Cash flowing in the water industry

While utilities and water treatment are yielding great returns for investors in the water sector today, a new wave of innovation is likely to return good profits over the next few years, industry watchers say. 

"Everything from next generation desalination technologies, to new innovative ways to implement reuse in closed-end systems," said David Henderson, managing director of Toronto's XPV Capital, in the Cleantech Group's water investing webinar yesterday (see The quiet profits being made in water today).

XPV invests exclusively in the water industry, with stakes in Toronto cooling tower water treatment company EnviroTower, and residential water purification systems maker Pionetics, based in San Carlos, Calif.

Henderson said water scarcity and security will also be big issues.

"There's going to be some very interesting opportunities in terms of being able to asses, analyze, address a problem, and then treat it, all automatically," said Henderson.

"I think you're going to see a huge wave of new companies that are going to come to the public markets and eventually be acquired by some of these big companies over the next five, ten years."

One company that was already gobbled up is Zenon Environmental, an Oakville, Ontario, maker of advanced membranes for water purification and wastewater treatment. Fairfield, Conn.-based General Electric (NYSE: GE) acquired Zenon last year for $656 million in an all-cash transaction, close to three times Zenon's annual revenue.

"It's a combination of the attractiveness of those revenue streams, and is there intellectual property involved in terms of its sustainable value. In Zenon's case it had very strong intellectual property," said Henderson.

Water utilities are also doing quite well, with Brazil's SABESP (NYSE: SBS) seeing its stock rise by 40 percent over the past six months, and 356 percent over the past three years.

EnviroTower, founded in 2004, says it's having no trouble finding customers.

"In many instances now, they're calling us," said J. Chris McFarlane, CFO of EnviroTower. "In recent weeks, we were approached by a large hotel chain, to consider deploying the system within their 300 or so company owned properties."

EnviroTower said it's installed over 50,000 of its physical water conditioners worldwide.

The company's electrostatic conditioner, paired with a separator, replaces the bulk of chemicals used in most cooling towers today to prevent scale and rust.

EnviroTower does use a trace amount of zinc and iodine in its mineralator to provide protection against any residual or chance bacterial contamination, and that has created some bumps in the road in its home country.

"In Canada, to offer the full system, where we would manage algae in particular, a biological challenge is we do need to have a regulator approve it. In the United States, we have the regulations in place to allow us to roll out the system in it entirety," said McFarlane.

He pointed out that the heart of the system, the conditioner, can go out globally without any change in regulations.

XPV said it looks for companies like EnviroTower that need up to $10 million in capital, and Henderson said there are plenty of opportunities in that range.

"A lot of people ask us, 'Is water going to be too capital intensive?' And certainly there's, because of the industrial nature of water, there potentially is more capital needed, but there's alternative sources for that capital, which means you can still make the kind of equity returns that we're all hoping to achieve," he said.

He said XPV has seen cases where for less than $10 million to $20 million in capital, "you're going to go all the way."

One of the biggest uses of capital in the water industry is for infrastructure, but Henderson said he sees the industry moving toward more of a mix of investment sources to cover the different stages of development.

"If you take renewables, for instance, solar and wind, you have a blend of different types of capital being invested. Everything from venture in the early days of setting up the projects, to project financing and debt financing to build out the wind towers or the solar fields."

There have been some wipeouts on the water scene, as with the postponed initial public offering from American Water Works. It was set to go public this quarter with a $1.5 billion share sale, but was shelved indefinitely this month due to unfavorable market conditions (see American Water IPO put on the backburner).

But the future still holds great potential, as the problems with water are not going to go away anytime soon.

"We're seeing a growing appetite for these technologies as new regulations and the scarcity and quality issues grow," said Henderson.