What happened
Shares in water and wastewater treatment solutions company Evoqua Water Technologies (AQUA) rose 15.5% this week through Thursday. The big news was Xylem's (XYL 1.36%) acquisition of the company in an all-stock transaction valuing Evoqua at around $7.5 billion.
So what
The deal makes good operational sense for both companies. Xylem generates 55% of its sales internationally. In comparison, Evoqua generates 82% of sales from the U.S.
Being part of a larger company with an established presence in Asia and Europe will help Evoqua's products find a new audience. Building scale in new geographies is difficult, and Xylem will also benefit from an expanded product range.
Moreover, Evoqua's heavy industrial focus (82% of sales) brings diversification to Xylem's revenue stream (currently 50% utilities, 35% industrial, and 15% commercial/residential).
The businesses' complementary nature is probably why the cost synergies associated with the deal are not exceptionally high. Management aims for $140 million in run-rate cost synergies within three years. However, that figure is less than 2% of the combined revenue now, let alone what the combined revenue will be after three years. A rough rule of thumb is to take a 5% target for cost synergies.
Now what
While the deal looks expensive for Xylem, the water technology sector tends to be richly valued. Xylem itself trades at 32 times next year's estimated earnings. And the acquisition adds growth potential in an industry servicing a crucial part of global infrastructure.
