PE firms clean China’s water

With the environment given prominent billing in the 12th Five-Year Plan - a national policy document published earlier this year - independent investors have been allowed to participate in the development of China's treatment and infrastructure platforms.

The government will offer financial support to companies that offer value-added solutions. A total of RMB4 trillion ($622 billion) has been earmarked for water infrastructure over the next a decade, focusing on areas such as dam construction, reservoir management and water treatment systems.

Pacific Equity Partners, in a report on the water treatment industry, concludes that the government's stance has created strong investment opportunities for private equity.

Investing in treatment

Earlier this month, KKR invested $113.8 million in convertible bonds issued by United Envirotech (UEL), a Singapore-listed Chinese water treatment company. If fully converted, KKR could own over 38% of the firm. UEL provides engineering services using membrane technology to municipal and industrial waste water treatment projects, and also operates a portfolio of waste water treatment plants across China.

According to the proposed subscription agreement, at least 90% of the proceeds from the bond issue will be put towards transfer-operate-transfer, build-operate-transfer (BOT) and build, own and operate projects. The remainder will be used for working capital requirements.

In the week following the KKR-UEL deal, Beijing-based buyout firm CDH Investments took an undisclosed stake in Sinomem, a Singapore-listed water treatment group, for $282 million.

One industry source familiar with investments in China's water segment tells AVCJ that the industry appeals to investors because it has potential but is still relatively underdeveloped. "China's water treatment industry is very young," the source says. "I think the reason why a number of private equity firms are eyeing the industry has to do with government's support of the development of the water treatment industry. Private equity capital can play a constructive role in bringing in capital and operational expertise to assist the healthy development of the industry over the long term."

The Chinese government has plans to spend $300 billion over the next decade to develop the water treatment industry, the source adds. The more external capital added to the pool, the faster the country can meet its goals.

The attractiveness of water treatment extends to its regulatory classification. While water supply companies are usually directly or indirectly controlled by governments, water treatment falls under a different category, giving independent investors far more leeway.

Private equity players have taken notice across the region. For example, a group consisting of K One W One from New Zealand, Khosla Ventures and Qiming Venture Partners from the US, and Softbank China Venture Capital from Japan collectively invested in New Zealand's LanzaTech in July of last year. Also in 2010, Nippon Mirai Capital purchased close to 100% of Asahi Tec Environmental Solutions Corp. for $30million in Japan.

In 2009, Standard Chartered Private Equity invested $32 million for a 40% stake in South Korea's Environmental Facilities Management Corp. (EFMC), in addition to providing an $8 million facility for business expansion.

China opportunities

Nevertheless, investment opportunities in China appear to dwarf those in other markets, which is likely a function of the country's size - and therefore need - as well as the poor state of its water treatment industry.

Carey Wong, research manager at OCBC Investment Research, says that years of rapid industrial growth have taken their toll on the environment. "We can devise alternative sources of fuel but there is no replacement for water - yet," he says. "Naturally occurring fresh water resources are running out and without recycling or desalinating the water, a lot of countries, including China and those in the Middle East North Africa region, could face a water crisis by 2020."

Virtually all of China's private industrial projects in the water treatment sector were funded by entities such as industrial park owners, factory owners and third-party operators. However, in recent years, Beijing has increasingly favored the BOT model, whereby the government awards a municipal project to an independent contractor who then fronts up the capital, builds the treatment facility and then operates for a set term, usually 30 years.

The BOT model has also proved effective elsewhere in Asia - even in nations like Singapore that sit at the opposite end of the clean water and environmental technology spectrum to China. If anything, this highlights the scope for of investments in water treatment across Asia.

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• Topics
• Greater China
• Cleantech
• KKR
• Standard Chartered Private Equity
• CDH Investments Management