by Stephen J. Hoffmann
In my last column, the question was presented as to whether consolidation represents a crucial turning point for the industry - a watershed moment - or whether it’s driving speculation - a bubble. This column removes any normative language from the conversation (i.e., what should be) and focuses on the reality of consolidation/takeover activity (i.e., what is).
After the largely unsuccessful privatization-driven wave of water utility acquisitions by global utility conglomerates, recent utility acquisitions have been driven by private investors. For example, AWG plc (Anglian) is being acquired by a venture capital firm and several pension funds. Macquarie Bank, an Australasian investor in global infrastructure assets, recently purchased Thames Water (owned by RWE) and Aquarion (Kelda’s U.S. water business). The CEO of Kelda summed up the current divestiture logic: “Given the current high valuation of U.S. water businesses and therefore limited opportunities for acquisition without further major investment, [it’s in our best interest] to exit the U.S.” The logic of the acquirers remains a mystery.
The growing disconnect in the valuation of public water companies will likely concentrate private equity investment in smaller management-owned industrial water companies. At the same time, the abundance of strategic acquisitions of public water companies has created a mark-to-market mentality among private owners. Whether this becomes a deterrent to private equity houses remains to be seen. In response, these investors are adjusting their traditional models to accommodate a more forward-looking approach; platform and build-up strategies.
This approach plays to the strengths of private equity - acceleration of change, governance and integration. As long as the Federal Reserve orchestrates cheap money, expect to see more private equity activity in water. Strategic industrial acquisitions will continue as well. Aside from household names like GE, ITT and Siemens, one doesn’t have to look far to see other major industrial companies are entering the fray. Ashland Chemical is rapidly redeploying its hoard of capital from the sale of its refining and paving businesses into water. Dow Chemical has combined its water operations into a single unit and has publicly stated it expects to grow it from $350 million to $1 billion within the next ‘few’ years; that isn’t a recipe for organic growth.
Some less than obvious consolidators include the Home Depot, Emerson Electric and Group Laperrier & Verreault; and foreign companies such as Ebara, ARCADIS NV, Impregilo Group and Nitto Denko, which owns Hydranautics. Private equity is likely to increasingly compete with industrial companies for large, visible water targets worldwide.
With global GDP expected to grow 4.7% in 2007, U.S. GDP to fall to 3.3% and the water industry growing at a brisk 10% pace worldwide, it’s not difficult to predict the flow of investment funds. But it’s critical that a reasoned approach to water industry investment takes precedence over purely financial transactions. And there seems to be the perception among large industrial companies that water markets can be an adjunct to existing operations; either because of a common client or application of existing core capabilities to water. To the extent that most water acquisitions have yet to enhance value to shareholders, the bet is on private equity in 2007 and beyond.
About the Author: Steve Hoffmann, managing director of WaterTech Capital LLC, is a cofounder of Palisades Water Index Associates LLC, founder of TheWaterInvestor.com and managing partner of Water Partners III, a private equity fund focused on water investments. Contact: 469-585-4875 or [email protected]
