Strange things are afoot in the Devonshire village of Bodham near Dartmoor. Poor and homeless children are vanishing from the docks, and fisherman Ben Tolliver is attacked by a sea monster while peering over the side of his boat at a wheel of underwater lights. Meanwhile, Roger Bridewell invites his friend Colonel Edmund Ross to Fulbright Hall, the home of his fiancée Alice and her father Sir Edward; however, Sir Edward distrusts the secretive Ross and his vulgar manservant Abercrombie, and suspects that they are not all that they seem. For now, though, he has more immediate concerns; something has been stalking and killing his ponies, and when he and his visitors hear the baying of an enormous hound out on the moors, Ross insists upon leading an expedition to find and kill the beast.

The Doctor offers to take Sarah anywhere in the Universe, and she chooses to meet her favourite author, Rudyard Kipling. The Doctor, however, miscalculates slightly and ends up on Dartmoor, where he and Susan encounter an enormous hound the size of a horse. It retreats without attacking them, and the Doctor points out to the shaken Sarah that it appeared intelligent -- and seemed to possess a rudimentary opposable thumb. He and Sarah then encounter Sir Edward’s hunting party, and when they claim to be lost, Sir Edward directs them back to Fulbright Hall to explain themselves to Sir Alexander Cromwell, the chief constable. On their way back they meet three teenage boys who have slipped away from the local boarding school, partly for an illicit smoke and partly to search for their missing friend Josh Andrews. The boys are smitten with Sarah, who is more than a little irritated with the Doctor when she realises that one of the boys is the young Rudyard Kipling.

The Doctor and Sarah reach Fulbright Hall, just as a villager arrives to report that Ben Tolliver’s boat has drifted back to the docks with only half of Ben Tolliver aboard. Sir Edward’s hunting party returns empty-handed, but the Doctor impresses Sir Edward with his keen intelligence, and convinces him to try to capture the monster alive. Ross, however, seems determined for some reason to see the beast killed. Sir Edward puts the Doctor and Sarah up for the night, and the next morning, the Doctor visits the village to investigate Tolliver’s death. The autopsy is conducted by young Arthur Conan Doyle, the medic from the whaling ship Hope, which has stopped off in Bodham on its way back to its home port. Doyle and the Doctor determine from the injuries that Tolliver was attacked by at least two seal-like creatures while peering over the side of the boat -- but why was he doing so and exactly what was it that attacked him?

Sarah is reunited with Kipling and his friends, and agrees to help them search for Josh, who went missing after they bragged about their own exploits with women and sent him to the local barmaid, Jen Anders. He never got to her, but Jen advises Sarah to ask the wharf rat Billy about other disappearances. The suspicious Billy directs Sarah to the local factory, which is owned by a man named Breckinridge; Sarah doesn’t get past the guards, but Billy has been watching her and now believes that she is genuinely interested in helping. He agrees to let her know if he learns anything more. Meanwhile, Cromwell is called out to the local cemetery, and the Doctor and Doyle accompany him to find that someone has made off with a corpse. The Doctor wonders if the Hope’s unscheduled stopover is related to these odd events, and accompanies Doyle back to the ship to question Captain Grey; instead, they find Abercrombie rifling the captain’s cabin. He flees before they can confront him, but he has left the captain’s log open, and the Doctor and Doyle see that Grey has a meeting scheduled with Breckinridge -- and Ross.

Alice overhears Ross ordering Abercrombie, the best burglar in the West End, to search the Hall for anything of value. Upset, she confronts Bridewell, convinced that his “friend” is planning to rob them. He assures her that Ross can be trusted, but as he speaks with Ross privately, urging him to come clean, Alice takes matters into her own hands and tries to search Ross’ possessions -- only to trigger a poison dart trap which knocks her out. Realising that he will never be able to explain his actions and that he has been investigating the wrong person all along, Ross clears out, intending to stake out the moors and kill his target that night.

Night falls, and the Doctor, Doyle and Sarah accompany Sir Edward on another hunt. This time they successfully locate the hound, but while it is clearly confused, hungry and desperate, it does not attack. The Doctor tries to communicate with it, but just as it seems that he is getting somewhere, Ross appears from hiding and kills the hound with a long-range, silenced air rifle. He flees before the others can capture him, and the furious Doctor has the hound’s body taken back to Fulbright Hall -- where he and Doyle discover that the “hound” was not an animal, but a horrifically mutated ten-year-old boy. Meanwhile, Cromwell convinces Breckinridge to give Sarah a tour of his factory, and although she disagrees vehemently with the industrialist on the subject of child labour, she is nevertheless impressed by his progressive views and forward thinking. He has already fitted out his factory with electric lights, and he claims to have met Grey to discuss using the Hope to lay cable across the Atlantic Ocean. Sarah departs, unsatisfied; Breckinridge is a farsighted, intelligent man with enlightened views on whaling and the uses of technology -- so why doesn’t he appear in any of her history books?

The Doctor decides to take a boat out to investigate Tolliver’s death, and Doyle and Sarah agree to accompany him. Doyle borrows a harpoon from the Hope, and takes the opportunity to ask Grey about his meeting with Breckinridge. Grey refuses to discuss it, claiming that Breckinridge was worried about the possibility of industrial espionage -- but he does let slip that it had nothing to do with laying cables. That night, the Doctor, Doyle and Sarah head out into the bay, where they see the underwater wheel of lights and are attacked by the same creatures that killed Tolliver. Sarah is knocked overboard, but as her heavy Victorian skirt starts to drag her down she is unexpectedly cut free by what appears to be a mermaid. Doyle kills one of the attacking creatures with his harpoon, but the others sever the rope with their teeth to prevent him from taking the body for examination. The Doctor pulls Sarah out of the water, and they return to shore, having confirmed to their own satisfaction that someone is using impossibly advanced technology to tamper with the course of evolution.

The mermaid, Lucy, returns to the slave pens beneath the bay, where she and the other missing children now live and work. The seal-like Guards continue to prevent their escape, and are particularly angry now that one of their own kind has been killed. Lucy, the oldest of the merchildren, soothes the others to sleep by once again telling the story of how she ended up here. She used to live on the shore with an abusive man named Colley, until she saw him murdered by two of his criminal acquaintances. To keep her silent, the two thugs took her to an underground laboratory, where a man named Ross used a “medicine” he had discovered to merge her body with an essence he had extracted from the body of a dolphin. As the first and oldest of the merchildren, Lucy feels a responsibility to look after the others, and although there are now twenty of the merchildren and only three of the Guards, she still refuses to act against their vicious captors until she feels the time is right.

While Sarah recovers at Fulbright Hall, the Doctor and Doyle visit Breckinridge’s factory. Breckinridge himself is not present, and the Doctor and Doyle thus bluff their way in, claiming to be government inspectors. While Doyle distracts the flustered foreman, the Doctor spots a hidden floor panel and detects the scent of formaldehyde -- needless in a cable-manufacturing factory, but useful for preserving body parts. He also notes that Breckinridge’s office looks out over the bay; if he works late nights as any self-made man should, then why hasn’t he reported seeing the circle of lights? He and Doyle depart, convinced that Breckinridge is involved in what is happening. Meanwhile, Sarah ignores the Doctor’s and Alice’s advice and leaves Fulbright Hall to stake out the cemetery and see if the grave robbers return for Tolliver’s body. Kipling spots her and accompanies her, hoping to impress her, but they are both captured by the grave-robbers -- the same two men who kidnapped Lucy. Billy has been keeping an eye on them, however, and he returns to the village to warn the Doctor and Doyle of Sarah’s predicament.

The Doctor sends Billy to Fulbright Hall to fetch help while he and Doyle return to the factory. On their way, they find Ross and Abercrombie heading in the same direction, and the Doctor demands an explanation. Ross admits that he is a secret agent for the British government, with a mandate to investigate matters that fall outside the purview of normal intelligence work -- and that his own brother, Percival Ross, is responsible for the events that they have witnessed here. Some time ago, Ross learned that Percival had found a means of hybridizing species, and he set about destroying his brother’s evil work. Tales of a monstrous hound on the moors led him to Bodham, where Breckinridge and Sir Edward had the money and influence to fund Percival’s experiments. Ross chose to investigate Sir Edward first, but now knows that he chose the wrong man. He knows little of Percival’s discovery, only that he can somehow use animal tissue to alter human children into hybrids, and human tissue to augment the natural abilities of animals. This explains Breckinridge’s attempt to buy supplies from the whaling ship, and the theft of corpses from the cemetery. And since Sarah is too old to survive the hybridisation process, Percival must intend to kill her…

Breckinridge’s thugs take Sarah to Percival, who explains that he witnessed the crash of an alien spaceship in Limehouse some time ago. Rather than help the amorphous alien within, he stole its healing gel and left it to die. When he tested the gel on a boy who had been bitten by a rabid dog, the gel somehow caused the boy’s and dog’s cells to merge together and created a viable hybrid. Percival was forced to flee London when his brother exposed his attempts to fund his work through counterfeiting, but he has found a new patron in Breckinridge, and with his help Percival has created a wholly viable new race of merpeople as well as the augmented seal servants which act as their guards.

The Doctor, Doyle, Ross and Abercrombie break into the factory only to be captured by Breckinridge and his thugs. Breckinridge takes them to Percival’s laboratory, where the Doctor identifies the gel as a Rutan healing salve; since Rutan tissue is amorphous, the gel must analyse the cell structure of whatever it is applied to before setting to work, and when compatible types of tissue are mixed together the gel combines them into a single organism. Breckinridge intends to use it to create a new race of slaves and employ them to lay cable beneath the ocean. Stung by the Doctor’s contempt, Breckinridge takes his prisoners to an observation gallery to show them the merchildren. Josh Anders is one of them, having stumbled across the grave-robbers as they delivered illicit supplies to the factory, but the other children were kidnapped from the docks, and thus, according to Breckinridge, would have lived wasted and pointless lives had he not intervened. The wheel of lights is the training ground on which they have been taught to lay electrical cable beneath the waves; through his slaves, he will control the oceans.

Sarah, furious, informs Breckinridge that Kipling will make a bigger name for himself than Breckinridge ever will -- and to prove her wrong, the equally furious Breckinridge orders Percival to transform Kipling into a merchild, although he may be too old to survive the process. Josh, however, sees his friend’s predicament through the viewing window, and furiously attacks his Guard, taking it entirely by surprise. The other children rush their Guards, overpower them by force of numbers and kill them. The Doctor and Ross take advantage of the distraction to attack their captors, but while they are fighting a stray bullet cracks the gallery window. The Doctor and his friends flee, and when Breckinridge sets a pack of augmented dogs on them, the vicious dogs turn on him first, tearing him apart. Percival, wounded in the fighting, flees back to his laboratory and plunges his hands into the healing gel -- just as the window cracks open and the sub-basement is flooded.

Billy alerts Sir Edward and Cromwell, who arrive with reinforcements just in time to save the Doctor and his friends from the mutant dogs. Breckinridge and Percival’s plans have been foiled, and there remains only the problem of the merchildren. Ross intends to destroy them, but the Doctor instead uses the TARDIS to take them to a water world where they can live out the rest of their lives in freedom.