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  • CFO Magazine

Water for Profit

Undaunted by tight regulations and huge infrastructure costs, companies dive into the water business.

However, “we’d like to consolidate the municipals as well as small private companies,” says Wolf. Indeed, if the municipally owned waterworks that serve 85 percent of Americans were to open up to privatization, the horizon for private water companies would expand exponentially. Such privatization deals are rare but not unheard of. For American Water, taking over municipal systems represents less than 1 percent of annual growth, according to Wolf.

Enter Private Equity

Publicly traded water companies are not alone among the private entities vying for the public systems. A private-equity arm of Macquarie Bank has already added Thames Water in Britain to its utilities portfolio, even as it awaits approval to take over Aquarion, which operates in four New England states. Highstar, an AIG private-equity fund, acquired Utilities Inc. with a similar strategy in mind. “We have long considered water infrastructure as an attractive investment opportunity and an excellent complement to Highstar II’s existing energy-infrastructure portfolio,” said AIG Global Investment Group chairman and CEO Win J. Neuger in a public statement regarding the purchase.

Not surprisingly, industry veterans are wary of such buyers, which are often known for pumping and dumping companies. “There’s a [business] model mismatch,” says Smeltzer. Not only equity firms usually budget for, the debt-heavy capital structure favored by most firms would reduce their profit potential in any case. “You usually capitalize a water utility with 50 percent debt and 50 percent equity, but private-equity firms tend to use only 20 percent equity,” Smeltzer says, and given that profits hinge on equity, they would likely be cut by 50 to 60 percent using that structure.

As with all potential buyers, when it comes to private-equity firms, regulators are “concerned about whether they’re adequately financed, whether they have managerial and technical experience, and most important, whether they’re in it for the long haul,” says Holland of the Pennsylvania Utilities Commission, which ultimately approved AIG Highstar’s bid for Utilities Inc.’s Pennsylvania properties. Connecticut Department of Public Utility Control commissioner Betkoski says that Macquarie’s decision to keep current management at Aquarion, along with its investment in other U.S. utilities, was a factor in his decision to approve its purchase of the Connecticut-based water company.

Some in private equity agree that they’re not a good match with the business model. Paul Schaye, a managing director of Chestnut Hill Partners in New York, says his firm has looked at large water companies but decided not to buy. Unlike manufacturing, where plants can be consolidated, “you can’t relocate water. The only way to grow is through acquisition of other water utilities, so your added value is not as great” as it could be in other industries, Schaye says.

Private equity may yet have a role to play in revamping America’s water system, though, if Michael Deane has anything to do with it. In a newly created position at the EPA, which sets the standards for water quality, Deane describes his mission as “developing innovative, sustainable, and market-based solutions for infrastructure financing and management.”

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