Investing in Water Infrastructure Development: A Conversation with Raul A. Deju, Partner at Brightstar Capital Partners

At Brightstar Capital Partners, we have a sharp focus on investing in and growing the value of middle market companies. A vital element of our value-creation model is the industry expertise that our roster of Senior Partners brings to our investment process and our portfolio companies.

One of our Partners, Raul A. Deju, is the Chairman of Texas Water Supply Company, a Brightstar portfolio company that brings water to the fast-growing Texas Hill Country. Raul is also a Ph.D. Hydrologist graduate from the New Mexico Institute of Technology, and author of seven books including “Regional Hydrology Fundamentals”, “The Environment and its Resources”, and “A Planet in Conflict.” Below, I ask Raul to give his perspective on how private capital can help forge a sustainable future in water development.

1. What is the present state of America’s water sources and systems and what are the key factors that will drive growth in environmentally conscious water infrastructure development in the US?

Americans are the world’s largest per-capita users of water. We use about 3 times as much water as an average European consumer and 6 times as much as an average Chinese consumer. Our water needs are served by a patchwork of over 50,000 public and private water systems, leading to fragmented and sometimes inconsistent water management. Even with all that demand, our average cost of water can be as low as pennies per gallon. So we place very heavy demands on our water infrastructure, but we don’t have consistent management policies or sufficient resources to invest in the proper maintenance and expansion of that infrastructure.

Forty percent of America’s water infrastructure is over 40 years old. As our population grows toward 400 million by 2050, supplying water represents both a public challenge and a private sector investment opportunity. Estimates indicate that to just rehabilitate the existing US water supply/treatment and delivery infrastructure will require in excess of $1 trillion over the next decade – and to improve the systems to best-in-class level would take well over $3 trillion.

Fortunately, our society is starting to value water as it should be valued, which creates a good climate for investment. People in urban areas are demanding the availability of good quality water and are willing to pay higher prices. In the past nine years the average price of water in the US has increased over 50% and such increases are likely to continue in the immediate future.

The global debate around climate change also has raised awareness of the topic of investment in water. Given the need to conserve water, many local systems are educating consumers about water-saving practices. Water systems across the country are also increasing the price of water to fund improvements to make their infrastructure more efficient and reliable.

2. Why is private equity an appropriate vehicle for investment in water infrastructure? What can private capital do that public resources cannot do as well?

Federal and state governments generally play a small role in water investing. Opportunities for investments in water have expanded as local governments run short of cash and must turn to the private sector to fund upgrades, run local systems and meet environmental standards. Also, consolidation in the industry is accelerating.

Private equity firms have the capital to invest in infrastructure – along with deep expertise in consolidating and turning around businesses – so they’re well-positioned to help our American water systems achieve greater efficiency.

At the same time, water infrastructure is an attractive vehicle for pension funds and other investors who are seeking alternative investments that avoid the volatility of equity markets while providing greater yields than bonds. Demand for sustainable sources of quality water is growing, the price keeps improving, and there is expertise in the private equity space to create value through water investments.

3. What are the most attractive areas for water investment: supply, distribution, treatment, client services, etc.?

Many fund managers now see the water space as an investment opportunity for the long-term on an essential commodity that is scarce in many regions.

For example, there are opportunities – especially in water-short areas where population is rapidly growing – to buy thousands of acres of land with viable water rights, aquifers, surface water access, and even small private water utilities that have been neglected. Opportunities also exist to invest in the efficient extraction of water from aquifers, the efficient use of surface waters, desalination, and even the re-use of treated water. Another opportunity is the consolidation of small water systems with large ones to create a larger company that can better deliver needed services. Or, one can invest in the infrastructure companies needed to repair and replace the current crumbling system and upgrade obsolete technologies.

4. How are investors building scale in water infrastructure?

Investors are increasingly consolidating a myriad of water companies – many of which are really too small to operate effectively. These investors are finding it profitable to acquire a small water system that can become the “anchor” for combining other small units into a bigger structure, which can then be upgraded.

Other investors are agglomerating water supply sources in fast-growing metro areas and selling very long term supply contracts to producing entities that are becoming water-short because of the rapid growth in their area of service.

5. What attributes must be present in a specific region or metro area (demographics, economic growth, public agency structure, etc.) to make it an attractive place to invest in its water development?

The best target areas for investment in water are those smaller systems that cannot meet the needs of their users, in areas where demographic growth and industrial use growth warrant price increases to pay back the investments needed to modernize existing water systems.

Economic development assistance and good working relations with regulatory bodies are also a must. The public and private sectors must collaborate to turn around our rapidly deteriorating water infrastructure – to make peoples’ lives better and increase the growth potential of our communities. There are things the private sector can do better, cheaper, and faster than the public sector, while the public sector can do some things that the private sector cannot. Through the right partnership, we can achieve success more effectively, faster and at the lowest cost to consumers. The private sector can create better service to customers with upgraded systems that are also operated in an environmentally friendly manner.