BY ANTONY CURRIE

What makes Connecticut Water Service so tantalizing? The staid Nutmeg State utility has been the unlikely subject of a months-long, four-way, governance-challenged bidding war. And on Monday it, and original suitor SJW Group, unveiled an amended deal that has the buyer now paying, at almost $850 million, a one-third premium for the business. That’s an impressive victory for the seller in an industry whose returns are usually capped by regulators at around 10 percent.

The new price may well flush away rival bidder Eversource, which had baulked at paying more than some $775 million. But SJW is also throwing out a merger-of-equals structure and going for an outright acquisition, in cash.

Diverting to this route obviates the requirement that SJW’s investors vote on the deal, which in turn effectively ices its own stalker. Rival California Water Services had offered $1.4 billion in cash for SJW and was lobbying the company’s shareholders to vote against the New England transaction.

Withdrawing the owners’ say is not the first governance issue the deal has faced. The most obvious is that SJW’s boss since last fall, Eric Thornburg, had spent the previous decade in charge of Connecticut Water – and is still a large shareholder. Monday’s changes, if cemented, will leave him almost $3 million better off compared to the original deal. He recused himself from discussions.

But SJW shareholders are now stuck with a transaction that yields a return on invested capital of barely more than 4 percent. That’s based on the consensus 2019 EBITDA estimate for Connecticut Water and a 21 percent tax rate. The weighted average cost of capital for the industry is around 5 percent.

It only makes sense financially if the new company can take advantage of its increased scale. That takes two forms: first, bulking up for needed infrastructure investments, including striking better deals for costs; second, preparing for a wave of water M&A in a fragmented industry parched for capital. The prospect of being in a better position for both is why gulping down Connecticut Water comes with a hefty price tag.

First published Aug. 6, 2018

IMAGE: REUTERS/Brian Snyder

BY ANTONY CURRIE

A Franco-Dutch utility deal is stirring up U.S. M&A waters. Suez is selling a fifth of its regulated business in the northeastern United States to pension manager PGGM for 30 times last year’s earnings. The $601 million transaction looks even pricier than the takeover battles currently being waged for two other water companies.

San Jose, California-based SJW Group’s agreed tie-up with Connecticut Water Service, worth $750 million when announced in March, does come in at the same multiple. But SJW is taking full control of its target. So all else being equal, investors could expect to get a premium relative to what PGGM is paying for a minority stake.

Shareholders in SJW may have reason to feel aggrieved, too. California Water Service piped in a $1.4 billion all-cash offer for its local rival in April. That works out to almost 24 times 2017 earnings. Just matching the Suez multiple would add another $375 million to SJW’s market value. Pour in a 30 percent takeover premium and investors could in theory demand $2.3 billion.

The Suez price is even more striking considering that the company is selling a chunk of its U.S. utility business to reduce leverage from last year’s acquisition of GE Water, an industrial business. That implies PGGM might have had the upper hand in negotiations.

Yet the comparisons muddy the underlying picture, which is that all the current offers look fully priced, if not verging on the excessive. The handful of publicly traded water utilities in the United States are expected to grow the bottom line by a decent 5 percent or more a year, according to Eikon data. But regulators determine how much these firms can charge customers, thus limiting returns on equity to around 10 percent.

Scarcity is playing a role in valuations. There are fewer than 10 listed U.S. water utilities, most of them worth less than $1 billion. So it doesn’t take much extra interest from investors – or rivals – to push up prices. Trouble is, with earnings power limited by regulators, overly exuberant buyers risk ending up high and dry.

First published July 31, 2018

IMAGE: REUTERS/Pascal Rossignol

BY GEORGE HAY AND NEIL UNMACK

Should Jeremy Corbyn win Britain’s next election, his Labour Party has said it will end private sector ownership of natural monopolies like water companies. The received wisdom is that returning utilities to the public sector will be exorbitantly expensive. But that depends how it’s done.

If a Corbyn government decided to buy out the UK water sector at current valuations, it would indeed have to pay up. The 2017 aggregate value of the 16 English water companies’ equity and debt is 80 billion pounds, according to the Social Market Foundation, a think tank. Stumping up for this would add 5 percentage points of GDP to the UK’s gross national debt.

Labour finance chief John McDonnell is okay with this, arguing that the companies’ cash flow would cover the additional interest on the government bonds issued to pay for nationalisation. But that might not remain the case if investors demanded higher yields on the rest of Britain’s debt, which is already at 90 percent of GDP. Besides, water companies might become less efficient if they were once again run by bureaucrats rather than profit-oriented managers. They are also expensive. The privatised groups typically trade at a premium to the value of their capital set by regulators, because yield-hungry investors are attracted to their stable cash flows.

To make his water grab more affordable, Corbyn could do two things. One option is to reduce the value of the sector’s equity, which the SMF currently puts at 34 billion pounds. The other is for the buying to be done by mutual or not-for-profit entities, which do not appear on the government’s balance sheet.

To achieve the first outcome the UK regulator, Ofwat, could lower the returns it allows water companies to make from charging customers. At the same time, the government could slap a windfall tax on utilities, for example those that have paid big dividends to their shareholders. There are precedents for both actions. In its last few price reviews, Ofwat has reduced the return on regulated capital water companies can earn. The fact that investors are still willing to pay a premium suggests those returns are still too high. Back in 1997, the Labour government led by Tony Blair imposed a windfall tax on utilities.

Britain also has examples of utilities being taken over by their customers. Welsh Water, which is owned by a not-for-profit company called Glas Cymru, has no shareholders and reinvests any surplus it earns in capital investment or lowering water bills. It last changed hands in the early 2000s, after a harsh regulatory review and a windfall tax eroded the price of water company equity, enabling it to be acquired for just one pound, with the rest funded by debt.

Imagine an onslaught from the regulator and Corbyn’s government knocked the UK water industry’s equity value to less than 15 billion pounds. A group of, say, 10 not-for-profit entities could then each borrow around 1.5 billion pounds to buy the equity of their local utility – just as Glas Cymru did – and assume its liabilities. A company funded with 100 percent debt may sound risky, but bond investors are already willing to lend more than 90 percent of British water groups’ regulatory capital value. Freed from the need to pay dividends to shareholders, not-for-profit buyers could deleverage. Welsh Water’s debt as a proportion of its regulatory capital value has dropped from 93 percent in 2001 to 56 percent in 2017.

A Corbyn government would still face opposition. Current water company shareholders – which include UK pension funds – would protest their losses. Bond investors might try to trigger early repayment of the existing debt. Meanwhile, the government would need the confidence of financial markets to attract fresh funding. That would be tricky, given that the state would just have just undermined that credibility.

The regulator could start by picking on the worst-run companies. The process of unwinding an entire privatised industry would still be risky and uncertain. And the whole enterprise would be easy to critique as driven by ideology rather than customer care. But when Corbyn talks about low-cost nationalisation, it’s not all hot air.

First published Feb. 19, 2018

IMAGE: REUTERS/Phil Noble

BY ANTONY CURRIE

The $1.9 billion deal for Israel’s Netafim is a glass half full. Mexichem leaked more than $220 million in value after announcing its acquisition of an 80 percent stake in the drip-irrigation pioneer from buyout firm Permira and its kibbutz backers. There are plenty of opportunities yet to tap, though.

The Mexican pipemaker is paying around 14 times the $136 million of earnings before interest, taxes, depreciation and amortization it reckons Netafim will generate this year. By comparison, Xylem last summer paid nearly 11 times EBITDA for Sensus, while Suez valued GE Water at a multiple of 12.5 times earlier this year.

Netafim is one of the most prized assets in the industry, however. It developed a method of channeling pipes directly to plant roots. Sensors and other technology have made the process even more efficient.

This drip- or micro-irrigation not only saves water but also can produce crop yields between 30 percent and 100 percent higher than flood irrigation. That has been a boon for the Israeli farming industry. It has to cope with a limited supply of water in a region prone to drought and mired in interstate conflict that has made importing food from a relatively water-rich neighbor like Lebanon impossible.

Operating in more than 110 countries, Netafim is the leader in drip irrigation, controlling around a third of the global market. The method is used on just 5 percent of the world’s irrigated farmland; flooding still predominates, with a 77 percent share.

That’s unsustainable, however. The world’s population is due to hit 9.8 billion by 2050, almost a third higher than today, according to U.N. estimates. That may require a 50 percent increase in food production, as people in successfully developing countries change their diets. Yet on current usage there may be a 40 percent gap between water supply – 70 percent of which is already used for agriculture – and demand by 2030.

Firms like Netafim are well placed to address such challenges. It is still growing in India and just getting started in China, where water pollution is another big issue. Longer-term that means Netafim should easily be able to fill its new owner’s coffers.

First published Aug. 7, 2017

IMAGE: REUTERS/Amir Cohen

BY ANTONY CURRIE

Suez’s pricey acquisition from General Electric just about holds water. The French company and its minority partner, Caisse de depot et placement du Quebec, are paying $3.4 billion for the U.S. conglomerate’s H2O unit. That looks high, but it doesn’t mean the deal is a washout for shareholders.

The headline price works out to a frothy 12.5 times GE Water and Process Technologies’ earnings before interest, taxes, depreciation and amortization. That’s a good chunk more than the 10.7 times EBITDA Xylem paid for Sensus last year. Worse, that target was a more profitable company, sporting a 19 percent EBITDA margin, whereas the GE division’s 13 percent margin is one of the industry’s lowest.

That ought to have merited a lower price. There was plenty of competition for the business, though, from rival operators like Honeywell and Pentair as well as from private equity. Suez is also paying for scale, which may seem strange considering its $15 billion of revenue last year was seven times that of GE Water’s.

But the deal vaults Suez from 10th largest in industrial water into third place. The 95 billion euro market is one of the more lucrative segments of the water business as companies seek to upgrade their infrastructure to save water and energy. It’s also expected to grow around 5 percent a year. That’s faster than the municipal market that currently makes up much of Suez’s business – and the reason why its revenue growth is almost flat.

Municipalities remain a potential cash cow. Many around the world need to either build or replace their pipes and sewer systems – once political will and economic reality allows. But industry is a bigger market, accounting for as much as a fifth of global water consumption compared with up to 8 percent by humans in cities.

Suez also reckons it can cut $69 million a year of costs, which brings the acquisition multiple down to 10 times EBITDA. Promised revenue synergies, as flighty as they often are, look less impressive: at $200 million a year, they’d add just $26 million to EBITDA, on GE’s margin. Luckily, the bigger picture for water should be enough to make this deal flow.

First published March 8, 2017

IMAGE: REUTERS/Vincent Kessler

BY ANTONY CURRIE

A $1.7 billion water merger is piping in a refreshing M&A taste. Xylem’s purchase of Sensus, revealed on Monday, will end the smart-metering specialist’s tenure as one of private equity’s longest-held investments. And unlike in some mergers, there’s no scarcity of logic behind Xylem’s investment.

The price, for one thing, looks right. The water-related technology outfit is paying 10.7 times adjusted earnings before interest, taxes, depreciation and amortization for Sensus. Some $50 million of expected cost cuts should reduce that to just 8.1 times once they are realized, way below Xylem’s own multiple of 14 and much lower also than publicly traded rival Badge Meter, which trades at 15 times EBITDA.

There’s scope for decent growth from putting the two companies together. In theory, that’s the case for a lot of mergers in general, and perhaps especially those involving water-focused companies. Population growth and rising relative wealth are boosting demand for water, meaning the smart management of supply and use – affected in large parts of the world by drought, flooding or both – is critical. Every player, from industrial users to municipal water and wastewater utilities need to up their game.

Xylem Chief Executive Patrick Decker is controlling the flow more effectively than many, though. While he reckons the two companies could add perhaps $100 million in annual revenue, he’s not using that as an excuse to overpay.

The Sensus deal also fits cleanly with the strategy he has espoused since taking the helm two-and-a-half years ago, including requiring deals to meet specific financial targets. It’s simple stuff, but it’s often ignored in favor of grand, general statements. Buying a private company with units abroad will also allows Xylem to use $400 million of overseas cash.

Decker also seems to have done, well, watertight due diligence. His team, for example, interviewed “a three-digit” number of Sensus’ customers. That not only helps gauge how much extra business there might be from a tie-up. It also surely gives a better sense of how the target company works and whether the two cultures will fit.

The deal finally allows Sensus owners Jordan and Goldman Sachs to offload a company they bought in 2003. Poor results forced them to bring in new management a decade later. Given that, their 7 percent annualized return looks palatable. But Xylem is the one with its glass now brimming.

First published Aug. 15, 2016

IMAGE: REUTERS/Regis Duvignau/Photo Illustration