JD Capital: New Picture Taking Shape in Water Industry
As the 13th Five Year Plan unfolds in 2016, China’s environmental conservation industry has been given great significance. According to Chinese Academy for Environmental Planning, during the 13th Five Year Plan period, total investment in the environmental conservation industry is expected to exceed 17 trillion yuan, among which a considerable amount will go to water industry.
According to JD Capital’s public utility investment team, environmental conservation industry lacked attraction for market capital because of its low ROI ratio; but with the changing investment logic and the implementation of favorable policies, the industry, especially water industry is growing rapidly nowadays.
JD Capital has invested in or developed cooperative projects in various environmental conservation areas centering around water treatment, including municipal water supply and drainage, industry waste water and solid waste treatment, urban environmental governance, water and soil rehabilitation etc.
“Driven by government policies and market demand, intensive competition and industry reshuffle has pushed environmental conservation industry, especially water industry, into an era of M&A featuring comprehensive environmental service,” analyzed by JD Capital.
Water industry under influences of government policies
In China, most water industry enterprises, especially the large ones, engage in various businesses along the industrial chain, including raw water treatment, water supply, water conservation, water drainage, waste water treatment and water recycling. In line with the growth path of the whole environmental conservation industry, China’s water industry also went through three stages of service outsourcing as relevant policy changes.
“Featuring policy-oriented development, market monopolization, public welfare in nature and stable revenue, water industry on the whole is almost immune from economic cycles, maintaining a steady growth and performance among economic fluctuations,” said the public utility investment team, “China is yet to reach its turning point of the Kuznets curve, thus promising large room for the environmental conservation industry to grow rapidly and enter the expansive investment stage.”
According to JD Capital, when Chinese government opened market of the former state-owned water industry, foreign giants in this area like Veolia and Suez, taking advantage of their brand and wealth, marked a strong presence in China’s market through direct investment, and stock purchasing, etc., thus getting a head start.
Later, as industrial standards and policies of municipal water markets fleshed out, market competition intensified. Many public-listed state-owned enterprises like Beijing Enterprises Water Group Limited and Beijing Capital Co., Ltd., by virtue of their deep pocket and rich social resources, rapidly emerged and developed. “These enterprises, optimizing asset portfolio with industry capital, began grabbing market shares nationwide through the business model of “sacrificing short-term gains for long-term profits.”
Since 2014, innovative financing models started to be applied in the water industry. Emerging public listed enterprises with financing channels like Origin Water and Beijing Water Business Doctor Co., Ltd. became industry pace setters.
“Driven by new policies under the 13th Five Year Plan, the water industry has entered into a stage of “financial-industrial combination plus,” analyzed by JD Capital public utility investment team. The team also holds that with policy support, enterprises in the water industry can maintain their stable capital flow in terms of operation incomes; but down the road, the high ROI ratio of the water industry is expected to decline, taking a toll on the enterprises’ profitability. Against this background, it has become a common priority for these enterprises to further tap into the capital market, conduct large-scale financing, and accelerate industry integration through M&A so as to reap profits of scale economy.
Capital expansion driven by both industry and finance
The initial fight for market share in China’s water industry is coming to an end as the large picture of market presence takes its shape.
According to JD Capital, with limited newly created market in the environmental conservation industry, established brands, especially water industry giants, have hit a bottleneck. For them to grow, they must transform from investment-driven entities into comprehensive service providers, promote market competition and industry chain expansion through M&A, upgrade technical industry functions, competition pattern and operation method, so as to upgrade business models and find new development opportunities.
In recent years, Kangda International Environmental Co., Ltd., a giant in the environmental conservation industry, has grown rapidly through a serious of M&A cases; many enterprises in this field followed suit, engaging in PPP competition and horizontal M&A for a fast expansion. Besides, Beijing Capital purchased solid waste assets from two enterprises, one located in New Zealand and the other Singapore, thus increased its profitability rate through vertical M&A, and expanded into such emerging markets as solid waste treatment and recycling. Some enterprises seek overseas M&A in the hope of improving technical strength or exploring new markets, one example being the acquisition of Norway Goodtech Environment AS by Anhui Guozhen Environmental Protection Protection & Technology Joint Stock Co.,Ltd.
As enterprises in the environmental conservation industry seek transformation and upgradation, many industry outsiders, under the encouragement of government policies and market demand, begin to pay attention to or even march into the industry. Among these outsiders, some are state-owned enterprises backed with solid financial strength; some are enterprises from declining traditional industries with a strong momentum to reform; and some are closely related to the water industry with a head start.
With industry outsiders coming from different directions, hoping to get a piece of the action, competition in the water industry is getting increasingly intense and complex.
Besides, as analyzed by JD Capital public utility investment team, the traditional municipal water supply and drainage market is reaching its saturation, which also propels the development many derivative areas. Compared with the mature municipal water supply and drainage market, these derivative areas are still at an early development stage with much growth potential and strong profitability. Over recent years, many industrial segments have developed strong technical power and mature profitability models, including industry waste water treatment, secondary water supply, reclaimed water reuse, sea water and brackish water desalinization, rural waste water treatment, sludge disposal, etc. Some enterprises that are small in size but strong in particular fields have made breakthroughs in the above-mentioned areas, making themselves potential quality M&A targets.
With its rapid growth, the water industry has also fared well on the capital side. According to statistics, the average P/E ratio of the water industry on A-share market was 86.9% higher than that on the Hong Kong stock market in 2014 and 309.2% higher in 2015, 196.3% higher than that on American stock market in 2014 and 321.1% higher in 2015. The strong profitability of the industry is becoming increasingly prominent.
Figure 1: P/E ratio of the water industry in domestic and foreign capital markets
The high valuation of the water industry in the capital market prompted industrial leaders like Beijing Water Business Doctor Co., Ltd, Infore Environment Technology Group and Hebei Sailhero Environmental Protection Hi-tech. Co., Ltd. to establish M&A fund for financing and market value management.
Meanwhile, securities traders, banks, private equity institutions and other financial organizations are also entering into the industry.
Industrial leaders emerge with M&A investment
According to statistics, in 2015 there are a total of 136 M&A cases in China’s environmental conservation industry, with a transaction amount of over 40 billion yuan; this M&A craze reached a new high in 2016 with 52 M&A cases launched during merely the first half of the year, the transaction amount nearly reaching 30 billion yuan.
“For a long time, we have been exploring investment opportunities in the environmental conservation industry,” said JD Capital public utility investment team. Based on its analysis of the horizontal synergy and vertical integration process of the water industry, JD Capital sorted out M&A and investment opportunities and mapped out a systematic value investment landscape featuring “project-industry”.
“For enterprises with mature business models and strong ability to expand both vertically and horizontally, we will, by giving full play to our investment advantage in both the industry and finance, participate in their private placements and maintain long-term cooperation. We will play an active part in their strategizing and decision-making process, so as to help them upgrade into bellwethers in industrial segments,” said the public utility investment team.
For large size enterprises already taking leading positions in their respective industrial segments, JD Capital plans to support their horizontal and vertical expansion through investment, so as to help the enterprises expand market shares and improve bargaining power along industrial chains, thus consolidating their position as industrial bellwethers.
For mature enterprises with a stable capital flow and clear operation models, JD Capital will help them improve M&A patterns, expand new capital channels, increase market values through capital operation, and customize cooperative plans, in a way to maximize interests for all.
JD Capital predicts that, as the water industry becomes increasingly mature and the capital market knows more about it, the internal growth speed of the industry will decline, and the price difference between primary and secondary markets will narrow. However, scale merit from industry integration is expected to become an important factor influencing enterprise value.
“Effective M&A, and reorganization of enterprises’ or even industrial resources, synergizing with the enterprises’ internal growth rate and the capital market valuation, will set the stage for new water industry leaders adaptive to new industry trends,” said the public utility investment team. Apart from the water industry, JD Capital will also keep a close eye on other industrial segments like air pollution control, solid waste treatment, and environmental monitoring, etc.