Acquisition and valuation trends in US water

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Recent transactions in the US water industry.

The M&A scene in America is changing. Diversified industrials and private equity are the new buyers while valuations have become more realistic following the high point of the late 1990s, says Steve Maxwell*.

Over the past decade, the US water industry has seen an increasing level of consolidation and a dramatic rearrangement of ownership. For many years, European players, primarily the French and British water companies, were the most active buyers \'their eyes clearly focused on what they believed would be a rapid shift towards privatisation of the vast municipal water and wastewater infrastructure in the US.

Beginning with Vivendi\'s purchase of US Filter in 1999, an acquisition hysteria developed, with the European firms battling each other to acquire water utilities, equipment manufacturers, chemical suppliers and others players in the business.

Prices were driven sky high, with several of the larger US private utilities selling out at valuations in excess of five times annual revenues, or as high as 15 to 20 times annual EBITDA (operating cash flow). This frenzy to establish a position in the US water market lasted the best part of five years and changed the competitive structure and face of the
industry.

However, by the middle of 2003, the situation was starting to reverse itself. The British and French companies, which led the original invasion of the US water industry, reconsidered their strategy and started to divest some of their hard-earned and high-priced water assets.

In September, Suez announced that it was selling its Nalco water treatment unit to a group of private equity investors for .2 billion \'roughly the same price for which it had acquired the business four years earlier.

In announcing this deal, the company cited a narrowing strategic focus and the need of the parent organisation to reduce its debt. Only weeks later, Veolia¡¯s US Filter unit announced plans to sell off many of the businesses it had acquired through the 1990s \'including its equipment and systems business, as well as its Culligan and Everpure
filtration businesses.

Veolia cited similar considerations to Suez \'the need for reduction of high debt at the parent company level, and a further strategic concentration on its historical core business.

Elsewhere, and on a somewhat smaller scale, RWE Thames Water (the parent of American Water Works) began the sale of its US equipment businesses, and Nuon, the Dutch utility which had also joined the water expansion fray, sold its Norit businesses back to private interests in the Netherlands.

American story
In retrospect, the ill-fated adventures of many of these firms in the US market can be summarised as follows:


  • In the mid-1990s, it was recognised that the US was by far the world\'s largest water market and that it was also still operating mostly under public control. Foreign water companies assumed that as water resource and funding issues became more critical, much of the US water industry would rapidly privatise, creating a huge market opportunity.

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  • Since the US had few privately-owned utilities upon which to build a North American foundation (a key difference between the US and France or the UK), foreign buyers had to acquire other types of water companies \'chemicals companies, equipment manufacturers and the like.

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  • Over the intervening years, the pace of privatisation has tended to slow rather than increase. Powerful political forces have risen up against privatisation, major projects have gone poorly or failed and the fears generated by impending privatisation have forced greater efficiency at many public authorities anyway \'a kind of de facto privatisation. Although the drivers are still strong, most observers now expect a smaller percentage of the total US industry to turn to private operation.

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  • Most of the foreign water services companies have come to the conclusion that they should refocus on their historical core competence in contract operating services; the equipment and chemicals businesses they acquired to build a foothold in the US are not really relevant to their objectives in the contract services market and may even be a hindrance.


In the place of these European purchasers, several American manufacturing conglomerates are emerging as the new buyers in this field \'and it appears that a greater number of such companies are likely to join the business as it matures and settles down to more reasonable valuations.

The table on the previous page highlights several of the major transactions in the US water industry over the past three years and dramatically demonstrates the high valuations which buyers are still willing to pay to gain a foothold in this industry.

Within this table are the names of many of the companies likely to be significant players in the future of the North American water industry.

While the days of the five to six times revenue multiples are gone, the right-hand column clearly demonstrates that the values in this sector remain fairly high relative to other industries.

However, most observers believe that valuations will gradually come down to a more reasonable and sustainable level.

The new buyers
In early May, Veolia announced the longawaited sale of its US Filter equipment business to Germany\'s Siemens (see GWI, May 2004, p18). This deal was transacted at a value of a little less than one times the annual revenue of the equipment businesses \'considerably lower than many other recent transactions.

Specific earnings figures for US Filter were not publicly available, although evidence from Veolia Environnement financial reports, and speculation among industry observers, suggests that the unit was not highly profitable \'and that the estimated EBITDA multiple might be somewhere in the low- to mid-teens.

This deal clearly establishes Siemens as one of the key international players in the water business and immediately positions the company for another competitive battle against General Electric in the global market.

Big appetites
The largest of the new US buyers, General Electric, is attracting the most attention from competitors and from potential sellers within the industry. Following the acquisition of several companies over the past few years (Betz, Osmonics and Glegg Water Conditioning being the three primary deals), GE has quickly risen to prominence in the water industry.

Although the company has not made a major acquisition over the past 12 months and still generates only .5 billion in revenues, its potentially dominant financial capabilities and its apparent strategic appetite suggest that it will be one of the major players in this business in the future. General Electric\'s CEO has declared that water is one of the primary growth areas for the company as a whole.

Pentair Corporation, another major diversified US company, continues to be an active buyer and builder in the water industry, having made a dozen acquisitions since 1995.

Besides the recent acquisition of Everpure, Pentair also bought WICOR, a producer of water systems, filtration products and swimming pool products and services. At the same time, Pentair announced the potential divestiture of some of its other non-water related businesses, culminating in a dramatic strategic repositioning of the firm into more of a pure water company \'the company now has more than billion in water revenues.

A third major US-based acquirer ITT Industries is also maintaining a rapid pace of expansion in the industry, having bought numerous smaller players over the past few years including, most recently, German UV treatment technology company Wedeco. ITT\'s water business also generates in the region of billion in revenues a year.

Smaller players
At a smaller scale, the same phenomenon is also evident. Earlier this year, Ionics completed the acquisition of Ecolochem, a water treatment company which offers services to the power and petrochemical industries.

Calgon Carbon, long a fixture in the US water industry, snapped up the remaining assets of the unsuccessful Waterlink consolidation experiment \'the Barneby and Sutcliffe carbon business.

And consolidation activity has by no means been restricted to the equipment and service sectors of the water industry; the water utility industry also continues to undergo some further consolidation.

The primary player here, Aqua America \'formerly Philadelphia Suburban Corporation \'continues an aggressive strategy of small regional acquisitions.

Predicting the future
With so many major transactions going on in such a short time period, the longer-term competitive situation in the water industry is difficult to predict.

Many new companies \'whose names were not even mentioned three years ago\' have emerged as significant players and it seems likely that we will see more new names entering the field in the future.

Several questions remain: Is bigger really better in the water industry? Some companies say yes, pointing out the huge financial commitments required to win large-scale water or wastewater operating contracts and the advantages to customers of ¡°one-stop shopping¡±. However, many of those same companies are now shedding assets and focusing on their more traditional niches.

How and when will this ongoing ownership rearrangement settle down into a more stable and predictable situation? And in the meantime, what will be the effects on shareholders, employees and customers?

Will private equity remain a significant ownership force in the water business, or is this a short-lived phenomenon?

Will we see another cycle of change and disruption in a few years when firms backed by private equity start to turn over ownership again?

Two things about the US water sector seem certain. First, the turmoil and rearrangement of the industry seems likely to continue for at least several more years \'change will be constant.

And second, well-managed companies, both large and small, involved in any aspect of collecting, treating, monitoring and distributing clean water will experience continuing growth and increasing demand for their services.