UK: BRITISH WATER MAKES WAVES OVERSEAS.

UK: BRITISH WATER MAKES WAVES OVERSEAS. - It used to be a parochial industry, but now British water thinks globally - and is taking risks. Its initiative is not just driven by business nous but by a wish to escape the regulators.

by Peter Wilsher.
Last Updated: 31 Aug 2010

It used to be a parochial industry, but now British water thinks globally - and is taking risks. Its initiative is not just driven by business nous but by a wish to escape the regulators.

Men (and a few women) from the once wholly-parochial British water industry are fanning out across the world. The great bulk of its 55,000 employees are of course still engaged in such routine matters as mending leaks at Matlock, treating sewage in Slough and enforcing sprinkler bans in Leamington Spa, and these familiar, everyday activities will naturally continue for the forseeable future to dominate the work rosters (and the profit and loss accounts) of the 10 great regional supply companies which were privatised just three short years ago. But increasingly managements are seeking to deploy such skills on a much broader canvas.

Chester-based North West Water, which has always been one of the most aggressive, can already claim to be operating in all five continents. And several others - Thames, Severn Trent, and Anglian for starters - are not far behind. This can be partly explained by the fact that they are rather good at their jobs. Water, in most countries - even in highly-advanced economies like the US and West Germany - remains a surprisingly fragmented business. The typical organisational unit is still, in most cases, the individual municipality, and Britain, which abandoned this approach many decades ago, is almost uniquely experienced in operating on a more substantial scale. This, as it turns out, has provided it with a set of highly exportable skills.

More controversially, though, the industry has been tempted - or perhaps driven would be a more accurate word - to look abroad (and, more broadly, beyond the limits of its traditional core responsibilities) by the rules of its own regulatory game. At home, every aspect of water supply and water treatment is subject to the stringent rules on quality, pricing policy and return on capital imposed by the Office of Water Services (OFWAT), the National Rivers Authority or the environmental authorities of the European Community. But doing the same sort of thing abroad (or, more debatably, moving into such tenuously related areas as hotels, insurance, closed-circuit television or garbage disposal, as various water companies have occasionally tried) provides one obvious way to evade the regulators' inhibitory grip.

That is why there are currently so many London, Birmingham and Manchester accents to be heard around the globe, discussing the best way to dig drains in Anatolia, decontaminate foul water in Perak or detect illegal connections in Mexico City (where the number of non-paying customers is believed to be over 500,000).

Such challenges delight the heart of executives like Allan Michaelson, North West's director of international operations. He has always seen one of privatisation's big pluses as the opportunity it offered to show off Britain's water expertise on a wider stage. 'Technically', he says, 'there's not much difference in the water-supply problems faced by Mexico City and Greater Manchester. It's just that we learned to solve ours a long time ago.' Pursuit of the resulting opportunities, though, may not always bring unmitigated joy to the shareholders or to the industry's often sceptical City observers. In a piece of extended analysis last autumn, Donna Lury, who works for Nikko Securities, calculated that, in the period from privatisation to end-March 1992, the 10 major companies had invested £550 million in their 'new' (meaning unregulated) activities, but were at that point seeing an annual return of a meagre £17.6 million. Since then, there has been a further avalanche of acquisitions and important contracts, and a couple of substantial rights issues, by Thames and North West, explicitly earmarked to fund their fast expanding 'non-core' activities. But there was little indication in the recent batch of preliminary results that the overall contribution from this source has significantly improved, and although Lury has not yet had the chance to dissect the full 1992-3 figures, she does not expect much change in her earlier conclusion: that in watery circles, the case for diversification is a long way from being proved.

Needless to say, the companies themselves contest this strongly. They dismiss most of the criticism as typical City short-termism, pointing out that most of these out-of-area initiatives are specifically designed to start producing big profits only in the mid-1990s. It is certainly no coincidence that the first major regulatory review of their mainstream operations, which is expected to put a severe crimp in their ability to go on raising domestic prices, earnings and the dividends they generate, takes place in 1994-5. It is only after that, it is argued, that the more exotic enterprises will be required to start making a serious contribution to revenues and, until then, everything should be concentrated on getting the foundations firmly into place.

For Thames, one of the industry's more aggressive empire-builders, that has involved development of an essentially three-part strategy, concentrated on exploiting its expertise in the provision of water and waste-water-related services. First, it offers itself as a designer, builder and supervisor of the necessary engineering installations, then it sets out to provide a full range of state-of-the-art equipment, both to operators like itself and to those customers, such as the food-processing industry, which requires particularly high-quality water-handling equipment. And finally, it has established a small group of specialists in the area somewhat grandiosely known as 'environmental services'. (This mostly means repairing and relining pipes, but also embraces an expanding demand for subterranean electronic mapping. Hard as it may be to believe, there are an astonishing number of water suppliers who have lost track of, or never bothered to record, precisely where their mains and sewer systems actually run).

Thames's key decision - to stick to the water business, which it reckoned it knew inside out, and keep well away from seductive alternatives such as the solid waste business which has attracted several of its opposite numbers - was made early enough to be included in the 1990 flotation prospectus, and has so far been rigidly adhered to. According to the company's finance director, David Luffrum, the non-regulated side is now contributing £300 million a year in annual turnover, all of which is financed, without burdening the parent, via funds raised in whatever local market may be appropriate to the work being done. He agrees that, at £2 million a year, the effort so far has not proved 'wildly profitable' but is satisfied it is well on track to provide 'a significant revenue stream', as planned, in the crucial years beyond the 1995 review.

The build-up started - pre-privatisation - with the 1989 acquisition of Portals Water Treatment (now known as PWT Worldwide) from the well-known manufacturer of bank notes and other security paper, for which high-purity water has always been a vital ingredient.

PWT, which cost Thames £30 million, embraced not only first-class design and construction teams, but also a number of highly-regarded branded products like the Permutit line of water-softening equipment. With the help of an £80-million convertible bond, specially raised for the purpose, each of these arms has since been strengthened through a string of further purchases. The most recent of these - Utag, in East Germany, for £33 million, and Leopold, in the US's Mid-West for £26 million - provide what could be vitally important toeholds in the vast markets of North America and Central Europe. At the same time, earlier this year, buying the water division of Simon Engineering (for £14 million) and entering into a £10-million joint venture with Northumbrian to pick up the Dorset-based pipe-lining specialist, Sub-Terra, enabled them to 'complete the environmental jigsaw'. As Luffrum says, 'We can now confidently look on ourselves as a full-service supplier for the world's water needs'.

This is far from an idle boast. With its huge £2,560 million London Ring Main Project now nearing completion, on budget and 21 months ahead of schedule, Thames can fairly claim membership of the world's civil-engineering elite. And its expanding reputation is already putting it on the short list for some of the most challenging contracts around. Its biggest success so far (though the negotiations are exceedingly complex and are unlikely to be definitively finalised before the end of the year) is the $700-million commission, secured in principle this spring, to resuscitate the water and sewerage system serving the city of Izmit, south-east of Istanbul. With two local construction companies as working partners, pipes and extra equity supplied by Mitsui and Sumitomo, and finance managed through Chase Investment and provided by sources ranging from Britain's Export Credit Guarantee Department to a consortium of Japanese banks, this revolves round the completion of the giant Yuvacik dam. This has been stalled since the mid-1980s, when the Turkish government ran out of foreign currency and since then has remained as an enormous developmental question-mark against the country's economic future. If Thames can now successfully run the risk/reward gauntlet and get the project working without bankrupting itself, it will have unquestionably established its credentials as a top international trouble-shooter. But the whole deal looks like a textbook example of what gives corporate officials sleepless nights.

This is not a straightforward build-and-walk-away arrangement. It is what the trade calls a BOT contract - build, operate and transfer. Under its proposed terms, Thames and its associates will make themselves responsible for finishing the dam, and then furnishing Izmit with a major water-treatment plant plus two pumping stations and 100 kilometres of trunk mains to link it all up to the perpetually thirsty citizens of distant Istanbul. That will take an estimated three years, after which Thames will run and manage the whole supply system for a further 15 years. Only then will it hand over the undertaking to a Turkish public utility, pocket its last cheque and know for certain how well or otherwise it has done out of the deal.

Luffrum, the man whose beauty sleep is probably most at risk, knows the list of potential hazards by heart. There is currency risk - notably the problems that could easily arise when revenues come in as often-fragile Turkish lira, while the debts (which represent 85% of the funding) have to be paid off in something much more internationally acceptable. There is resource risk, exemplified by the fact that the whole contract could turn on Izmit's willingness to buy 140 million cubic metres of water a year at a pre-arranged price, whether it uses it or not. There is also force majeure risk, which could arise if some natural or political catastrophe blocked final settlement. And there is always the little matter of what Istanbul will agree to pay for its water, once its city fathers realise how vital their assent is to ultimate success.

Luffrum robustly dismisses such fears. The whole art of the BOT formula, he says, lies in knowing how to hedge your bets, skirt the hazards and make sure that you get paid adequately for your efforts as you go along. If you can get it right, you give yourself a highly effective edge - especially against the globe-spanning civil-engineering giants, like Bechtel, who can build things with awe-inspiring efficiency but flatly refuse to take responsibility for continued operation. He had better be right: a lot of British water's future is starting to revolve round its ability to handle a portfolio of similar long-term commitments.

Anglian has taken the plunge, with a 5% stake, alongside the ubiquitous French contractors Lyonnaise des Eaux, in the £2.6-billion, 30-year refurbishment of Buenos Aires's antiquated water-supply system. Severn Trent is another, with a quarter share in the £600-million restructuring job that is now under way in Mexico City. Most committed of all is North West, which first dabbled in the intricacies of BOT and Third World water-privatisation back in 1988 - long before it joined the private sector - and this year alone has signed up for a formidable list of jobs, priced collectively at more than £1.7 billion.

The work schedule on Michaelson's desk includes Malaysia (43 towns where more than half the inhabitants have never previously enjoyed the privilege of decent drains), Bangkok (on behalf of 700,000 citizens whose sewage now goes straight into the city's canals), Melbourne (where, with its local partner, Tranfield, it edged out 12 other international rivals) and Macau, the former Portuguese city on the southern tip of China. But potentially the most exciting remains Mexico City. North-West's share of that action (alongside Anglian, Severn Trent and both the big French contenders, Lyonnaise and Compagnie Generale des Eaux) covers the prime residential suburbs ('Not precisely Kensington and Chelsea,' says Michaelson, 'but also not the Gorbals').

The distinction may turn out to be quite important, at least in the context of sleepless nights. Mexico is notorious for the number of its citizens who tap surreptitiously into the water system, but have never yet deigned to receive - let alone pay - a bill. A significant part of the remit, for all participants, will be to devise effective ways, first of tracking them down and then persuading them to contribute (which could easily result in riots). With 5,000 of its people now working abroad, and 50 on its permanent international-planning strength, North-West is very happy to keep the lowest possible profile when it comes to accepting any risk of broken heads.

They are very happy, though, to help contribute intellectual solutions. 'Mexico is skipping a whole generation of water technology,' says Jim Southworth, North West's operations manager. In two years, as he admiringly reports, the city will have computerised maps of its whole hitherto mysterious mains layout, electronic facilities for both issuing bills and tracking down leaks and unregistered consumers (using ultrasonics), and meters, read remotely from strategically-placed radio vans, which will probably be the most advanced in the world.

All that path-breaking activity is made possible, of course, only by imaginative use of computers and software, and that too is turning out to be one of UK water's big competitive strengths. Severn Trent is the company which has hitched its fortune most enthusiastically to that particular mast. All its rivals have acquired a good deal of advanced capability in this area, but mostly as an adjunct to other things. The company has gone a significant step further and set up Severn Trent Systems as a fully-fledged international consultancy service.

The original recognition, by Severn Trent's chief executive, Roderick Paul, was that, like his own, every utility in the world was a voracious consumer of information about its customers and their ever-changing needs, about regulatory and environmental requirements, about billing, material and labour costs and how to reduce them and, above all, about the best way to manage human and other resources under intense competitive pressure. But once one of them had completed the analysis and written the programmes needed to make usable sense of the data, the needs of the others were likely to be sufficiently similar to provide the basis for a business opportunity.

Eighteen months ago, it was decided to part company with IBM, which had managed Severn Trent's hardware and software needs, and strike out alone. The market assessment is that any organisation with a substantial workforce needs much the same kind of information services as Severn Trent has developed for itself - especially if it combines a large volume of small routine jobs with a small volume of large and complicated capital projects - the typical water industry mix. Research indicates a demand running to £150 - £200 million a year for such services in the UK alone, and many times that on the international canvas. Now, by buying one of the leading independent US operators in the field, the Houston-based Computer Systems and Applications (CSA) group, and recruiting a high-profile executive team, under the direction of CSA's Jim Oliver, to refine and market the resulting range of expert systems and solutions, Severn Trent hopes to win itself a major slice of the business.

It is early days yet to judge the soundness or long-term profitability of the move. But in the race to escape the clammy embrace of the regulators, it is probably less hard on the nerves than chasing Mexico's water-rate bilkers or digging up the sewers of old Macau.

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