Elliott Management, a US hedge fund, has bought the bonds of the troubled British utility Thames Water in an attempt to bet the markets are too pessimistic about the losses investors might have to bear.
Elliott has built up a position on the bonds of the heavily indebted water firm at a discounted price to the face value, according to people familiar with the trade.
Thames Water, which provides water to 16 million people in London and its surrounding areas or a quarter of England and Wales’ population, has seen its bond prices plummet after its parent company defaulted earlier this month.
Elliott’s bet focuses on the highest-ranking bonds from more than £16bn in debt, which is contained within a regulatory ringfence. This encircles the utility core and requires it to adhere to regulatory conditions. Investors are more concerned about potential deep impairments, so some of these bonds trade at a little over 70 pence per pound.
A person familiar with the situation said that these levels were below Elliott’s worst-case expectations. The hedge fund firm also believes that the debt can potentially survive the current crisis at Thames Water. The two people who spoke to us said that Elliott had a relatively small position and was still evaluating if it should be increased to a larger holding.
Elliott has declined to make any comments.
Last week, the government released contingency plans to deal with a possible nationalisation of Thames Water. The water company has been at the center of public outrage over sewage contamination and mistrust in England’s privatised system.
The £15bn in top-ranking bonds would be subject to losses of between 5-10% if the utility was forced to return under public control. The £1.3bn in so-called Class B debt that is still within the ringfence, but has a claim of lower rank on the company’s financial flows, could face impairments even greater than 35-40%.
Elliott is known for its activist equity investments in the UK. These include pushing for changes at pharmaceuticals company GSK, and, more recently, at Scottish Mortgage Investment Trust.
Elliott is one of many distressed debt investors who have bought bonds from Thames Water in the belief they will be sold for less than their value by nervous fund managers. The hedge fund, however, has avoided bonds issued by Thames Water’s holding firm Kemble which are outside of the regulatory ringfence, and trade for less than 15p.
Elliott is well-known for its aggressive tactics when dealing with creditors. For example, it seized an Argentinean naval vessel after a long dispute with the Latin American country. However, British legislation limits the ability of bondholders in the Thames Water company to seize assets if Thames Water cannot service its debts.
In the event of insolvency, the debt secured by the securitisation will be secured against the proceeds from a sale of the property to an appropriate owner. Last month, the current shareholders, including the sovereign wealth funds from China and Abu Dhabi declared Thames Water to be “uninvestable”. They also retracted plans to inject another £500mn in the business.
The owners of the water company, including pension funds Omers of Canada, the British USS Universities scheme and other investors, are at odds with the regulator Ofwat about the amount of equity required to support it. The water company needs billions of pounds in order to upgrade its aging infrastructure.
Thames Water updated its business plans on Monday, increasing the amount of money it intends to spend on their network to combat environmental concerns such as sewage leaks from £1.1bn up to £19.8bn.