By Stephen J. Hoffmann
The increasing number of mergers and acquisitions (M&As) in the water industry is no longer surprising news. Most in the water business fully anticipate further consolidation; USFilter is unwinding itself, private equity dollars are targeting water investments, and strategic acquirers are looking to bolster existing operations or enter new growth markets.
Aside from the shear volume of water deals, it’s informative to categorize the acquisition activity by motivation—geographic expansion, product expansion, new distribution channels and technology driven. An informal analysis of the stated or implied motivations behind recent transactions provides insight into the likely direction of future consolidation activity, and may provide guidance as to how firms can position themselves to take advantage of the trend.
Behind a purchase
There are many reasons why a company may buy another company including access to managerial or technical talent, reduction of operating costs, access to new product lines or markets, growth in market share, reduction in the number of competitors, and access to new technology, manufacturing capacity or suppliers—just to name a few. In the post-USFilter age of consolidation, M&A activity in the water business seems to be motivated more by market-driven strategies than pure financial considerations. Judging by the multiples paid for strategic acquisitions (eight to 13 times EBITDA*), corporate buyers are paying a premium to quickly snap up products and/or gain control of distribution channels (see Table 1). In this context, it’s too early to determine if the objectives of recent deals will be met. Several examples illustrate the motives behind some recent acquisitions.
In the commercial and residential segments of water treatment, a key driver in M&As is supplier consolidation and the corresponding necessity to evolve with the changing distribution channels. Consolidation at the wholesale distribution levels tends to favor strong brands. This was the backdrop behind the Watts Water Technologies’ acquisition of Flowmatic Systems. The need to mitigate reduced construction spending led to the pursuit of a wider target range of markets and applications. In many of its plumbing channels, Watts is able to use its brand dominance to obtain exclusive arrangements with distributors. But outside that channel, in consumer markets for its filtration products, the larger buyers are water treatment dealers and distributors. This is where Watts’ channel strategy associated with the Flowmatic acquisition comes in. It’s Watts’ goal to leverage its brand recognition into a broader line of wholesale products and the retail channel where purchases have been traditionally based on price rather than brand (see Channel Strategy at Watts). Additional filtration product acquisitions are likely to follow.
Most other acquisitions have been motivated by the desire for new product offerings. The $95-million acquisition of Isco Inc. by Teledyne Technologies was product motivated. Isco added to Tele-dyne’s instrumentation businesses and provides a platform for future growth. The purchase brings to five the number of environmental instrumentation companies Teledyne has acquired in the last several years.
The acquisition of Advanced Pollution Instrumentation and Monitor Labs expanded Teledyne’s industrial gas analysis business into the environmental markets. Plus, the acquisitions of Tekmar-Dohrmann and Leeman Labs added laboratory instruments for the detection and analysis of organic and inorganic compounds. Isco’s water quality monitoring instruments, including samplers, flow meters and on-line process analyzers, complement these existing product lines. In addition, Isco’s liquid chromatography systems and chemical separation instruments give Teledyne the opportunity to enter biotechnology and drug discovery markets. From Isco’s perspective, sale of the company ends a prolonged period of competitive struggles and uncertainties associated with patent-related issues. It also provides the resources necessary to grow its instrumentation business, increasingly dominated by larger industrial companies.
The Pentair acquisition of WICOR Industries is significant in that it transformed the company into an almost “pure-play” water business, largely defined by a nearly $2-billion Water Technologies group. While the acquisition added revenues to Pentair’s pool and spa equipment business, the main motivation was the expansion of filtration and purification products. Pentair’s water strategy began before WICOR, however, with the acquisition of Plymouth Products, and then the Everpure line from USFilter. The Plymouth acquisition was motivated by the need to put a distribution network in place; Plymouth’s products route to market is generally through independent distribution. There was some industry consternation when Culligan opted to make its dealers exclusive distributors. It’s likely that this change in distribution strategy was the motivation for the sale of Plymouth (note that Culligan hasn’t attracted a buyer yet).
Many of the industry concerns when Pentair bought Plymouth haven’t played out—there were no price increases to dealers, stocking wasn’t an issue and relationships with dealers weren’t changed. At the same time, operating efficiencies were achieved. According to Pentair, in the first year of ownership, Plymouth Products’ profits improved 17 percent while EBIT margins gained 150 basis points. The acquisition of Everpure filled a gap in Pentair’s product offerings to the commercial market and added distribution channels into the food and beverage segment. WICOR added products across a broad range of new categories—pumps to agricultural, marine and leisure markets; booster pumps to the POU market, and water processing systems and high-performance pumps for industrial markets. WICOR products are expected to generate sales of approximately $825 million this year and be accretive to Pentair’s earnings in the first year.
Technology and products
The acquisition of WEDECO AG Water Technology by ITT Industries was technology/product driven, continuing ITT’s strategy of offering customers a portfolio of water and wastewater products. WEDECO, a leading manufacturer of ozone oxidation and ultraviolet (UV) disinfection equipment, will become a part of the Sanitaire division of ITT’s Fluid Technology group. The acquisition gives ITT an opportunity to round out its water and wastewater treatment business while offering a complete line of pumps, water filtration and disinfection products. WEDECO’s product line was viewed as a complement to Sani-taire’s Biological and Filtration divisions, strengthening its leading businesses through strategic acquisitions of adjacent technologies.
The acquisition of a controlling interest in US Peroxide by Trojan Technologies was also motivated by the revenue-enhancing possibilities of new products. US Peroxide is the single-largest North American direct supplier of hydrogen peroxide and Trojan’s environmental containment treatment (ECT) products require the use of H2O2 in conjunction with UV treatment. Trojan utilizes UV-oxidation in about 90 percent of its ECT contracts and believes that, by offering turnkey solutions, it can increase market share and drive sales growth. In all likelihood, the acquisition was an attempt to offset Trojan’s decelerating customer demand and doesn’t address key execution concerns relative to cost control and earnings. Trojan could easily find itself the subject of a product-motivated acquisition.
Looking into the crystal ball
The question now is what other large players might have similar motives and drive future acquisitions in the water business. In the United States alone, there are a number of possibilities. Three examples are IDEX Corp., Crane and Ashland Inc. IDEX Corp. is somewhat similar to Pentair several acquisitions ago. The company could easily transform its mix of pumps, dispensing equipment and engineered products into a more focused fluid handling company with a significant presence in water.
Ashland Inc., soon to be flush with cash from the $3-billion sale of its oil refining stake with Marathon, could also increase its presence in the water business. Ashland could opt to gain a foothold through its strength in chemicals vis-à-vis a GE Betz Dearborn approach. With the Drew Industrial division as a platform (it’s already a leading distributor of water treatment chemicals), Ashland could easily expand into a variety of complementary treatment technologies like corrosion control, analytics, cooling systems, process separation applications and wastewater. The Environmental Services arm of Ashland’s distribution business could also expand in a number of directions including filtration, recycling, remediation or engineered solutions.
Finally, Crane Environmental is well positioned with its environmental unit to continue its pattern of acquisitions. Crane is a leading supplier of specialized water purification solutions for the industrial and commercial markets. The company, formed through the integration of Cochrane and Environmental Products USA, has an extensive distribution network that could accommodate a variety of add-on acquisitions. Potential targeted segments include water conditioning products, purification technologies and membrane-based systems.
Motivation for a buy
The larger diversified industrial companies with a desire to increase their presence in water are looking for acquisitions that can drive top-line revenue growth. These acquisitions are generally product-motivated transactions that can generate additional sales. At the same time, the added benefit of acquiring product lines creates the ability to reduce combined costs through the leveraging of existing supply chain and manufacturing activities. Quite often, it’s this added benefit on the cost side that substantiates the acquisition model and justifies the higher multiples often paid by strategic acquirers.
While the motivation for financial buyers is, quite often, strictly financial, the motivation of strategic buyers provides insight into industry trends. Judging from the variety of strategic objectives, water treatment firms are well advised to focus on a competitive strategy that plays to their particular product or distribution strengths. By implementing a business model that leverages core capabilities, many water companies will be in a better position to attract acquisition interest.
Judging from the motivations analyzed in this survey, it can be generalized that most strategic acquirers are either looking for new products to sell into an existing customer base, seeking distribution channels to sell existing products into new markets, or both. These motives comprise factors from which it’s easier to generate net tangible assets and enhanced rate of return, as opposed to the “softer” considerations such as critical mass, access to technology, and competition reduction that were prevalent early in water industry consolidation. The key drivers of the next phase of consolidation are likely to relate to market characteristics rather than technology cycles.
About the author
Steve Hoffmann is president of WaterTech Capital, of Dallas, a private equity firm that specializes in investments in the water industry. The company also engages in strategic advisory services and corporate finance activities. Hoffmann can be contacted at (469) 585-4875, email: firstname.lastname@example.org or website: www.watertechcapital.com