Southern Water sewage dumps show scale of clean-up job for Australian owner

The foul brown seawater that prevented people from swimming at stretches of popular English beaches on some of the hottest days on record this summer was the result of a sharp increase in outages at Southern Water’s sewage pumping stations – and a sign of it extent of the task ahead its owner, Macquarie.

A year after the Australian wealth manager took over the regional water monopoly in a £1bn emergency refinancing, Southern is facing a spate of maintenance troubles.

More than half of the pollution incidents across its network – which include the popular tourist destinations of Herne Bay, Whitstable and Brighton – have been due to a rise in pumping station outages, while aging infrastructure means outages are occurring with increasing “frequency and severity”. the network, according to company filings viewed by the Financial Times.

Southern also sparked anger from some of its 4.2 million customers across Kent, Sussex and Hampshire when it became the first water company to impose a hose line ban in August. Most mains are over 100 years old, causing a fifth of treated water to be lost through leaks.

Southern wasn’t the only provider to pollute beaches and impose tube bans this summer; There has been a national outcry against the water and waste management companies that were privatized with a £1.6 billion government donation more than 30 years ago to improve their networks.

But Southern is one of the most financially stretched, making upgrades harder.

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The £1bn equity that Macquarie injected into the deal in September 2021 averted Southern’s collapse after its previous owners, a JPMorgan-led consortium, warned the company could default on loans .

Of that, just £230million has been used to improve Southern’s operations, according to a consultation by regulator Ofwat on the transfer of ownership, which was completed last week. The remainder was used to reduce loans between the complex holding companies used by its previous owners, who retain a 38 percent stake.

Separate company filings provided to the FT warn that Southern’s “risk profile has deteriorated over the year” and that the “company remains at risk of a credit rating downgrade due to poor operating performance.”

The company’s net debt has risen from £5 billion to £6 billion over the past year, which Macquarie says is more a result of rising inflation than new borrowing. Already at least a fifth of the typical household bill of £400 a year goes towards paying interest rather than infrastructure improvements and services.

The number of pollution alerts this summer from Surfers Against Sewage, which uses real-time information from monitors on key drains to warn swimmers of health risks, suggests sewage dumps are a far more common occurrence than the Environment Agency data suggests.

A stretch of coast where raw sewage was reported to have been discharged near Seaford, Sussex, after heavy rains in August
A stretch of coast where raw sewage was reported to have been discharged near Seaford, Sussex, after heavy rains in August © Dan Kitwood/Getty Images

Martin Bradley, head of Macquarie Asset Management’s European real assets team, emphasized that a turnaround program is “showing early signs of operational improvement”.

This includes a 50 per cent increase in capital investment to £632m in the year to March 2022 to halve the EA defined pollution incidents compared to last year.

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Macquarie is also investing in 30,000 monitors across the network “as part of a long-term transformation that will result in Southern Water becoming more sustainable and resilient,” Bradley said.

But it’s still unclear how Macquarie is managing a decades-long backlog of work at a time when the cost-of-living crisis is making it harder to pay bills and increasing the risk of default, especially as water companies are legally barred from shutting off supplies.

“Interest rates have been exceptionally low over the past decade, and this would have been an ideal time to fund large investment programs,” said Colm Gibson, head of regulatory practice at Berkeley Research Group. “Now, with rising interest rates, it’s getting harder.”

Macquarie is best known for its decades-long stake in England’s largest water and waste group, Thames Water, which it sold in 2017. The company has been criticized for increasing Thames’ debt, taking dividends and paying little corporation tax – all while presiding over leakage and pollution failures. Macquarie has highlighted that £12bn was invested in the network over that period.

Since 2005, the Australian wealth manager has bought more than £50bn worth of infrastructure assets in the UK, many of them former state monopolies, benefiting from a steady stream of government-backed income. These included Cadent Gas, the UK’s largest gas distribution network, a stake in National Grid’s gas transmission business and South East Water.

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Ofwat noted in the Southern acquisition advisory that Thames had “performed poorly on a number of metrics and concerns were raised about the company’s financial management”.

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There are now fears that this will be repeated at Southern.

In July, Macquarie appointed two former Thames executives to Southern – Lawrence Gosden as chief executive and Bob Collington as chief operating officer. Southern’s new majority shareholder is based in tax-friendly Luxembourg.

Macquarie has also signaled a possible return to dividends as early as next year if Southern’s “performance is on an improving path.”

The Australian asset manager said the capital it is providing would “enable Southern Water to invest significantly to address its $2bn network of underperformance and damage to the local environment”.

It has also pledged to simplify Southern’s corporate structure, including the replacement of Cayman Islands-registered financing companies, which it says is set to take place next week.

Ofwat remains optimistic that Southern’s situation will improve. The regulator said it has made it clear that “very profound changes are needed and are overdue to improve and strengthen Southern’s performance” given its role as a provider of an essential public service.

But Kate Bayliss, an infrastructure finance expert at SOAS University of London, said history to date “suggests that investor returns will always be Macquarie’s priority, rather than the long-term social and environmental well-being of water utilities.”

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