Christopher Gasson looks at the implications of this month’s two big deals.
There have been two big transactions this month involving valve manufacturers: the IPO of Rexnord and the merger of Pentair and Tyco Flow Control. Both have been broadly welcomed by the markets: Rexnord gained 19% in early trading while Pentair rose 15% after the deal was announced.
It is interesting to think what the positive reception of these two transactions means to the water industry. I would argue that the success of the two companies is going to be essential if our industry is to repair the damage to its reputation caused by the reported disappointment that GE and Siemens have experienced in the water sector.
Rexnord, Tyco and Pentair are all reformed industrial conglomerates. Though very much smaller than GE and Siemens, they have a similar mindset. They own portfolios of operating companies which they reposition over time to ensure that they can offer their shareholders a rate of growth which is better than the market as a whole. All five of these companies have, over the past decade, selected water as a sector which offers good long-term prospects, and set up divisions which focus on water. GE and Siemens are more involved on the treatment technology side, while Pentair, Tyco and Rexnord are more involved in pumps, valves and other infrastructure equipment (although Pentair’s portfolio includes X-Flow membranes and swimming pool accessories).
Neither GE nor Siemens has been entirely happy with the profitability or the growth rate of their water businesses, and this discomfiture, though rarely voiced on the record, has cast a shadow over the sector. There is a widespread feeling in the industry that GE and Siemens are more likely to want to sell some of their water assets than to add significantly to their portfolios. This weighs down on valuations in the sector, and it is a real worry for investors in early-stage water technologies. If the industry leaders aren’t hungry to buy new water technology assets, then why should private equity investors bother growing them in the first place?
The Pentair-Tyco Flow merger and the IPO of Rexnord illustrate that there are at least three other well funded companies (including Xylem, which spun off from ITT last year) which are hungry for water assets, and have no complaints about either the growth rate or the profitability of the industry. They may be predominantly involved in the infrastructure equipment sector, but it is inevitable that in the long run they will diversify into the broader water technology sector. Pentair has already done so with its acquisition of X-Flow last year, while Xylem has been steadily diversifying beyond its core pumps business for many years.
Both Rexnord and Pentair should be able to show good earnings growth over the next two years. There are plenty of synergies to be had from merging Pentair with Tyco Flow Control – the management promises that one third of them will be available from day one. Rexnord offers a subtler proposition. It will remain highly levered after the IPO (see story p8), which means that small improvements in the top line will deliver much larger improvements in the bottom line. Both companies should benefit disproportionately from a recovery in the US. They are also well positioned in China, where they have established high-end brands in the local market, as well as manufacturing capability to supply the international market.
There has been a huge increase in interest in venture capital investment in water technology over the past five years. After the dot.com bubble burst, and global warming because a major international concern, large quantities of venture capital funding switched to the clean tech sector, and as that sector has become overvalued and the challenges facing the water sector have become more widely publicised, so the interest of clean tech investors in the water sector has risen. To date, however, relatively few have been prepared to take the plunge. This must in some ways be due to the lack of clarity in terms of the exit. With the IPO of Rexnord, the merger of Pentair and Tyco Flow, the spin-off of Xylem, and the resurgence of Veolia with a new emphasis on technology, the exit routes for investors in earlier-stage water technology companies are becoming clearer. It is good news for us all.