KKR’s dealmakers are no strangers to trying to make money from messy situations.
Even so, a trip to Thames Water’s sprawling Beckton Sewage Treatment works is not the most inviting assignment. Originally built as part of the Victorian sewage system overseen by Sir Joseph Bazalgette, Beckton is now the biggest waste treatment works in Europe, serving more than 4mn Londoners. It has required extensive upgrades to try to curtail human waste flowing into the river Thames during torrential rain.
Executives from the US private equity firm recently took in the sights and smells of Beckton during a whistle-stop tour of Thames Water’s major facilities, as part of the intensive due diligence KKR is undertaking to try to take over the near-insolvent utility and rescue it from the brink of nationalisation as it struggles under nearly £20bn of debt.
KKR’s £4bn proposal made it Thames Water’s preferred bidder to take control of the water company that serves 16mn people across London and the Thames Valley. The US firm, which has $638bn in assets, is in the middle of a 10-week exclusivity period in an equity-raising process for the water company, whose existing shareholders essentially walked away last year. Thames Water is seeking to agree a deal by June.
KKR faces the challenge not only of wringing profit out of Thames Water’s creaking infrastructure but also securing the blessing of regulators and warring factions of hedge funds that hold the utility’s bonds. If this were not hard enough, KKR must do this in an environment where Thames Water has become a lightning rod for widespread public anger at the state of the nation’s waterways.
Even KKR’s due diligence efforts could stoke controversy, given that Thames Water is covering part of the bill for the roughly 100 people the firm has evaluating a deal, according to people familiar with the matter.
While it is not unusual for companies to cover some costs for potential acquirers — which for KKR include employing advisers at investment bank PJT Partners, law firm Kirkland & Ellis and management consultant Roland Berger — Thames Water’s £15mn monthly bill on restructuring advisers has already provoked outcry.
Some campaigners have also highlighted KKR’s buccaneering past, with the early pioneer of leveraged buyouts infamously dubbed the “Barbarians at the Gate” in the late 1980s for its raid on US conglomerate RJR Nabisco.
Charlie Maynard, a Liberal Democrat MP who spearheaded a public-interest court challenge to Thames Water taking on more high-interest debt, said that allowing the utility to remain heavily indebted under new private equity ownership was “like watching a rerun of a horror movie”.
“This is what got Thames Water into trouble in the first place,” he added.
Thames Water responded that the bid was a “holistic and fundamental recapitalisation”.
People close to KKR have emphasised that its infrastructure division targets lower annual returns — about 10 per cent to 15 per cent — than its higher-octane private equity funds, while holding on to assets for longer periods of time than traditional funds would be comfortable with.
This $86bn infrastructure division is of growing importance to KKR, as macroeconomic turbulence has curtailed dealmaking, making it harder to return cash to investors in its private equity funds.
Infrastructure is a key part of KKR’s recent push into raising money from wealthy individuals, who are lured by the prospect of owning uncorrelated, cash-generative assets. One of the firm’s Luxembourg infrastructure funds targeting individual investors has recorded an annualised return of about 13.5 per cent since its June 2023 launch, recent filings show.
Not all of its recent infrastructure investments have lived up to the plain-sailing pitch, however.
The Luxembourg fund’s second-biggest asset is FiberCop, the fixed-line telecommunications network carved out from Telecom Italia last year in a marquee €22bn deal.
KKR has clashed with FiberCop’s management over a projected €449mn earnings hole, the Financial Times has previously reported, sparking the US firm to take greater control over the politically sensitive business.
FiberCop, which like Thames Water traces its roots to a state-owned enterprise, has previously said the 2025 budget was in line with the original shareholders’ agreement and denied that there was tension among its owners.
One of the architects of the FiberCop deal, KKR partner James Gordon, is also spearheading the Thames Water buyout.
As with several of his senior KKR infrastructure colleagues, Gordon spent much of his early career at Australia’s Macquarie, Thames Water’s former owner that has faced criticism for saddling the utility with more debt before cashing out in a 2017 sale.
None of KKR’s prominent Macquarie alumni were directly involved in the prior Thames Water buyout, according to people familiar with the situation.
Still, the difficult legacy of the Australian group’s ownership is just one reason why any bid for the utility faces heightened scrutiny.
Ofwat, the sector regulator, was frustrated at Thames Water’s decision to grant KKR a period of exclusivity that has frozen out other bidders, according to people familiar with the matter. While the watchdog has no say in how Thames Water manages its equity raise and officials believe KKR is a credible potential owner, they would have preferred continued competition among bidders, the people added. Ofwat declined to comment.
Thames Water said in a statement that “there is no certainty that a binding equity proposal will be forthcoming as it remains subject to diligence, documentation and regulatory and other approvals.
“As a result, certain senior creditors continue to progress in parallel alternative transaction structures to seek to recapitalise the business. Given this, inherent competition remains during the process.”
KKR’s most serious competition was CK Infrastructure, part of Hong Kong’s wider CK Hutchison group that has deep roots in Britain. CKI and KKR are already co-owners of Northumbrian Water, holding majority and minority stakes, respectively.
People close to the talks note that KKR took a more conciliatory approach towards Thames Water’s influential top-ranking creditors. CKI’s bid, in contrast, was conditional on bondholders in Thames Water’s near-£20bn debt stack taking deeper haircuts.
While the precise contours of the restructuring that would accompany KKR’s planned £4bn equity injection are yet to be hashed out, Thames Water’s senior bonds could face writedowns of 25 per cent or more, according to those close to the discussions.
KKR’s preliminary bid included a component offering these bondholders the opportunity to invest in Thames Water’s equity and take as high as a 50 per cent stake, according to a person close to the talks. This could allow US hedge funds such as Elliott Management and Silver Point Capital that hold the debt to become shareholders alongside KKR.
Given the disparate holders of these bonds, which also include large insurers and asset managers, several creditors expect to be offered a “Chinese menu” that allows them to take on different proportions of new debt and equity based on their risk tolerance.
KKR is planning on wiping out Thames Water’s £1bn of lower-ranking class B bondholders, although it will need to demonstrate to London’s courts that writedowns have been applied fairly. The courts only approved last month a £3bn emergency loan from senior bondholders after a protracted legal challenge from junior creditors.
If KKR fails to appease bondholders, creditors could present their own rival bid for the utility. Failing that, Thames Water could still face temporary nationalisation through the government’s special administration regime.
Even with a deal, the hard part of running a beleaguered utility that serves nearly a quarter of the UK population begins.
KKR executives have emphasised that a full turnaround could take anywhere between seven to 12 years, only after which could they potentially cash out through a listing.
The utility has paused its challenge to Ofwat over its most recent determination on the amount by which Thames Water can raise customer bills. However, KKR wants to persuade the regulator to lessen legacy fines, according to people close to the firm.
KKR has proved willing to take on regulators elsewhere. In September, the firm and other investors in a Finnish electricity network took legal action against the Nordic country,after the Finnish Energy Authority tried to curb rising power transmission prices. The dispute is ongoing.
Yet the scale of the challenge at Thames Water remains formidable even for the most hard-nosed investor.
“There are lots of easier deals KKR could do and still meet its [minimum expected return],” said an adviser to some of Thames Water’s creditors. “Equally large and more experienced infra funds have failed after seven years of trying [to turn Thames around].”
