By Stephen J. Hoffmann
Consolidation in the water industry is not a new phenomenon. An ultra-fragmented market worth over $400 billion is the epitome of a consolidation play. A recent report in Barron's just added fuel to the consolidation fire and identified several potential takeover targets such as Aqua America, Pentair and Watts Water. Water has become an investment category, elevated almost to the status of an asset class. There's a tremendous amount of capital with enormous pressure to invest, chasing a limited number of suitable deals. With respect to the historically staid water "industry," does this uncharacteristic visibility represent a watershed development stage in the business or a water bubble?
While the simplest of chemical compounds, water is politically, economically and technologically one of the most complicated of our essential resources. What's not complicated is the rationale behind investor interest. Virtually every country on the planet is experiencing some combination of water quantity or quality issues – supply and demand. From a purely economic perspective, it's unequivocal that massive amounts of capital will be required to resolve the global challenges. Water companies stand to benefit from the financial forces currently allocating capital to the business – that's the watershed argument. Whether it's an efficient allocation remains to be seen.
Consolidators seek to purchase companies in fragmented industries for a variety of reasons, including: deregulation, access to new markets, penetration of existing markets, acquisition of new products/technology, economies of scale, reduction of competition, removal of excess capacity, or as a platform for any of the above. But while the frenzy in the water business is often couched in these terms, value creation inherent in the process seems to be lacking. This is combined with a large, and growing, disconnect in the valuation of water companies.
The abundance of strategic acquisitions, mainly of public water companies, has created a mark-to-market mentality among private owners. And it's highly likely certain financial buyers will bid up multiples even farther. This has left traditional private equity firms waiting at the altar as they struggle to reconcile investment models with reality of the marketplace. The myriad of participants belies the logic behind typical industry consolidation. Nonetheless, takeovers, mergers and buyouts will continue. And given the acquisitive demand by large industrials, it's inevitable hedge funds will seize upon market opportunities – the bubble argument.
When the various reasons for consolidation of the water industry are scrutinized, it's clear deregulation won't be among the immediate factors. That leaves the rationale to straightforward regulatory and economic elements within the municipal segment and structural forces within the industrial segment. Again the question: Does "consolidation" represent a watershed opportunity for the business and a windfall for private industrial water companies or a water bubble just waiting to burst under the pressure of too much capital seeking an unrealistic return.
And while we're talking potential takeovers, let's add Badger Meter, Met-Pro, Calgon Carbon and Gorman-Rupp to the list; all for different reasons. The next column will hone in on the likely acquirers of industrial water companies and explore the factors by which potential targets are likely to be judged.
About the Author: Steve Hoffmann is managing director of WaterTech Capital LLC, a co-founder of the Palisades Water Index, founder of TheWaterInvestor.com and managing partner of Water Partners III, a private equity fund focused exclusively on water investments. Contact: 469-585-4875 or [email protected]
