Venture Capitalist Sees Water as a Strategic Investment
The water sector has traditionally been shunned by investors because it has been heavily subsidized and regulated. They believed that no one made profits in water because investment returns were often capped.
But six years ago, venture capitalist David Henderson, managing director of XPV Capital in Toronto, realized there were real returns in water.
“There was this whole world where water is mission critical, and these water processes enable pretty well everything on the planet,” he said. “You start to see that there’s a very strong value proposition for water technologies that can bring efficiencies or improve security or quality in those processes.”
XPV may be the first venture capital firm in the world to focus exclusively on water. When I was in Toronto earlier this month, I met with Henderson and discussed with him why water is a market whose time has come.
The water industry has been overlooked by other investment firms, said Henderson. When XPV started investing in water in 2006, “it was at the beginning of a transition in the industry,” he said. “The best time to invest in an industry is when it’s under change because that’s when the most opportunities arise.”
There are several reasons why water is expanding now, said Henderson. There is a large need for new and updated water and wastewater systems, driven by population growth, urbanization, and industrialization of world economies.
Half the world’s population now lives in cities, Henderson pointed out. “Urban environments are much more demanding on water systems and much more challenging on the wastewater side because you’re concentrating everything,” he said.
Water infrastructure is a huge challenge – and a huge opportunity, he said. In the western economies, most water infrastructure was built post World War II, with a lifespan of 50-70 years. It is now beginning to fail. For example, in the United States, 250,000 water lines burst a year, or about one every two minutes, according to a 2010 investigative series by reporter Charles Duhigg at the New York Times. U.S. cities currently lose one-fifth of their water to leaks and suffer 1.2 trillion gallons of wastewater spills each year, according a report from the U.S. General Accounting Office. And repairing just the U.S. water infrastructure is expected to cost more the $600 billion by 2019, according to that country’s Environmental Protection Agency.
The developing world has a parallel problem: Many countries don’t have proper infrastructure, but they need it, thanks to their booming economies. “It’s difficult to build the kind of centralized systems that we have in place in North America in a city like Beijing, when you already have 20 million people living there,” said Henderson.
Industrialization is also increasing demand for water, in particular because diets are shifting from plants to meat. “You see this in places like China and India where they go from low-water diets, which is more vegetarian, to protein diets, which require heavy water use,” said Henderson.
Increased industrialization also creates demand for better wastewater treatment in industrial applications and demand for water generally, which is required in “everything we manufacture on this planet,” said Henderson.
But that demand is not just simply for water, he said. “It’s the right quality and quantity of that water; it’s the right timing of water.” Providing these elements is a money-making proposition.
Climate change is also driving expansion in the water industry, he said, because it is changing the planet’s hydrological systems. Creeping desertification in areas that have recently seen been population explosions — for example, the Southwest United States — requires creativity and innovation in order for water maangers to continue to meet demand. Big floods in other regions — the Northeast United States; Queensland, Australia; parts of China — are also inundating infrastructure, causing loss of life, property damage, ruined crops, energy supply disruptions, and contaminated water supplies.
These costs are underlining the vast need to manage water differently than we have in the past.
While the present market is primarily industrial, opportunities are emerging on the municipal side as well, Henderson said. “Cities are getting much more aggressive in inefficiencies in their systems because of the financing collapse and the state of government balance sheets,” he said.
In response to all these challenges and opportunities, outsiders are moving into the water industry.
Innovation typically comes from outside a given industry, Henderson pointed out, from someone who thinks differently. “Young people are now getting into the water industry,” he said. “They don’t carry the 50-year history of what this industry is supposed to be.”
He continued: “A lot of it isn’t going to work, just like any innovation research, but I think there will be breakthroughs as we see that cross-pollination.”
Some universities are beginning to include water in their cross-pollination efforts. Henderson pointed to MIT’s energy program, which is starting to include water. “All those energy guys are starting to think about water. That’s where innovation sparks. It makes me optimistic about solving some of these things like desalination, which is probably the ultimate water-energy nexus challenge,” he said.
At first blush, it’s a bit mystifying why a venture capital firm focused on water would spring from Toronto, a city built on the shore of Lake Ontario, one of the largest freshwater sources in the world.
It’s more obvious why water-scarce regions like the Persian Gulf, Southern California, the U.S. Southwest, Singapore, and Israel would be leaders in water technologies and management.
“It’s the laws of scarcity. If you don’t have enough of something that’s essential to all life, including not just human but society, well you’re going to be innovative in how you manage that,” said Henderson.
But, although it may seem counter-intuitive, water-rich places are also rich in innovation, he said.
Ontario is one of the top regions globally for producing innovative water technology, he said, pointing to companies like Zenon andTrojan.
“Places with a lot of water, like around the Great Lakes, attract all the water-intensive industries,” Henderson said. In Ontario that has been manufacturing, mining, food and beverages, and big pharmaceutical.
Eventually, water-based industrialization leads to water regulation, he said.
“In North America, in Canada, in Ontario, in the United States, it was the Clean Water Acts,” he said. And because water is such an important component of their operations, these water-intensive industries invested heavily in innovation to ensure that they could comply with the regulations to their processes would be sustainable and to secure the water itself for future operations.
Today, globalization allows such companies to peddle their innovations worldwide, Henderson said. “Zenon grew up in that era of the ’80s and ’90s where we globalized the world. So suddenly all that great innovation that they developed here in Ontario could be sold in Singapore.”
Government incentives and cooperation with business have also played a role in Ontario’s emergence as a leader in the water industry, a topic I will cover later this week. Tomorrow I will continue the interview with Henderson, discussing the dramatic changes he sees coming in how we manage water – and the investment opportunities those changes will provide.
“Even though Ontario has an abundance of freshwater, we’re not taking it for granted,” said Henderson. “I believe the cities and regions that make water a strategic priority are going to have a big advantage over regions that don’t.”