Update on the proposed merger of Vivendi Water UK plc and First Aqua (JV Co) Ltd

Last November the Competition Commission concluded that the merger of Vivendi Water UK plc and First Aqua (JV Co) Ltd would operate against the public interest because it would prejudice the Director General of Water Services' (DGWS's) ability to make comparisons between different water enterprises. However, the Commission's majority did not believe this detriment to be great enough to justify prohibiting the merger. They recommended that Vivendi's £2bn purchase of Southern Water be allowed to go ahead, provided the French Company sold its 31.4 per cent stake in the South Staffs Water Company. Vivendi agreed to the sale, but Melanie Johnson, UK Competition Minister, ruled that this remedy was 'not appropriate'.

The Office of Water Services (OFWAT) commented that whilst they too believed that the Commission had underestimated the extent of the detriment and thus the remedy required they had no wish to lock the current industry into a particular structure, or to eliminate the incentives on management that the threat of takeover can provide. They thought it would be inappropriate for the Secretary of State to block the merger but could not offer any clear-cut solution to the problem.

In January of this year, determined that the merger would go ahead, Vivendi joined forces with Royal Bank of Scotland to engineer an alternative financial structure, which they hoped would satisfy the Government's objections.

New proposal by Vivendi

Under the new proposal, Vivendi would acquire a 19.9 per cent stake in Southern Water through a new holding company to be called Southern Water Investments Limited (SWI). The Royal Bank of Scotland through a second new holding company to be called Southern Water Capital (SWC) would initially own the other 80.1 per cent. The banks interest in SWC would subsequently be reduced to 49 per cent, as they intend to grant Vivendi an option to purchase a further 5.1 per cent stake of the new holding company and have plans to sell the remaining shareholding to other institutional investors.

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The acquisition itself will be effected by the simultaneous completion of two agreements;

• Vivendi's acquisition of First Aqua, through SWI; and
• SWC's acquisition of 80.1 per cent of SWI, a holding company through which SWC will exercise control of Southern Water.

It is intended that Southern Water will undertake a refinancing of its regulated business through the capital markets by a ring-fenced whole business securitisation with a structure consistent with previous successful re-financings in this sector.

Southern Water will continue to be managed by the existing executive management team.

UK Competition Commissioners Comment of the 14th March 2003

After reviewing the new proposal Melanie Johnson accepted the following remedy:

• Vivendi should undertake to implement the alternative minority holding proposals in substantially the form described above:
• Vivendi should undertake to limit its voting shares in SWI to not more than 25%:
• Vivendi should undertake to appoint no more than 2 directors (or 29 per cent of the total, whichever is the smaller) to the board of each company within the holding company group except Southern Water. These directorships should be non-executive;
• Vivendi should undertake to appoint no more than 3 directors (or 29 per cent of the total whichever is the smaller) to the board of Southern Water. These directorships should be non-executive:
• Vivendi should formally confirm to the Office of Fair Trading (OFT) that neither it, nor any of its associates, would enter into any contracts with either holding company or Southern Water (or any of Southern Water's associates), prior to the completion of the new arrangements and that the signing of such agreements is not a condition precedent of the transaction:
• SWI should undertake that it will appoint and maintain at least 1 director on the board of SWI and Southern Water with substantial experience at senior level within the water industry; and
• Southern Water must consent to modification of its licence to require it to provide a separate data set for the Hampshire part of its water supply area, so that it can be used as a separate comparison.

Melanie Johnson is inviting third party comments on the proposed remedy to be sent to the OFT. She has asked the OFT to advise her if he receives any third party comments, which may cause her to re-consider the above remedy.

She has also asked the OFT to start the process of obtaining undertakings from Vivendi and SWI to cover parts 1-6 of the above remedy. Part 7 of the package will need to be implemented by the Royal Bank of Scotland and Southern Water through modification to Southern Water's operating licence.

For further information, please contact Richard Temple at [email protected] or on + 44 (0) 20 7367 3738.