Shares of AquaVenture Holdings(WAAS) - Get Report has advanced nearly 16% since the firm's initial public offering on Oct. 5, but the provider of water purification services will likely face significant headwinds this year.
Although the longer-term picture is positive, the company faces notable challenges in the short term with significant operating losses and the IPO lock-up expiration on the horizon in April.
AquaVenture Holdings came to market at a time when concerns about the future of potable drinking water were at the forefront of the news cycle. Amid concerns about climate change and pipelines in the West it is important to remember that AquaVenture Holdings isn't the first firm to popularize the water-as-service theme, and not all these offerings have held investors' attention.
Back in 2010, several new water-related exchange-traded funds were making a splash in the marketplace. These included the equal-weighted First Trust ISE Water Index Fund and the PowerShares Water Resources Portfolio, alongside the Claymore S&P Global Water Index ETF and PowerShares Global Water Resources Portfolio.
Although all four of these ETFs still exist, average daily trading volume is anemic in all but the First Trust ISE Water Index Fund. This underscores that the theme of water investments isn't new, and it hasn't particularly piqued the interest of ETF investors.
AquaVenture Holdings provides water as a service to customers around the world to help them ensure that their water is affordable and safe. It offers water treatment and purification services to businesses and governments and operates through its subsidiaries, Quench and Seven Seas.
The company, which was founded in 2006, is based in Tampa, Fla., and has more than 500 employees.
In June 2014, Quench acquired Atlas, which allowed it to greatly expand its market in Boston. Quench operates in the U.S., while Seven Seas builds, designs and operates water treatment facilities in the Caribbean, Chile, Saudi Arabia and the U.S.
Before the IPO, the company raised $157.91 million in six rounds of funding, with its most recent round taking place on May 1, 2015. Notable investors include Element Partners, TPG Growth and T. Rowe Price.
The offering was of 6.5 million shares.
Although AquaVenture Holdings priced at $18 -- the low end of the stock's expected $18 to $20 range -- returns have been impressive.
But there are still serious concerns about the company's profitability.
A recent article in Barron's highlighted how the company's losses over the past decade add up to a $183 million deficit.
For the year ended in September 2016, AquaVenture Holdings reported a $44 million loss on $111 million in revenue, with accountants finding material weaknesses in its past two fiscal years' bookkeeping.
There are also a number of risks that the company itself has highlighted.
In its filings with the Securities and Exchange Commission, AquaVenture Holdings identified different risks for Quench and Seven Seas.
For Quench, these include competitors' activities, customer attrition, economic conditions, supply chain disruptions and others. The company identifies its risks for Seven Seas as depending on a small customer base because of the complexity of its projects.
Competition is also a major factor. Future growth for Seven Seas depends on the company's ability to secure new contracts in a highly competitive environment.
AquaVenture Holdings identifies its need to offer competitive compensation for its executive team in order to retain them.
The company isn't the only one in its sector feeling the pressure, however.
Shares of competitor Consolidated Water have fallen by two-thirds since 2007.
A recent problem for Consolidated Water is that the British Government recently cut the rate that it is offering to pay one of the companies plants located on the island of Tortola. With the plant's contract about to expire, commentators think that the British Virgin Islands government will renew the contract at a lower rate.
But with profitability concerns at AquaVenture Holdings and a strong stock performance since going public, pre-IPO investors and insiders may look to cash in some of their 18.9 million shares at the first opportunity on April 4, when the 180-day lock-up period expires.
This is equivalent to nearly triple the total shares outstanding and could potentially flood the market, resulting in a sharp decrease in the share price.
The top two principal shareholders listed in the company's S-1 are Element Partners and Virgin Green Fund. These two shareholders include several individuals.
If any of these major shareholders decides to cash in a significant number of shares, AquaVenture Holdings could come under pressure when the lock-up expires.
Our firm has found abnormal negative returns in the two weeks surrounding many lock-up expirations. We expect to see a decline in the stock around April 4, and therefore recommend that investors sell their positions or consider shorting shares ahead of the expiration.
Be wary of AquaVenture Holdings in the short term and consider a short position. But investors should cover short positions after the IPO lock-up period.
After all, environmental pressures will continue to make potable water a vitally important and increasingly scarce resource long into the future.
This article is commentary by an independent contributor. At the time of publication, the author was short WAAS and CWCO.