One of the investment themes that Nanalyze readers often tell us they are most passionate about is weed water. It makes sense: Only about 3% of the H20 on our water-logged planet is freshwater. And humans can only reasonably access less than 1% of a resource that is objectively more valuable than gold, oil, or even weed. It is expected that there will be a 40% gap between global water supply and demand by 2030. Plenty of companies are creating technologies to bridge that gap by conserving or optimizing the ways we use water, some as simple as detecting leaks. Others are manufacturing and operating desalination technologies and infrastructure for tapping the other 97% of available water.
You would think that demand for such a scarce commodity would create a dynamic, high-growth market for the right company. Yet our thirsty MBAs have yet to find a pure-play water technology company that we would want to hold for the long haul in the Nanalyze Disruptive Tech Portfolio. Since our preference is to invest in the market leader of an industry or sector, we were briefly interested in a French company called Veolia (VIE.PA) after we came across this list from Global Water Intelligence (GWI).
Last year, the company’s revenues related to water tech and operations recorded organic growth of 7.5% to nearly $20 billion. However, Veolia is more broadly a utility company that also draws significant revenues from energy and waste services. In fact, management expects revenues from water to fall from about 41% today to just 33% by the end of the decade, according to GWI. That brings us to the No. 2 company on the list – Xylem (XYL).
Xylem: The Biggest Pure-Play Water Stock
Xylem should be a familiar name to long-time readers of Nanalyze. We first profiled the company nearly five years ago as a way to invest in smart water technology. We liked the company enough to include it in our Nanalyze Disruptive Tech Catalog, with the intent to check in to see if its aggressive pursuit of upping its technology game would pay off with significant revenue growth. However, when we revisited Xylem stock more recently, it seemed apparent that it was more of a value play for investors who prefer profitable companies with modest dividends rather than a growth stock ready to go bonkers. But then last year Xylem acquired a major competitor, Evoqua, for a $7.5 billion all-stock deal to become the biggest pure-play water company in the world.
What, if anything, does this acquisition change?
What Does Xylem Do Again?
First, a quick refresher on what Xylem brings to the table. The company specializes in providing solutions for managing water resources. It offers a range of products and services that help move, treat, and analyze water, with a focus on developing tech to address water-related challenges, such as water scarcity, aging infrastructure, and water contamination. Applications range from public utilities and industrial settings to residential and commercial buildings.
In other words, Xylem sells more stuff than you can find at your local Home Depot. For instance, the company offers a platform called BLU-X for real-time management of sewage and wastewater systems that uses sensors, weather data, digital twin technology, and artificial intelligence to prevent things like sewer blockages and overflows or to optimize wastewater treatment to comply with regulations. In South Bend, Indiana, for instance, the city implemented Xylem’s intelligent sewer system and reduced sewer overflow volumes by more than 70%, which reduced E. Coli concentrations in the St. Joseph River by 50%. The city is expected to save more than $500 million in capital expenditures required to comply with regulations. That’s what we call a return on investment (ROI).
The Impact of the Evoqua Acquisition
The big question for Xylem is what the ROI will be on the $7.5 billion stock deal to buy Evoqua Water Technologies, which was No. 37 on GWI’s list of the world’s top water companies before the acquisition. Evoqua specializes in water treatment solutions and technologies for municipalities and industrial customers, like UV systems that kill microorganisms such as bacteria, viruses, molds, and pathogens without using chemicals.
At the time of the announcement back in January 2023, the offer represented a premium of 30% above Evoqua stock’s closing price. It was also triple the price that Xylem had offered to Evoqua back in 2017 before the latter decided to go public instead. The company currently occupying the No. 37 spot on the GWI list is an Italian utilities firm called Acea that had more than $5 billion in revenue in 2022, including about $1.4 billion related to water. Currently, its market cap is less than half of what Xylem paid for Evoqua for substantially less total revenue. Presumably, Xylem is counting on synergies for the acquisition to add shareholder value . For example, management claims the merger will generate about $140 million in cost synergies within three years. On the other hand, Xylem spent more than $100 million on restructuring and realignment costs last year, and the company expects to incur between $50 million and $70 million on similar expenditures in 2024.
The most obvious and immediate impact of the acquisition, however, is on Xylem’s bottom line: Revenue from 2022 to 2023 jumped more than 33% to nearly $7.4 billion. Interestingly, more than a third of revenue growth occurred organically outside of the Evoqua acquisition.
We can see that Evoqua accounted for nearly $1.2 billion in 2023 revenue, with most of the money coming from a segment called Integrated Solutions and Services (ISS). Most of the organic growth – revenue generated by Xylem sans Evoqua – is concentrated in the Water Infrastructure segment and Measurement and Control Solutions (MCS) segment. We’re MBAs, not plumbers, so here’s a breakdown of the different segments heading into 2024:
The graphic reflects a recent realignment that combined the ISS business from Evoqua with a chunk of Xylem’s business involving dewatering and assessment services into a new segment called Water Solutions and Services.
Should You Invest in Xylem Stock?
We never tell you where to spend your money, but we can give you a few things to consider if Xylem stock is still on your radar.
Looking ahead to this year, Xylem is guiding to between $8.4 billion and $8.5 billion in revenue, which represents about 14% to 15% revenue growth. That sounds pretty good until you consider that only 3% to 5% is organic growth. That means Xylem appears to still be largely a single-digit-growth company minus Evoqua. However, the growth versus value picture should become clearer in 2025 after the company has a full year of combined revenues in the bank. After all, the Evoqua acquisition did not go through until late May, so we would expect to see higher overall growth in the first half of the year before it begins tapering off.
Still, there’s a lot to like about the world’s biggest pure-play water company, especially the exposure to digital and automation technologies. There is even some indirect exposure to water tech startups through the Xylem’s accelerator program, which has supported several dozen companies since 2022. For instance, this year’s cohort includes startups developing advanced pathogen detection technologies and novel leak-detection materials, as well as AI that can predict flooding, inspect pipelines, and simplify regulatory compliance reporting. Xylem has about $2 billion in cash and liquid assets, and during the company’s most recent earnings call, management said it is focused on small to medium acquisitions in the immediate future. One company’s accelerator is another company’s technology pipeline.
Xylem estimates its total addressable market (TAM) at a mere $700 billion, so there is presumably plenty of room to run. The company especially sees growth opportunities in emerging markets outside of the United States and Western Europe including China, India, Eastern Europe, Latin America, and Africa. But these are not necessarily easy markets to crack. For instance, revenues from China, estimated in the mid-single digits, are expected to be flat in 2024.
Conclusion
Despite the ocean-sized TAM, we have to come back to the conclusion from our last article: Xylem stock is a better value stock than a growth stock. And that’s not a bad thing. The company has now increased its dividend for 12 straight years. Maybe in another dozen years, we would consider adding Xylem stock to our dividend-growth portfolio, Quantigence. In the meantime, we’ll continue to see how well Xylem management does its job managing the biggest acquisition in the company’s history. If it can achieve organic double-digit growth through 2025, with guidance of doing more of the same into 2026 and beyond, then we would revisit Xylem then. Otherwise, see you sometime in 2036.
