Innovation Pipeline

Thomas Rooney is a veteran of the water industry and knows all to well the classic problems and new opportunities. He is currently the managing director with RCI, an engineering consultant practice. But in his prior executive position at Insituform, he was privy to the vagaries of the water business. Knowing the pain points for the industry and having a view for where things are headed, we decided to sit down with him and get his perspective on the investment opportunities, the technological innovation and challenges facing both the water utilities and buyers. This interview is an excerpt from a recently published, in-depth investment research report called Water Matters: Venture Investment Opportunities in Innovative Water Technologies by The Artemis Project.

Innovation Pipeline: Based on your experience in the water industry, what do you consider to be the biggest drawbacks for new investors placing investments in water tech sectors?

Thomas Rooney: The biggest drawback is the dearth of pure-play water investments. Many top-tier water players are just a small part of a conglomerate such as GE, Danaher, Siemens or Pentair. There are a handful of pure water, mid-tier players such as Insituform and Mueller, and then a huge drop-off to a highly fragmented level of micro-tier players. The top-tier players can’t really be considered water investments. The mid-tier players are trading at huge multiples to earnings as a result of their scarcity, making them hard to rationalize. That leaves investors with the challenge of scouring over hundreds of small or micro-level water technology companies in order to invest smartly in water. Add to that the fact that this is a truly global market and the new investor needs to scour North America, Europe, and Asia as a minimum. Bottom-line is a dearth of obvious choices, high multiples where it’s obvious, and a great deal of due diligence to find a clean deal at a reasonable multiple.

Another serious drawback to investing in water is the fickle nature of the spending that underlies water. With 50,000+ water “utilities” in the USA alone, you have a highly decentralized, unsophisticated client base making erratic buying and spending decisions. Add to that the fact that spending on aged water systems is rarely seen as politically advantageous and you quickly get spending that at best is reactionary or break-fix, but more often than not spending is only driven by federal mandates, if at all. The bottom-line is that spending on aged water systems is a low-priority discretionary spend of last resort. If public coffers are full the money gets spent, but if times are tough, the spending spigot stops quickly. All of which makes investing in water tricky due to high volatility.

The irony here is that that which makes water tricky to invest in also makes it very lucrative for the smart investor. The smartest investors are the ones who do the due diligence required to spot the small “under-the-radar-screen” technologies and/or companies, invest in them early, grow them to size (often using a platform plus add-on strategy) and then go public or flip them to a strategic buyer. Past examples would be Zenon (now GE Water) or US Filter (now Siemens), while others are in the embryonic stage right now.

IP: In terms of water infrastructure, you mentioned there was a critical need to forge private and public partnerships to provide the investment for infrastructure repair and updating. Can you explain how these infrastructure investments in cities would be good opportunities for investors? And what are the biggest challenges to overcome in making these infrastructure repairs get done?

TR: Public Private Partnerships (aka PPP’s or P3’s) typically include either:
1) Full Privatization,
2) Outsourced Operations & Management or,
3) Performance Contracting.
The water industry (and water users) would benefit enormously from one or all of these forms of public private partnership. Without going into great depth, current water municipalities (50,000+ in the USA) would benefit from private sector knowledge in three basic areas:
1) Operations Management,
2) Financing Long-Term CAPEX, and most importantly
3) Market Pricing.
The water industry is currently run so sub-optimally that enormous value can be added by the private sector. It is in unlocking (and sharing in) all of this value-added through Public Private Partnerships that makes this a good opportunity for investors.

The big caveat here is that PPP’s are gaining acceptance overseas but, for various reasons (unions, political tradition, Enron-CA-Energy), PPPs are not popular in the US market. On the flip-side, there are some great examples of PPP successes overseas. Manila Water (a publicly traded, for-profit company) was very successful privatizing the eastern half of the city of Manila in the Philippines. The UK has privatized much of Britain’s water systems, and the French have enjoyed success with privatized water for decades.

A great deal of money will be made by investors if or when PPPs become common in the US market. The potential gains to water systems (because they are so badly broken) are so substantial that Customers, Utilities and the Private Sector will all share in a win-win-win scenario.

IP: What do you see as the biggest hurdles to overcome?

TR: The biggest challenges to getting this done are essentially all political and stem from one or more experience drivers and belief sets. In the US we have an aversion to privatizing water utilities because we think of water as essentially an unlimited and cost-free (or at the very least a low-cost) public right. We have just come off of a very bad experience with deregulating electricity in California, not to mention the fact that Enron (a private company) profiteered at the expense of the public. And finally, politically powerful labor groups get up in arms as soon as you mention privatization, as they perceive that new operations efficiencies mean job losses.

The final issue is that the truth hurts! When a private sector company gets a chance to fully and honestly assess the current status of an entire water utility they almost always conclude that the system and operations are far worse than anyone had expected, or admitted. The resulting rational, long-term operations/maintenance/investment game plan is simply not politically feasible. No politician is willing to take ownership of the horrible truth that these water systems are failing, appropriate investments have been deferred for 50 years, and water is more expensive than people have been led to believe for generations. In this case, killing the messenger is more politically expedient than dealing with the message! What the messenger would be telling us, at a national level, is that we need to invest between $400-billion and $1-trillion in our water systems over the next 20 years, not to mention that water rates will need to be raised on the order of 500% (not including inflation) over that same period. Numerous studies confirm the order of magnitude of the capital investment required, and places like Europe already pay 3-times what we pay in the USA for water.

IP: How do Public Private Partnerships fit into the picture?

TR: Public Private Partnerships are absolutely necessary to get us up and over this massive dilemma, but it will take years to overcome the political resistance. That said, there will be some earlier successes. Specifically, watch for energy service companies (aka “ESCO”s) to engage this market using performance contracting. I predict that ESCOs will soon discover that failing water infrastructure results in huge energy waste (remember the Water-Energy Nexus). Few if any have picked up on the fact that excess pumping costs (electrical costs) amortized over 20-30 years would cover most (and in some cases all) of the cost to repair leaking pipes. The earliest winners in full privatization are likely to be the big guys like Macquarie or Carlyle who have the fortitude to push through the politics and then the financial savvy to float billions for capex and then sell it off in the form of long-term municipal-grade paper.

IP: How does innovative technology fit into the picture for the next generation water infrastructure? What types of technology are you bullish about - and which ones are long term bets and why?

TR: Innovative technology will play a key role in four distinct areas. 1) Water purification in developing countries. 2) Low energy substitutions/applications all across the water spectrum. 3) Water recycle & re-use technologies. 4) Technologies to reduce or replace water in agricultural irrigation.

Innovative technologies will be critical to water purification in developing countries. Depending on whose statistics you use, between 30 and 50% of the world’s population does not have access to purified drinking water. Depending on where you go, water is either non-existent (vast regions of Africa), not easily accessible (no piping infrastructure exists), or the water is untreated and dangerous to drink. The net effect is that as new economies sprout (most notably in India and China) governments have to wrestle with huge populations screaming for purified water. Building old-fashioned large centralized water/sewer treatment systems is an option, but would entail an extremely costly and monumental effort. Advanced water purification technologies are likely to enable governments to flatten and decentralize water purification into more of a micro-utility or even a point-of-use (POU) approach. WaterHealth International is a good example of an ultraviolet-based micro-utility approach and Agua Pure (a not-for-profit) would be a good example of a ceramic filter based POU approach. We are likely to see these flattened, decentralized approaches dominate in 3rd-world developing countries and the numbers could be significant given the billions of people for whom these strategies would apply. The analogy here would be that of telecommunications. When Poland became free and realized that it had very little wire-based communications, it leap-frogged technologies all the way to cellular rather than invest in expensive wire-based communications infrastructure. The same will play-out through the use of next generation water purification technologies.

Low Energy consumption will begin to drive new technology use throughout the water sector as people begin to focus on the amount of energy consumed in the lifecycle of water usage. This “Water-Energy Nexus” is just coming to the forefront of people’s thinking and it will begin to drive and favor those technologies which enable energy savings. Most obvious in this category would be low-energy desalination technologies. Many technological advances have been made through the use of next-generation membrane technologies, but I don’t think we have seen the best to come from membranes designed at the nano-level. Another group of low-energy water treatment technologies that will enjoy commercial success is the area of physical water conditioning. EnviroTower, based in Toronto is a solid example of this kind of physical water treatment where you get treated water with low (and in fact negative) energy use. The area that I’m the most bullish about in the low-energy arena is in industrial recycling of water. Currently most industrial applications use water in a one-pass application. The water (and energy) consumption benefits of industrial water re-use and recycling are significant. Heretofore businesses have dealt with water as a low-cost, infinite supply commodity, but shortages have changed that paradigm. A whole raft of new and advanced technologies are being developed to enable commercial/industrial re-use and re-cycling of water. Some industries require ultra-pure water (silicon wafer production), while many industries require much lower (but assured) water quality. In all cases reduction of water consumption is critical.