Contrary to many innovative industries, water technology companies have been largely absent from the M&A scene in the last couple of years. This is quite surprising given that water technology represents, in our view, an attractive fit for industrial and testing/diagnostics companies seeking to find new avenues of growth and, potentially, to reduce their revenue and earnings cyclicality. Indeed, the water theme offers a secular growth profile in relation with the water shortages that have become a global issue and most water companies are cash-flow generative and well-established businesses, desired qualities in the current market environment.
Yesterday’s takeover of Evoqua by Xylem (both company portfolios) could then clearly mark an inflection point in the sector’s M&A momentum. First, this is the largest ever transaction in the water space with a $7.5 billion enterprise value and could spark reactions from industry competitors. Second, the comfortable price premium offered (+29%, but only 20% as of writing due to Xylem’s share price decline as the transaction will be fully paid in shares) and high valuation multiples (23x 2023 EBITDA) could incentivize water technology companies to be more open to M&A talks with larger companies, amid more stringent financing conditions for growth companies. Finally, the Xylem-Evoqua deal points to the business model shift water companies are currently embracing and, more specifically, the transition away from hardware (Xylem: filtration systems, pumps…) to software and services (Evoqua).
Evoqua is notably considered as one of the leading players in Water-as-a-Service, a service in which the company treats the water that goes in and out of customers’ facilities or that is reused within the facility process and offers outsourcing services to handle the on-site water treatment operations for clients. The business (and the business model) should dramatically expand over coming years as large corporates recycle as much water as they can in their production processes in order to become net water positive and avoid potential water shortages.
Other segments that could attract M&A attention include notably water metering and desalination.
Water metering, which used to be a hardware business, has now largely become a software and platform business, with smart devices measuring both water quantity and quality in water infrastructures and analytics solutions enabling greater visibility and control over water resources and offering actionable intelligence to operators. Accordingly, profitability of the business should improve over time and make pure players such as Badger Meter a good fit for industrial companies that are gradually shifting their business towards digital services (Internet of Things) for their installed base of machines.
Turning to desalination, the pipeline of projects is rapidly expanding across the world (China, Morocco, Egypt…) as global concerns over water resources intensify, giving strong visibility on the long-term growth potential of the industry. Given this promising outlook and the scarcity of listed pure players, Energy Recovery appears as an attractive M&A target. The company is a provider of pressure exchangers for the Reverse Osmosis process that transfer the pressure from the brine circuit (generated wastewater) into the feed circuit, greatly reducing the energy input needed and sparking massive cost savings for desalination operators.
Overall, an M&A wave in the water technology industry would make sense as there’s a large number of potential targets in the $1 to $5 billion market cap range (Energy Recovery and Badger Meter stand at $1.2 billion and $3.4 billion, respectively) that could be easily integrated into larger industrial groups and that offer an attractive mix of growth and profitability.