Item — HN Reader

> "It's even simpler than that ... their goal is to extract profits"

According to the article, profit has not been the primary goal for the utilities though, because there is limited scope for extracting profits from uncompetitive essential utility services - the focus instead has been on maximising shareholder returns. So in the case of the water utilities, they "borrowed £53bn in debt while distributing £72bn to shareholders", which of course is what the issue is now interest rates have risen significantly. The article describes this as "the tension between generating strong returns for investors in uncompetitive monopoly conditions and providing high-quality, affordable infrastructure to the public". The end result is still the same though - transfer of wealth in a socially destructive direction.

6 comments

https://uploads-ssl.webflow.com/62306a0b42f386df612fe5b9/637...

Specifically table 1 on page 2, "The ten industries with the highest profit margin", has the spots 1 (elec: 42.5% profit), 2 (gas: 40.5%) and 8 (water: 32.1%) being utilities.

Sounds like good "modern" governance. You've got assets? Use them as collateral to take on debt so you can free up capital and give it back to the shareholders. Value!

That is inevitable with super low interest rates for a super long time, especially near zero. Your options are to acquire appreciating assets quicker than your competitor, or you get left behind.

See people who bought homes at 5% down versus people who waited to have 20% down. The people who took on more debt were rewarded nicely with huge gains, and the people, who were prudent, now decide on paying a few hundred thousand more, if they were even able to keep up with saving a larger down payment.

This is a very naive reading of the situation - it almost comes across as twisting in knots to avoid placing the blame on the responsible party: the company and its owners who were responsible for this.

> Your options are to acquire appreciating assets quicker than your competitor, or you get left behind.

This is wrong twice over! First of all, they are effectively monopolies, they have no competitors in their industry. The only thing they are competing against is which company can extract money the fastest (at the expense of the company and English citizens). Second of all, from the article, they aren't spending the raised money on capital investments.

> For example, South East Water—thousands of whose customers were left without running water this summer—spent more on dividends and servicing its debt than on infrastructure in the two years to March 2022. Water bills for Britain as a whole have increased by around 360%, more than double the rate of inflation, since privatisation. Over that time, annual capital investment by the ten largest water and sewage companies has fallen by some 15%, according to research by the Financial Times (FT).

Privatization is an utter failure here, just as would be predicted given the situation, and it's crazy to see an attempt to rationalize it away.

> This is wrong twice over! First of all, they are effectively monopolies, they have no competitors in their industry. The only thing they are competing against is which company can extract money the fastest (at the expense of the company and English citizens).

I think that's what the poster above was trying to say - they're not competing for customers, they're competing for investors. Effectively their only products are ROI and share value.

And when I say it out loud, I get a little shock, as I realize how much all industries are trending that way. No matter how consumer-facing your business is, the real competition is for capital investment. Consumers had better hope that capital investment depends on their happiness, because if it doesn't, their happiness is going to slide far down the priority ladder.

Thanks, you explained it better than I did.

The irony is we might all be complicit in supporting this dynamic by choosing to invest in whichever 401k/pension fund option offers the highest returns and lowest expense ratios.

Utility companies in Illinois are private & can only charge X% (10% for electrical) more than they invest. Frankly, the power & rail network here are amazing, in large part because that system incentivizes maximum reinvestment as they can then charge more money and return larger amounts to share holders.

Competitors who take large loans and fail to deliver are out competed by alternatives who went a more efficient route.

The profit margins are fixed, but everything is still competitive.

I am not claiming it is a good thing for society.

>The only thing they are competing against is which company can extract money the fastest (at the expense of the company and English citizens). Second of all, from the article, they aren't spending the raised money on capital investments.

The owners of the company are competing with others in society to buy land/houses/cars/services/etc.

If the owners want cash they can do the same thing, take out a loan vs the value of the stock to buy more X. The advantage when a company does it is your liability stops at the value of the stock where leverage isn’t.

Except, not every investor wants every investment to be highly leveraged in this way. The entire point of utilities in most peoples portfolios is as very stable dividend stocks. It’s the people running the company who have incentives to do these kinds of transactions.

This is highly specific to the period of time with rapidly rising interest rates - not generally true. It does sting though as someone still looking to buy a house.

A better question is, where do they keep finding such gullible lenders?

That The Economist, the City of London's answer to Pravda, published this article at all is telling.

The lenders will come out alright. Even if the utilities end up being renationalised their debt will be converted into government bonds. The mugs here are the public, which end up paying to service the debt that has been used to issue dividends.

> That The Economist, the City of London's answer to Pravda, published this article at all is telling.

Do you mean it's extremely left wing? Or pro-authoritarian capitalist? Or the most left-wing publication you can find in an otherwise capitalist group?

I mean that it usually parrots the party line (in hte case of Pravda, literally). Criticizing privatization is for them heresy of the highest order.

I wouldn’t read that much into it.

Pravda is both the Russian word for ‘truth’ (правда) and was/is a publication advancing the interests of the USSR/Russian state establishment.

The ‘economist’ implies a similar ‘truthfulness’ (it must be right about the economy if it’s an economist!) and advances the interests of the London financial establishment.

I'd assume they meant (generally) uncritically pro City of London corporations and the London influenced strain of economic liberalism which they represent.

But I do think it's a bit of hyperbole in a way, although I'm only tangentially familiar with the publication.

How are shareholder returns and profit different?

Profit is the gain made by the enterprise. Shareholder returns are monies paid out to shareholders.

When the board is more like a group of Huns than a Shepard, you find that after you pay out the shareholders, the enterprise is toast. In some cases, like most recently in big box retail, the private equity investors are running an obvious and odious, but legal, fraud.

With utilities, the business is all about capitalization and cash flow. They should be stable and boring businesses. When they are exciting, the management is burning the candle at both ends.

Profit is extracting money from customers.

Shareholder returns can come from profit, or selling off assets, or taking on loans, or underfunding pensions, or probably other ways financial experts can invent.

The financing agreements surely require business assets and equity as collateral. At the end of the day, any cash flow that goes to the owners has to come from long term profits from the business, which comes from extracting money from customers.

Maybe not today or this year or next year, but everyone is always going to want a return on the money they put in, whether it be owner or lender.

Unless I sell off assets. Or take loans now, give the proceeds to the shareholders and get a bonus for it, and leave before the company declares bankruptcy. Or leave a unfunded pension obligation.

Or run a nationally important service into the ground and then need emergency government money to keep providing it.

Do we consider the government a customer?

If it's buying goods and services. I would not treat it as a customer, and instead one of the unenumerated other ways of generating shareholder dividends, if it paid money to keep a nationally vital industry from imploding under the weight of its bad choices.

Borrowing is accounted differently from earnings. But yes, at the end of the day the people getting rich don't care which pile of money it comes from, and the people getting poor service are equally unhappy.

"borrowed £53bn in debt while distributing £72bn to shareholders"

There is the difference

No lender is going to lend a business money just so it can pay the owners.

They must have used the debt to finance operations, as opposed to cutting the dividend or even putting more money in.

This allowed them to continue to have profits in the short term, at the expense of higher interest costs in the long term (which probably cause higher prices for customers in the long term).

> No lender is going to lend a business money just so it can pay the owners.

Of course they will! There's an entire industry (leveraged buy outs) built around it. And more generally, lenders will let you do dumb things with the money they lend you. As long as they expect to get paid back.

So, could a small business borrow money to pay it's owners? Probably not, it's not likely to get paid back. Could a multinational corporation borrow money to pay dividends? Yes, it's happened.

Money is fungible. Lending should only be used for capital investments, not operations or maintenance. The lender's money may have been used for what little capital investment is still happening, but the money they would have otherwise used was diverted to shareholders.

In the case of the UK water companies the parent fund was often involved in getting or making the loan e.g.

Water company does a debt bond issue, parent owning fund takes a % of the issue (enough so that the bond issue is a success at a good price), parent fund extracts all the funds raised as a dividend, and sells the % of the issue it own too

All while extracting management fees etc too

Right, so the “parent” posts a profit, and it comes (either tomorrow or next year) from revenue earned by the “child” that borrowed, trading revenue tomorrow (going to lenders) in exchange for cash today (going to “parents’” owners).

Without getting into the weeds, my point was that in order for owners to end up with cash in their pocket, the business has to earn a profit, at some point. And that profit must come from revenue (higher prices for customers) minus expenses (lower quantity/quality for customers).

You can insert a lender in there to shift when those cash flow changes happen, but the money must come from customers, eventually.

Barring any research and development that results in technology that will allow for lower expenses and/or increased production, but I do not think that is the case here.

This is how a lot of the private equity industry is funded. Shareholders are "de-risked" taking the proceeds of a refinance out of the business upfront. The financier offers the upfront loan in return for a consistent stream of their cash flow (the interest and capital on the loan, and sometimes not even the capital). These businesses tend to have very steady cash flow generation.

Didn't InstantPot just go bust for the same reason? Somebody decided to lend them too.

I do not know what “same reason” means here.

Instant Brands went bankrupt because it could not pay its debts in a timely manner, so lenders decided to take the collateral.

It is possible lenders did not do sufficient due diligence, or maybe they got unlucky, but they did not lend Instant Brands money specifically so Instant Brands’ owners could pay themselves (maybe they did if there was corruption in this case, but it is not the norm otherwise why would anyone lend to anyone?).

And of course, Instant Brands’ owners will lose equity and credibility in the bankruptcy, so it is not like any dividends made possible due to the financing were “free money”.

Wow. Yes, they do. It happens most fiscal quarters.

You can return value to shareholders that doesn’t come out of profits. For example, selling off your assets doesn’t make you profit, but gives you cash on hand. If that money is returned to shareholders, you’ve changed your balance sheet, but haven’t made any profit. An even simpler example is just selling the company to someone else. The shareholders get whatever the agreed on price was to take it private.

> For example, selling off your assets doesn’t make you profit

if it's on the balance sheet and you sell it for more than it cost you, then you have to book it as non-operating income, i.e. capital gains, i.e. profit.

Ok, so you make X percent profit but the proceeds are more, and you distribute the proceeds to shareholders. You can also sell at a loss and still make distributions to shareholders. This is Private Equity 101.

You can for example buy back shares

The money to buy back shares has to come from profits.

It can come from a claim on future profits which aren't realized, which is the case here.

When does profits don't materialize, the company goes bankrupt, the government rescues it (can't just cutoff power and water!) and everyone is happy! Well everyone but the majority of taxpayers who aren't also shareholders of the utilities...

> The money to buy back shares has to come from profits.

There's this thing called a "leveraged buyback" where a company borrows money from lenders and uses that money to buy back shares.

That would be actually a nice policy: only allow buybacks using taxed profits. Unfortunately, it's not there yet

Why would that be a good idea?

Because buybacks in any other fashion only increase debt.

It's the shareholders cashing out, so rather than a failed business with shares of $0 value, they have money and the loans are someone else's problem.

Lots of corporate tax code is about taxing the money flows from the company to the physical persons. Somehow buybacks weren't taxed until recently.

It would be a simple regulatory change that would (maybe ?) substantially mitigate the harm leveraged buy outs cause the economy and society.

You left out the "to shareholders, the majority of whom are international investors".

A water company caring about some international investors more than the people they serve, and siphoning money out to those foreign interests, borders on treason.

It sounds just like the utilities went through a PE buyout experience.

How is that now extracting profit for the shareholders exactly?