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June 2001: Volume 43, Number 6

The Water Industry -- Dawn of Phase Two
by Neil D. Berlant

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The past two years have been difficult for an investor focused on the water industry. Not because the investment performance was necessarily poor, but because it was difficult to get investors interested in anything except "tech" stocks. Pointing out that tech doesn't exist without water was a useless argument, but I tried. On Nov. 15, 1999, I wrote a report recommending a water treatment equipment company where I said:

"It's ironic that as Wall Street is consumed with the impact technology and the Internet are having, and will have on our lives in the future, projections analysts use to justify their recommendations take into consideration the impact of change anticipated over several years. We agree, the Internet is truly changing our lives. However, we believe the probability there will be a water crisis is of greater consequence to humanity, and yet we're paying scant attention to it. At least 300 million people live in regions of severe water shortages. By the year 2025, it will be three billion! The irony is that today we have available to us the solutions to these water problems. What has been lacking is the will to solve them. In our opinion, as the problem grows larger, and the cost of water continues to rise, investors will realize water investments offer the prospect of enormous growth."

Much has changed since Nov. 15, 1999. Fast forward to the end of the first quarter of 2001 and note that we've just experienced the worst decline in Nasdaq history, off 25 percent in the January-March period, and down 65 percent from its peak a year ago. The Dow Jones Industrial Average was down a much less jarring 8.42 percent in the first quarter and 10 percent for the year. Happily, I report that in the same period of time, water industry securities have enjoyed considerable success. Prices of a large number of stocks I follow have increased substantially in the first quarter. For example, Calgon Carbon Corp. was up 31.52 percent, and Consolidated Water Co. was up 35.71 percent. Glacier Water Trust Preferred was up 32.61 percent, Isco Inc. was up 23.21 percent, Met-Pro Corp. was up 27.86 percent and, finally, Watts Industries Inc. was up 20.36 percent. Our model portfolio of 20 stocks was up slightly more than 7 percent for the quarter.

From oil to water
I think investors are finally realizing the water industry offers considerable potential. In fact, the phrase "water will be to the 21st Century what oil was to the 20th Century" is widely appearing in books, magazines and speeches. It seems as though people are now seriously contemplating the seriousness of water shortages and poor water quality. Contributing to this change in awareness is the increasing price of water. Keep in mind, anything you get for free -- or virtually free -- you hold in low regard. As the price moves higher, consumers begin to question what they're getting. The increasing price contributes to a growing public concern over water quality. This, in turn, leads to a booming bottled water market and exploding home water treatment device market.

The water industry has undergone significant changes over the past 15 years. In my opinion, the first phase of the evolution of the water industry began approximately in 1987 and continued on through the early part of 2000. During that 13-year period we saw the Phoenix-like rise of USFilter from virtually zero to several billion dollars in revenues, and its subsequent acquisition by Vivendi. An enormous number of mergers and acquisitions were the hallmark of this period.

Entering a new age
The question today is whether the boom years of the industry ended with Vivendi acquiring USFilter. The answer is a resounding no! I believe we have just entered the second phase of the evolution of the water industry. Further, I believe this phase will be even more exciting, with an even greater number of mergers and acquisitions. What's different today than when the first phase began is the "players" are larger, concerns about water are greater and the industry's economics are improving.

Consider the scope of the companies that are players today. In addition to the obvious giants Vivendi and Suez Lyonnaise des Eaux, some of the mammoth companies that are major participants in water include GE, Dow Chemical, DuPont and Bayer, among others. Peculiarly, these companies are rarely mentioned as participants in the water industry. Perhaps this is because the amount of business they do in water is small in relation to their overall size; however, in all cases, the size of their water industry business is huge when compared to today's pure play water companies. Furthermore, and more telling about changes under way in the industry, these behemoths are expanding their water business. For example, Bayer recently bought Sybron Chemicals and GE recently bought Glegg, a manufacturer of high-purity water equipment serving the power industry. GE is also expanding its activities in drinking water through its appliance division. For a moment, consider the weight of the word "appliance." It appears GE is saying that water treatment systems will be in all homes, just as there is a refrigerator or a garbage disposal.

A 'watershed event'
An even more extraordinary development is the announcement by the American Water Works Co., the largest U.S. investor-owned water utility, that it's going to market residential water treatment equipment. EcoWater Systems Inc. in St. Paul, Minn., will manufacture and supply the point-of-use/point-of-entry (POU/POE) equipment. EcoWater is already manufacturing private-label water treatment equipment for GE, Sears & Roebuck and others. This is indeed a "watershed event" for the industry, one that will have far-reaching implications for water treatment dealers and consumers throughout the nation.

Much attention is focused today on the power crisis gripping the nation. Little attention, however, is being given to how this crisis relates to the water industry. Perhaps too few realize the biggest user of ultrapure water is the power generation industry. No wonder GE, a major player in power, is also expanding in the high-purity segment of the water industry. It would appear GE's recent purchase of Canada-based Glegg wasn't a fluke after all. Even though this acquisition occurred well in advance of front-page news of power shortages, GE appears to have anticipated these developments. GE is only one of a great many large companies focused on both water and power. Other companies that generate considerable revenues in this area include, but aren't limited to, Ionics Inc., Osmonics Inc. and many others.

Conclusion
The most curious thing about the water industry is considering how much has been going on, how large it is in sales generated and how it permeates every aspect of our lives, it remains an enigma as to why we tend to under-appreciate it. I'm convinced that, as mentioned previously, it's because only until recently water was so inexpensive as to not matter. Still, rising price and concern about availability are irrevocably altering the perceived value of this most precious commodity. It will no longer be "water down the drain" or "water over the dam." The cavalier dismissal of water, I believe, will soon be gone forever.

About the author
Neil D. Berlant is senior vice president of Wells Fargo Van Kasper, a private brokerage firm based in Los Angeles. He's also the founder and managing partner of Water Research Associates. Prior to joining Wells Fargo Van Kasper, Berlant was first vice president of investments with Paine Webber Inc. from 1991 to 1999. He has consulted Fortune 500 companies and participated in negotiations concerning mergers, acquisitions and venture capital investments. Berlant received his bachelor's degree in finance from California State University in Los Angeles. He can be reached at (800) 225-8552 ext. 3417, (310) 443-3418 (fax) or email: neilwater@FSVK.com