iSight - Investing in the global future
Water, water everywhere?
Innovation in the water industry has traditionally been slow but, with at least 240 million people in urban areas predicted to lack access to clean drinking water by 2015, why are there so few investment opportunities?
On paper the water industry reads like a sure thing, almost a gold rush in the making. In fact, rather better than gold, because in a world that is getting hotter, water is the resource that everyone needs more of.
With growth in demand already putting world water resources under pressure, urbanisation and climate change are combining to accelerate that phenomenon. It’s a volatile mix. “The water war stories we’ve all read in the newspapers overdramatise the situation,” says David Lloyd Owen, managing director of water supply consultancy Envisager. “But not by much. The demand for water is in many places galloping ahead of the capacity to deliver it.”
The numbers involved in making an assessment of the world’s thirst can be hard to grasp because they are so large. Around the world governments are failing to make the required capital investment at a rate of billions of dollars a year.
At current rates of spending, says Owen, global governments’ capital investment is on-course to fall short of what is required by at least $2,663 billion – and possibly as much as $4,536 billion – a capital investment gap that private finance will be called upon to fill.
The new concern about water resources was brought sharply into focus at the turn of the century when the Millennium Summit of the UN General Assembly set Millennium Development Goals (MDGs) in an effort to tackle world poverty, hunger and disease. The MDGs on water and sanitation pledged to reduce by half the proportion of the world’s population without access to safe drinking water and basic sanitation by 2015.
But already those laudable ambitions seem unattainable thanks to sharply rising oil prices and the worldwide population drift from rural to urban. Taking access to clean drinking water alone, the World Health Organisation estimates that 107 million urban dwellers were without a service in 1990. By 2004 the number without access to clean water had grown to 170 million. The WHO predicts that by 2015, that figure will have grown to 240 million.
The challenge is even greater when it comes to sanitation. In 1990, 475 million urban dwellers had no sanitation service compared with 611 million in 2004. The WHO expects that figure to rise to 692 million by 2015.
Owen’s analysis of the situation boils down to three simple propositions: the demandsupply mismatch is a vast problem; and the response, to date, has been largely inadequate; however, the resulting opportunities for the innovator are vast.
Desalination remains the Holy Grail of water supply technology. It is now far cheaper and more efficient than it once was, but it remains by far the most energyhungry of the water supply options. Owen sees more potential in technologies that focus on water re-use and recovery. The potential market for small scale technologies like rainwater harvesting is, he says, enormous, but technologies that are easy to replicate are at a premium.
Is the global water industry ready to meet the challenge? “Everybody agrees, at a top level, that water should be a huge market,” says Ali Erfan, a 3i Venture Capital partner. “On the face of it you would think new ventures could not fail because water is not a ‘nice to have’ it’s a ‘must have’.”
At first glance, he says, the investor could not possibly fail to make money. But, despite water’s high-profile since the MDG process, the industry offers little in the way of early entry opportunities. “You have toask ‘does the industry as a whole have an appetite for innovation?’ Sadly, the answer is no. Water is provided by municipalities and utilities that are natural monopolies – traditionally their prime concern has been to guarantee that when you turn on the tap, water flows out of it. By nature they are very risk averse, although there are some exceptions.”
Water providers are typically old, established organisations, he says. They employ bright people but they have an agenda that leaves little space for innovation. And, there’s little hope that the sort of businesses that supply water and sanitation will undergo an ethos re-fit any time soon. “You can’t ask risk averse organisations and people to become great technological innovators overnight – it just isn’t going to happen,” Erfan argues. “These aren’t 100-man companies whose culture you change in a week, they’re big businesses with a long-established culture, heritage, and way of doing things.”
“That’s not to say it cannot be done,” Erfan continues. “Israel’s water monopoly Mekorot has set out to pursue innovation, backed all the way by a government that sees new water technology as a key export opportunity. The company has set up the WaTech programme, which is working to incubate technology companies. The initiative offers help and capital to entrepreneurs who can bring new products and ideas to the table. But, despite the seemingly limitless world market for new water technology, the Mekorot approach is not sufficiently mirrored elsewhere. I do not believe, for example, that any UK or US municipality or utility has yet taken up the ideas lab model to the extent Mekorot has.”
Perhaps it’s no surprise then that the really bright ideas that Envisager’s Owen is hoping for remain thin on the ground. Riskaverse monopolies are a poor breeding ground for imaginative leaps and bounds.
“A lot of the technology you do see in the water industry is very evolutionary innovation that moves things along by 10 or 15 per cent,” 3i’s Erfan says. “It’s very rare to come across technologies you think could change the face of the industry.” Where technological innovation pushes beyond evolutionary to revolutionary, it is likely to run up against the monolithic nature of the industry, he says. “The more innovative the technology the more difficult it will be for utility companies to adopt.”
Even the super-innovators from industries like software and telecoms would struggle to operate in the world of water. However good an innovation may be, the cards arestacked against an innovator operating in a market with three-year sales cycles and investment programmes that are set in stone for years to come. “You may come up with the most extraordinary widget, but they will tell you they can’t use your widget – however good it is – until 2012. That’s not an investment proposition for a venture capitalist,” explains Erfan.
That’s why Erfan and his 3i colleagues have struggled to find early stage companies with the right ingredients that make them good early stage investment propositions. Of 15 or so early stage prospects he has looked at in Israel, the UK, Germany and the US over the past few months, none has ticked all of 3i’s boxes. “I can’t see a path to exciting, triple digit, year-on-year revenue growth. But that said, eventually the right early stage opportunities will emerge and we are keen to be there when they do.”
So, where is the opportunity today? For the moment 3i and other private equity firms are concentrating on later stage companies, businesses with an existing revenue stream and a clear path to growth, and preferably ones that are not targeting solely the municipality or utility market. Erfan explains: “One of the areas we are looking at are later stage companies that are addressing the industrial markets.
These can be much more attractive because you’re not selling to a handful of potential utility customers, instead there’s hundreds or thousands of companies that could be customers. And they tend to be lighter on their feet and more used to innovation.” 3i has over 100 of these late stage companies on its ‘possibles’ list – businesses founded since 1980 with revenues ranging from a few million euros to hundreds of millions.
He also sees opportunities for the development of powerful consumer brands in the water industry. “This is one of the areas I have actively on my radar – for early and late stage opportunities. With consumer consciousness of cleantech issues on the up there’s a noticeable shortage of brands making a play for an emerging and global consumer market.”
“Given 3i’s multi-faceted capability, I also have colleagues who are very active in much later stage investments in the water industry, including infrastructure deals and buyouts.”
Despite the MDG’s target date of 2015, the water “gold rush” looks likely to happen at a much more leisurely pace; the century’s turn hasn’t been enough to push the industry up a gear or two. “Maybe this will have to play out over a 20 or 30-year period, enough time for the whole industry to really change its DNA,” says Erfan. “As far as innovation is concerned the industry is well behind where it should be. But as an investor you have to have hope and I’m optimistic – demand for water is huge, as are the issues, and this industry will have to find ways to make innovation happen more quickly.”