Crapping on Capitalism: The Sorry Tale of Thames Water and What It Means for Our System

Have we taken capitalism too far? Recent tales of Thames Water and a few other companies suggest we have.

I’ve been an ardent capitalist since before I really understood what the term meant. I grew up during the Reagan administration and the final chapter of the cold war where capitalism (us) finally prevailed over communism (them). And I still believe that capitalism is the best and really the only viable economic system.

But it is open to abuse, and I’m worried, because it seems that extremes in behaviour are getting more common. Let’s take Thames Water as an example.

For my friends outside the UK, Thames Water is the monopoly water provider serving much of southeast England. It was privatised in 1989 and is today overseen by government regulator Ofwat.

The company, along with many of the other UK water companies, has been dumping huge amounts of raw, unprocessed sewage into the UK’s waterways for years. The cause? Mostly it’s down to chronic underinvestment in its own infrastructure.

At the same time, the company has taken on tremendous amounts of debt. So much debt, in fact, that the UK government grew concerned over the summer that rapidly increasing costs of borrowing thanks to rising interest rates might cause the company to collapse. According to reports from the Guardian and Bloomberg, total debts are now about ￡14.7 billion, and the company’s gearing (its debt to capital ratio) stands at about 80%, against an Ofwat guide of 60%.

Meanwhile, even as it’s racked up that huge debt pile, it’s paid out ￡7.2 billion to its owners.

Now, there’s an argument about whether these payments were technically dividends. The reason is that Thames Water’s ownership structure is so confusing and complicated that the FT labelled it ‘murky,’ and the paper’s Lex columnist recently urged “radical simplification.” But most people, including the FT, call these payments dividends. The company says they aren’t.

I don’t really care, because whatever you call them, they are the heart of the matter.

Company management has — repeatedly and for more than 30 years — decided to pay out capital to its shareholders rather than investing in the infrastructure that the company requires to perform its function. In other words, due to conscious under investment by management, the company is fundamentally failing in its most central reason for existence.

How do we know?

Because they’ve had to dump huge amounts of raw sewage into the UK’s rivers and streams. That’s an operational failure of the highest order. The only thing worse would be failing to provide clean water to paying customers. (I wanted to drop a snarky sentence in here about how outages were also on the rise, but this is really difficult to establish without combing through Ofwat records. Certainly, the number of press reports of outages has increased, but that may simply be down to the company and the sector being under more scrutiny.)

Still, Management failed — repeatedly and for more than 30 years — to make the right decisions for the health of the business.

Ofwat also failed —?repeatedly and for more than 30 years —?to ensure that the company’s finances made sense and were providing for the long-term health of the infrastructure for which Thames Water is responsible.

And all of this has me worried about capitalism. Let’s look at some of the problems here:

First, there’s the trend towards private ownership. Thames Water is owned by a messy mix of private investors. But let’s remember that Thames Water is a utility. They’re meant to do two jobs very well —?providing water to customers and processing waste water back into the water cycle. Infrastructure investments are meant to be boring. They should return consistent income via modest dividends to shareholders with a relatively small but consistent level of growth. But private investors generally prioritise short term cash returns over long term value returns. Would being publicly traded have helped? Maybe. The public markets would have ensured a level of scrutiny from a wide array of banks and analysts. There would also be disclosure requirements that would make the company’s activities more transparent.

Which brings us to the second problem: Weak and failing regulation. Ofwat does compel a large measure of financial and other disclosure, but they’ve obviously dropped the ball on Thames Water and, indeed, pretty much the whole sector. I’m not a big fan of hyperactive government regulation of private businesses, but for a public utility operating in a government ensured monopoly, active oversight with real accountability are essential. The relationship between regulator and company should be adversarial, especially when the company is privately held, because the regulator is literally the only means of ensuring transparency and preventing mismanagement.

The third problem is cultural: Boring isn’t cool. But companies like Thames Water should be boring, but running a boring company is a huge challenge for management. How do you motivate people? How do you create a culture that’s hungry to serve customers above their expectations in a business that isn’t dynamic? I don’t know, but we need to figure out how to appreciate and reward boring success more than we do at present. A lot thinking was done on this topic following the 2008 financial crisis, as we all saw how banks had given up boring in pursuit of greater economic dynamism, and thereby created a huge risk. The exact same thing has happened with Thames Water.

Finally, there’s the dividend problem. In shareholder capitalism, the shareholders are meant to benefit from company success. That’s usually measured in profits. (There’s a much bigger argument about how much profit a business should make, especially a regulated one, but we’ll save that for another time.) In this case, Thames Water wasn’t really distributing its profits. They were leveraging the company — not to mention their service and the health of their customers — to pay their shareholders.

That’s a basic violation of central bargain at the heart of the capitalist system.

Now, they can call it something else. I’m sure their finance folk will point to their enviable track record of profit performance. But common-sense exposes that as utter bunk.

Finance folk will also argue that all of this is down to interest rates. That borrowing ‘free’ money at historically low rates was a good way to finance the company. And I can see what that made sense at the time, although any idiot could see that interest rates would have to rise at some point in the future.

As a result of all this, the Guardian reported this week that 28% of the average Thames Water customer bill goes to debt service.

And a couple of weeks ago, under public and political pressure, the company recently proposed an investment plan, in which it says it will spend ￡18.7 billion on upgrading its crappy network and pipes in order to tackle pollution and improve service, but the plan includes 40% in rate increases between now and 2030. Ofwat is now reviewing the plan, which requires their approval.

In the meantime, their owners have provided a cash injection to help keep the company afloat. Although some reports have suggested that the cash comes with strings and may, in effect, be just another loan. The company denies this, but it's now under a formal investigation for dividends it paid out just a few weeks in October.

Bottom line, the lesson I take from the Thames Water situation is this: For people like me, who think that capitalism is the best system, we need to work harder to protect it. We also need to remind ourselves of some of the system’s key principles and force companies to be a little more literal and a little less clever about the financial games we tolerate from them.

One final note: This is a personal reflection, but it’s important to mention that, to my knowledge, I have never worked for or advised any water company in the UK or anywhere else in the world.

So, I end with a question: What else do you think we need to do to protect capitalism from its own worst instincts?