1

Badger Meter, Inc. Hold

BMI : NYSE CFA Institute Global Investment Research Challenge January 30, 2009 Marquette University

Recommendation

A five year discounted cash flow model in conjunction with various valuation multiples yielded a price target of $23 per share for the common equity of Badger Meter Inc., resulting in a hold recommendation.

Investment Thesis

Substantial Growth Opportunities – The threat of water shortages has led to the increased monitoring of previously unmetered building units. Increased water connections and the conversion to Automatic Meter Reading (AMR) has created a $7.35 billion market opportunity.

Solid Market Position – Badger Meter maintains a stable 28% share of the $5.8 B North American basic water meter industry. BMI’s proprietary ORION technology presents an opportunity to grow their 20% share of the higher margin AMR industry.

Strong Balance Sheet – Total debt makes up just 17% of BMI’s balance sheet. Net Debt to EBITDA of 0.62 compares favorably to their larger competitors, Itron (3.88) and Roper (2.14). This gives Badger Meter the flexibility to buy back shares, increase its dividend, or make strategic acquisitions.

Municipal Funding Pressure – A slowdown in utility capex due to reduced municipal budgets will hinder the trend towards AMR, restricting near-term growth in the water meter industry.

Delayed Replacement Cycle – Two thirds of unit shipments at Badger Meter are replacement units. Our independent survey found that utilities are temporarily lengthening the 15 year replacement cycle, negatively impacting sales volumes for meter manufacturers.

Global Industrial Slowdown – 20% of BMI’s revenue is derived from worldwide industrial manufacturing. Limited economic expansion will confine growth in this segment to less than 2% CAGR over the next three years.

Price: (1/30/09) 23.99 Rating: Hold FY Dec 2007A 2008E 2009E

52WK H-L: 17.58-62.74 Price Target: $23 Revenue (mil) 234.8 260.4 240.5

Market Cap (mil): 354.8 Institutional Holdings: 76.2% Net Income (mil) 16.5 22.3 17.7

Shares Out (mil): 14.8 Insider Holdings: 5.4% EPS 1.26A 1.51E 1.20E

Float (mil): 13.8 Return on Equity: 20.1% P/E 23.0x 15.9x 20.0x

Avg. Daily Volume: 229,178 Debt to Assets: 17.0%

Dividend (ttm): 0.40 Dividend Yield (ttm): 1.67%

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Company Background

Founded in 1905, Badger Meter, Inc. (BMI) produces flow measurement devices, specializing in residential and commercial water meters (79.2% of 2007 sales). The company manufactures manual-read meters as well as automatic meter reading (AMR) and advanced metering infrastructure (AMI) technologies. Through its industrial segment (20.8% of 2007 sales), BMI sells a variety of flow measurement devices ranging from precision valves to industrial non-water flow meters. Badger Meter operates in the United States, Mexico, and the Czech Republic, with sales concentrated in the US (88% of FY2007), Latin America (7%), and Europe (5%). Currently, Richard Meeusen (54) serves as President, Chief Executive Officer, and Chairman of the Board of Directors, while Richard Johnson (54) serves as Sr. Vice President, Chief Financial Officer, and Treasurer.

Water Meter Industry

Badger Meter operates in the $5.8 billion water meter industry.1 Utilities use meters to monitor water usage of their residential, commercial, and industrial customers. According to the American Water Works Association (AWWA), the 53,000 U.S. water utilities serve 75 million metered connections including 68 million residential and seven million commercial/industrial. In addition, there are about 13 million unmetered connections as well as 21 million unconnected private wells (US Census Bureau). The market is highly concentrated, with the top 400 utilities serving over 40% of the U.S. connections. The next 4,000 utilities serve 40%, while the remaining 48,000+ utilities serve 20% of water service connections. Water meter manufacturers sell to utilities through both a direct sales force and third party distributors.

Competitive Economics Figure 1: As seen in Figure 1, the water meter industry is oligopolistic in nature; the top four manufacturers control 92% of the market and have competed for over 100 years. Because of its highly concentrated nature, the industry maintains high barriers to entry from both a capital and technological perspective. The capital intensive manufacturing process lends itself to economies of scale, making it unlikely for new entrants to profitably compete in the existing market. The water meter industry is not susceptible to substitute products as there is no alternative way to measure water usage. The commodity-like nature of basic water meters results in price being “90% of the decision,” according to BMI’s CFO, Richard Johnson. Badger Meter’s largest competitors include:

Elster Metering (private) – As a subsidiary of Elster Group, a 170 year-old conglomerate, the company produces residential and bulk meters along with AMR metering systems.

Neptune Technologies (ROP) – This competitor is a part of the Industrial Technology Segment of Roper Industries, Inc, which designs, manufactures, and distributes industrial equipment and components. Specifically, water made up 16% of ROP’s 2007 end-market revenue.

Sensus Metering Systems (private) – Sensus Metering Systems provide water, gas, heat, and electric meters in addition to both AMR and AMI meter reading solutions. Metering made up 83% of 2007 net sales.

1 Assuming all current metered connections (75 million) incorporate AMR technology, the industry opportunity is approximately $9.375 billion.

Badger

28%

Sensus

20%

Neptune

30%

Elster

14%

Other

8%

Water Meter Market Share

Source: BMI Data

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Types of Meters

Reading Meters The water meter industry has experienced a structural shift in data collection, from manual reading to technology-based solutions. (Figure 2) Figure 2:

Manual Reading A manually read meter has an odometer that converts rotations within the meter to usage increments. This number is then physically collected and recorded by a meter reader on a monthly basis.

Automatic Meter Reading (AMR) AMR technology uses a radio signal to electronically transmit data to a mobile receiver. AMR systems allow utilities to collect more accurate data in a more timely and efficient manner, resulting in cost savings.

The adoption of AMR technology is attractive for meter manufacturers due to:

High Margin Product - The conversion to AMR has been the driving force behind increased profitability within the industry. AMR is a higher margin business because the price point on a basic meter is $25-$30, whereas the AMR package (meter and radio) is around $150 with minimal additional manufacturing costs.

Differentiation Opportunity - The manual read water meter business is highly commoditized with price being the primary consideration. AMR provides meter manufacturers the chance to differentiate themselves through heightened accuracy of transmission signals, ease of use, or pit sealant technologies. These provide an opportunity for manufacturers to capture market share from competitors in an industry where customers have traditionally been reluctant to switch products.

Of the 75 million installed basic water meters, 31.3 million have been converted to AMR (~42%). Market share by unit is as follows in Figure 3: Figure 3:

Name Purpose Main Customers Special Features

Magnetized measuring tool physically rotates Residential Most popular for

Rotations recorded on register, conveted to usage Small Commercial single family residential

Low to moderate flow rates housing

Measure water velocity through known capacity Large Commercial Best for high velocity,

Convert flow into usage unobstructed water flow

A velocity meter that measures high flow rates Large Commercial Much larger in diameter

Straight-through meter with no internal measuring element Fire Protection to better accommodate

Master Meters high flow rates

Magnetic Flow Meter with no internal measurement device; Water Treatment

("mag meters") Electromagnetic properties measure water flow Sewage Facilities

Disc

Velocity

Turbine

Measures unclean water

Badger

20%

Sensus

15%

Neptune

29%

Itron

14%

Elster

5%

Master

11%

Hexagram

3%

Other

3%

Water AMR Market Share

Source: BMI Data

Manual58%

AMR/AMI42%

2007 Meter Reading Breakdown

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There are, however, two negative factors about the conversion to AMR systems from the water meter manufacturer’s perspective:

Low Barriers to Entry - Radio manufacturing has very low barriers to entry relative to water meter manufacturing. The trend towards AMR opens up the market to manufacturers who provide radios to other industries which makes the AMR business much more competitive than the basic meter business.

Declining Price Point – Pricing on electronics declines faster than that of other manufactured goods, making future pricing and profitability much more difficult to project.

Advanced Metering Infrastructure (AMI) AMI incorporates radio data transmission via a fixed network of stationary transmitters that intermittently sends data to a computer system maintained by the utility. This technology is in the early adopter phase for water utilities. AMI systems are most useful to water utilities in difficult-to-access areas such as industrial parks, airports, military bases, and gated communities. The primary benefit of an AMI system is the real time interval data, which allows a utility to more closely monitor usage of water, gas, or electricity. This system is more prevalent in the gas and electric industry due to the option to control devices within the customers’ premises, an unnecessary feature in the water industry. AMI does not necessarily cannibalize AMR because many cities will utilize a hybrid system incorporating AMR for their residential customers and AMI for their heavy usage industrial customers. Because of the following factors, it is believed that AMR systems, not AMI will be the primary growth driver for the water meter industry going forward:

Industrial connections make up less than 10% of the industry

AMI costs utilities 10-25% more per unit than AMR

The necessity of the incremental data for water utilities is questionable

Badger Meter, Inc.

Utility Segment Description The Utility segment provides residential and commercial water meters and meter reading technologies to water utilities throughout North America. The segment constituted 79.2% of 2007 company revenue versus 80.9% of 2006 revenue. Meters The company offers the following water meters in its Utility segment:

Disc Series Meters – Utilized in residential settings

Turbo Series Meters – Ideal for high volume commercial locations

Fire Hydrant Meters – Allow utilities to generate revenue from open fire hydrants

Compound Series Meters – Designed for varying flow levels from highly populated buildings

Mag Meters – Measure liquids non-intrusively using a micro-processor; can be used in a wide variety of locations with less maintenance and decreased risk of clogging

Fire Series Meters – High-performance meters used in fire service protection

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Meter Reading Solutions The company provides proprietary and non-proprietary meter reading and data management solutions for its water meters. Approximately 50% of water meter shipments include radios. Meter reading solutions include:

ORION Mobile AMR – Transmits meter data up to 1000 feet to drive by receivers. With 60% of the nation’s water meters located in harsh underground pit environments, Badger’s ORION pit unit utilizes its superior sealant technology to prevent leakage.

Itron Mobile RF System – Presently, Badger Meter offers Itron’s Mobile RF System through a licensing agreement terminating in 2011. Notably, ORION radios outsell Itron radios by a 2 to 1 margin (800,000 vs. 400,000 ttm 3Q08).

ORION Hybrid AMI – Utilizes both AMI and AMR technologies to provide better customer service and increased data availability along with AMR’s lower cost.

GALAXY Fixed Network AMI – Transmits data up to one mile away over power lines, broadband, or WiFi. Management anticipates continued AMI growth of 7% over the next few years. Last year Badger Meter acquired full rights to the GALAXY technology. The company differentiates its GALAXY pit unit with Badger Meter’s superior sealant technology.

Utility End Markets Badger Meter’s primary customer base is the middle 4,000 utilities (40% of connections) because of low margins on the largest municipal projects and low volume on the smallest projects. However, BMI will, on occasion, pursue large municipal projects if pricing is not compromised. For example, in 2007 Badger Meter won a contract with the City of Chicago to install ORION Mobile AMR technology on 162,000 presently installed water meters and to replace 82,000 water meters. The contract was worth approximately $40 million over a 3 year period, making the City of Chicago the largest customer of BMI at 5% of total sales. Breakdown Figure 5: Badger Meter charges $25-$30 per meter and $125-150 per meter-radio combination. There is an additional 10-25% premium for its GALAXY fixed network AMI radios. BMI generates approximately 40% margins for ORION and GALAXY sales, while Itron margins are less than the aggregate company margin. Revenue breakdown of the segment is detailed in Figure 4 based assumptions shown in Figure 5. Figure 4:

Utility Segment Revenue $183,750 100%

Water Meters $52,500 28.57%

AMR/AMI $131,250 71.43%

Orion $82,571 44.94%

Itron $41,286 22.47%

Galaxy $9,323 5.07%

Source: BMI Data/ Team Estimates (revenue in $000)

Total Metered Connections 75 million units

BMI Market Share 28%

BMI Metered Connections 21 million units

BMI 2007 Meters Sold 2.1 million units

% of Shipments w/Radios 50%

Meter + Radio 1.05 million units

Price $150

Radio Revenue $157,500

% Utitlity Revenue 86%

+% of Meter-Only Shipments 50%

Meter Only 1.05 million units

Price $25

Meter Revenue $26,250

% Utility Revenue 14%

2007 Utility Revenue $183,750

% Total Revenue 78.2%

Source: BMI Data/ Team Estimates (revenue in $000)

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Industrial Segment Description The Industrial segment, 20.8% of 2007 revenue versus 19.1% in 2006, consists of niche flow measurement applications for use across a wide variety of industries. Meters The industrial segment provides a variety of enhanced meters for industrial use including: (Figure 6)

Turbine Meters – Measure wide flows of water in water treatment and conditioning facilities.

Positive Displacement Meters – Measure water and other liquid flows for inventory and process control of food and beverage, chemical, and petrochemical applications.

Electromagnetic Inductive Flow Meters – Non-intrusive meters that use a micro-processor allowing for use in a wide variety of locations with less maintenance and decreased risk of clogging.

Impeller Flow Meters – Installed into piping for irrigation, building automation, and energy management. Monitors and transmitters can be added to enhance data acquisition and management.

Precision Valve Meters – Used for fluid control and measurement in medical research, pharmaceutical production, food and beverage, petroleum, and heating and air conditioning.

Automotive Fluid Meters – Measure engine oil, grease, and transmission fluids and provide a Fluid Management System to monitor and control fluid consumption and inventory.

Figure 6:

Industrial End Markets Industrial products are sold to companies in North America, Europe and Latin America. Latin American sales consist largely of electromagnetic meters; European sales are mainly small valves, electromagnetic meters, and automotive fluid meters. Industrial meters are sold in the petroleum, food and beverage, pharmaceutical, petrochemical, water processing, waste water treatment, textiles, and the power industries. Breakdown As industrial flow measurement systems are installed by clients on a project basis, sales can be quite volatile. Though 2007 Industrial revenue grew at 11.5% y/y, management’s estimated industrial segment growth is 5-6% annually. Due to the specialty nature of the segment, industrial products typically carry a higher gross margin than basic water meters (2007 Group gross margin was 35%).

Impellers3.6% Industrial

2.9%

Concrete1.8%

Mag Meters3.2%

Automotive4.4%

Valves4.8%

Industrial Product Breakdown(as % of BMI Total Revenue)

Source: BMI Data

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$-

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

USD

/ m

etri

c to

nn

e

Quarterly Gross Margin vs. Spot Copper Prices

Copper (grade A cathode, LME spot price)BMI Gross Margin

Cost Structure The following are ongoing expenses for BMI’s operations:

Raw Materials – Badger Meter manufactures the majority of its product casings out of bronze (81% copper, 7% lead); the remaining 12% is comprised of aluminum, stainless steel, and cast iron. BMI’s smaller residential meters contain plastic resins in the inner chambers.

Labor – As of 3Q08, the company employed 1,100 people, of which 200 were covered by a collective bargaining agreement. The 200 union workers, employed in the Brown Deer, WI plant, earn $30/hr. In contrast, the Nogales, Mexico plant workers earn $5/hr.

Manufacturing – Since 1919 the company has invested heavily in state-of-the art, stainless steel machinery at its WI headquarters, which houses R&D, as well as production for all segments. Plant capacity is 6,000 residential or 300-350 commercial water meters per day. The company also operates in Tulsa, OK, Stuttgart, Germany, and Brno, Czech Republic.

Mexican Transition – In 2008, the company completed construction of a 120,000 sq foot facility in Nogales housing both AMR/AMI electronic radio manufacturing and the production of BMI’s proprietary pit sealant. BMI plans to transfer other manufacturing processes to the Nogales factory to capture significant labor cost savings.

Pricing BMI does not hedge copper, its largest material input cost. Instead, it purchases copper on the spot market. Historically, BMI implements price increases/decreases based on the copper spot price. Additionally, copper price escalators are built into contracts longer than 90 days. Although there is a two quarter lag in permanent price adjustments, this method is preferred to temporary, fluctuating surcharges.

Margins

Badger Meter's gross margin averaged 34% over the past five years (Figure 7 below); it remained relatively stable despite pressure from rising commodity prices. These cost increases were largely offset by a beneficial shift in sales mix towards higher margin AMR/AMI and Industrial segment products. During the same time period, operating margin (Figure 8 below) steadily improved, from 7.7% in 2003 to 13.0% in 2007. The improvement resulted from corporate cost cutting as the company grew and gained economies of scale. Figure 7: Figure 8:

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Historical Margins

Gross Profit Margin Operating Margin

8

Financial Statement Summary For a detailed list of financial comparables, please see “Industry Peers” in the appendix. Below is a summary of key takeaways of this analysis.

Flexible Financial Position – Badger Meter is in a better fiscal position than their larger competitors due to management’s disciplined approach to capital allocation. As a result, 2007 Net Debt/EBITDA is 0.62 vs. 3.88 at Itron and 2.14 at Roper. This gives BMI the flexibility to buy back shares, increase its dividend, or make strategic acquisitions.

Uncertain Capital Structure – While management has targeted a capital structure of 30-40% debt, short and long term borrowings make up only 17% of BMI’s balance sheet. Interest coverage of greater than 30x outpaces the industry average of 14x by a wide margin. This flexibility can be viewed as a positive in the current business environment.

Consistent Cash Flow Generation – While generating strong returns, BMI has consistently produced cash flow in excess of operating requirements. Free cash flow has grown at a 10.8% CAGR over the last 8 years. Therefore, Badger Meter is able to fully invest in the emerging technologies that are reshaping the competitive landscape of the water meter industry.

Low Free Cash Flow Conversion – Although cash flow generation is consistent, Badger Meter has historically converted less than 25% of EBITDA to free cash flow. This dramatically underperforms the industry average of 51%. All other competitors convert at a 40+% rate. BMI generates less revenue in favorable tax environments, resulting in a higher corporate tax rate. This contributes to the lower conversion rate relative to peers.

High Asset Turnover – Badger Meter has an asset turnover rate of 1.39, much higher than the industry average of 0.98. This contributes to an above average return on equity (19.52% vs. industry average of 16.88%) despite the lack of leverage relative to peers. BMI’s high asset turnover is attributed to the recent shift in revenue mix towards higher price point radio equipment.

Lean Manufacturing Process – BMI’s working capital requirements average 11.5% of sales. This compares favorably with the industry average of 24.0%, due in large part to BMI’s focused product offerings relative to their more diversified peers.

Growth Opportunities

Water Shortage – According to a study by the Government Accountability Office, at least 36 states face water shortages within the next five years. It is estimated that consumption declines up to 25% when water usage is monitored. This shortage and subsequent conservation efforts drive the need for more metered units as well as a more accurate and efficient reads on existing units.

Manual Read Meter Conversion to AMR/AMI – Of the 75 million unit market, there are only 31.3 million AMR units, representing a 42% conversion rate. If all existing water meters were converted to AMR/AMI, this would amount to a $5.4 billion expansion of the market.

Unmetered Housing Units – Assuming utilities will begin to meter the 13 million unmetered connections (12 million residential and one million commercial/industrial), suppliers like Badger Meter would have a $1.95 billion market opportunity.

Completion of ORION Deployment – Of contracted ORION projects, Badger Meter estimates that only 25% are completed. The remaining 75% of projects translates into an unbooked backlog of $650 million for BMI.

Replacement of Trace Technology – Of the 2.5 million customers who originally purchased the Trace system, approximately one million have not converted to the new ORION system. Complete conversion of these units represents an additional $100 million opportunity.

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Risks

Utility Funding – According to BMI Management, water meters are funded through utility operating budgets and municipal revenue bonds. Based on our proprietary survey, two thirds of purchases are funded through operating budgets, while the remaining are funded by municipal bonds (see appendix). Municipalities face declining tax revenues from decreasing home values (Figure 10: Nov. 2008 y/y Composite 20 Case Schiller Index: -18.2%) and increased costs of raising funds in the capital markets (Figure 9: AAA-rated, 10-year general obligation municipal bond yielding 120% of the present 10-year treasury yield). This will pressure water meter spending.2

Figure 9: Figure 10:

Source: Bianco Research Source: Standard & Poor’s

Replacements – Badger water meters typically have a lifespan of 15-20 years, as shorter replacement cycle ensures higher accuracy. Due to the current economic condition, customers may elect to postpone replacing their meters. Our survey found replacement cycles ranging between 12- 30 years.

AMR/AMI Technology Adoption – BMI’s strength is clearly in AMR. Should AMI technology become the industry standard, the company may not be positioned as an industry leader. Furthermore, due to current funding pressure, utilities may postpone technological upgrades. This could affect BMI’s unbooked backlog as well as new business.

Macroeconomic Weakness – The International Monetary Fund (IMF) anticipates 2009 North American GDP growth to be 0.3% (averaging 2.75% from 2010-2013), although economists have more pessimistic forecasts. With over 75% of sales generated in economies of near zero GDP growth, 2009 will be a challenging year (Figure 11). BMI’s conservative industrial position is somewhat recession-resistant; management considers negative EBIT growth to be a bad year.

Figure 11:

2 Obama Stimulus Package – Congress is considering the American Recovery and Reinvestment Act of 2009. The Jan. 29, 2009 draft of this plan includes $6B designated for the Clean Water State Revolving Funds. Of these funds, 80% can be used for municipality projects. Also, $2B is allocated for the Drinking Water State Revolving Funds, part of which is designated for the assistance of municipalities. While this stimulus creates potential upside BMI, both the timing and allocation of these monies is unclear and cannot be currently incorporated into financial projections.

Country 2009 2010

United States -1.6% 1.6%

European Union -1.8% 0.5%

Brazil 1.8% 3.5%

Mexico -0.3% 2.1%

Source: International Monetary Fund

Regional GDP Projections

10

Valuation A five-year DCF with a weighted average cost of capital of 8.17% and a terminal EBITDA multiple of 7.5x yielded an intrinsic value of $23 per share.

DCF Summary

Key Assumptions

A downturn in utility capex for the next two years, stagnating growth in new metered units as well as delaying replacement units. We expect the market to rebound in FY2011 and to normalize thereafter. An economic recovery prior to 2010 could compromise the accuracy of our forecast.

BMI maintains a constant market share of 28% throughout our forecast period. We believe this is valid based on the stickiness of the customer base and the undifferentiated core offerings.

Constant real pricing for water meters and radios; any material deviation would pressure margins. Therefore revenue growth is solely a function of volume.

Badger’s increased radio shipments proxy as an industry-wide trend. Our assumptions imply an AMR conversion rate of 59% by 2013 from the current 42%. Accelerating AMI adoption or prolonged delay in AMR conversion would affect our forecast.

While discussing acquisition strategy, management stated that they would pay 7-8x EBITDA for an industrial flow measurement company. Valuing BMI at this terminal multiple is consistent with the current industry EV/EBITDA average of 7.73.

Sensitivity Analysis

2008 2009 2010 2011 2012 2013

Revenue $260,420 $240,522 $241,538 $285,804 $300,445 $315,437

y/y change 10.90% -7.64% 0.42% 18.33% 5.12% 4.99%

Operating Profit $36,506 $30,065 $30,192 $38,584 $42,062 $45,738

% margin 14.02% 12.50% 12.50% 13.50% 14.00% 14.50%

Taxes $12,998 $10,619 $10,964 $14,161 $15,466 $16,844

Net Income $22,300 $17,698 $18,274 $23,602 $25,776 $28,074

Less: W/C Change $6,578 ($10,996) $3,786 $12,034 $2,782 $2,848

Less: CapEx $13,021 $9,621 $9,662 $11,432 $12,018 $12,617

Add: Depreciation/ Amortization $9,013 $9,094 $9,170 $9,472 $9,811 $10,185

Net Cash Flow $11,714 $28,168 $13,997 $9,608 $20,787 $22,793

PV Factor 1.08 1.17 1.27 1.37 1.48

PV Cash Flow $26,040 $11,962 $7,591 $15,184 $15,391

Valuation WACC Calculation

Terminal EBITDA Multiple 7.5x Cost of Equity:

Projected EBITDA, 2013 $55,924 Risk-Free Rate 4.50%

Terminal Value $419,426 Expected Market Return 10%

Discounted TV $283,218 x Beta 1.10

k: 10.55%

Sum of PV FCF $76,168 Cost of Debt:

PV of Terminal Value $283,218 Expected Future Cost: 6.00%

Net Debt $21,397 Tax Rate: 37.50%

Value of Equity $337,990 After-Tax Cost of Debt: 3.75%

Shares Outstanding (Ths) 14,788 Cost of Capital:

Target Price $22.86 Debt 35% 3.75%

Current Price $23.99 Equity 65% 10.55%

Implied Return -4.73% WACC: 8.17%

7.00% 7.50% 8.00% 8.50% 7.00% 7.50% 8.00% 8.50%

-20% $21.50 $21.03 $20.57 $20.12 7.0x $22.73  $22.23 $21.74  $21.26

-10% $23.59 $23.07 $22.56 $22.06 7.5x $24.08 $23.55  $23.03 $22.52 

0% $25.68 $25.11 $24.55 $24.01 8.0x $25.43 $24.87 $24.32 $23.78

2009 y/y

Revenue

Growth

Rate

Terminal

EBITDA

Multiple

WACCWACC

11

Appendix

Income Statement for Badger Meter (Including Projections)US GAAP

Thousands of USD FY 2002 FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013

12/31/02 12/31/03 12/31/04 12/31/05 12/31/06 12/31/07 12/31/08 12/31/09 12/31/10 12/31/11 12/31/12 12/31/13

Revenue 167,317 183,989 205,010 203,637 229,754 234,816 260,420 240,522 241,538 285,804 300,445 315,437

Cost of Goods Sold (111,317) (123,470) (137,532) (130,218) (153,126) (153,418) (169,741) (155,137) (155,792) (182,914) (192,285) (201,879)

Gross Profit 56,000 60,519 67,478 73,419 76,628 81,398 90,679 85,385 85,746 102,889 108,160 113,557

Selling, General & Admin (42,805) (46,419) (47,281) (46,263) (47,840) (50,782) (54,173) (55,320) (55,554) (64,306) (66,098) (67,819)

Operating Income 13,195 14,100 20,197 27,156 28,788 30,616 36,506 30,065 30,192 38,584 42,062 45,738

Interest Expense (1,849) (1,737) (1,607) (1,492) (1,299) (1,291) (1,209) (1,748) (954) (821) (821) (821)

Other Expense (Income), Net 91 988 (610) 0 0 0 0 0 0 0 0 0

Earning from Operations, Before Tax 11,437 13,351 17,980 25,664 27,489 29,325 35,298 28,317 29,238 37,763 41,242 44,918

Income Taxes (4,166) (5,774) (8,347) (9,500) (10,921) (10,939) (12,998) (10,619) (10,964) (14,161) (15,466) (16,844)

Earning from Operations 7,271 7,577 9,633 16,164 16,568 18,386 22,300 17,698 18,274 23,602 25,776 28,074

Loss from Discontinued Ops 0 0 0 (2,911) (9,020) (1,929) 0 0 0 0 0 0

Net income 7,271 7,577 9,633 13,253 7,548 16,457 22,300 17,698 18,274 23,602 25,776 28,074

Shares Outstanding 12,882 13,170 13,444 13,696 14,154 14,519 14,788 14,788 14,788 14,788 14,788 14,788

EPS from Continuing Operations $0.55 $0.57 $0.71 $0.94 $1.15 $1.26 $1.51 $1.20 $1.24 $1.60 $1.74 $1.90

Consensus EPS $0.95 $1.21 $1.54 $1.58

Revenue Growth 20.77% 9.96% 11.43% -0.67% 12.83% 2.20% 10.90% -7.64% 0.42% 18.33% 5.12% 4.99%

Common Size:

Revenue 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

Cost of Goods Sold -66.53% -67.11% -67.09% -63.95% -66.65% -65.34% -65.18% -64.50% -64.50% -64.00% -64.00% -64.00%

Gross Profit 33.47% 32.89% 32.91% 36.05% 33.35% 34.66% 34.82% 35.50% 35.50% 36.00% 36.00% 36.00%

Selling, General & Admin -25.58% -25.23% -23.06% -22.72% -20.82% -21.63% -20.80% -23.00% -23.00% -22.50% -22.00% -21.50%

Operating Income 7.89% 7.66% 9.85% 13.34% 12.53% 13.04% 14.02% 12.50% 12.50% 13.50% 14.00% 14.50%

Interest Expense -1.11% -0.94% -0.78% -0.73% -0.57% -0.55% -0.46% -0.50% -0.50% -0.50% -0.50% -0.50%

Other Expense (Income), Net 0.05% 0.54% -0.30% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Earning from Operations, Before Tax 6.84% 7.26% 8.77% 12.60% 11.96% 12.49% 13.55% 12.00% 12.00% 13.00% 13.50% 14.00%

Tax Rate -36.43% -43.25% -46.42% -37.02% -39.73% -37.30% -36.82% -37.50% -37.50% -37.50% -37.50% -37.50%

Tax (as a % of Sales) -2.49% -3.14% -4.07% -4.67% -4.75% -4.66% -4.99% -4.41% -4.54% -4.95% -5.15% -5.34%

Earning from Operations 4.35% 4.12% 4.70% 7.94% 7.21% 7.83% 8.56% 7.59% 7.46% 8.05% 8.35% 8.66%

Loss from Discontinued Ops 0.00% 0.00% 0.00% -1.43% -3.93% -0.82% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Net Income 4.35% 4.12% 4.70% 6.51% 3.29% 7.01% 8.56% 7.59% 7.46% 8.05% 8.35% 8.66%

Interest Expense 1,849 1,737 1,607 1,492 1,299 1,291 1,748 1,748 954 821 821 821

Total Debt 35,701 39,634 36,103 32,911 29,687 19,239 33,017 33,017 18,017 15,499 15,499 15,499

Interest Expense % of Total Debt -5.18% -4.38% -4.45% -4.53% -4.38% -6.71% -5.29% -5.29% -5.29% -5.29% -5.29% -5.29%

Actual Projected

12

Balance Sheet for Badger MeterUS GAAP

thousands of USD FY 2003 FY 2004 FY 2005 FY 2006 FY 2007

12/31/03 12/31/04 12/31/05 12/31/06 12/31/07

Current Assets:

Cash 2,089 2,834 4,403 3,002 8,670

Receivables 26,304 26,879 30,450 29,276 30,638

Total Inventory 29,654 35,646 31,970 33,290 34,094

Finished Goods 8,010 14,121 11,875 9,122 8,225

Work in Process 8,494 9,054 9,048 10,302 10,660

Raw Materials 13,150 12,471 11,047 13,866 15,209

Prepaid Expense & Other Current Assets 1,193 2,016 2,309 3,179 3,450

Deferred Tax Assets 3,758 4,007 3,432 3,737 3,082

Assets of Discontinued Operations 0 0 0 6,875 0

Total Current Assets 62,998 71,382 72,564 79,359 79,934

Property, Plant, and Equipment (at cost) 104,081 107,295 109,810 113,249 125,678

land & improvements 3,360 3,487 7,416 6,337 7,177

buildings & improvements 28,069 28,252 27,867 29,922 39,448

machinery & equipment 72,652 75,556 74,527 76,990 79,053

less accumulated depreciation (61,243) (65,279) (65,940) (68,540) (71,100)

Net PP&E 42,838 42,016 43,870 44,709 54,578

Intangible Assets (at cost, net amortization) 1,336 1,160 1,026 636 477

Other Assets 16,236 4,009 4,101 4,211 4,919

Deferred Tax Assets 3,354 0 0 3,510 3,435

Prepaid Pension 0 17,290 17,726

Goodwill 7,089 7,104 6,580 6,958 6,958

Total Assets 133,851 142,961 145,867 139,383 150,301

Current Liabilities

Short-Term Debt 3,543 17,539 8,847 15,093 10,844

Current Portion of Long-Term Debt 5,645 5,348 7,431 1,944 2,738

Accounts Payable 14,895 11,069 11,484 10,597 11,363

Accrued Compensation & Benefits 6,619 6,166 6,436 6,181 5,988

Warranty & After-Sale Costs 3,767 3,817 3,610 2,954 1,917

Income & Other Taxes Payable 2,583 982 1,778 621 8,359

Liabilities of Discontinued Operations 0 0 0 8,321 0

Total Current Liabilities 37,052 44,921 39,586 45,711 41,209

Noncurrent Liabilities:

Other Long-Term Liabilities 0 326 634 557 627

Deferred Tax Liabilities 5,699 7,437 6,584 199 244

Accured Nonpension Retirement Benefits 5,069 4,490 3,955 6,903 6,083

Other Accrued Employee Benefits 6,410 6,902 6,332 8,266 7,040

Long-Term Debt 24,450 14,819 15,360 5,928 3,129

Commitments & Contingencies 0 0 0 see note

Total Long-Term Liabilities 41,628 33,974 32,865 21,853 17,123

Total Liabilities 78,680 78,895 72,451 67,564 58,332

Shareholder's Equity

Common Stock 4,846 9,872 10,056 20,553 20,902

Class B Common Stock 0 0 0 0 0

Capital in Excess of Par Value 20,079 18,313 23,376 19,428 24,655

Reinvested Earnings 58,928 64,928 74,258 77,479 89,061

Accum. Other Comprehensive Loss (Income) 1,280 2,024 1 (12,041) (9,191)

Employee Benefits & Restricted Stock (1,285) (1,065) (1,357) (744) (682)

Treasury Stock (28,677) (30,006) (32,918) (32,856) (32,776)

Total Shareholder's Equity 55,171 64,066 73,416 71,819 91,969

Total Liabilities & Shareholder's Equity 133,851 142,961 145,867 139,383 150,301

Actual

13

Cash Flow Statement for Badger MeterUS GAAP

thousands of USD FY 2003 FY 2004 FY 2005 FY 2006 FY 2007

12/31/03 12/31/04 12/31/05 12/31/06 12/31/07

CFs from operating

Net Income 7,577 9,633 13,253 7,548 16,457

Changes in Working Capital:

Receivables (3,846) (823) (4,335) 1,373 301

Inventories (4,152) (5,622) 2,691 (1,531) 241

Prepaid Expenses & Other Current Assets 26 (862) (343) 302 (58)

Current Liabilities 3,719 (6,697) (1,341) (1,384) 2,142

Total Change in Working Capital (4,253) (14,004) (3,328) (1,240) 2,626

Total Non-Working Capital Adjustments: 10,759 9,869 8,436 10,442 9,192

Depreciation 7,683 7,033 6,164 6,589 6,308

Amortization 149 212 195 418 159

Tax Benefit on Stock Options 585 877 1,370 0 0

Deferred Income Taxes 323 1,483 (318) (2,081) (1,149)

Long-Lived Asset Impairment 0 0 0 1,369 0

Gain on Disposal of Long-Term Assets 0 0 0 0 (495)

Noncurrent Employee Benefits 1,317 2,264 2,758 3,116 3,167

Contributions to Pension Plan 702 (2,000) (2,000) 0 0

Stock-Based Compensation Expense 0 0 267 1,031 1,202

NET CASH FROM OPERATIONS 14,083 5,498 18,361 16,750 28,275

Free Cash Flow 7,030 (74) 9,273 5,690 12,304

EBITDA 15,409 16,878 19,612 14,555 22,924

Capex for Property, Plant, & Equipment (7,053) (5,572) (9,088) (11,060) (15,971)

Capex as a % of Sales -3.83% -2.72% -4.46% -4.81% -6.80%

Proceeds on Disposal of Long-Lived Assets 0 0 0 0 3,194

Other (Net) (301) (655) (271) (516) (341)

NET CASH FROM INVESTING (7,354) (6,227) (9,359) (11,576) (13,118)

Net Increase (Decrease) in Short-Term Debt (16,812) 13,996 (8,230) 8,971 (7,957)

Issuance of Long-Term Debt 27,970 0 10,000 0 0

Repayment of Long-Term Debt (16,900) (9,943) (7,376) (14,919) (1,943)

Dividends Paid (3,425) (3,633) (3,923) (4,327) (4,866)

Proceeds from the Exercise of Stock Options 1,207 1,949 2,434 3,057 1,517

Tax Benefit on Stock Options 0 0 0 2,935 1,997

Treasury Stock Purchases (1,066) (1,711) (3,323) 0 0

Issuance of Treasury Stock 607 816 1,286 579 170

NET CASH FROM FINANCING (8,419) 1,474 (9,132) (3,704) (11,082)

Net Change in Cash Balance (1,690) 745 (130) 1,470 4,075

Acutal

14

Industry Peers

BMI KTII SNHY ITRI ROP SPX (GBP) MLAB ESE Average

General Information

Price 23.99 72.77 16.09 66.25 42.03 8.50 19.05 35.69

Shares 14.79 2.78 16.66 34.47 89.71 75.97 3.18 26.11

Marketcap 354.77 201.91 268.02 2,283.92 3,770.59 645.76 62.01 932.00

Balance Sheet

Debt/Assets 17.01% 13.24% 0.32% 39.47% 33.05% 5.77% 0.00% 25.18% 16.75%

Net Debt (Cash) 28.08 (7.51) (32.73) 1,057.47 1,190.08 (15.31) (6.73) 204.98 302.29

Net Debt/EBITDA 0.62 (0.17) (0.67) 3.88 2.14 (0.17) (0.83) 1.89 0.84

Interest Coverage 30.38 29.37 - 0.92 9.31 5.55 - 8.25 10.47

Inventory Turnover 4.46 4.09 10.38 6.99 4.49 - 1.75 4.67 4.60

AR Turnover 7.78 6.58 8.99 5.61 5.96 4.42 5.74 5.59 6.33

AP Turnover 12.42 9.78 19.14 5.89 9.19 - 31.75 9.28 12.18

Operating Metrics

WC/Sales 11.52% 26.16% 27.44% -2.79% 9.93% 33.53% 70.00% 16.34% 24.02%

Gross Margin 35.02% 42.51% 34.43% 33.62% 51.36% - 63.94% 40.03% 37.61%

Operating Margin 14.11% 15.91% 22.38% 4.32% 19.94% 16.91% 34.88% 12.98% 17.68%

Net Margin 8.01% 10.94% 15.21% 1.42% 12.52% 12.16% 22.20% 7.49% 11.24%

Asset Turnover 1.39 1.22 1.44 0.64 0.56 1.12 0.78 0.67 0.98

ROA 11.11% 13.30% 21.97% 0.91% 7.04% 13.58% 17.28% 5.03% 11.28%

Financial Leverage 1.76 1.67 1.18 2.76 2.03 1.65 1.06 1.98 1.76

ROE 19.52% 22.18% 25.89% 2.51% 14.26% 22.40% 18.29% 9.98% 16.88%

FCF/EBITDA 18.95% 43.24% 55.29% 54.33% 70.46% 55.24% 46.12% 55.67% 49.91%

Inventory Days 81.89 89.13 35.15 52.25 81.23 - 208.49 78.17 78.29

AR Days 46.89 55.51 40.60 65.05 61.25 82.61 63.61 65.27 60.10

AP Days 29.38 37.33 19.07 61.93 39.71 - 11.50 39.31 29.78

CCC 99.39 107.31 56.68 55.37 102.76 - 260.60 104.13 98.28

Valuation

P/E ttm 15.38 8.09 9.41 19.43 13.60 11.67 13.64 16.30 13.44

P/B 3.21 1.73 2.44 2.06 1.88 2.64 2.42 1.99 2.30

P/S 1.35 0.84 1.43 1.09 1.64 1.42 2.92 1.48 1.52

EV/EBITDA ttm 8.33 4.67 4.85 11.47 8.88 6.61 6.64 10.36 7.73

Dividend Yield 1.58% 0.00% 2.72% 0.00% 1.98% 6.62% 2.11% 0.00% 1.88%

FCF Yield 2.44% 8.80% 9.85% 6.88% 10.21% 7.85% 6.18% 6.48% 7.34%

Company Key

BMI Badger Meter, Inc.

KTII K-Tron International, Inc.

SNHY Sun Hydraulics Corporation

ITRI Itron, Inc.

ROP Roper Industries, Inc.

SPX Spirax-Sarco Engineering plc

MLAB Mesa Laboratories, Inc.

ESE Esco Technologies, Inc.

15

Proprietary Survey In early January, 2009 we sent out the following questionnaire to 75 members of the Association of Metropolitan Water Agencies and received 25 responses from a variety of municipalities including Anchorage, AK; Sioux Falls, SD; Topeka, KN; and Corpus Cristi, TX.

Hello, I am a Marquette University senior participating in the Chartered Financial Analyst (CFA) Institute Global Investment Research Challenge. As a part of the Challenge, I am researching Badger Meter and the water meter industry and would greatly appreciate your response to a few questions below: Who supplies your water meters? What is the most influential factor in who supplies your water meters (price, service, quality, location, etc.)? How do you read your water meters: manually, AMR (drive-by radio), fixed network AMI, or a combination? If you read them via AMR or AMI, who supplies your radios? Are you considering switching to reading your meters differently? Which method of reading the meters are you considering and why? Are you planning on ordering new water meters in the next year? If so, how are you planning on funding your water meters (budget, bond offering, etc.)? Thank you in advance for your response.

16

Survey Response The subsequent responses gave us substantial insight into the ordering and funding process for meters in addition to the rate of technological adoption (Figures 12 and 13). We also received anecdotal responses about the effect the challenging macroeconomic environment is having upon various municipalities. Figure 12: Figure 13:

The typical municipality process for meter replacement projects proceeds as follows: develop technical specifications, compile a list of acceptable manufacturers, open the contract for bidding, and finally choose a manufacturer. Initially, it is most critical for the water meter manufacturers to meet the technical specifications as that will allow them to bid on the contract. Many times the specifications may mandate that a meter is compatible with a competitor’s meter reading system. In one instance, Anchorage, AK has considered using Badger Meter water meters but has not purchased BMI’s meters because they are not compatible with the city’s Neptune data collection system. Additionally, it is important to have a strong reputation of quality meters and service in order to make it onto the bidding list. Many of the utilities had long histories of purchasing water meters from a sole manufacturer. For example, Raleigh, NC has had more than a 25 year track record of using Neptune’s meters. Importantly, one respondent from the City of Springfield, MO Electric, Gas, and Water Utility noted that Badger Meter has a very good reputation within the industry. However, once the contract is opened to bidding the primary factor for the final choice is price. Once a manufacturer is deemed to provide acceptable meters, it is very challenging to prevent them from bidding on contracts as it requires a very good reason and extensive paper work. Price becomes the final determinant because of the public nature of the majority of water utilities in which they are mandated to provide the lowest cost, acceptable product to tax payers. Therefore, Badger Meter’s greatest challenge is to provide competitive pricing within its mid-sized utility niche. For larger contracts, Badger Meter may get priced out as Badger tries to maintain a healthy, 30-35% gross margin but in smaller municipalities the contract size may not be large enough for Badger to be profitable.

0

2

4

6

8

10

12

Manually AMR AMI

# o

f R

esp

on

den

ts

How do you read the majority of your water meters?

Badger

25%

Neptune

35%Elster

AMCO

5%

Sensus

15%

Hersey

5%

Combination

15%

Who Supplies Your Water Meters?

17

AMI

54%

AMR

14%

No

interest

32%

Which other means of reading your water meters would you consider?

Figure 14: Figure 15:

Source: Bianco Research

The most common form of funding for meter purchases and replacements is through the budget established for the municipality from city taxes (Figures 14 and 15). Notably, 57% of all respondents reported that they purchased their replacement meters from budgeted funds. The remainder funded their meter purchases through municipal bond issuances or a combination of bond issues and budgeted funds. Approximately 43% of all responding municipalities access the public debt markets for funding meter purchases. With the present turmoil in the capital markets, this could pose challenges for large meter orders. The municipal bond market has been quite volatile as presently the AAA-rated, tax exempt, 10-year, general municipal bond is yielding 3.29%. Figure 16:

We received a variety of responses as to how municipalities read their water meters with nearly half of all respondents reading their water meters manually. However, over half of those reading them manually were in the midst of a pilot program for AMR or were using AMR for a portion of their routes. The other utilities read their meters primarily through AMR (40%) or using fixed network AMI (10%). Just over half of all utilities were in the midst of evaluating fixed network AMI though others noted that presently it was not cost efficient and the additional data provided did not offer significant worth for water utilities. (Figure 16) The benefits that were noted included reduced routes, leak

detection, improved customer service, and assistance in water conservation. Interestingly, Denver Water notes that it will take 12-15 years for their AMR system to pay for itself.

Municipal

Bonds

43%

Solely

Operating

Budget

57%

How do you fund your water meters purchases?

18

Anecdotal Responses

Residential Water Meter Life We received varying responses about the length of time before a residential water meter would be replaced. Minneapolis’ Supervisor of Meter Services remarked that their life testing of their Badger Meter residential water meters indicted 25-30 years could be expected on a residential meter. Interestingly, Helix Water District serving San Diego, CA suburbs currently changes out their residential water meters every 15 years. Depending upon the conditions of the water, the location of the meter, and the city’s geographic location, residential water meter life can vary quite substantially. Many utilities may be able to delay the purchase of replacement meters for a few years until economic conditions improve. Case Study: Springfield, MO Springfield, MO, a city of approximately 150,000 citizens, provides a solid example of the effect of the challenging macroeconomic environment upon an average municipality in an area of the country that largely did not participate in the housing boom and subsequent bust. The city utility is constrained by budget cuts from lower tax revenues and lower water revenues. Springfield is receiving lower water revenues as the largest user of water from the utility, a private, commercial factory, was closed in 2008. In addition, the city formerly received water revenues from opening taps in new homes but new housing developments have been non-existent. Typically, the city would order 2,000 water meters annually with 1,200 for new homes and 800 for replacements. With so few new homes built over the past year, the maximum number of water meters that the city will purchase in 2009 is 1,000. The decline in water meters purchased is a function of the utility’s funding. In 2008, the utility was budgeted with $100,000 to institute a pilot test of AMR meters (able to purchase 600-800 AMR meters). In early 2008, the utility was initially budgeted an additional $100,000 for 2009 to continue the pilot test. This past fall, the 2009 budget for the pilot test was cut to $15,000 (able to purchase 100-150 AMR meters) before being eliminated completely in early December. Therefore, the AMR pilot program is being put on hold with no expansion in 2009. The utility is expecting to have the 2010 and 2011 budget for the pilot program to be cut to $15,000. Springfield’s challenges with no new housing growth and private, commercial companies that are struggling illustrate some of the universal challenges that municipalities face across the country.

19

Disclaimer This report reflects the personal views of analysts (Alison Bettonville, Christopher Cebula, Brian Finnie, Margaret Hughes, Anna Toshach) about the subject security, Badger Meter, Inc. Marquette University does not otherwise guarantee or provide assurance in respect to the obligations of any of the above entities. This research has been prepared for the general use by the students of Marquette University. This research is based on information obtained from reliable sources but accuracy is not assured. We accept no obligation to correct or update this information or the opinions in it. No member of the team accepts liability whatsoever for any direct, indirect, consequential or other loss arising from the use of this research and/or further communication in relation to this research.