BARRON'S
August 19, 1996
Precious Fluids

By HARLAN S. BYRNE·

When media tycoon Ted Turner was asked where he would invest if he were trying to match his phenomenal success in cable TV, his answer was surprising simple and surprisingly Low-tech. Water, he said. Turner went on to explain to his audience, a 1992 seminar at Harvard Business School, that the water business in many ways resembled the cable TV industry 20 years ago. Hard to fathom at first, perhaps, but true. The U.S. water business has a fragmented structure, steady demand (from the dawn of humanity, in fact), lots of local monopolies, and fairly manageable regulatory requirements. Turner, now in the embrace of Time Warner, hasn't in any obvious way gone beyond mere conjecturing about water, but others are acting on his hunch.

With designer water from Europe being sold on U.S. supermarket shelves at $l.50 a quart it's easy to see why. Americans are more concerned than ever about their water supply. They know how important the stuff is for health and well-being, and they're willing to pay for it. The appeal of owning a renewable source of H2O is obvious. How to get a piece of the action is less so.

Baling Out
Right now about 80% of the water systems in America are owned by cities, counties and towns, so investors' interest has been concentrated for the most part on the remaining 20%. But as cities and towns feel pressure to upgrade their pipes and pumping stations, the expense will Likely drive many of them to consider selling off their water systems to new owners. The same goes for smaller, privately owned water outfits.

And make no mistake, there's plenty of room for consolidation Today there are nearly 60,000 water systems supplying 220 million people in the U.S., and 90% of them serve only about 3,000 people each One-half of the population receives water from the 280 largest systems, mainly municipal affairs.

As for publicly traded water stocks, there are only 17. For investors, these stocks offer not only a bet on long-term growth through acquisitions, but also a highly dependable income stream and healthy dividend yields, some as high as 6%. Now that the stock market is looking increasingly volatile, such characteristics are sure to attract attention. Among the water companies analysts are following closely are American Water Works, United Water Resources, Philadelphia Suburban, California Water Service and Southern California Water.

Among the more aggressive acquirers is Philadelphia Suburban Corp., which reports making 13 acquisitions of smaller companies over the past three years, with another six likely to be added before year-end. "We look for this trend to accelerate," predicts Chairman Nicholas DeBenedictus. His company currently serves more than 850,000 customers in an area covering 400 square miles and more than 80 municipalities in suburban Philadelphia.

While many companies gladly scoop up the industry's minnows, the country's largest publicly traded water firm, American Water Works, is concentrating on the biggest deals, having made about 40 smaller acquisitions in the past six years. Based in Voorhees, NJ., not far from Philadelphia American Water Works in February completed a $409 million acquisition, calling it the “largest asset purchase in the history of the water industry in the U.S.” The acquired company serves 400,000 people in the Wilkes-Barre and Scranton areas of northeastern Pennsylvania.

 

American now serves about seven million people in 21 states including Pennsylvania, New Jersey, Tennessee, Indiana and California George W. Johnstone, president and chief executive officer, sees many more deals ahead.

The potential for growth by the bigger U.S. companies hasn't gone unnoticed overseas. French and British companies are now busy setting up U.S. water operations. Particularly noteworthy have been the activities of two French giants: Compagnie Generale des Eaux and Lyonnaise des Eaux. Generale des Eaux owns more than 14% of Philadelphia Suburban, 20% of Consumers Water of Portland, Maine, and 42% of Air & Water Technologies, which is actively involved in management of water and waste-water systems. Lyonnaise, meanwhile, has a 26% stake in United Water Resources of Harrington Park, NJ., the nation's second-largest water company. Lyonnaise also holds a major stake in a water engineering and operations group known as JMM.

Both of the French companies also are said to have smaller investments in other U.S. water companies. At this stage, the French show no interest in complete takeovers of U.S. companies, perhaps because they want to avoid tangling with U.S. regulators.

Probably the biggest allure in the U.S. water industry, for foreigners as well as Americans, is the prospect that many of the big municipal water utilities will be privatized. On a limited basis, it's already happening. Examples include Philadelphia Suburban's takeover of two Pennsylvania municipal systems, one covering the Borough of Media, the other in the Borough of Bristol.

Far bigger was the recent transaction American Water Works shuck with Howell Township, N.J., where voters and elected officials agreed to sell the water system for $35 million.

Other examples abound, and the logic behind such deals is pretty apparent. Municipalities have to keep the water flowing freely and cleanly, hut they are strapped for cash to keep the systems in top shape. Expect the trend

toward privatization to grow as the federal government tightens the spigot of aid dollars to cities and towns.

Environmental mishaps are another concern In fact, several municipal water systems in recent years have had incidents of water supplies becoming contaminated, often with fatal consequences. A notorious case was the Milwaukee water system, which in 1993 was blamed for more than 100 deaths because of suspected contamination from farm animal waste. Investor-owned water companies, by' contrast have received high marks for water quality.

Nonetheless, privatization is coming slowly. True, there has been a. tremendous amount of talk about it and much legislative effort to push it too. Municipal leaders, including New York

Mayor Rudolph Guiliani and Chicago Mayor Richard Daley, have given lip service to privatization of municipal operations. As yet, however, not much has happened.

A piece of legislation that would have made privatization easier got stalled in Congress recently. But it stands a good chance of passage next year, according to Debra G. Coy, environmental analyst for HSBC Securities, an arm of the giant Hong Kong & Shanghai Bank. Among other things, the legislation would do away with strings attached to federal grants given to water systems for improvements.

It's worth noting that the U.S. has lagged many other countries in privatization. The French water system is 75% privatized, while the United Kingdom network of water plants was completely privatized by Margaret Thatcher's government in 1989. That privatization, incidentally, has been highly profitable For the private British water companies, but has raised widespread protest from consumers complaining about higher prices and poorer service.