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Investors Business Daily
Investors Business Daily

California Drought Puts A Spotlight On This $7.5 Billion Acquisition

Water technologies provider Xylem announced Monday morning it will buy Evoqua Water Technologies in a $7.5 billion all-stock deal. The deal hints at water-industry consolidation, amid the recent ramp up of water-supply tensions over the the California drought and Colorado river shortages. XYL stock edged lower Wednesday and AQUA stock dipped after spiking more than 15% Monday following the announcement.

Per the terms of the deal, shareholders of Pittsburgh-based water treatment company Evoqua will receive 0.48 XYL stock for each AQUA stock they own. That works out to $52.89 per share with a 29% premium based on Jan. 20 closing prices. Xylem is an S&P 500 component.

Washington, D.C.-based Xylem expects the acquisition to deliver $140 million in cost synergies within three years. The deal is set to close in mid-2023, pending shareholder and regulatory approval. Following the acquisition, Xylem shareholders will own 75% of the combined company and Evoqua shareholders will own 25% of the company.

The acquisition occurs as communities and water managers across the Western United States seek alternatives, as traditional river and ground water sources come under increased pressure. Despite recent rains, the Western U.S. is experiencing its most extreme drought in a millennium, according to some estimates. Roughly 65% of America is in some form of drought, according to data from the U.S. Drought Monitor.

Parts of Colorado, Kansas, Oklahoma, Nebraska, Nevada, Utah and Oregon are in "exceptional droughts," which are the most extreme drought conditions. And Texas, California, Montana, New Mexico, North Dakota and South Dakota are all in severe-to-extreme droughts, Drought Monitor data shows.

The California Drought/U.S Water Crisis Intensifies

Water stocks, many of them utilities, have traditionally received little attention from investors. But supply-demand dynamics have intensified over the past year, placing increased attention on suppliers of water purification and treatment, desalination and other related technologies.

A megadrought, which scientists say started in 2000, reduced flows in the Colorado River system to record lows by the second half of 2022. That led to a 75% decline in some of the largest reservoirs in the West, including Lake Powell and Lake Meade. In October, the federal water manager, the U.S. Bureau of Reclamation, warned California, Arizona and Nevada that it could impose supply cuts in order to protect the Colorado River and its two main reservoirs from overuse.

In order to avoid arbitrary penalties, the agency urged states to reduce water usage to 2 million to 4 million acre-feet, which is only a third of the river's average flow. The result has set up a complex map of battle lines, between states, communities, agriculture and industries.

That has led to extreme circumstances, such as in Arizona's Rio Verde Foothills suburb. There, residents filed a lawsuit against the city of Scottsdale for cutting off 500 homes in the community from the municipal water supply. Meanwhile, Phoenix doesn't have enough groundwater supplies to continue with community construction plans in the White Tank Mountains, after the Arizona Department of Water Resources reported the region will be short 4.4 million acre-feet of water over the next 100 years.

In California's San Joaquin Valley, Tulare, Kern and Fresno counties, water is now being hauled to smaller towns that have run out of supplies, CNN reported. More than 1,400 wells in California were dry in 2022 according to state data, a 40% increase year-over-year.

Water Stocks, AQUA, XYL, VEOEY, ERII

AQUA stock edged lower Wednesday after climbing 2.2% Tuesday. It rallied 15% Monday, jumping past a 45.50 entry and to its highest level since April. Shares are near the top of the buy range, which extends to 47.78. Meanwhile, XYL stock rose dipped Wednesday and is down about 7% this week and trading near mid-November lows. XYL stock is up 3.5% the last three months and flat over the past year.

Veolia Environment may be the world's largest desalination operator, with nearly 2,000 projects to its name. That includes the Kurnell Desalination Plant in Sydney, Australia, able to supply 15% of the city's drinking water. Veolia shares rose 1.5% Wednesday after gaining 1.8% Tuesday.

General Electric, also a busy player in the desalination game, edged up slightly Wednesday and rose 1.2% Tuesday after beating expectations for its earnings report. Energy Recovery is a desalination pure play. Shares climbed 1.7% Wednesday to claw back Tuesday's losses.

Another desalination play is Brookfield Infrastructure Partners' Poseidon Water subsidiary. Brookfield shares dipped on Wednesday and Tuesday after they gained 2% Monday.

Among other related stocks on Tuesday, American Water Works rose 2.4%, while American States Water climbed 2.5% and California Water Services Group traded 1.9% higher.

You can follow Harrison Miller for more news and stock updates on Twitter @IBD_Harrison.

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