationalising the water industry in England

The research draws on a range of existing academic studies, as well as publicly available data from Ofwat, the London Stock Exchange and the annual accounts of the water companies. The report seeks to provide an overview of the likely implications of nationalisation on public sector debt levels, and to provide points for discussion with respect to the ongoing impacts of nationalisation for public sector net borrowing.

We emphasise that this report is not a full assessment of the merits and drawbacks of a nationalised versus a privatised water industry; our focus here is to consider the costs that the government could initially face if it wished to purchase the companies from their current owners.

The key findings of our research are:

• Our best estimate of the costs of obtaining control of the regulated businesses gives a ‘takeover value’ of £90bn.
• If the government were to purchase the water industry’s assets at a takeover value of £90bn, it would entail a 5% increase in government debt levels.
• The government would also need to meet the long-term investment requirements in the water sector, which we estimate to stand at over £100bn over the next 25 years, in 2016/17 prices. The research assesses how public sector capital expenditure would have been divided in the 2016/17 fiscal year, if water investment in that year was undertaken by the government. It reveals that water investment would be the third biggest category of capital expenditure, accounting for 13% of all public capital expenditure.
• If the government were to acquire the water industry’s assets for less than the market price, it would have financial implications for UK households, including the workers in the water companies. There are major UK ownership interests in the listed companies with more than six in ten of shareholders across all three listed regional water and sewerage companies being UK-based. The figures are similar across the three listed firms, ranging from 60% in Severn Trent to 70% in Pennon (owner of South West Water and Bournemouth Water). Further, many workers own shares in the listed water companies. A third of employees in United Utilities participate in their employee share scheme, as do two thirds of South West Water employees and 70% of Severn Trent’s UK employees.
• If it were to purchase the water companies in England, the government would acquire an asset which at present makes a profit. A wide range of factors would determine the profitability and self-sufficiency of a state-owned water industry. Factors that could affect profitability include:
  • A potential increase in public sector borrowing costs in the event of a government rolling out a programme of nationalisations and higher levels of spending.
  • Water pricing becoming increasingly politicised, leading to a detachment between prices and costs in the industry.
  • Transition costs associated with nationalisation, including the need to establish a new regulatory regime and management incentives.
  • Whether the public sector would match the productivity growth of the private sector, which has seen productivity in the water and sewerage industry increase by 64% since 1994.

Our methodology for estimating the value of the water industry involved:

• Drawing on data from the London Stock Exchange and company annual accounts, we estimated the current enterprise value of the regulated parts of England’s water companies. Enterprise value measures the market capitalisation of the water companies, plus their net debt levels, and is a widely-used gauge of company value. Across all the water companies in England, we estimate an enterprise value of £80bn for the regulated parts of the businesses.
• Factoring in a typical acquisition premium of 20-30% to the equity value for obtaining total control of the regulated businesses gives a “takeover value” of £87bn to £90bn. This is an estimate of the costs faced by a private entity in acquiring these assets at present. It excludes transaction costs such as legal fees which would need to be factored in on top of this.
• Our bottom-up estimate is of a similar order of magnitude to the “RCV times 1.3” rule, which is used widely in the sector. Based on Ofwat’s latest regulatory capital value (RCV) data, the value of the regulated part of England’s water companies is £64bn. RCV is often seen as a proxy for the intrinsic “value” of the water industry, and thus a proxy for the value that would need to be paid by a private entity wishing to acquire the water companies. However, we note that RCV is an imperfect measure of company value. Recent transactions in the industry have seen water industry assets traded for more than the RCV, and a “rule of thumb” of “RCV times 1.3” is widely used to place a takeover value on the water companies.  Applying this rule of thumb across all water companies in England would suggest a takeover value of £83bn associated with acquiring the regulated assets of England’s water companies.

This report was commissioned by Anglian Water, Severn Trent, South West Water and United Utilities, and was produced independently by the Social Market Foundation, which retains full editorial independence, using publicly available information and sources. Any views expressed in the report do not necessarily reflect those of the commissioning bodies.