Water is valuable now!
Even though it has historically been considered a commodity, freshwater resources are now frequently being treated as precious resources due to increasing scarcity across the globe.
Our oceans, lakes, rivers and man-made water reservoirs are increasingly threatened from multiple stress factors including (just to name a few):
Chemical additives (man-made)
Lack of proper maintenance
Lack of understanding, oversight and investment
All the above factors are exacerbated by worldwide droughts, which together create an environment that is increasingly impacted by water scarcity issues. Nationally, examples like restaurants in California only serving drinking water to guests on request and leakages, algae outbreaks and now even deaths from scenarios like those occurring in Flint, Michigan are all driving social awareness of water in mainstream society.
This growing awareness is not really a secret anymore either. While farmers and scientists have been dealing with these issues for decades now, savvy business investors like Warren Buffet and T. Boone Pickens have known and moved to exploit this market opportunity for some time already.
It is also hard to deny that societal awareness of the importance of water is at historic levels, with recent high profile statements from President Obama, Pope Francis and economic leaders at the World Economic Forum in Davos all highlighting water’s growing importance to global prosperity and development.
What has been painfully slow to change is society’s perception and acceptance, at all levels, of the need to change how we ‘value’ water. Although slowly, even at a ‘turtles’ pace, it seems that an ‘awakening’ on this issue of water might finally be emerging. Even though the tortoise eventually beats the rabbit in Aesop’s famous fable, the question is ‘do we have time to wait that long’?
Even Hollywood provided a good example of this awakening in 2015. The Big Short (Oscar Nominated for Best Picture) is a movie focusing on how a few investors, including most prominently Dr. Michael Burry from Scion Capital, profited hugely from the recent global financial crisis.
More specifically, they anticipated and profited from the sub-prime mortgage crisis, which rocked global markets starting in 2007. At the end of the movie, we learn that Dr. Burry had closed his fund in 2008 to invest his personal fortune in what he saw as the next major undervalued asset class, water (in his case, mainly targeting farm land with water rights). In fact, the investment community has been ‘hot’ on water for decades now, so this move by Dr. Burry was not really that contrarian, which we will discuss later in this article.
Water: commodity vs precious asset?
One constraint with changing the way that we value water is that unlike what most people want to think, water, even though it falls freely from the sky, is not a commodity!
And its ‘value’ in any analysis is derived from a complex mix of dimensions including:
1) Where (it is located)
2) When (is it available)
3) How Much (can be accessed)
4) How Reliable (is the supply)
5) What Quality (can be guaranteed)
6) Who (is monitoring this water resource)
Note: A different mix of these variables can change the value of water resources dramatically and can make it very hard to come up with consistent estimates.
What is clear about this value is that the traditional, well known Diamond-Water paradox, which justifies water as almost valueless based on its abundance (versus a diamond’s high value based on its scarcity), is breaking down.
And quite rapidly too. Currently, demand for water in the US is growing across multiple sources including municipalities (to support growth), oil & gas companies (particularly for fracking) and the environment itself (whether court ordered to protect endangered species or through NGO (non-governmental organizations) conservation efforts, which all impact valuations. What is clear though is that this awakening to the value to water is progressing at different speeds at each layer of society.
Classic investment principals mismatch
For consumers, while they are increasingly willing to spend large sums of money for bottled water (US market estimated at $15 billion in 2015) there is much more resistance to increasing water services rates.
In the most recent survey of national residential water rates (tap water, wastewater and storm water services) for the Top 30 US cities conducted by Circle of Blue (a water consultancy), rates increased on average 5% in 2015. While this increase is consistent nationally it does hide a wide variability in individual rates that can be perplexing.
For instance, water rates varied for a family of four from a low of $29 per month in Memphis, TN to a high of $154 in Santa Fe, NM. Even more troubling, Fresno, which is in the center of California’s drought stricken Central Valley, provided tap water services on average for $27 a month. It can be difficult to incentivize conservation when a service is essentially ‘free’.
Compare these amounts to other standard household expenditures like cable bills or mobile phone bills, both of which can easily cost hundreds of dollars a month for a family of four, and we can see how the value of water in the consumer space is still evolving slowly.
For businesses, the awakening to the growing value of water is progressing much more quickly, mainly driven by quantifiable impacts to cost structures and expanding areas of risk management.
For water-dependent industries, the growing impact of water-related issues on cost structures is apparent; for instance:
• Coca-Cola and its bottlers have spent almost $2 billion in recent years to improve water efficiency and improve water quality
• BHP Billiton needed to invest $2 billion to build several desalinization plants in Chile to maintain its ongoing mining operations
The awareness on water’s value is not limited just to the ‘normal suspects’ – in the CDP 2015 Global Water Report, almost two-thirds of the over 1,200 companies participating reported exposure to “substantive water risks” and 27% reported that water risks had negatively impacted their businesses in 2014.
Investment Communities & Philanthropies
In the investment community, as stated earlier, the water industry has been ‘hot’ for several decades, with much of the focus directed towards M&A deals targeting specific segments like wastewater services, equipment providers, monitoring and testing companies and design/building firms.
Much of this M&A activity was driven by businesses looking to either establish a foothold or consolidate their position in the water industry (i.e., GE, John Deere, ITT, and Pentair to name just a few), but many larger private equity firms like Blackstone and Carlyle and investment banks like JP Morgan have also been active in the space.
One key issue constrains growth though – while the US water industry was estimated at $150 billion in 2014, only about one-third of this market is held in private hands (e.g., the majority is public water utilities). So there generally has been much more demand than supply for quality deals, which has tended to create large premiums for acquisitions ranging in the 10x – 15x EBITDA range (EBITDA/earnings before taxes, depreciation and amortization).
Equity investments into the water industry have also seen a lot of interest though results over the past decade have varied widely mainly due to the large variety of sectors within the industry to potentially target.
In the philanthropy segment, the expanding focus on the value of water in the business segment can also been seen in the growing efforts of business organizations and NGOs like Ceres and the World Business Council for Sustainable Development, who have launched multiple projects over the past five years to build tools and methodologies to help investors and companies to identify and measure the value of water in business operations.
Moving towards a tipping point?
Have we reached the tipping point where society has awakened to the value of water?
Clearly, we are seeing more and more events like the water crisis in Flint, Michigan, the ongoing protests over the Dakota pipeline or the crippling droughts in California and Texas that are keeping water issues top of mind. However, translating this awareness to an increased societal willingness to value water appropriately is still ongoing. Until consumers, businesses and governments start to price water based on its true economic cost there will continue to be inefficiencies in how water assets are utilized and they will continue to be under-valued. Some of the “hidden” costs included in a true economic cost analysis include:
1) Identifying and acquiring new water supplies
2) Upgrading systems to improve efficiencies
3) Maintaining and growing distribution systems
4) Improving water quality
A good data point on how this is not being done comes from TruCost, an environmental data and consulting company, which estimates that “…based on current production locations, if water were to be priced according to its availability [or scarcity] 27% of profits would be at risk across the world’s largest companies.”
Due to the largely illiquid nature of private sector transactions, institutional hedge funds may take a wait-and-see approach for now. Private equity funds can bridge this gap, but their limited partner investor base will push for returns typically in a 3-to-5 year or 4-to-7 year investment period, which may not fit many investment profiles. Therefore, this environment can present significant opportunities for investments from other sectors such as family office investors with large pools of patient capital.
Christopher Meissner, formerly a vice president with France Telecom building wireline and wireless products across multiple international markets, has now joined GCH Partners as the Director of Sustainability after completing his Masters in Sustainability Management at Columbia University.
Gregory Mark Hill was formerly in M&A and tech investment banking in New York and Silicon Valley, venture capital in China/Asia, and now is in private equity to the sustainable sector and serves as adviser to asset management platforms, impact start-ups and social entrepreneurial organizations.