Water Treatment Chemical Growth Assured

21 February 2005 00:01  [Source: ICB Americas]

After several turbulent years of M&A activity, two companies, Nalco and GE Betz, hold more than 50 percent of the US market for water treatment materials and services. However, the waters may not remain still for long: Nalco’s November 2004 IPO was a hit, raising $667 million, and some observers believe GE Betz may soon be on the block. Meanwhile China, with one quarter of the world’s population, is emerging as a key opportunity for service companies with the scale and capability to meet a rising wave of demand.

New York City-based private equity firms Apollo Management, the Blackstone Group and Goldman Sachs Capital Partners bought Nalco from Suez in November 2003 for about $4.35 billion, including about $1 billion in debt. The firms still own more than 50 percent of Nalco after the IPO.

The Nalco Holding Company achieved 2004 sales of more than $3 billion, supported by accelerating fourth-quarter revenues, the company says. For the year, sales grew 9.6 percent to $3.03 billion, with organic sales—excluding acquisition, divestiture and currency impacts—up 5.2 percent from the 2003 base of $2.77 billion.

“We expect [Nalco’s] consolidated sales to grow 5.5 percent in 2005,” says JPMorgan Securities analyst Jeffrey J. Zekauskas. “Gross margins should improve to 50 percent from 49.3 percent in 2004, due to improved price/mix in [Nalco’s Industrial & Institutional Services unit] and some pricing improvements that should partly offset raw material pricing pressure.”

Nalco’s businesses are organized into three divisions: Industrial & Institutional Services, which includes water treatment chemicals, with about 50 percent of sales; Paper Services, with 23 percent; and Energy Services, which deals with upstream and downstream refining and petrochemical manufacturing, with 27 percent.

Formed in 1928 as National Alu-minate Corp., Nalco existed as a publicly traded company from 1947 until 1999, when Suez Lyonnaise des Eaux Group acquired the company for $4.5 billion ($4.1 billion in cash, the rest in assumed debt), and renamed it Ondeo Nalco. That same year, Suez bought Calgon Inc. for about $421 million, and merged it with Nalco.

In early 2002, Hercules Inc. sold BetzDearborn to GE Specialty Materials for $1.8 billion, which renamed the acquired company GE

A GE Betz formulated products and services unit in Trevose, Pa.

Betz. GE believed that there were many synergies with the deal, especially with GE Medical Systems and GE Power Systems, and observers noted that with the purchase, GE bought immediate market share in the water treatment business. GE Betz is based in Trevose, Pa.

“GE made that purchase from Hercules because it was a low price, and at the time, the world was in the middle of a recession,” says John Goin, senior partner of the Manhattan, Kan.-based consultancy Lake View Associates. “But GE is a bank on wheels: they saw a good investment, and they had a war chest that could sustain Betz and keep it healthy and growing during any lean years while the economy recovered.”

GE Water & Process Technologies is GE Betz, GE Osmonics and GE Glegg. Besides manufacturing water treatment chemicals, the business unit also makes pumps, filters and fluid controls. In late 2004, GE agreed to buy water treatment company Ionics for $1.1 billion.

“Now that we have had a few years of stable, strong economic recovery, I am sure that GE is in the process of spinning off Betz,” adds Mr. Goin. “GE knows that Betz is a self-standing enterprise that has no internal synergies with other GE businesses. A Betz (or a Nalco for that matter) is its own thing; not a portion of a light bulb company or bank. I think GE bought Betz for a financial reason, and that they will sell it for a financial reason. GE will spin off Betz in the next 18 months: The environment for selling it will be getting better, and probably the prime time for financial reasons to sell Betz will be in the next five to 10 months. Betz will be spun off as a completely independent IPO.”

Demand in North America for water treatment specialty chemicals products and services will be steady, the analyst projects. From its current value in the mid-$90 millions, activated carbon will grow to $110 million by 2010. Ion exchange resins will grow from an estimated $133 million to about $157 million in 2010. Organic flocculants will grow from roughly $600 million to $700 million, and formulated materials and services will rise from around $2.2 billion to over $3 billion.

Globally, growth rates for water treatment chemicals on the whole, from 2005 to 2010, will be 3.8 percent per year, with the market expanding from $6.725 billion to $8.103 billion.

Ion exchange resins will have 3.2 percent global growth per year, from $354 million in 2005 to $415 million in 2010. Organic flocculants will grow at 4.1 percent per year: $1.452 billion to $1.774 billion; and formulated products and services will grow 4 percent per year, from $4.472 billion to $5.43 billion.

“Key trends of water consumption and recycle rates in the industrial markets are higher each year, supporting such growth estimates,” says David Muldoon, Ciba Specialty Chemicals’ vice president for water treatment, North America.

“Increased rates of industrial capacity utilization would probably lead to higher demand for Nalco’s products and services,” says JPMorgan’s Mr. Zekauskas. However, “Rising interest rates and higher energy and raw material costs may limit the potential for rapid margin expansion,” and “a sustained increase in energy and raw material costs could depress operating margins. We believe that there is some risk that price competition could occur between Nalco and [GE Betz] leading to a contraction in margins.”

Meanwhile, the activated carbon market is dominated by Calgon Car-bon Corp., notes Mr. Goin, with the company having an “overwhelming market share” of nearly 90 percent in the segment. But because the company has been so efficient in its push for more-robust and longer-lasting materials, the market has a very low growth profile. A similar situation exists in organic flocculants, which is dominated by one player, Cytec Industries Inc., which led the development of this technology.

Spurred by the implementation of various environmental regulations, including the Clean Water and Clean Air Acts, US demand for virgin activated carbon is forecast to grow by 4.3 percent per year to 215,500 metric tons per year in 2008, says the Cleveland, Ohio-based research firm The Freedonia Group. “These laws, as well as activated carbon’s low cost and excellent performance, drive demand in many large-volume markets such as municipal and industrial water treatment and industrial air purification.” Freedonia says that the continued penetration of consumer water purification systems and the replacement requirements of existing systems “will provide favorable opportunities for activated carbon since it is a commonly used filtration material.”

In early February, Calgon Carbon said its 2004 net income jumped 31 percent to $5.9 million on a 21 percent increase in revenues to $336.6 million. But despite the company’s sales surge, Calgon president and chief executive John Stanik noted that last year was not an easy one: “In 2004, we dealt with the continuing challenges of competitive price pressure and rising costs.”

Increasing energy, raw material and transportation costs are credited with increasing prices in the water treatment chemicals sector. GE Water & Process Technologies increased prices for all of its products and services in October 2004. “It is more expensive to do business now than it was two years ago because of current market conditions,” a company representative says.

As the market has been impacted by the rising cost of raw materials, producers have attempted to pass on the increases to their customers. Nalco raised prices for various products in July and October of 2004. “Cost increases in energy and specialty che-mical raw materials, particularly those materials linked to crude oil and natural gas liquids where prices are at historic high levels, have been very significant,” the company explained. “It is now necessary to take this pricing action.” Nalco’s increases in July ranged from 5 to 10 percent, and the October price adjustments were 6 to 9 percent increases.

At the beginning of January, Ke-mira raised coagulant prices 6 to 10 percent (depending on the grade) in response to rising raw materials costs. A Kemira representative says that the outlook for 2005 “shows no signs” of upward pricing trends ending.

Despite pricing pressures, Kemira has been busy in the water treatment chemicals market, attempting, like Nalco and Betz, to grow through acquisition. In November 2004, Helsinki, Finland-based Kemira Oy acquired coagulant producer Eaglebrook In-ternational Group Ltd., based in Mat-teson, Ill.

Financial details were not disclosed, but reports suggest the trans-action was valued at somewhere be-low 70 percent of Eaglebrook’s net sales, which tallied at about $65 million in 2003. Kemira’s water treatment chemicals division, Kemwater, is already the global leader in producing inorganic coagulants, with revenues of $338 million. The addition of Eaglebrook will create the leading producer of inorganic coagulants in North America, with sales of more than $165 million. Eaglebrook sup-plies iron and aluminum coagulants to wastewater and potable water markets.

“Regarding Betz and Nalco’s domination of this market, I don’t foresee that there is going to be a third giant water treatment chemical company emerging in the immediate future,” says Mike Henley, editor of the Littleton, Colo.-based journal Ultrapure Water. “Certainly there is the possibility of a company like Ashland deciding to grow their business and trying to acquire some of the smaller companies, but there is no indication right now of anything like that happening.”

“After the Betz IPO deal there will not be as much M&A activity, as there are no longer many inviting acquisition targets available,” says Mr. Goin. “New ventures in China, particularly joint ventures between Chinese and non-Chinese firms, will certainly be interesting though.”

“As industry moves to a place like China, you can be sure that the water treatment chemical companies will move there—and not just because of the accumulation of other businesses, but also because of the growing business opportunities,” says Mr. Henley.

Lake View Associates is currently working on a multiclient study of China’s water treatment product demand. The firm observes that while the Chinese are not yet as technologically developed as North America, they are developing at a very rapid pace, with an interest in improving their citizens’ standard of living. “They are about one-fourth of the world’s population, and they are rapidly ap-proaching the point where they can produce what we produce better, faster, cheaper,” says Mr. Goin. “The breakout period for China will be between the years 2007 and 2017.” In those years demand will grow intensely, by 25 or 30 percent per year, and perhaps 45 percent per year for selected periods and products. “In about five years’ time, you will see a market develop that is bigger than the US market—probably the biggest regional market on Earth.”

The New York City-based consultancy Frost & Sullivan says that the Chinese water treatment chemicals market was set at $364.5 million in 2002, and will grow at 14.4 percent per year to $920 million by 2009.

Because water treatment chemical customers such as chemical formulators and water service companies are demanding a large assembly of technologies and technical expertise to meet their global demands, suppliers increasingly offer “total solutions” and a “one-stop shopping experience,” notes Frost & Sullivan. At the same time, the customer base has been consolidating, aggravating competition, increasing customer clout and, consequently, adding to pricing pressures.

Customers are increasingly receptive to the services business model, says Frost & Sullivan. Following the sale of a chemical or a chemical treatment package, it is beneficial if the manufacturer is able to provide full-service backup in terms of on-site technical and customer service to the end user. “Offering on-site services support is likely to be instrumental in increasing customer retention,” says Suchita Chaudhari, research analyst for Frost & Sullivan’s chemical and materials group. “Response time can be reduced by offering round-the-clock monitoring of water systems and identifying process efficiencies such as water remediation.”

“Solutions are tailored, as much as possible, to the customer’s specifications,” says Ciba’s Mr. Muldoon. “We do this by bringing in our expertise and our knowledge so we understand the customer’s process or issues, and then Ciba can fine-tune and narrow it down to the key product area and equipment requirements, as well as the technology that may best fit the customer’s application.”

When Degussa announced in No-vember that it was planning to divest its water treatment operation, a factor in its decision was that the business was—despite €170 million ($221.9 million) in sales—too small to become a major provider of the solution systems customers have grown accustomed to.

“The overall water market is very large, and we are seeing strong growth in all the markets related to it,” says Hal Moffat, vice president, global marketing and specialty chemical sales, water technologies, Ashland. “Obviously, especially China will be fueling a lot of that demand. In the Americas and in Europe, there will be solid growth. The future is very strong—especially as the technologies are growing and developing to meet environmental restrictions.

“We see strong market growth driven by innovation,” he adds, “with many new products and technologies making their way to the marketplace. Meanwhile, customer needs are going to become increasingly complex and diverse.”

Len Gelosa, senior vice president, water technologies, Ashland Specialty Chemical, says, “Customers want reliability and cost-control. Customers want to partner with a water treatment company that provides them peace of mind.”

Observers note that with the continued expansion of the world’s population, the demands on water providers will grow. “These dynamics inexorably lead to more and more water becoming polluted, just as more and more people are demanding to have purer and purer water,” says Mr. Goin. “This has an upward spiral of positive financial and economic implications for the water treatment industry.”

A GE Betz formulated products and services unit in Trevose, Pa.

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