A Thirst for Growth

Ah, the hidden glories of Paris. On the Oise River northwest of the city, the SEDIF water-purification plant uses a nanofiltration system that forces water through 84 acres of membranes housed in a giant matrix of 190 metal tubes. South of the capital in Valenton, one can breathe the swampy odors of a massive wastewater plant that treats 159 million gal. of sewage every day and converts the solid waste into 82,000 tons of combustible pellets--enough to provide 80% of the sewage plant's annual energy needs. And there's that old favorite, les égouts de Paris, the city's sewer and water system dating to the 14th century, a stop for tourists. Granted, the group of American mayors and water experts who recently took in the infrastructure sights didn't pose for pictures. But anyone seeking a fitting image of Gallic irony could hardly do better than the water business in France.

France is the land of public service par excellence, where a whiff of sacrilege still adheres to the very notion of privatizing basic infrastructure. Trains, hospitals, universities and pensions are all largely state provisions. But water--a sector that remains a function of municipal government in 90% of U.S. cities--is the almost exclusive domain of two companies, Suez Environment and Veolia Water.

The business of slaking the world's growing thirst is lucrative, controversial and surprisingly French. Veolia is the world's biggest player in the management of water services. Last year sales rose 10.4%, to $13.2 billion, and earnings 16.7%, to $1.5 billion. Suez drew more than half its 2006 sales of $14.9 billion from the water business, making it the sector's No. 2 in the world.

Veolia in particular is focusing on global expansion. "Ten years ago we did 85% of our business in France. Now it's 45%," says Antoine Frérot, Veolia's CEO. For his company, moving out means moving up: in another 10 years, Frérot figures that Veolia's annual growth in the mature market of France will be 3%, as opposed to 15% or 20% in North America and China.

Suez boss Jean-Louis Chaussade says his company is pursuing "organic growth" everywhere, including through its U.S. subsidiary, New Jersey--based United Water, which has contracts for 7 million people throughout 19 states. "For me, an organic growth of between 5% and 6%--a good three or four points above general growth rate--is the best possible kind of growth," says Chaussade. "Keeping that balance is what made us grow in France and what will make us grow in the U.S. and elsewhere."

Whatever their strategic differences, both Suez and Veolia turn water into cash in the same basic way: securing long-term concessions from public authorities to run, maintain and, if necessary, build water and sewage systems, but not buy them. Both reject the notion that they are privatizing water. "We're delegated providers of a public service," insists Frérot. The idea is to stay "asset light" and profitable while running publicly owned facilities. "In France we've developed over many years a kind of partnership between public and private that works well in the water sector," says Chaussade. "It's an equilibrium between public responsibility and private know-how."

Water is a monumental opportunity. JPMorgan estimated the world municipal water and wastewater business in 2005 at $465 billion a year; by 2015, it figures, it will have almost tripled to $1.2 trillion. Some 40% of the world's population does not have adequate water and sewer systems, according to the U.N. And it's not just the developing world that needs to ramp up investment. The U.S. will have to spend as much as $41 billion a year until 2019 to maintain its water infrastructure, according to one Congressional Budget Office study--that's almost twice the $21.6 billion invested in 1999. "We've got thick pipes from the 19th century becoming obsolete at the same time as thinner ones laid after World War II," says Peter Cook, executive director of the National Association of Water Companies. "If we don't invest more, we're going to face a real crisis."

Suez and Veolia work on the principle that as private companies with broad expertise, they can channel that investment more efficiently than municipal waterworks can. And since it's not they but the owners of the pipes that pony up the money for investment (usually by issuing municipal bonds), these companies can be more financially agile than conventional utilities.

In May 2002 Veolia's U.S. subsidiary beat out Suez-owned United Water for a $1.5 billion 20-year contract to manage water distribution in Indianapolis, the largest such current contract in the U.S.; United Water already had the contract to run the city's wastewater system. The city had purchased the waterworks from a private owner that was struggling, says Tim Hewitt, president and CEO of Veolia Water Indianapolis. "When we started, there were taste and odor problems, and the previous owner had basically told people to get over it." Veolia couldn't do that since the agreement sets incentives for customer satisfaction--along with everything else from water quality to sourcing from local and minority-owned enterprises. Veolia's experts, bolstered by local university researchers, pinpointed the problem as stemming from algae blooms in the reservoirs. Precise application of liquid copper sulfate (yum!) took care of that. "When we took over, there were 500 or 600 complaints a year about taste and odor. Now we're down in the range of 30," says Hewitt.

It's hardly been a picnic though. In January 2005 Veolia issued a boil-water advisory after allowing some subpar water into the system, and came under fierce local criticism for playing fast and loose with public safety. Hewitt insists that the water quality always met EPA standards and that the incident could as easily have happened in a municipally run facility. "We went into this deal with our eyes open, knowing we'd have better and worse years. This is a long-term investment. The Europeans are very patient. And we're on target for success over the 20-year period."

By any measure, the Indianapolis deal has been considerably more harmonious than a 20-year management contract forged in 1998 between Atlanta, under now jailed mayor Bill Campbell, and Suez subsidiary United Water. That arrangement descended into a cacophony of charges and countercharges until it was mutually dissolved in 2003. Its failure may be one reason that the U.S. market, once praised for its explosive potential, has been "a little frustrating," as Hewitt says. But the frustration is relative: Veolia's U.S. business grew 12% last year.