JOHN ROBERTS - UNITED UTILITIES - (UU.L)
CEO Interview - published 09/11/00

DOCUMENT # KAN002

JOHN ROBERTS is the Chief Executive of United Utilities Plc. Mr Roberts graduated from Liverpool University in 1967 with a degree in Electrical Engineering. He joined the Merseyside and North Wales Electricity Board and held a number of posts in engineering, corporate planning and finance, becoming Chief Accountant in 1984. Following the privatisation of the electricity industry in 1990, he was appointed Managing Director of Manweb Plc in 1991, and then Chief Executive in 1992. He left the company in 1995, following its acquisition by Scottish Power. In 1996 he joined Hyder Plc, initially as Chief Executive of Swalec, and then was appointed Chief Executive, Hyder Utilities. In September 1999, he was appointed Chief Executive of United Utilities, the group which comprises North West Water and Norweb, based in Warrington. Mr Roberts was President of the Electricity Association from 1997 to 1999. He is a member of the Royal Commission on Environmental Pollution. He was a member of the Council of Liverpool University until 1996 and rejoined the Council on the 1st December 1999. He is a Fellow of the Institution of Electrical Engineers and a Fellow of the Chartered Association of Certified and Corporate Accountants.

Sector: Utilities

TWST: Could we start with a brief profile of United Utilities, just to set the context?

Mr. Roberts: United Utilities was formed in 1995 with the takeover of Norweb Plc by North West Water Plc, two northwest utilities that had been privatised in the late 1980s. It currently has five businesses: North West Water, which provides water and wastewater services to 2.8 million customer premises in the northwest of England, covering an area from the Welsh to the Scottish border. Its turnover was over GBP1 billion last year, and its operating profit was GBP460 million. Norweb Distribution — our electricity distribution business — operates on a slightly smaller footprint than North West Water as it does not include Cheshire and Merseyside to the south of the region. It distributes electricity to 2.2 million customer premises. Last year its turnover was GBP346 million, and its operating profit was GBP147 million. Vertex was formed at the time of the acquisition of Norweb by bringing together the back office operations — such as IT and customer services — of the electricity and the water businesses. Initially, it was an in-house service provider, giving back-office support and infrastructure facilities to those businesses. Progressively, it is growing its order book outside the group, focusing on three main sectors: local and central government, customer contact centres and utilities. It now has clients in all of those areas. Last year, its turnover was GBP183 million, and its operating profit was just over GBP12 million. United Utilities International develops and operates contracts around the world, in water and electricity, in partnership in the water business with Bechtel, through our joint venture, International Water. It has operations in Mexico, the Philippines; it distributes electricity in Buenos Aires in Argentina; it also has water operations in Poland, Bulgaria and Australia. Last year sales were over GBP75 million, including sales via associates, with an operating profit of GBP8 million. Norweb Telecom is a business that was created in Norweb before the acquisition by North West Water. It began with a network of optical fibres constructed around the existing distribution network but since then it has grown rapidly. It now has a national network and focuses on small and medium enterprises. Its turnover last year was GBP79 million and it made an operating loss of GBP16 million, which is the nature of businesses in their growth phase. It's currently growing its revenue by about 60% each year. That is the business — grounded in the water and electricity utility business in the northwest of England, but beginning to grow outwards from that. We are in the middle of a large reorganisation.

TWST: Let's look at the business climate that's precipitated this reorganisation, and then give me the details of the reorganisation.

Mr. Roberts: Our core businesses of water and electricity distribution are regulated monopolies, and they have both had price reviews that will apply from 1 April 2000. These reviews were finalised late last year. It was no surprise that in both water and electricity distribution, the regulators have reduced our prices significantly, and in the case of water, they've also set us a substantial investment programme. In water, our turnover has been reduced by GBP85 million each year as of 1 April 2000, and in electricity distribution by GBP55 million each year; so overall a GBP140 million reduction in turnover each year for our two regulated businesses. In addition, to achieve our regulatory targets for the next five years, we have to take GBP300 million off our water cost base and GBP100 million off our electricity distribution cost base — that's GBP400 million cumulatively over the next five years. That is about 25% of our controllable costs. In addition, in water we are required to invest over GBP3,000 million over the next five years. It's the largest UK investment programme of any water company. In electricity distribution, there is a GBP500 million investment programme. When we analysed our regulatory determinations, we had two issues: first, would we accept them or reject them and seek a ruling by the Competition Commission? We took the view that although these were tough challenges, we expected them, and we set our plans to rise to that challenge. To have gone to the Competition Commission, would have meant time, effort and money spent by management, and continued uncertainty over the stock price. There was also no guarantee of significant improvement. We decided that we would not go to the Competition Commission, and accepted the price reviews. That was the first decision. Second, having accepted the reviews, what were we going to do with our dividend? We got the final reviews late last year, and we were scheduled to announce our six month results on 10 December. We would announce our interim dividend, and the market would see a clear signal in relation to the price reviews. We canvassed our major investors, and they were of the same view — do not cut your dividend unless you have to. We took the view, looking at the numbers, that we could live with the results, albeit with reduced dividend and interest cover. What was uppermost in our minds was that in water, which is where most of our profit comes from, the price profile is -9.3%, -1%, 0, in years one to three, then importantly in years four and five we are allowed to increase our prices, first of all by 4% and then 4.5% above inflation. That means, that our income, while taking an initial hit, is rising at the end of the review period, as are our profits. This will feed through into our cover ratios. So we have some comfort that we are on a rising, rather than a falling, trend. That helped us in our decision not to cut our dividend. It leaves us in a position that we have a significant cost-cutting challenge, but we are confident we can do that. By cutting costs we can support the basic earnings stream of the business, which is a low-risk way of sustaining earnings. Cutting costs is, of all the things that management can do, the most controllable directly by management. You are not reliant on the market or the competition. The market accepted this, but also pointed out that you can not sustain an attractive financial profile by only cutting costs. It will level out, and we want to see growth — not high-risk growth, but some upside. We have looked closely at our business and assessed how we are going to sustain and deliver low-risk earnings that can offer growth. We asked ourselves, what are we good at? Utilities have a habit of pursuing growth in areas where they are not skilled. We spent time looking at the business and evaluating how we should take it forward. We have two core skills: Managing assets is one of our core skills. I've already described how we are investing GBP3.5 billion over the next five years. Our other core skill is managing relationships with customers. We have 2.8 million water customers. We want a business strategy and organisation to deliver it that is founded on these two core skills. Therefore, we are taking the businesses that I talked to you about and recasting the shape of the organisation. We are going to create four main business divisions. First, is our licensed asset management business. We are bringing under a single common management the two regulated asset bases of water and electricity distribution. We have to achieve GBP400 million operating cost reductions in these two businesses over the next five years. We have plans clearly thought through and established that will deliver this target. But we want to go beyond that and outperform our regulatory targets. We believe we can do this by bringing together the management of our two asset bases, because they are essentially very similar. They are distributed networks of water pipes and electricity cables both in the same geography. There are multi-utility synergy benefits to be achieved by common management. This business will focus on cost reduction, while delivering the customer service standards and capital programme set for us by the regulators. From this division flows the basic earnings stream for the business — a low-risk regulated earnings stream that is founded on efficiency improvement. We recently announced the appointment of Les Dawson as Managing Director of this business. He is currently Head of Operations for Transco, responsible for the UK's gas network. He is an experienced asset manager, whose extensive experience in the gas industry will be of substantial value in achieving future growth in this business. Alongside this is another business focused on asset management, but in a more commercial sense. Our contract asset management business takes the philosophy that we're pursuing in United Utilities International, which is to win contracts to manage other people's assets. At the moment, its focus is outside England and Wales. We manage assets in selected areas overseas, but we are now beginning to win contracts throughout the UK. In England and Wales the utilities industry is beginning to change. People are beginning to question whether you need to own and operate assets, and to contemplate separating the two. We see this as a business opportunity. Contract asset management will focus on managing other people's assets throughout the UK and overseas. It will be built around the already established United Utilities International business; but the "international" tag will be dropped. Gordon Waters, Managing Director of United Utilities International has been appointed Managing Director of this business.

TWST: That presumably is quite different in terms of its financial profile; it's not as capital-intensive.

Mr. Roberts: It is using our management capital to win contracts and then run assets, rather than using our financial capital to acquire assets. The financing and the financial profile of this business is different from our licensed asset management business, which is very capital-intensive. The third business is customer-facing, and it is a new business — a customer sales business for water. Competition is coming into the water industry. Large customers can already choose their supplier, and we believe over time competition will spread. In many ways, the water industry now is where the electricity industry was a number of years ago. Only large customers had choice, but the right to choose was extended. Now all householders can choose their electricity supplier even though people said it couldn't happen. Choice will also become more prevalent in the water industry. As well as that, it is clear that managing a customer base requires different skills from managing an asset base. At the moment, that skill is embedded within the management structure of North West Water. It makes sense to bring that out as a separate activity in its own right. We have a water customer base of 2.8 million premises. If you look at an analyst's valuation of the group, they attach no value to that, whereas they do attach value to an electricity customer base, because they are actively sold products and services. Therefore, we see an opportunity to grow value by selling more products and services to our water customer base, and this is the reason for establishing the business. It will employ less than 100 people; in that context it will not be huge, but it will be a water equivalent of an electricity retail supply business. The marketing alliance with TXU Europe following the sale of our energy supply business, which I will talk about in a moment, represents a significant advance in the development of our customer sales business. The alliance covers the provision of electricity and gas to North West Water customers and water and wastewater services to the enlarged TXU Europe customer base. Bob Armstrong, currently Deputy Managing Director of North West Water, has been appointed Managing Director of this business. The fourth business is Vertex, our business process outsourcing arm, which is growing its external business portfolio. Our intention for Vertex is to keep it, because it's built on one of our core skills — customer relationship management. However, in terms of our share price, it is valued at utilities multiples, whereas if you look at its peer group of stand-alone business process outsourcing companies, they have much higher earnings multiples. It would be our intention to partially float Vertex to recognise and realise that value for shareholders. As to when we would do it, we believe it would be credible to consider an IPO when half of the turnover of Vertex is external to the group. It was 10% last year, it is growing in the current year, and we do have some positive developments that I will talk about in a moment that will accelerate that progress. That then gives us our core portfolio of businesses: the licensed asset management business, the contract asset management business, the customer sales business and Vertex. They give a combination, in the licensed asset management business, of very low-risk, financial performance, and in the other three businesses, the opportunity to provide non-regulated growth, but all the time working with our core skills. That leaves me with two businesses that I have not talked about: energy supply which we sold recently and our telecoms business. If you look at energy supply, we had a good, strong brand and a profitable business. However, the nature of the wholesale electricity market is changing. The government is bringing onto the statute book its utilities bill, which will dismantle the pooling and settlement system that regulates and runs the wholesale electricity market in the UK. This will come into play later this year and will make the energy supply business more risky. At the moment, if our portfolio is out of balance, we can either sell into or buy from the pool: The pool is a single, national transparent wholesale price, and energy supply is a relatively low-risk business. Once the pool is abolished, we will be commodity traders contracting with generators to buy electricity, and selling it on. But the market must physically balance. The National Grid has to ensure that enough electricity is being generated to be sold to the end user. It will run a balancing market which will control, on a four-hourly basis, the physical generation of electricity, and it will monitor the contractual position of all the participants in the market. If generation has to be switched on or off or demand suppressed to balance the market, it will have to compensate generators or suppliers. It will do that by penalising those participants whose portfolios are out of balance. This will lead to a balancing price which could be volatile, either up or down. If a generator, with whom we are contracted, had a problem and lost their generation, or if we made a wrong forecast, we could be seriously exposed. This is a business that has a 1% profit margin. We would have to have a commodities desk trading 24 hours a day. To stay in this market we really would need to establish a trading position — which involves higher risk, I have already said that our strategy is one of being relatively low-risk and dealing with things we understand. When I put all that together, this is not a business which we ought to be in long-term. However, right now those who want to be in the business long-term are keen for market share. Most have generating capacity which provides them with a natural hedge for volatility in the balancing market. We completed the sale at the beginning of August. We sold the business to TXU Europe for GBP310 million cash. In addition, TXU Europe assumed responsibility for Norweb Energi's power purchase agreements, against which there was a book provision of GBP176 million at 31 March 2000. The fair value of this provision, disclosed in our annual report, was GBP241 million. Gross consideration was effectively just over GBP550 million, which equates to GBP240 per customer. More importantly for the long-term growth strategy of the business, Vertex was awarded a seven-year contract by Eastern Energy, a subsidiary of TXU Europe, worth around GBP350 million. Vertex also received confirmation of Norweb Energi's seven year contract worth about GBP300 million. This provides Vertex with secure revenues of over GBP650 million over the next seven years. That helps us on our way to establishing Vertex as a credible player that we can IPO.

TWST: How close to the 50% will it bring you?

Mr. Roberts: Vertex's external order book is now over GBP850 million, with external customers providing 50% of the total annualised turnover. It also provides a significant enhancement of our non-regulated earnings. Vertex is now well positioned as a leading provider of business process outsourcing services to the UK utilities sector with responsibility for around 8.2 million customer accounts.

TWST: What are your plans for the money that you have raised from divesting the energy supply business?

Mr. Roberts: We plan to reinvest that in the business. We have significant growth opportunities in Vertex and our telecoms business. These proceeds will enable us to pursue our business development plans. Also we have not sold our energy supply business because we need the money: we have sold it for strategic reasons. At the same time we need to use those proceeds to generate the best shareholder value. Norweb Telecom is growing quickly; however, long-term, we do not see ourselves as managers of a telecoms business. What we propose is to follow a path similar to other utilities who have developed telecoms businesses. That is an IPO in which, initially, we would sell a minority stake, continue to grow it, but ultimately exit the business with a full IPO. We are on track to have the initial offering in the Spring of next year. We announced recently that we had appointed a new Managing Director to the business: Hugh Logan. Hugh was Senior Marketing Director with BT; Marketing Director of BT Cellnet, and most recently Chief Executive of Martin Dawes, a subsidiary of BT. He has been one of the senior figures in BT looking at their approach to the small and medium enterprise market, which is where we are targeting Norweb Telecom. The business is growing rapidly, with turnover growth of 60% last year. We have invested GBP125 million and are in the final stages of creating a national broadband network of 2,500 kilometres from Scotland down to London and Liverpool across to Leeds. Our target market is small and medium enterprises. We are not looking at the residential market, nor are we looking at the very large corporates. We're looking at a niche sector, which is succeeding very well, as our growth rate demonstrates. We sell a wide product range, initially based on voice, but we are rapidly diversifying. We acquired a mobile reseller in February of this year, again aimed at the business market. We are now developing our e-business capability and offering a range of voice and data products. It is an area in which we can significantly grow and develop shareholder value, but longer-term we see ourselves exiting. That is our basic repositioning of the business. It gives us a clear and focused strategy based on our core skills and delivering shareholder value through, first of all, the low-risk security of being more efficient in our core regulated business, but also offering growth in our non-regulated businesses.

TWST: Can you indicate your role in this; what is your day-to-day activity?

Mr. Roberts: Leading the business as a whole, guiding and shaping the detail of the structure. My job is to co-ordinate and make sure we are keeping on track. Also while we are doing this, to make sure the business continues to deliver its financial performance. We must deliver our GBP400 million cost reduction over five years, which breaks down into GBP80 million a year. Clearly there's an element of phasing, and we will build up this year and next to our full level of efficiency savings. This year we are aiming to take GBP40 million off our cost base — GBP28 million in water, GBP12 million in electricity. It is important for us that we do not lose our focus on efficiency improvements. It is my duty to make sure that this does not happen. Third, is dealing with investors, communicating our strategy and making sure they understand what we are doing. The message I am getting is that they are comfortable with our strategy. What they want to see now is delivery.

TWST: You've spoken to your institutional shareholders; what about the other side of the fence, the analysts; what do they make of this?

Mr. Roberts: Again, the overall reaction that I'm getting is favourable. The analysts, I think, see this as a clear, straightforward strategy, one that makes sense. But it is also sufficiently flexible to take account of the inevitable changes that will arise in the future. One other initiative is our involvement with Western Power Distribution in its bid for Hyder, the Welsh multi-utility. Hyder runs Welsh Water and the South Wales electricity distribution network. It is very similar to the operation that we have, but on a smaller scale. Hyder has run into financial difficulties, as a consequence of the price reviews and the windfall tax. Western Power Distribution, which runs the electricity distribution business in the southwest of England and is ultimately owned by Southern Corporation of the United States and PPL from the US, has made a bid of 365p a share. They are interested in acquiring the electricity distribution business, but do not wish to operate the water business. They have negotiated and agreed with us an operating and maintenance contract, under which we would operate the water and wastewater network of Welsh Water on their behalf. It would be a significant innovation as it has not been done before in the UK. It would be a big O & M contract but at the same time a ground-breaker, the first time ownership and operation of assets have been separated. The Takeover Panel has now ruled in favour of WPD's bid. However, the award of the O & M content has now been challenged legally. We can only await the outcome of this process. But we are in a position to have a major O & M contract to run a water and wastewater business, which will make us, in one step, a major O & M outsourcer within the UK.

TWST: Are there any other issues you'd like to highlight in the interview?

Mr. Roberts: The water industry is going through a period of considerable change, mainly as a consequence of the price review we have been talking about. Kelda, which is Yorkshire Water, have said that they want to separate the ownership from the operation of their assets, and change the asset-owning business from an equity-owned business to a mutual, owned by its customers, 100% debt-financed in the bond market. Although Kelda have abandoned their plans following concerns expressed by Ofwat, it is a development which we are watching with considerable interest. Other water companies might follow suit. Clearly that offers more opportunities for a company like ours that is positioning itself to be a big O & M operator. As the largest water company in the UK and the only one on the FTSE 100, we see ourselves as being proactive in this market and see opportunities. We believe the kind of business portfolio and the strategy we have is best supported by a conventional equity structure. Nevertheless we are keeping developments under close review, and it is an interesting development that could potentially offer some opportunities for us. We are lining up the business to have a sound and solid strategy, a structure that supports that strategy, facing a utilities industry that is going through a significant change. Change always means opportunity.

TWST: If you were sitting down with a potential US investor, is there anything you'd like to add that would compel him to buy in?

Mr. Roberts: I think what we offer US investors would be a very interesting perspective and a way to invest in the UK utilities market in a positive and relatively low-risk way. But also to invest in a business that, in the longer-term, has potential. I think they would be buying into a utilities stock that is something more than a bond equivalent. It is something that offers security, but also some interesting up side.

TWST: Thank you.

JOHN ROBERTS
Chief Executive Officer
United Utilities Plc
Birchwood Point Business Park
Birchwood Boulevard
Birchwood
Warrington WA5 7WB
United Kingdom
+44 (0)1925 285 005
+44 (0)1925 285 020-FAX
www.unitedutilities.com

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