The falling cost of financing U.K. water assets may boost merger activity in the industry even amid a regulatory price review, according to Goldman Sachs Group Inc.
“The M&A interest in the U.K. water sector reflects the low cost of finance for regulated assets despite a regulatory tariff reset next year” by Ofwat, Goldman Sachs analysts Andrew Mead and Fred Barasi wrote in a May 17 note to clients, citing declines in yields of U.K. government bonds this year that are index-linked.
Part of the attraction in U.K. utilities stems from a decline in real interest rates, with index-linked gilt yields from the U.K. government bonds now in negative levels, Goldman Sachs wrote, adding that real interest rates are expected to be negative for 10 years.
The Goldman note came after Severn Trent Plc, the U.K.’s second-largest publicly traded water utility, rejected a possible takeover approach last week from Kuwait Investment Office, Borealis Infrastructure Management Inc. and Britain’s Universities Superannuation Scheme, saying it undervalued the company.
Severn Trent shares have risen 12 percent in the past week compared with 5.3 percent by the U.K.’s biggest publicly traded water company, United Utilities Group Plc, and 7.5 percent by Pennon Group Plc, the U.K.’s third-largest water utility.
The Severn approach occurred at a time when Ofwat is consulting on prices that water and sewerage companies must deliver for the years 2015 to 2020, with final prices to be published next year.