(Based on an interview with John Goody, December 1996)

The global water business is changing the way companies operate. Water is undoubtedly one of the fastest- growing environmental industry segments in the world. In the United States, the $75 billion sector is expected to create the largest volume of revenue expansion in the environmental industry, with revenues forecasted to reach $96 billion by 2000. Worldwide, the estimated $200 billion industry is drawing U.S. players into a highly competitive but highly fragmented marketplace. Asia and Latin America provide an exciting backdrop for international competition that pits large operators/developers against one another as they vie for environmental infrastructure contracts.

Consolidation among U.S. firms has accelerated in the industry to cope with growth in industrial and municipal demand for clean water and wastewater treatment equipment and services. These same companies are reinventing themselves with an eye to emerging global opportunities.

In unprecedented moves that have permanently altered the structure of the U.S. water and wastewater industries, the two largest players, U.S. Filter Corporation (USF, Palm Desert, California) and Wheelabrator Technologies (WTI, Hampton, New Hampshire), have joined hands to become the single, most dominant player in the domestic arena and more competitive in the international marketplace. The decision is seen as a recognition that the two together could create a formidable, full-service entity that would make its mark as the largest American-owned entity in the global water and wastewater infrastructure arena.

At the same time, USF is acquiring WTI's industrial water process and manufacturing units. The sale is part of WMX's goal to divest noncore businesses, such as equipment manufacturing, in an effort to concentrate on its core business of operations (WMX owns 58 percent of WTI).

Restructuring parent company WMX Technologies (Oak Brook, Illinois) has changed the big picture forits subsidiaries. Since 1994, the group has been in transition from a conglomerate with a portfolio of company subsidiaries to a more seamless operation of core businesses. Chastened by the group's lackluster performance in recent years, the world's largest environmental services company is streamlining businesses and sharpening focus. The result of this dramatic makeover is a more integrated "family" of firms focused on four main business lines: waste management, clean water, clean energy, and engineering.

As part of this restructuring, WMX has already consolidated Chemical Waste Management, making Rust International directly owned by WMX. It also divested Rust's process engineering, construction, specialty contracting, and similar lines of businesses. WMX holds a majority share in Wheelabrator Technologies, which holds minority interests in two other WMX-controlled subsidiaries, Waste Management International (WMI, London) and Rust International (Birmingham, Alabama).

WMX's strategic review led to a realignment in 1995 of Wheelabrator Technologies' offerings in two main lines of business clean water and clean energy. As a group, WTI provided water, wastewater, biosolids, air quality control, waste-to-energy, and independent power solutions for communities and industries worldwide. WMX expected to play a more dynamic role in the global businesses of water and waste-to- energy incineration through more streamlined operations at WTI.

To highlight the company's redefined goal as a comprehensive provider of manufactured systems and operations in the water and wastewater industry, Wheelabrator Water Technologies (WWT), set up as a wholly owned subsidiary of WTI, was formed with John Goody as CEO.

At the time of WWT's formation, the thinking was that the water infrastructure entity, backed by WMX, would serve as the vehicle for competing in rapidly emerging water and wastewater infrastructure programs worldwide. WWT intended to provide integrated water systems and services. WTI was seen as having an edge in industrial applications, particularly in biosolids management. Central to WWT's plan was to seek out the "predictable, sustainable revenues that come from owning and operating input/output water treatment plants for industry and drinking water and wastewater plants for municipalities," said Goody.

It quickly became clear, however, that the strategy had not been as effective as anticipated in part because WTI did not possess all the components that were critical to success. Goody said WTI realized that to be successful, it needed to sharpen the focus even more. "This year, as I looked at Wheelabrator Water and where I thought the company would go, what suited our long-term strategy was a much stronger focus on privatization and outsourcing. That being the case, the systems and manufacturing companies didn't fit the long-term goal of pursuing service and operating contracts (privatization and outsourcing)."

In September 1996, WTI announced it had agreed to divest its industrial water process and manufacturing units to U.S. Filter Corporation (USF, Palm Desert, California). As part of the agreement, WTI will sell the manufacturing and systems engineering companies to USF for $385 million in cash. These units include: Wheelabrator Water Technologies and all of the subsidiaries: HPD, CPC Engineering, Johnson Screens, Wiesemann, Memtek, Westates Carbon, and Custom Engineered Systems businesses in the United States, as well as Wheelabrator Asia Pacific, Rossmark (Netherlands), Darchet Engineering (Singapore), Sun Chi Environmental Industries (Taiwan), and additional subsidiaries in England, Ireland, France, Spain, Japan, and Australia. In addition, several minority-held companies are included. See diagram above.

According to Goody, the move evolved as part of WMX's overall goal to concentrate on what it believes it excels in operations. As Goody explained, "WMX is very much focused on operations. We like operating plants, long-term contracts, and recurring revenues. And we like manufacturing and systems engineering a lot less. As we looked at what was happening in the water market, we could see that the opportunities seemed to be fourfold. The first was in consolidation of a very fragmented industry; the second was in privatization particularly in municipal plants in the United States, but also extending overseas; the third was in outsourcing; and the last one was really an internationalizing of all this."

A fundamental weakness in the WWT offering was the lack of front-end, process water capability, an area in which it evidently felt it couldn't compete with the likes of U.S. Filter. WTI was hampered by the fact that "there really wasn't very much out there to acquire," Goody said. And USF had effectively preempted potential acquisitions. "A lot of it had to do as well with the fact that USF had already acquired many of the companies that we would have had to acquire to round out the full-service strategy," Goody said. WTI had been preempted by USF, while "What we did was preempt U.S. Filter a little bit on the wastewater side. At the end of the day, someone had to marry with somebody else. If we're the people who wanted to focus on long-term contracts, it seemed that selling those assets to U.S. Filter would be the right way to go for our current and future shareholders."

Amid the ongoing consolidation in the U.S. water industry, WTI saw fit to yield to the company that was already well on its way to being the dominant player in water and wastewater treatment. As Goody sees it, "U.S. Filter focused a lot, at least initially, on the front-end part of the water treatment process [on the process water, high purity, and ultrapure water]

that we hadn't. But they had less strength than WTI on the wastewater side. So, rather than get into that growth area of consolidation of the industry, we should focus on the areas we know that we're very good at. We believe we're the leaders in privatization. We certainly have one of the best contract operations and the first contract operation in the country," Goody said.

For WMX, which is trying to reduce debt and increase profits from its huge asset base, the divestiture reflects the group's intent to sell non-core and underperforming businesses. It plans to sell assets worth $1 billion in the next 18-24 months. WTI executives have said the cash generated by the deal would be used by the company for "strategic core business investment, debt reduction, and share repurchases."

According to analysts, the likelihood of WMX, which owns 57 percent of WTI, buying back the public shares of WTI is now greater. CS First Boston analyst Michael Hoffman reportedly said that, with the WTI sale, "there's no question in my mind that WTI is now dressed up to be bought back by WMX."

WTI appears intent on turning the opportunity around to its full advantage. It plans to create a 50/50- owned joint venture company with USF that would be the leading private water and wastewater treatment services organization in North America and possibly overseas. "A combination of those two [companies]," Goody said, "would develop what USF's Dick Heckmann calls the 'Big American Water Company.'"

Both companies jointly announced that WTI will contribute its EOS contract operations group, which manages water, wastewater, and groundwater treatment facilities, and its municipal and industrial water and wastewater treatment facilities development group. USF will contribute certain assets through which it builds, owns, and operates high purity industrial water and wastewater treatment facilities.

The joint venture gives WTI what Goody describes as "the best technical resource" (i.e., USF) to be successful in the privatization and outsourcing businesses. "On top of that, the joint venture would have 300 offices and distribution points around the United States, which would also make it a very local company. This opens a lot of possibilities in the municipal area, because we're there on the ground next to the water and wastewater treatment plant in the community we're trying to serve," Goody added.

Goody views each side's contributions as "very complementary. They don't have anything we have, and we don't have everything they have. WTI has the development capability and you can't underplay that. That includes financing capability. If you're the leader of an industry or running a Fortune 500 company and somebody comes along and wants to handle a wastewater treatment plant, do you give it to a small private company that may not be making any money? Or, do you give it to a company with a $20 billion asset base behind it (WMX alone probably has an $18 billion asset base) and a borrowing and financing capacity exceeding most of the rest of the industry? What WTI brings is the contract operations group and a track record of project development in water. On the U.S. Filter side, they bring an unrivaled parallel base of technology, which brings us the ability to manufacture most of what we are selling. This means that when you're giving process guarantees (contracts are typically for 20-year periods), you can identify what the maintenance and replenishment schedules will look like, and how reliability will look. All these things come in. The other thing that the joint venture brings is 300 offices. We're a very large company but that makes us very local too. That's a powerful story to tell."

Goody added: "Take our project financing capability along with Wheelabrator's EOS, the contract operations company, which also operates some industrial plants. Combine it with U.S. Filter's outsourcing group the applications engineers with expertise particularly on the high purity, ultrapure water end of the business support it with the best mobile water operations coming from U.S. Filter, and we think we have a tremendous combination of companies."

The joint venture will have $100 million in annual revenue at its inception. It will operate more than 200 municipal and industrial water and wastewater treatment projects, making it the largest such enterprise of its kind in North America.

Goody believes that the focus will be on industrial contracts initially. "It's a development company now. I would anticipate that industrial projects probably will come on quicker than the municipal projects. But then the larger municipal projects will ramp up over the next five years, probably comprising the bulk of the revenues just because of the sheer size of municipal wastewater plants." Geographically, the group will concentrate on the United States, "because that's where we think a lot of the potential for privatization is right now. We think that with both companies coming together into this joint venture with the Treated Water Outsourcing [a 50/50 joint venture with Nalco Chemical Corporation of Naperville, Illinois] and [Wheelabrator's] First Choice outsourcing organization we have a very strong offering in the marketplace."

Both sides are optimistic about growth prospects for the joint venture. The industrial outsourcing market for process and high purity water and wastewater in the United States is projected to grow at 30 percent a year, reaching $15 billion by 2005, according to industry estimates. More than thirty cities with $3 billion of water and wastewater treatment assets are reportedly considering privatization schemes. Company executives said such facilities represent annual revenue of $1 billion annually and an $18 billion backlog. In addition, more than $30 billion of assets may also be privatized in some form.

Goody, who occupies the position of CEO for the joint venture, believes there is a tremendous market opportunity in privatization. "There are probably eighteen cities right now that have either announced requests for proposals or that we think are about to do so. There are about another twenty hiring consultants doing studies. Those thirty-eight will generate close to $1 billion a year of revenues if they all privatize. I don't know that all of them will. I feel sure some of them will and I feel sure that we will win some," he said.

Although he declined to predict exactly how fast he thinks the joint venture will grow, Goody said he expects it to grow significantly. "Without looking at the data base of opportunities, I think the opportunity is only limited by our ability to get out there and talk to industrial clients. There's a tremendous story to be told in persuading people, helping them understand what their costs are, and the various technologies that can be brought to bear to improve the cost structure. Although those numbers are out there in the marketplace, whether they are right or wrong, my perception from the real project opportunities that come through and from the prospects list is that there is a tremendous market out there . . .," he explained. (According to Rob Joseph, privatization project director, evidence exists that the public sector privatization market could develop rapidly in the United States.)

As a joint venture, the group will provide a compelling full-service offering with resources that can be brought to bear by both organizations. "In the United States, in order to operate as a full-service company, you've got to have a sizable organization to provide the one-stop shop. . . . There will be a lot of competition, but not all will be one-stop shops. . . . I don't know that there will be more American companies that will come together and grow. I also see a lot of companies in the water business that will be competitive with both the joint venture and with USF. They'll be competitive in lot of different areas," said Goody.

Leveraging WMX's core activities and client base would be key to providing truly full-service offerings. "Now we can go to the client as WMX and USF and say, 'look Mr. Client, we can handle your solid waste needs, recycle, treat your water and wastewater, provide your power needs, and do any combination of these.' We think there's a tremendous opportunity to do more 'inside the fence'."

Goody explained that WMX's core activities include water "because we wanted to focus on what WMX does well: long-term contracts with recurring revenues, and these exist in privatization and outsourcing. The waste-to-energy business and environmental consulting business are also essential parts of the business. Solid waste happens to be the biggest chunk of the business because it forms the roots. Those four together form a total environmental services offering. So you can go to a client and deal with a broad range of services."

Was the joint venture intended to give either player greater clout in competing with the large European competitors? Prior to the transaction, Goody said he was "was very, very comfortable with competing against the French and British in the United States. I think I can beat the British firms for sure hands down. I think we can certainly beat the French in the United States. I was never concerned about that." With the joint venture and the backing of the $10 billion WMX, he said, "I think we're going to have an offering that will be competitive overseas with these groups."

WTI said it still expects revenues at more than $1 billion for 1996. (It reported $1.45 billion total revenues in 1995.) "When the transaction is complete at the end of November, clearly there'll be a month or so when the water piece of the business won't be in there. So from that point of view, it would be less than $1 billion. We expect, going forward next year, that WTI will still be a $1-billion-plus company."

Goody commented that cash payment is about 83 percent of the revenues. "We don't value companies based on revenue. You can look at future earnings streams in terms of a multiple of earnings. I will only say that we are satisfied. But I also think that we give great value in these businesses to U.S. Filter."

Globally, the picture changes for both companies in revenue growth. Goody believes that after the transaction, USF will be in a lead position, certainly in Asia, as well as a strong position if not a lead position in Europe in terms of manufacturing systems in the water business. Although details of the strategy for the international water business remain unclear, Goody said that the business will initially focus on the industrial area more than on the municipal.

In Asia, the agreement calls for the sale of Wheelabrator's Singapore operations which are headed by Ram Gupta, president of Wheelabrator Asia-Pacific (Singapore) to USF. Prior to the agreement, Gupta outlined Wheelabrator's regional strategy, which was to focus on building a portfolio of industrial water treatment projects initially comprising a large number of small industrial projects (see previous US-AEP case study on Wheelabrator Pacific). This "portfolio" approach reduces the risk of investment in any one facility. WWT's approach was to develop local capability and show solid growth and steady expansion over the next few years.

For the joint venture, Goody believes there will be a lot of emphasis on the industrial area "because we see a lot of opportunities there first. Then, as we get more experienced, I think you'll see us moving into the BOT/BOO (build-own-transfer/build-own-operate) privatization area." He did emphasize that the group sees opportunities in both. But on the development side, Goody said a number of things have to happen. "Waste Management International handles international waterworks. We are going to be working with them to exploit overseas opportunities."

Regionally, Goody believes that USF will have an "unrivaled position out there in terms of American companies anywhere. That competition will include Kurita Water industries [Tokyo]. [The joint venture] certainly makes them very strong in the Asian-Pacific region."

After the divestiture, what remains is the largest and most profitable part of WTI. "When you take the water company out, the gross margins of the business improved because the margins from the trash plants were absolutely excellent. The cash flow won't be affected by taking these companies out. I think what you'll find is that there's an emphasis not just on trash-to-energy in other parts of the world, because we're developing refuse-to-energy plants in the United States. I think you'll see a big emphasis on "inside the fence" work in which we do the same kind of thing we do for water; that's outsource the power plant for industry. One of the strengths we think we bring is we can package all that together," said Goody.

A more substantial role is expected for WTI Technologies on the international front in coming years in anticipation of a large growth market. This growth is being driven by laws limiting the amount of landfill wastes in some countries in Europe and Asia. Last year, WTI agreed with WMI to develop new international incineration projects. This would allow WTI to develop new waste-to-energy projects around the world, except in Germany and Italy. Under the agreement, WTI has primary responsibility for the early stage of project development; WMI has the right to acquire up to 49 percent of the equity in all joint venture projects. Previously, under the terms of an internal company allocation agreement, Wheelabrator was not allowed to develop trash-to-energy projects outside North America.

Revenue for the Clean Energy segment totaled $839.5 million in 1995. This was essentially flat compared with 1994 because higher revenue from operating energy plants was offset by lower construction revenue from a facility in Lisbon along with further declines in air-related sales, the company reported.