Investing In Watertech: Fishing in The Right Waters

Water may be a simple word, but it has multiple and far-reaching dimensions.

It's an important habitat for millions of species, and the condition of this habitat can directly and indirectly affect our personal health, local economies and other aspects of our lives. It's also one of the most important inputs for agricultural and industrial production, accounting for 90 per cent of humanity's water consumption.

In the agricultural sector, irrigation is the biggest consumer of water. Consider that it takes roughly 1 cubic meter of water to produce what ends up as 1 kilogram of bread. Industry also relies heavily on water, be it for power generation, semiconductor manufacturing, pharmaceutical production or food and beverages. No wonder water is often compared to oil. Both are precious and limited, and modern economies would wither without either resource.

Water is also essential for public safety and personal care. We fight fires with water, bathe in water, wash our clothes with water, and we use water as a medium for discharging human waste. The last point - wastewater - isn't often discussed, but how we collect and treat it is just as important as assuring clean water supply.

Last but not least, we need water as a potable liquid. We drink it and cook with it, and while this represents the lowest volume of consumption in the water balance, it's what makes the issue of clean water a highly emotional topic.

Depending on where one is in the world and how water will be used, expectations put on the quality of this resource can range considerably. The same holds true for how we discharge wastewater into natural water bodies. This makes investment in the space both an opportunity and a challenge.

So where are the markets and cost drivers related to water? Agriculture may account for 70 per cent of global water consumption, but only 2 per cent of the annual $463 billion (U.S.) water market is linked to irrigation equipment. Tradable water rights will drive technological development, but water will remain a cheap source for food production. Industrial equipment and services make up 5 per cent - also not a big portion. It is, however, an important niche because of its faster adoption rate, due in part to established economic incentives and short decision paths. For example, roughly 80 per cent of industrial process water is reused already today.

The largest segment of the global water market - about 70 per cent - is linked to utilities. Operational expenditures such as labor, energy and consumables are the most important accounts. Yet, the real pain only becomes visible if one explores the costs per unit of water. About two-thirds is related to distribution and sewer networks delivered to consumers. This cost is mainly linked to the upfront investment in pipeline infrastructure and only long-term depreciation periods in the range of 30 to 50 years allow for the low water prices consumers pay today.

What are the most prominent market drivers acting on these segments?

• Demographics are dynamic and unpredictable. Depreciation cycles will have to be adapted. It might not be a sensible solution to build expensive pipeline networks linked to central treatment plants in certain locations around the world. Examples include Eastern Germany, where some cities have declining populations, or China, where rapid urbanization makes it difficult to plan.
• In the western hemisphere, a recurring theme is aging water and wastewater infrastructure. This means smart monitoring of systems to both ensure high water quality and avoid water losses will be increasingly important in the coming decades. The ability to intelligently plan and execute rehabilitation of these systems will also prove crucial.
• Large emerging countries are water hungry. Rapid industrialization and a move toward western-style nutrition are driving up demand for water in regions already battling scarcity. A conventional meat based diet requires two to three times more water per energy unit eaten than a vegetarian diet. On the back end, municipalities and industries generally lack adequate wastewater handling.
• Climate change accentuates water quantity issues further. Regional water scarcity, variable precipitation patterns and elevated evaporation rates ask for sustainable options of water supply (e.g. water reuse or desalination) and efficient water use.
• Finally, public awareness of the need for safe water has put a spotlight on enhanced treatment. It’s generally known that inadequate treatment can lead to acute health risks as a result of microbial or viral contamination. People are also more aware that there are chronic health risks associated with heavy metals, pesticides, hormones and pharmaceuticals making it into the drinking-water system. At very low concentrations, some of these substances have an endocrine impact, while others can cause cancer,

Through a financial lens, the water sector is clearly a bull market. Public awareness is high and rising, and this is driving stricter regulation and enforcement around the world. Meanwhile, public-equity capital is desperate for pure-play water companies, as demonstrated by the recent initial public offerings of Ecodis, Modern Water, Energy Recovery Inc., and Suez Environnement.

Pictet and SAM water funds (€3.5 billion and €2 billion respectively), as well several other recently formed water-themed funds, have become important drivers in this scene. Acquisitions have also continued, as seen with Dow Water Solutions and its purchase of OMEX from China last year. On top of this, several large industrial players not yet active in the water space have signaled their desire to enter the market.

Despite all this, finding good investments in the water space is a challenge. Markets tend to be fragmented, highly local, and show long adoption cycles. Compared to other sectors, technical innovation has been lacking in the past and technological risks are higher due to the many unknowns when dealing with water. In geographies such as Europe, creative water technologists lack the business acumen to transition from R&D to commercial production and deployment. On the other hand, rising public awareness is starting to attract more talent and ideas to the marketplace alongside tougher regulation and enforcement.

The bottom line is that investment in the water space requires an understanding of science, industry, market verticals and regions, as well as a functioning network in all of these areas. It is the basis to assess technologies, their appropriate applications, and whether the associated business model allows for rapid growth. Timing, such as knowing the right investment stage to enter, also plays a key role. Having a firm grasp of all these areas will help assure venture-grade returns.

Helge Daebel is a water sector specialist at Emerald.

Emerald has reviewed more than 500 water deals during the past eight years and has made very promising investments in the areas of:

• Water conservation - AquaSpy provides smart irrigation monitoring.
• Water treatment - Inge Watertechnologies produces ultrafiltration membranes, modules and racks (see article in this issue).
• Smart infrastructure rehabilitation - Pressure Pipe Inspection Company investigates and assesses water pipes (see article in this issue).
• Ocean Wave Power Generation - Pelamis and Oceanlinx