Private equity taps Indian water

It is a familiar scene when India's summer rains come late: reservoirs - and the taps they feed - run dry, prompting parched residents to storm the government tanks that deliver water to cities. Where drinking water is available, it trades at high prices on the black market, while key parts of the urban social infrastructure shuts down. For example, there isn't sufficient water to flush public toilets.

This is largely a man-made problem. While India's rainfall is not particularly low compared to many dry climate regions, inefficient water management, poor regulation and waste on a fantastic scale have caused significant shortages nationwide. Few cities can boast a constant supply of drinking water; in most cases, it is available in households for just three hours a day.

"Everyone in India knows that its high time that we focused on urban infrastructure including sewage systems, sanitation and water supply, that's why I think the water sector is promising from an investor's perspective," Prasad Gadkari, director at IDFC Private Equity, tells AVCJ. "However, India still needs to improve the building blocks to turn such promises into a bigger tangible reality."

Ample market

Home to the world's second largest population, India has only 4% of global fresh water resources. Population growth, alongside rising urbanization and associated pollution, have driven down per capita water availability from 5,177 cubic meters in 1951 to only 1,820 cubic meters in 2001. The level is expected to fall to only 1,140 cubic meters by 2050. Private equity capital, which tends to emphasize production efficiency and strong governance, has started to address the demand and supply gap in recent years.

CLSA Capital Partners (CLSA CP) is among the pioneers. Earlier this month, the private equity player invested $15 million for a 20% stake in New Delhi-based Earth Water Group, a water and wastewater management and technology company. The capital will be used to support the company's existing core businesses, as well as enabling it to acquire new technologies and businesses in areas such as zero liquid discharge.

"India's water sector is highly fragmented but it has been growing rapidly at almost 25% per year for the last decade. Over 65% of water is now untreated, compared to 80-90% in Beijing," says Peter Kennedy, head of CLSA CP's Clean Resources Fund. "Private investors have taken the lead in distributed waste water treatment."

Other recent movers include Aditya Birla Capital Advisors, which committed INR400 million ($8.7 million) to SMS Paryavaran. The company undertakes projects in water transmission, treatment, storage and distribution as well as sewerage systems management and industrial effluent collection. Meanwhile, Jaldhara Technologies, a specialist in water, wastewater and effluent treatment products, received $2 million from Nexus Venture Partners in May 2011.

However, private equity activity in the sector is still nascent. In total, around $300 million has been invested in the last couple of years - far less than the capital committed to other Indian infrastructure channels such as roads, ports and power. According to a 2011 report by Bain & Company, private equity is one of the engines for infrastructure growth in the country, with commitments reaching $4 billion in 2010, up four-fold from 2006.

"We have seen maybe 12-15 deals in the water sector, but the number is still so small when compared to its potential," IDFC's Gadkari says. "In the last couple of years, the country has attracted close to $10 billion private equity money in other infra sectors such as roads and power; I see no reason why water supply cannot attract the same amount of investment appetite."

Regulatory hurdles

The Indian government is not blind to the problem. Six years back, it rolled out a massive city-modernization scheme - Jawaharlal Nehru National Urban Renewal Mission (JNNURM) - to improve living standards and infrastructure in urban areas. More than 30% of the scheme's $12 billion budget was earmarked for the water sector, Gadkari claims, citing official data.

The problem is that private equity investors are unwilling to make large-scale investments without a stable and transparent policy framework.

India suffers from fragmentation of responsibility at both central and state levels. In most cases, a water project requires involvement from numerous state and local regulators and they tend to immature in terms of accounting, due diligence and project management. These bodies often come up with their own ad hoc interpretations on water pricing and s-ervice quality. Such ambiguous and ever-changing policies have prevented water companies from establishing nationwide operations.

"The lack of standardized bidding documents today has become a key concern for private investors. The mindset of local bodies must change so that they recognize the benefits of private sector participation and award large-scale project mandates, which would lead to an increase in average deal size," Manish Aggarwal, a partner of KPMG India, tells AVCJ.

In addition, while the Indian government has successfully implemented the public-private partnership (PPP) model in power and road developments, it has yet to take root in the water sector. The stumbling blocks range from water rights and tariffs to operational transparency. Without a framework that creates an alignment of interest between all stakeholders - investors, lenders, governments, companies and citizens - PPPs are unlikely to solve water shortages and deliver strong returns for private equity players.

"As the government currently finalizing the architecture and form of JNNURM II, I remain bullish on the sector," says Aggarwal. "When you go early, you can generate large returns, but obviously you risk running into a situation where the evolving policy framework doesn't favor your sector and you end up with much smaller profits."

Bet on diversity

Rajesh Sinha, South Asia principal investment officer at International Financial Corporation (IFC), is also optimistic, arguing that the need for capital among expansion-focused water sector players has pulled down valuations.
In March, IFC agreed to invest $25 million in water management company Doshion, marking its third deal in the sector. It has previously invested $15 million in WaterHealth International and $5 million in Vishwa Infra.

"Doshion is one of the few end-to-end solutions providers in the water sector engaging in engineering, procurement and construction (EPC) services, manufacturing of water treatment plants and pipes, as well as a number of BOT projects," says Gadkari of IDFC PE, which has been an investor of Doshion since 2007. "We would always like an exposure to multiple elements because that provides a good hedge against slowdown in any one particular activity."

While no one can predict the details of the forthcoming policy framework, PE investors keen on the sector are advised to focus on water companies with at least 2-3 product lines. CLSA-backed Earth water Group is a classic example of a multi-strategy firm, pursuing businesses including waste water treatment, value-added technology and marketing solutions.

"We believe the company has a holistic view of the sector and is building a mini water ecosystem within itself," says CLSA's Kennedy. "We also intend to leverage synergies between our portfolio companies in a move to minimize risks as they may help support one another's business."

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• South Asia
• Technology
• India