Citigroup, RBS steal CSFB’s thunder as Southern Water securitisation pulled

UK utility Scottish Power astonished the City last Friday (March 8) by announcing that it would sell its subsidiary Southern Water to First Aqua, a special purpose company backed by Citigroup/SSSB and Royal Bank of Scotland.

  • 15 Mar 2002
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The vehicle will pay £2.05bn for the company, or nearly 98% of Southern Water's regulatory asset value of £2.1bn.

The sale pulled the rug from under Credit Suisse First Boston, which had spent the last six months structuring a £1.9bn securitisation of Southern Water and was on the verge of launching the deal.

Scottish Power originally tried to sell Southern Water early in 2001, but various bids fell through and last July the company instructed CSFB to embark on a securitisation that would extract value from the water company while keeping it within the group. The deadline set was the end of March.

Now, in the absence of a normal industry buyer, a financially led consortium has taken the initiative and given Scottish Power the result it really wanted - a clean sale.

The development is a dramatic new turn in the restructuring of the UK's privatised water sector. For several months it looked like there would be an orderly progression of recapitalisations, all modelled after last year's ground-breaking Glas Cymru deal.

First Southern Water, then Anglian Water, and later perhaps South West Water and Yorkshire Water, would use the structured finance techniques of ringfencing, taking security and tranching to increase the leverage on what are essentially simple, highly predictable infrastructure monopolies.

Scottish Power's about-face injects a new sense of urgency and competitiveness to the process.

Not only are these restructurings going on, employing sophisticated financial engineering in situations of unprecedented public visibility - but the technique is well enough developed that there can be rival bidders for the same business, just as there are in conventional M&A.

For the securitisation market, Citigroup and RBS's coup is as audacious as Citigroup's capture of the £1.5bn Punch Taverns mandate from Morgan Stanley two years ago.

Lee Rochford, CSFB's co-head of European securitisation, gave a positive interpretation: "The nature of the engagement was always transparent," he said. "CSFB recommended a dual track programme to Scottish Power, which allowed it to explore both securitisation and disposal options at once. It was always clear that disposal, at the right price, was the preferred route."

Market sources believe CSFB will keep the lion's share of its fees, but the Southern Water deal was to have been the lynchpin of its campaign to be one of Europe's dominant securitisation houses in 2002, as it was last year.

Observers expressed sympathy for CSFB, as it had lost the deal through no fault of its own. Scottish Power pursued two projects simultaneously, one in public and one privately, and plumped for the sale at the last minute.

Ironically, RBS was backing both transactions. A team led by head of securitisation Philip Basil was one of the prime movers of the First Aqua plan, along with the securitisation team at Citigroup and others.

In January, RBS also came in as joint bookrunner on the securitisation that CSFB had structured - though here, its role was simply to help sell the bonds.

"RBS is a large institution which has relationships with many people," said Basil. "It is not unheard of for different teams in a bank to be working on different aspects of the same situation, and we employed very strict Chinese walls between them."

Neither Citigroup nor RBS would reveal much about First Aqua. But it is clear that RBS will only provide senior debt (a loan of £1.7bn). The equity will come from other "institutional and private investors", according to a statement.

Citigroup, First Aqua's adviser, is believed to have played a leading role in sourcing the equity. A spokesperson for the bank said Citibank owned a 1% share of the equity.

The securitisation planned by CSFB would have ringfenced Southern Water's £109.1m of existing debt with £1.8bn of new borrowings, raising gearing to around 90% of the utility's regulatory asset value (RAV) of £2.1bn.

Instead, the utility will be sold for £2.05bn - almost 98% of RAV. The deal should go through in April, depending on EU and shareholder approval.

Assumed in the sale price are Southern Water's existing debt and a £40m expenses charge for the group's banks and advisers.

Vivendi Environnement, the French concern which last year is believed to have bid for Southern Water with UK utility Centrica, has entered into a £374m put and call agreement to acquire preference shares in First Aqua in three years' time.

Should Vivendi choose to exercise the option, it has stated that the acquisition would depend on long term non-recourse financing.

The exact nature and strength of Vivendi's interest is unclear, as is the financial structure of First Aqua, but it seems very likely that the two banks would not have embarked on the venture unless they were comfortable holding the risk themselves for some time.

To make the investment attractive, the banks are expected to launch a securitisation of First Aqua later this year. Sources speculate that the deal might be completed at the same time as the acquisition in April.

While the sudden timing of Scottish Power's decision to sell may have caught investors and analysts unawares, the choice itself is hardly surprising.

As early as January 2001 Scottish Power had hired CSFB to explore ways of releasing capital from the water arm to pursue wider strategic aims in the energy sector.

The sale will allow Scottish Power to monetise the equity interest in Southern Water, which it would still have held under the restructuring plan. Cash from the sale will also repay a £734.5m inter-company loan from Scottish Power to Southern Water.

At close to 100% of RAV, the sale price appears to be a fair indication of Southern Water's value.

"The securitisation option ensured that the full value inherent in the business could be unlocked," said Rochford.

Nonetheless, Scottish Power expects to book a loss on sale of around £450m based on Southern Water's net assets. It bought the utility for £1.83bn in 1996 at a 40% premium to RAV.

Although the sale fits Scottish Power's overall strategy to exit the water sector and was expected as far back as January last year, the proposed sale has not pleased some of Scottish Power's investors. The company's share price fell by 12% on March 8, when news of the proposed sale broke and the company announced simultaneously a lowered target dividend cover.

It is unclear how much value Scottish Power would have been able to extract from its equity interest in the ringfenced Southern Water had the restructuring gone ahead. That sum would have depended on both the performance of the company and debt service triggers in the structure.

Still, some equity analysts have seen the outright sale as negative.

Merrill Lynch, which reiterated its "reduce/sell" evaluation on the stock, noted that the disposal would dilute dividend per share cover in 2002 and 2003 and subsequent years by at least 5p per share, and that earnings per share visibility in those years would deteriorate.

For the new equity investors, however, the asset holds the promise of stable, long term cashflows, potentially at a higher leverage than almost any other sector.

  • 15 Mar 2002

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