The Labour Party has long argued that some utility companies should be renationalised and a prime target would be water companies if they got into power. If they were nationalised would current shareholders expect to get compensation and if so at what level? An article in the Financial Times over the weekend covered this issue and anyone holding the shares in water companies should be aware of the implications.
Shadow Chancellor John McDonnell said recently that he expected a compensation bill of only £14.8 billion based on paying the “book value” of the companies. That’s on the basis that shareholders should not be compensated for future profits, only what they have put into the business historically.
The two largest listed water companies are United Utilities (UU.) and Severn Trent (SVT). The comparison of the current market capitalisation of those companies with the book value (i.e. shareholders equity) shown on the last Annual Report Balance Sheet shows the following:
United Utilities: Book value: £2.95 billion, Market Cap: £5.56 billion.
Severn Trent: Book value: £0.99 billion, Market Cap: £4.76 billion.
In other words, shareholders might expect to receive only 21% of the current market share price in the case of Severn Trent and 53% in the case of United Utilities. The book value is not a basis for the valuation of companies because shareholders value companies on the basis of future profits, cash flows and dividends. The book value is, for most companies, of more interest to accountants than investors.
It would appear that the Labour Party would ignore the normal principles of independent valuation of companies and rig the valuation process to obtain the lowest possible figure. Is this legal one might ask or could it be challenged in law?
It’s worth pointing out that this is exactly what happened the last time the Labour Party was in power when Northern Rock and Bradford & Bingley were nationalised. In those cases shareholders received nothing because the valuation was based on artificial terms of reference. The valuer was forced to assume that they were worthless based on the companies having received financial support from the Government.
A fair valuation of any company is what a willing buyer is willing to pay a willing seller. In the case of listed companies, that is clearly what the market price of the shares is based upon. The shareholders in Northern Rock challenged the artificial assumption in the UK courts but lost in the Supreme Court based on the presumption that Parliament had the right to set the valuation assumptions. The European Court of Human Rights (ECHR) refused to hear the case.
So shareholders in the UK listed water companies need to consider these facts very carefully. The risk of future water company nationalisation seems not to have been reflected in the share prices of water companies even though Mrs May’s leadership of the Conservatives has improved the electoral chances of the Labour Party while Corbyn compounds the difficulties of the former by frustrating a decision on the Brexit Withdrawal Agreement with the apparent objective of prompting a General Election. How the politics will work out is anybody’s guess but those investors who have purchased shares in these companies because of their high dividend yields should surely not ignore the capital risk.
Institutional investors are some of those most exposed because you only have to look at the portfolios of high-income funds to see they are stacked up with the shares of such companies. Pension funds held by millions of people would be some of those most affected.
Let us hope that this threat never comes to pass.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
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