Viridor Limited (PNN) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Pennon Group conference call. My name is Felicia, and I'll be coordinating your call today. [Operator Instructions] I will now hand over to your host today, Chris Loughlin, Chief Executive Officer. Chris, please go ahead.

Okay. Thank you very much and good afternoon, everyone, and thanks very much for joining us at a very short notice. I know it's an extraordinary time at the moment, and I guess many of you will be working from home today. So please, before we forget, can I just say, look after yourself, look after your family, look after your colleagues, and I hope all goes well for you. So the purpose of the call is to, amidst all this uncertainty and market turmoil, hopefully let you finish your day with some, what we believe, is some very good news. So I'll start with a few brief introductory comments. I'm sure you've all had opportunities to see the stock exchange announcement that we just released in the last few minutes. So a few brief introductory comments from me, then hand over to you for Q&A. And obviously, Susan is on the call as well. And Susan and I will try and do the questions between us. So just starting with the background to this announcement. I think you all know, you're all familiar with the fact that back in September 2019, we announced -- the Pennon Board announced that we were undertaking a strategic review of the group. And I guess we can talk about the background in a little bit more detail. But that was based on the strong financial and operational performance at Pennon, in the round, at Viridor, South West Water, looking forward to the next 5-year period for South West Water. And driven by that strong operational financial delivery, it opened up a range of wider strategic options than we would normally have. And we wanted to do a broader strategic review to think through what we might do in that regard. So as you probably see, what's been announced today, or in the last hour or so, is that following that detailed strategic review, we have been looking at a number of options, and we're pleased to announce that we've concluded a proposed sale of Viridor for an enterprise value of GBP 4.2 billion in round numbers, and that represents an enterprise value to EBITDA multiple of something in excess of 18.5x, which is a significant and healthy multiple. And the enterprise value that we've concluded is a significant uplift from the current implied trading valuation for Viridor and, of course, an even greater uplift on that -- that was implied -- trading value that was implied when we started the strategic review. So after some reflection, the Board has unanimously agreed that this transaction is in the best interest of our shareholders but, of course, also in the best interest of our customers and our employees and Pennon, Viridor, in particular in the round. So Viridor has been nurtured by Pennon for probably about 30 years now and one of the few strong successful stories of diversification since privatization comes to this next chapter. And so we think this transaction is accelerating the realization value, which we've been nurturing and developing over, as I say, almost 30 years. So the net proceeds after -- are expected to be approximately GBP 3.7 billion after completion, so just after adjusting for the estimated transaction costs. So one question will be in your mind, what do we intend to do with the net cash proceeds? Well, obviously, we will reduce Pennon's company borrowings, make a return to shareholders, and probably return -- retain some funds for future opportunities. So we continue with the strategic review. It's very much business as usual as that. So Viridor is successfully delivering on its vision. It's transforming waste into energy. It's got high-quality recyclers and opportunities in the plastic area. And I think today's announcement is a positive step forward for Viridor. It will continue to invest significantly in future growth. So that's some of the -- what's being announced today. So what happens next? Well, it's very much business as usual for the time being, because there will be a transition period now. I need to make that -- sure that transition period goes as smoothly as possible. There's 1 or 2 conditional approvals that we require, not least of which from our own shareholders, merger control clearance from the European Commission and a few other things as well. So we expect to move through that transition period through April 2020. So it will be very much business as usual until then. As I said already or hinted already, we'll continue with that wider strategic view. We'll consider value-creating opportunities as they arise for the new Pennon. And of course, we'll have the next opportunity to update on that at the full year results presentation scheduled for the 4th of June. And I know you'll be asking the question, but the dividend policy as is carries on until then, and then we'll announce a new dividend policy for the coming 5 years, probably in June of this year, the full year results. So to state the obvious and to conclude, really, following completion, Pennon will become a U.K.-focused water infrastructure group comprising of South West Water, Bournemouth Water, Pennon Water Services. And we'll aim to continue our position of being a sector-leading regulated water company here in the U.K., focused on delivering customers -- for customers, communities and our shareholders, and hopefully, continuing our strong track record through the remainder of the next 5-year period. So if that's okay, I think I'll stop with that, and just give you that -- those introductory remarks and hand over to our facilitator for handing over to the Q&A session.

[Operator Instructions] The first question we have is from Dominic Nash from Barclays.

Congratulations on getting the deal done. I've got 2 questions, please. The first one is that you seek an EV of GBP 4.2 billion, but there's an extra potential GBP 200 million of payments coming at a later date. Is that on top of the GBP 4.2 billion? And could you just give us some color as to what that corresponds to? And secondly, are there any break fees in place in this? Or are there any protections in place if KKR were to change their mind?

Thanks, Dominic. And I think, I should have said, we should give credit to Susan, who's working very, very hard on this deal for the last few weeks and days. And I think the financial question is best handled by Susan. But of course, the GBP 200 million is on top of the GBP 4.2 billion. But Susan, do you want to talk about that and the break fees?

Yes, happy to. Afternoon, Dominic. So your deferred consideration, obviously, it's been through a commercial negotiation. And as Chris just commented, yes, the GBP 0.2 billion is on top of the GBP 4.2 billion. So that deferred consideration may increase value further. It is a contingent amount on settlement as a potential outstanding condition. And just to give you an example of what has been there then, and as you may be aware, obviously, it's been in our results. Previously, there is an outstanding claimant amount due from Interserve. And obviously, we anticipate to collect on that. And that's one of the items that is included in that deferred consideration. So yes, it is very much on top of the GBP 4.2 billion and includes some of those examples. The next question you asked about was break fee. Yes, there is a break fee included within this transaction. And I think there's a footnote actually in the announcement that talks about a break fee of some GBP 42 million. And then in terms of conditions precedent, which I think you asked about in terms of the sale, the condition precedent we've got, obviously, we've got the approval from Pennon shareholders. There is, obviously, the antitrust clearance from the European Commission for KKR and then release of certain parent company guarantees and other obligations to swap out. And obviously we'll confer with KKR to make sure those conditions are achieved. And obviously, we're both going to work towards completion from this year.

The next one comes from James Brand from Deutsche Bank.

Congratulations. And as you said to whilst at the start of the call, I wish you and the team good health as well in this difficult time. I have 2 questions. The first was, just on the transaction, the GBP 0.5 billion of additional debt and debt-like items and customary costs that bridge the gap between the GBP 3.7 billion of cash and the GBP 4.2 billion of enterprise value, pre the flagship potential GBP 200 million of add-ons. Could you just detail what's in there? I presume that the environmental liabilities of Viridor are in there, which were about GBP 200 million. The other GBP 300 million, is there any actual gap that's being transferred across? As we're looking at your kind of net debt, we're trying to work out what the adjustment will be. How much should we kind of take off within that GBP 500 million? That's the first question. And the second question is, you probably very legitimately might just say, "We'll wait until the full year results." You commented on maybe retaining some proceeds, but also returning proceeds to shareholders. We're thinking about the rough quantum here as to whether we should be expecting most of the sale proceeds to come back to shareholders or maybe less. What should we be thinking? Should we be thinking the vast majority comes back to shareholders and a small amount is retained? Or is that a TBD?

Thanks very much, James. Shall I just try and answer the first -- the second one first. Really, as you might anticipate, if we had something definite to say, we'd put it in the announcement. We don't have anything definite to say in that regard. We just wanted to give the market some indication of what was in our mind. And as I say, it's a combination of those 3 things. So I think probably that's all I'll say, and we'll keep the market informed, as appropriate. So Susan, do you want to talk about the debt and debt-like items?

Yes. Of course. Yes. So in terms of debt and debt-like items, yes, you're quite right, James, that the environmental provisions that are in there, GBP 0.2 billion of those and then the other GBP 0.3 billion. So there are long-funding finance leases that are held. Obviously, we have many of those across the group. There are long-funded finances that are held at the Viridor entity. So that incorporates those long-funding finance leases. And then there is the leasing accounting change that happened, which is IFRS 16, and that is included in that number as well. That gets you to the GBP 0.5 billion. And then if you want to think about what does that mean from a group perspective in terms of debt, I mean, obviously, if you look at our half year results that we had in November, the group has got debt of about GBP 3.3 billion overall, and the hybrid is GBP 300 million, so about GBP 3.6 billion at the group level. Now in that, obviously, South West Water's financing is entirely ring-fenced and is unaffected by this transaction. And South West Water has a net debt position of just over GBP 2.2 billion. So really, you're talking about debt items that are within the group, post-transfer of those that are, obviously, already within Viridor, leaves about GBP 1 billion of debt at the Pennon company level. So when you're thinking about that cash proceeds, we have said in the statement that, obviously, we'll be looking to pay down some of that holdco debt. But obviously, as Chris said, we obviously need to think about what are our opportunities might be. But that just gives you an idea of the debt that tells, at Pennon company level, that obviously, we will be considering post this transaction

But when we're thinking about the transaction, we should be thinking about the net cash, and then we should be taking GBP 200 million off your provisions, and then taking GBP 300 million off your net debt to reflect the...?

Correct. That is correct.

Our next question comes from Mark Freshney from Crédit Suisse.

Congratulations. Two questions. Firstly on how you would think about levering South West Water. You talk about retaining some cash, but would the amount that you would -- I mean, presumably, you would take South West Water to 60% net debt to RAB. And then you may retain some for future growth opportunities on top of that. Can we expect you in the next couple of months between now and June to identify what those opportunities are, which would, of course, be a moving piece? And just secondly, in the past, when you've done capital restructurings, you have returned -- albeit in the water business, you have returned money to local stakeholders. Is there anything that you would consider on that this time around?

Thanks, Mark. And I think probably combination Susan and I can answer those. I mean, capital restructuring, as we've said previously, have been related to South West Water. And I think the relationship between South West Water and its retail customers, the householders, is somewhat different than to a business-to-business relationship, which is what we tend to have with Viridor. So I think it will be less appropriate in that regard. So that isn't something that I think you could envisage. In terms of levering at South West Water, I mean, Susan can talk about that, but I don't think we want to be too explicit about it. And I think we've always been saying that we've been tracking opportunities for further value in the water sector. We will be focusing on the water sector. As you know, we always point to the fact that when we acquired Bournemouth Water, we thought it was a very good transaction for our shareholders and very good for the customers as well. And indeed, that was endorsed by the CMA when they said this was a net positive to not only our customers but also customers nationally as well. We'd continue to have a high probability of setting the benchmark frontier for the industry as a whole. Yes, we'll be very mindful of the Ofwat guidance about what's an optimum level of balance sheet for South West Water. So yes, we will keep that in mind, of course. And we will continue to track opportunities as they may or may not arise in the water sector. On a number of -- you've said already that well done for doing the transaction in this environment because it is a, well, unstable market at the moment. So it's difficult to predict. So I'm not suggesting for a moment we would set ourself the deadline of 2 months. Susan, is there anything you want to add to that, particularly the latter point?

I don't have anything specifically.

Okay. So thanks very much, Mark.

The next question we have is from Jenny Ping from Citigroup.

Two questions, please. Firstly, just going back to the very first question in terms of the GBP 200 million of potential additional receipts, are you able to give us a feel in terms of the timing? If that were to happen, when you would expect to receive that? And then secondly, just going back to Mark's question on the type of assets that could potentially come onto the market or may or may not come to the market, what is at the end of it all you conclude this is -- there isn't anything suitable in the market in the water space and further consolidation doesn't work, does that mean -- is that an automatic, we will then residual any excess cash to shareholders further from here? Or how should we think about that?

Okay. So Susan, do you want to give some more color on the timing. I know what the answer is, the GBP 200 million deferred consideration. But do you want to say that?

Yes, absolutely. So Jenny, as I said at the beginning, obviously, it's been commercially negotiated and includes items we're expecting settlement on a number of outstanding positions. We have a number of years to which it is open to obviously gain from those receipts. So yes, it's a good, long time period to allow us to maximize that potential.

So on the second one. I'm afraid I'm not going to give you much more color, Jenny, I'm sorry. But we've consistently said over the years that we track our opportunities in the water sector, and they -- it isn't as a [indiscernible]. I think liquid market ready to get back. It all depends on when shareholders or the existing shareholders feel that they would think of exiting their positions creates an opportunity for us. We've always retained some sort of flexibility on our balance sheet to have some flexibility to invest in the future. So I don't think you can [ thank us really well ], I was saying to Mark, I don't think we can say that we'll track it for the next 6 months, over the next 6 months or a year or whatever. If nothing happens, we'll think again. That just isn't how it is. So I think we'll just continue to track the opportunities. But related to turmoil, which is a short-term turmoil, I hope, maybe longer, who knows? You may know better than we do, but we need to look through that and look through -- into both South West Water and Viridor move to long-term business with really good returns providing essential services. So we need to look on that broader horizon when we're thinking about our next opportunities in the new Pennon.

The next question comes from Fraser McLaren from Merrill Lynch.

Nice to see that there are some aspects of life which are able to continue in spite of these interesting times. Just 3 very brief questions, please, if I may. One, you mentioned separation cost in the statement. Could you help us to quantify those, please? Secondly, are there any pension fund liabilities which transfer across with Viridor? And then thirdly, have you had any thoughts about just which methodology you may wish to use for the value return to shareholders?

Then, maybe yours, Susan? Everyone has been very disciplined up until now, Fraser. Everyone has asked 2 questions, and you asked 3. So you get some sort of prize. I'm not sure what it is. Susan?

Yes. So Fraser, in terms of separation costs, yes, we have put in the announcement there will be some separation costs, but they are relatively small compared to the other numbers in this announcement, as you might anticipate, and we're talking single-digit millions really in terms of what that looks like. And then on the pension side, probably important thing to say that there are kind of few active members of defined benefits scheme that we have across the group in Viridor is that's only 2% of Viridor's employees are in a defined benefit scheme. And as such, Pennon is retaining these obligations. In terms of the pension liabilities for the group, at the half year, that was circa GBP 40 million, which goes on liabilities, kind of GBP 20 million plus. And then the last question that you asked around the value return to shareholders. I think, as Chris alluded to, we obviously will make further announcements in terms of where we get to with that. But as you might understand, we obviously want to speak to shareholders as well and understand their views in terms of their expectations.

Another question from Martin Young from Investec.

I won't get on the naughty step like Fraser, so I'll just ask 2 questions. The first, and I guess the answer is that there isn't, but is there any tax liability on this sale that you would have to pay over? And then secondly, just revisiting this whole issue of return of value timing, looking at opportunities, et cetera. Obviously, very, very clear that you will take your time to look at potential opportunities. But in terms of the timing of any return of value announcement, is that completely divorced from the events of the 4th of June?

Okay. Well, tax liabilities, obviously, Susan can answer, but I know what the answer is. But I think we're probably going to not give you [indiscernible] the second one about timing of the announcements. But Susan, do you want to take those up?

Yes, of course. Yes, so tax considerations. So the transaction, which fall under the substantial shareholding assumptions and is exempt from the assessment of capital gains, I think that's what you're alluding to, Martin, is the answer to that question. And then in terms of timing of what our proposals are, I mean, obviously, I've just said we've got to speak to shareholders and understand their views and there'll be a class 1 circular to come out, which will be the next issue that you'll see into the market so you can see some more detailed aspects within that class 1 circular. And obviously, that will come out. And then we've got, as we mentioned, the full year results in June as well.

The next question we have is from Liam Turner (sic) [ Iain Turner ] from Exane.

Can I just ask you...

It's not Liam. It's Iain.

It's Liam. I'm taking anything these days. On the kind of legitimacy debate, obviously, you've done a great deal, and there's profit. But do you think you're going to come under any pressure to share those profits either with your local authority customers, whose contracts are a key part of paving the way to allow these developments to the AFWs or with employees or with the South West Water customers?

Yes. I mean, I think we do tend to think of them as different businesses, and we are sending -- we're always trying to run them as a separate business, so we think there's a lot of commonality in them. But the legitimate debate is one that the new owners will pick up in due course, and they were thinking I'm sure about the broad aspects of whether there should be any returns or sharing of benefit. As I said, I think I've answered already that we didn't anticipate that would be the case actually. And we believe that this is a very different situation as business-to-business customers or business-to-local authority customers. So we wouldn't [indiscernible] for that. But going forward, that will be a matter more for the new shareholders, I think.

We have another question from Verity Mitchell from HSBC.

Congratulations on the deal. And just kind of really small questions. You did create some synergies when you created the structure, so it's slightly different from separation costs. Are you going to have to create a few more costs in terms of the services that you're not sharing anymore? That's the first question. And the second question is, we just assume that your hybrid will be repaid when it comes up for renegotiation this summer?

Susan, do you want to take those?

Yes. So...

[indiscernible] certainly the hybrid, let's talk about now.

Yes. Yes, so in terms of the hybrid, then obviously, as you mentioned, Verity, obviously, the core break for that is in May. And as I said, I think earlier on this call, given the position that we will have, we will obviously be thinking about those net cash proceeds and how we'll be looking at our debt at a Pennon company level, post the receipt of those proceeds. So yes, you're quite right, the hybrid has the first call date in May. And that will be part of those considerations.

Yes. And the synergies. I mean obviously, we'll obviously look at 2 separate businesses as we move the transition of Viridor to the Pennon Group over the next few months. We're saying we'll do sort of zero-based budgets for both, but more particularly for what retains is retained in Pennon and South West Water. And we've got a reasonably good track record of being the forefront of efficiency, and I'm sure, going forward, that will be the case as well. There is some benefit of having scale, but that will also be factored into our considerations for any strategic developments that we do going forward. You heard us talk about the advantage of bringing Bournemouth Water and South West Water together, for example, allowed us to have quite a bit of synergistic benefits. You don't make 2 back offices and so forth. So that, going forward, in due course.

And we have a follow-up question from Mark Freshney from Crédit Suisse.

While we've got you, just a couple of questions on business planning, given coronavirus and South West Water. Can you talk about the challenges there, whether there may be extra costs or considerations that we should take into account? And just secondly, given the CMA review of 4 other companies, which I don't think includes any companies that close to you apart from Bristol, but what are your thoughts on the CMA and high-level observations?

Yes, coronavirus is starting with that, Mark, and it's actually first and foremost on our minds at the moment. And as a company, we're doing an awful lot of preparation in trying to anticipate what might impact on us. And clearly, in our minds, first and foremost is the safety of our own employees and of all our customers. And secondly and equally important, I suppose, making sure we continue to retain the service to the communities we serve because water and sanitation are absolutely vital fundamental building blocks to society going forward. Everybody is putting their efforts, and quite rightly so, to strengthening the health services. But food and water come very close behind that to make sure we can retain those things. So we're having daily planning meetings, daily -- at the executive level, daily at operational level within the company and a cascade of the organization. You're familiar with the sort of business continuity plans and the sort of insight that management plans that we have in the whole industry but in South West Water as well so climatic events such as the lease release and so forth. And we've implemented quite a lot of those arrangements. I thought of splitting teams, making sure we have diversity at all locations. A lot of people are working from home, and certainly the most vulnerable ones. So a lot of work, both at the company and an industry level, sorry, as well, so we're coordinating at the industry level. Too soon to say what costs are, but it'll have some cost implications. But at the moment, that's just a very, very minor secondary consideration to the other considerations. I think it's too soon to say anything on that, really. CMA review, obviously, we don't have too much insight into that one. We're not particularly involved in that -- we're not involved in that, sorry. We're not involved in that at all. I mean, there's a lot of activities being suspended or being sort of held in advance because of the turmoil in the society at the moment and the increasing turmoil. So I have no idea what impact that will have on the CMA timescales. But clearly, resources are stretched. And it is essential that all organizations, all companies, whether they're referring to CMA or not, to focus on reality. Focus on the things that are important, which is to say health and safety of the customers and our employees and water -- wholesome water supply. So not too much to say on that, but you're very right to say that the whole industry, and each and every company I know is focused on that really seriously.

[Operator Instructions] We have a question from James Brand from Deutsche Bank.

Sorry, it's just kind of a follow-up question. I just had a follow-up question, just on the coronavirus and the kind of the last answer. I was wondering whether you could just remind us how the adjustment mechanisms work on volumes. I have, in my mind, that there's a kind of 2-year lag and an adjustment mechanism, which kind of neutralizes any changes in household volumes. I can't quite remember exactly how it works for industrial and commercial volumes, whether there's an adjustment mechanism also in place there. So maybe you could just remind us of that, please.

Yes, I can say that, James. Yes. So yes, there is a revenue true-up. And it's, as you said, is that kind of largely because of the time at which you submit your tariffs for the following year. So it is 2 years. And then for the non-household customers, yes, obviously, there's the wholesale volumes for non-household customers that will be part of that. So yes, there is a revenue true-up mechanism in place.

So that applies for industrial and commercial customers as well as residential or just for residential?

Yes. As the wholesale. Yes, the wholesale volume.

At the wholesale level.

For the whole thing.

Wholesale level.

Wholesale, sorry, James. A wholesale volume.

Wholesale level, and it's a true-up for your wholesale business, but not for the retail business? Is that what you mean by that?

Yes.

Or you mean wholesale as in industrial and commercial supply?

Okay. So wholesale volumes, for the volumes that are delivered. And then on the retail side, the retail margin. And the true-up mechanism what the wholesale volumes that come through. The true-up mechanism are for those volumes, not for margin.

There are no further questions. No further questions on the line. No.

Okay. Well, if that's the case, can I just say, again, thanks very much for joining us. And we'll say we think despite all the market turmoil and all the uncertainties and difficulties, this is good news, for -- not only good news for our shareholders, good news for our customers, good news for Viridor and its employees. And we reiterate what we said at the beginning, which is difficult days, and please take care of yourselves, take care of your family and all your colleagues. Thanks very much.

Ladies and gentlemen, this concludes today's call. Thank you all for joining. You may now disconnect your lines.