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The desperate search for long-term yield can lead you down strange pathways. For Borealis – the infrastructure arm of Toronto-based pension fund OMERS – sewers and leaking pipes are a good place to bet the pensions of Ontario's civil servants. On Monday, Severn Trent, a water utilty that serves 3.7 million customers in the English Midlands, said it had received a bid approach from a consortium led by Borealis and including Kuwait Investment Office and the U.K.'s Universities Superannuation Fund.
The tentative offer has already boosted the stock market value of the Coventry-based water company by £1-billion ($1.55-billion) but Severn Trent has rebuffed Borealis' suggested price, said to be "only a modest premium" to the value before news of the bid sent the shares soaring. At this level, the consortium would have to pay in excess of £5-billion to acquire Severn Trent and a valuation significantly higher than rival U.K. quoted utilities. Borealis is looking at some very dear drains, and is also contemplating regulatory risk: Severn Trent is currently three years into the U.K. water regulator's quinquennial price review. So, there is the possibility that the investor consortium will be facing a revenue squeeze within a year of acquisition.
Still, it seems to be attractive to Borealis and the simple reason is dividend. Because central banks are conducting a Dutch auction with interest rates, the usual investment choices for pension funds are not delivering enough yield to match the cash needs of the maturing funds. Wherever you look, government bonds yield less than 2 per cent, and that makes businesses like Severn Trent look attractive, even after a takeover premium. At the current bid-inflated share price, Severn's historic yield is 3.5 per cent and, unlike bond coupons, dividends have the potential to increase.
These utilities offer cash flows almost as secure as Treasuries and better than some government bonds. Even if it fails to capture the water company, OMERS could do worse than fill its boots with U.K. commercial property. The yields on prime London commercial real estate are about 6 per cent, three times the level of 10-year gilts, and if the loose money policy sparks rampant inflation, property is probably a good place to be.
Carl Mortished is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights.
Carl Mortished