OMERS: Writing off Thames Water was ‘the right fiduciary’ call

OMERS Infrastructure “exercised the right fiduciary duty” in writing off its investment in beleaguered UK utility Thames Water, the Canadian pension fund’s global head of infrastructure tells Infrastructure Investor.

Michael Hill, who was appointed to the role last summer, says the situation “is largely out of our hands at this point” following the write-off revealed in May and the special measures the company was placed in by regulator Ofwat this month. OMERS, which is Thames Water’s largest shareholder at 31.7 percent, had valued the company at about £990 million ($1.3 billion; €1.2 billion) at the end of 2021.

“We’ve taken our people off the board and we’ll have to see how it plays out,” Hill says.

Asked if OMERS had a full picture of how this might play out when it became the company’s largest shareholder in 2017, Hill responds: “Obviously, we’re very disappointed with the outcome. You don’t go into an investment like this expecting this outcome. We’re very disappointed on behalf of customers in London and all of our stakeholders that we represent. Our team gave a tireless effort to try and get us to a better outcome and in the end, I think we made a decision that was based on our fiduciary obligations to not continue to invest.”

Thames Water had its credit rating reduced last week by Moody’s to Ba2 from Baa3, which could breach its operating licence. It has a debt burden of about £18 billion, which stood at circa £11 billion in 2017.

Quizzed on whether OMERS would learn from leverage levels going forward, Hill says: “Once we understand how it all plays out, it’s fair to assume we’ll look very carefully at all the aspects of our experience with Thames Water and think through all the different dynamics, as we do with every investment we make.”

USS, the UK pension fund that owns about 20 percent of Thames Water, said last week the experience with the water company “will influence our future approach” to regulated assets, although Hill doesn’t necessarily draw the same conclusion.

“When we look at any investment, we think about the range of all the risks when we assess the opportunity and the regulatory framework is definitely one [of them],” he maintains. “We’ll continue to be focused in any given investment on what that regulatory overlay is and what the relationship with the regulator is going to look like. It’s one of many risks.”

OMERS and its fellow shareholders had previously stated they would be willing to invest £3.25 billion of additional capital into the company, depending on the regulator accepting the business plan it had provided for the next regulatory period. Ofwat said this month the plan was “inadequate”.

In May, an OMERS spokesperson stated: “On 28 March 2024, the shareholders of Thames Water concluded that the UK regulator, Ofwat, was not prepared to provide the necessary regulatory support for Thames Water to have an investable business plan. Consequently, no shareholders provided further funding to Thames Water and the value of our Thames Water investment has now been written off.”

‘Refocused’ strategy

Thames Water, of course, is a portion of the wider OMERS Infrastructure portfolio, which stood at C$36 billion ($26 billion; €24 billion) at the end of 2023. In February, OMERS’ annual report revealed an unusual dip in the performance of the infrastructure unit, returning a net 5.5 percent, down from 12.7 percent in 2022. It has a 10-year average net performance of 10.7 percent.

The annual report attributed this to “operational underperformance in a few specific assets” in the energy, utilities and transportation sectors. While Hill declined to comment on specific assets beyond this, he indicates that Thames Water certainly played its part.

“We have a portfolio built over many years with foundational and hard-to-replicate infrastructure assets. We have assets that any manager would die to have,” he declares. “The performance over the long term has been very positive. The core of our portfolio continues to perform extremely well and [is] proving to be very resilient in a really choppy market. If you had the ability to look into our performance, factoring Thames Water into the 2023 results, you’d have the answer to your question.”

Going forward, as well as searching for new assets, Hill says OMERS would be “investing heavily in our existing portfolio”, with a focus on energy, digital and transportation assets in Canada, the US, Western Europe, Australia and India. A series of social infrastructure investments in the healthcare sector such as CannAmm, DynaLife and LifeLabs have been sold over the past 12 months, with the LifeLabs realisation coming earlier this month.

“Our strategy is really to refocus on our core markets. I think our view was in order for us to continue to be successful in the way we have been in the past [that] it made sense for us to be very focused,” Hill maintains.

This will include further investments in Canada, where the government has urged its large pension funds to pour more capital locally. Hill says OMERS will “look at opportunities as they come to us” and cites OMERS’ single largest asset in Bruce Power, a 6.5GW nuclear plant in Ontario.

However, with about 60 percent of the OMERS portfolio tilted towards energy investments, Hill is cognisant of the need to maintain that exposure and also diversify. Shortly before Hill’s arrival last year, OMERS invested in DigitalBridge’s Canadian fibre business Beanfield Metroconnect, its fifth digital infrastructure asset.

“One of the things I did when I got here was we took a look at our strategy and the various aspects of what we want to try and accomplish over the next five years. Our focus on subsectors was one of the aspects of that strategy,” Hill says. “Overall, it was driven by what the fund needed us to deliver and what we saw as being the critical features of the industry. Those were the two things that framed how we thought about strategy. We wanted to be very focused on areas we understood well and ones that we knew would be the subject of fairly significant tailwinds.”

Beanfield was one of two new investments last year for OMERS, in addition to Dutch energy infrastructure solutions business Kenter. OMERS is understood to be close to agreeing its first new deal of 2024.

“We’ve looked at and participated in a number of different processes, looked at a number of different assets and just haven’t been able to find the right value. We’ve tried to be very disciplined,” says Hill.

As a direct investor, OMERS holds a unique position in that it also garners third-party capital for such deals. The Strategic Partnership Program, first established as the Global Strategic Investment Alliance in 2013, has now collected C$6.6 billion from 18 investors, deployed into 13 assets. Hill declined to state how much of this third-party capital has been invested in Thames Water, but pledged to continue to grow the platform after it raised a further C$525 million last year.

“The focus this year is on continuing to develop capabilities both in terms of being able to build partner relationships and also service existing partner relationships,” he says.

In another differentiation to other direct investor peers, OMERS is a particularly active divestor of assets, although that was also more muted last year amid a difficult dealmaking environment overall. Hill, however, is keen to renew this focus too, pledging to analyse the portfolio on a consistent basis for potential opportunities.

OMERS currently has 21 percent of its asset mix in infrastructure. While predecessor Annesley Wallace told Infrastructure Investor in 2022 of hopes to reach C$64 billion in infrastructure AUM by 2027, Hill was more circumspect.

“We’re not really focused on AUM as a goal. Our programme is going to continue to grow and attract capital but the emphasis will be on being a smart, sophisticated investor,” he says.