In a parallel political universe, Ofwat’s pricing framework for the English and Welsh water companies for the next five years would have been redundant before it was announced on Monday. Incoming Labour ministers would instead be inspecting their soon-to-be nationalised assets.
None of that will now happen, so the key issue in a still-privatised world is different. Will any of the companies that have bleated behind the scenes about a “politicised” regulatory process dare to allege unreasonable harshness on the part of Ofwat? Will any appeal to the Competition and Markets Authority (CMA)?
We’ll have to wait eight weeks – the permitted period for an appeal – to find out, but the likely suspects would be well advised to swallow their medicine.
First, Ofwat’s review is pitched as the “toughest ever”, but so it had to be. Shareholders since privatisation in 1989 have enjoyed a dividend bonanza so this was always going to be a moment to lean in the opposite direction. That’s not evidence of politicisation; it’s just a recognition that regulation has been too lax. Ofwat’s new demands will strike most bill-payers as reasonable: lower returns on capital; a reduction in bills by £50 on average, ignoring inflation, over the next five years; and a 16% cut in leaks.
Second, Ofwat has given some ground between its “draft” and “final” calculations. Companies, in aggregate, will be allowed about £1.5bn of extra expenditure to meet performance targets. The concession is not huge in the context of a £51bn spending programme, but it’s a softening.
Third, the new regime will only look “tough” to the laggards, judged by efficiency. Note how the share price of Severn Trent, one of three companies that got top-of-the-class “fast track” status during Ofwat’s review, is within pennies of its all-time high. Its shareholders see little to frighten them.
Fourth, an appeal to the CMA is not a one-way bet. The competition regulator is allowed to conclude that Ofwat should have been harder. That thought ought to concentrate minds in the boardrooms of the four companies – Anglian, Northumbrian, Thames and Yorkshire – that are thought most likely to appeal. It’s time for them to accept that, in a privatised but regulated system, owners have to take a hit sometimes.
On – then off – the buses
It’s hard to keep up with transport firm FirstGroup’s view of its best strategy. Back in May, the “future emphasis” for the group was going to be First Student and First Transit, its two North American bus contractors, since they had “the greatest potential to generate sustainable value and growth over time”.
Now both operations may be sold. What’s prompted the U-turn? One can point to the arrival of David Martin as chairman in August but, since he seemed to endorse the May vision only last month, the latest development looks to be a lobbying triumph for activist investor Coast Capital, aided these days by fellow investor Robert Tchenguiz. The duo demanded a sale of all US assets, not just the Greyhound coaching business, a few weeks ago; now they may get it.
A UK-only future would be a mighty come-down for FirstGroup, which can currently call itself one of the world’s largest transport companies with 100,000 employees. Indeed, even within the UK, the future of the bus division is unclear, as FirstGroup is exploring what form of “separation” is possible while meeting pension obligations.
If the buses were also to exit along with the US assets, all that would be left would be the UK rail business, from which FirstGroup seemed to be contemplating an orderly retreat only a year ago. Then it won the West Coast Partnership franchise and all is now apparently right with rail.
One can view this strategic soul-searching as an exercise in “rationalisation”, the polite term for a break-up. It’s hard, though, to escape the feeling that there’s a simpler alternative to uncertain deal-making: just run the businesses better.
Going up … ?
Mike Ashley has been banging on about his “elevation” strategy for years and now he has something to show for it: a share price that elevated by 31% in a day. Context is everything, however. The improvement to 472p merely took the shares back to where they stood at the start of 2016, which is roughly when Ashley adopted his other obsession – diversification.
House of Fraser, the main product of that ambition, clearly isn’t getting worse, which was why the shares jumped on Monday. But the eventual returns from the HoF deal remain a mystery. Ashley runs a tighter ship than the old management (no surprise there) but the long-term investment demands in the department store business are anyone’s guess.
