Call it the ultimate liquidity preference: the unveiling of a new wastewater treatment platform pairing private equity giant KKR with water-focused growth equity investor XPV Partners has drawn attention to the in-demand and idiosyncratic private market for water infrastructure and technologies. Investable Universe spoke to XPV Partners founder and managing partner David Henderson about the new KKR co-investment, and how his firm approaches thematic investing in water.
For Henderson, a role for private equity in developing municipal and manufacturing water supplies is neither novel nor particularly controversial.
“We are entering an era where we can have conversations about where private capital can be helpful and where it can’t,” says Henderson, who has led XPV for 12 years. “What is not widely understood is that most products and services that treat and move water already come from private capital—pipes, technology, filters and software all come from private industry. Most average citizens are starting to become aware of that fact, and of what effective water policy can mean for economic growth.”
In December, KKR’s Global Impact Fund announced that its investment in the platform together with significant minority shareholder XPV, will help to address the problem of nutrient management in municipal and industrial wastewater treatment facilities.
In the U.S. alone, the issue’s scope is immense, and occurs wherever food is grown. According to EPA figures obtained from KKR, fertilizer nutrient contamination—primarily nitrogen and phosphorus—has officially impaired 53% of America’s rivers, 71% of its lake acres, 79% of estuary square miles and 98% of great lakes shoreline miles. Residue from plant nutrients overstimulates growth in freshwater areas, contaminating drinking water, causing dead zones and poisoning fish and wildlife habitats.
Tighter regulations have made it harder for wastewater facilities to achieve new effluent discharge standards, creating an acute demand for point-source treatment.
The platform combines two of XPV’s portfolio companies, both nutrient management market leaders in the space—Nexom, a technology solution provider for primarily small and medium sized municipal wastewater facilities, and Environmental Operating Solutions (EOSi), an environmentally sustainable specialty chemical provider for industrial and municipal wastewater facilities.
While the new venture is its first partnership with KKR, water related investing is the stock-in-trade of XPV, the U.S.-registered, Toronto-headquartered fund that manages assets primarily for institutional clients.
“It’s a great partnership in that we bring a lot of industry-specific expertise to the table, while KKR brings strategic understanding of the market and the ability to pursue a global mandate for the platform,” Henderson says.
He explains that XPV’s limited partner base is very similar to that of traditional private equity funds: endowments, pension and insurance funds, and family offices. Most of these funds are domiciled in North America, although XPV is seeing rising interest from some European, Middle East and Asian-based investors.
From a universe of 9,000 water-focused companies worldwide that the company is actively tracking, XPV’s portfolio spans 16 companies spread across a variety of water investment themes, situated at different junctures along the industrial, commercial and municipal value chains.
“Common to all of our companies is the acknowledgement of water as the mission-critical input. If you don’t have the right quantity and quality of water, power plants cannot generate power as an example, which pretty well impacts every aspect of society. Without high-purity water, you can’t produce semiconductors, which means you can’t produce smartphones,” he explains.
XPV targets all stages of development, growing businesses by providing access to expertise, capital and its scaling-up platform. There is no set exit strategy for these companies. XPV is open to IPO exits for the companies it develops, but typically sells to large strategic buyers—e.g. private equity titans like KKR or the “ready set” of water-focused companies and conglomerates looking to acquire or bolt on new technologies—once they achieve scale.
Henderson compares the company’s approach to an athletic “farm team” that prepares rising talent for big league play.
“Scaling a business is the biggest challenge to water companies, especially municipal players, due to the heavily regulated nature of these markets,” he explains. “People generally don’t want a lot of experimental R&D being done on their drinking water.”
Different Growth Model
Committing venture capital in a highly regulated, public goods market like water requires a fundamentally different approach to milestone setting.
“The risk/reward profile of water companies doesn’t fit the box for traditional venture capital,” Henderson explains. “It’s a different growth model. Investors that will do well in water-related opportunities are those who are part of the sector and focus on strategically growing their business.”
Nor is XPV necessarily focused on acquiring patent portfolios. Unlike a chip maker, for example, a “ring of patents” is not a prerequisite for a water-focused firm to make an attractive investment.
“We would invest in a company without patents, but with some other form of intellectual property—the right reference customer, for example, because that’s what allows companies to scale, especially those working with municipalities,” he said. “A good municipal reference customer is actually a strategic advantage, because municipalities don’t compete with each other. If they find a water solution that works for them, they’ll tell their neighbors about it.”
Looking ahead, Henderson says the next wave of investment is likely to target on-site water recycling technologies:
“We’re seeing interest grow in water recycling all across the value chain in the utility, oil, gas, mining, food and beverage spaces. And specifically, we think decentralization of water treatment will be a compelling theme. Water is heavy—it’s seven pounds to the gallon, and it changes state but never leaves the cycle, making it expensive to move and handle. Innovations that enable communities and industry to recycle water on the spot will be very attractive.”