Making It Rain: How Private Investors Are Turning To Water For Outsized Returns
06.20.14
Features

Although seemingly abundant and available for some, water scarcity is increasing at an alarming rate and has become a focal point for both the public and private sector. Heavy industrial production combined with the increased demands from a rising population have led to questions of how governments and corporations will be able to ensure adequate water supply in future years. Leading minds from organizations such as Shell, Coca Cola, Unilever, IBM, HSBC, Deutsche Bank, The Nature Conservancy, and others are working together to research, develop and test new technologies and operational improvements to reduce our generation’s water footprint. Improved water efficiency, like improved energy efficiency, helps governments maintain political stability, helps businesses reduce operating expenses and helps consumers reduce daily living costs. With the sweeping implications of water on our society, investors have begun to place their bets on how to play the sector in areas such as water infrastructure, water treatment and water-related manufacturing.

The challenge facing the water industry is an impressive one. According to the OECD Environmental Outlook to 2050, global water demand will rise over 50% through 2050; this will cause 40% of the world’s population to experience some type of water shortage during this same time period. The Environmental Protection Agency estimates that 36 states in the US are dealing with local or regional water shortages. Additionally, the states that report increasing population also highlight growing per capita water usage. This swelling demand for water has been accompanied by a gradual reduction in supply exacerbated by the country’s aging water infrastructure.

Much of the country’s water-related infrastructure was built in a pre-war era and is now showing signs of heavy wear and tear. Equipment and pipelines are in dire need of replacement. The 2012 American Water Works report noted that US water infrastructure breaks down once every minute, which equates to 540,000 breakages each year. Moreover, this aged infrastructure leads to about six billion gallons of fresh water lost to leaks per day.

While water utilities were historically financed entirely by municipal bonds, there is significant doubt that municipal bond issuances will continue to cover the capital required for associated infrastructure rebuilds, and key municipal leaders are thus focusing on private investors. It is anticipated that approximately $1 trillion will be needed in U.S. water infrastructure investment over the next two decades. The average U.S. household in large metropolitan areas could see water bills triple to help chip in (the average US consumer pays close to $3.75 for 1000 gallons of water, amongst the cheapest in the world), but a vast funding gap would still exist and therein lies an opportunity for private investors.

According to the EPA, out of the U.S.’s 51,592 community water systems, 24,290 are privately owned, 1,343 have shared ownership, and most others are owned by the local municipalities. These municipalities are looking to privatization as a means to eliminate water-related losses from their financial records. Private companies with backing from private investors have the opportunity to acquire water systems at reduced multiples, consolidate operations to produce economies of scale, and bring in experienced executives to build robust organizations. Private equity firms have been selectively investing in these types of opportunities over the past several years, such as Table Rock Capital’s investment in Rialto, a California water and sewer system privatization, and KKR’s investment in New Jersey’s Bayonne Municipal Utilities Authority.

Within water-facing sectors, wastewater management is perhaps one of the fastest growing segments of the industry. It has received increase attention as of late due to the vast improvements being developed by leading companies. In the US, less than four percent of treated wastewater is actually used by an end consumer, and companies such as Organica Water and Envirogen are providing innovative technology and services to help move the needle. Organica Water, founded in 1998, has developed a unique approach to solving urban water challenges across the world in a cost and resource-efficient manner, and it is experiencing accelerating demand from clientele. In the last few years, Organica has acquired 15 contracts in France alone. It raised investment in Series B financing from International Finance Corporation, who was joined by WLR China Energy Infrastructure Fund.

Meanwhile, Envirogen offers a broad range of treatment and process-related applications for both industrial and non-industrial customers. With locations in both Europe and the United States, the company serves a market in excess of $100 billion worldwide. However, in spite of the growing volume of investment in wastewater management, industry funding needs are largely unmet. The U.S. Environmental Protection Agency (EPA) reports that wastewater companies will require an investment of $300 billion in the next two decades.

Other players in the water ecosystem who also stand to benefit significantly are a variety of manufacturers. The continued upswing in the water replacement cycle benefits those manufacturers providing machinery and parts for the industry. Specifically, firms manufacturing pumps, pipes, flow control units, metering systems, filtration devices, and other distribution infrastructure items will experience increased demand for their products. Moreover, they will be viewed as attractive acquisition targets given the synergies derived from vertical integration. In particular, manufacturers seeking to grow from a single product firm to a full systems provider will be aggressive in acquiring complementary product and services companies to enable an expanded offering to existing clients.

For example, companies such as Xylem and GE have grown through strategic acquisitions in recent years. Xylem, a water infrastructure company, announced a series of acquisitions including OI Analytical, YSI and MJK Automation. Smaller companies like Black Bison Water services have taken up this means to expand as well. Black Bison recently completed its second acquisition of a salt water disposal property. The deal was financed with funds from a mortgage facility provided by CorEnergy Infrastructure.

In this transformative era for the water sector, private investment plays an important role to catalyze the development of new technologies and support the expansion, acquisition and reorganization efforts of the various players that make up the industry. In water, we will continue to see an industry undergoing significant macro and micro changes. For investors, staying informed and connected with participants in the sector can yield high return opportunities.

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