The skeleton in the attic is alive and kicking

I was in Paris yesterday to interview Veolia Environnement CEO Antoine Frérot for the July issue of Global Water Intelligence (it is going to be a great read – look out for it). The idea was to talk about some of the issues I raised in the magazine back in March under the headline “Veolia’s ‘skeleton in the attic’ vision”.

One of the points he wanted to get across was the fact that the old model – long-term operating contracts with predictable returns and no capital exposure – is alive and well. My original argument was that very few new long-term utility operating contracts are coming to market these days, and the old ones that are coming up for renewal – like the SEDIF contract awarded today – are so competitive that even when you win, you lose, because the cost of winning is so high.

When you look at the details of today’s SEDIF contract award (see news story) you might draw the conclusion that I am right and he is wrong. Veolia’s annual contract fee is likely to fall from €360 million to just €250 million from the beginning of next year, leaving shareholders unimpressed. There are three reasons for the fall. The first is that the headline figure does not include the revenues from the “Est Ensemble”, which has threatened to leave the syndicate, and will agree later in September whether it wants to accept Veolia’s terms. The second is the reduction in the scope of the contract. The new contract will not include works on capital projects – this will be bid out separately. The third reason for the reduction in the value of the contract is the reduced amount Veolia is getting paid for carrying out the operations.

The scale of this third item is probably the most important issue at stake. It is difficult to calculate on the basis of the information released, but Sedif says that the cost to households will be 14% less if the Est Ensemble opts out, and 20% less if the Est Ensemble stays in. It is a fantastic reduction in tariff (as long as the Est Ensemble stays in). No public water utility in the world has ever delivered such a large cut in the cost of service through more efficient water operations.

Although this might seem like the profit is being squeezed out of Veolia, the details of the deal actually underscore the long-term potential of Veolia’s model. If the best SEDIF had been able to squeeze out of Veolia was a 10% reduction, it would imply that Veolia had not been able to get much value out of the business in the two decades since the last informal bid process in 1987/8.

The whole performance of outsourced private water operations would not be living up to its promise of delivering significant efficiency savings to its customers. The fact customers may end up paying 20% less is the best proof that outsourced utility operations have a great future.

That is not to say that losing the revenue won’t hurt in the short term, or that it will be easy for Veolia to make up for the shortfall by winning other long-term contracts in the near future. It does mean that in 10 or 20 years’ time, Veolia’s market share of the global water business will be significantly greater than it is today.

The challenge for Veolia is to find shareholders who understand the strength of this long-term proposition, despite the short-term setbacks that contract renewals entail.