Clean Tech Exam Flashcards
What is the situation with primary energy demand presently?
Growth requires energy
Context: Consumption expected to grow across the board (China & Asia driving in particular); OECD stable
Fuel mix is set to change significantly, moving away from coal towards renewables.
(UN wants to triple annual rate of investment within decade) to combat climate change & maintain deployment
Substantial private capital flows are required => need to match conditions that attract capital. Has to be profitable - still building relationships with the capital providers.
What is driving the new wave of tech investment?
Macro: Change in financial markets, global economies, power sector => growing demand renewables.
Sector: Opportunity in power = tech advancements, lowering costs, improving track records, strong policy and disruptive technology (e.g. battery storage) => decarbonisation driven by demand.
Also, great sense of optimism and faster rate of growth due to forecast opportunity & policy push.
Half investments in energy = renewables + emerging markets now 60% projects.
How does policy play a part?
Policy takes background - enabler. Crucial for risk.
Focus on what is & fiduciary responsibility.
Positive Policy: project attractiveness & investor security.
Policy uncertainties: create investment risk, retroactive policies are the most damaging.
COP21 sent ambitious signal to global markets and energy generation – consistency and clarity.
Clean tech investment historically?
Historically financed: utility equity & bank debt + specialised funds.
Investments in this sector has been a sure way to lose money/got renewable energy wrong.
First wave of clean tech investment 2006-2014 = oversupply in markets (oil prices fell), subsidiaries, recession. VC clean tech did very poorly – lost money.
Previously small and complex nature of renewables the need for capital = underserved
Risk/Return continuum & importance for clean tech?
One for both players and instruments. Memorise.
Variety of investors different risk appetite.
Need to improve our ability to match early stage, high risk projects, with the right investors and then hand them over to more risk averse investors further down the line.
Return can be ‘sticky’ (reverse x & y) i.e. you accept any level of risk to see the return you want to see (15-18% following crisis).
Something that looks safe can actually be risky depending on financial structuring
General Principles for Capital Structure and debt?
The ideal way to finance technology infrastructure is with low-cost (low risk) debt (usually against cash flow).
But to gain debt financing, a venture will need to start with more expensive forms of financing (equity)
Introducing debt = actual ROE (capital gain/capital invested) increases immediately; R(E) goes up, applies to all financial assets (as does risk though).
Finance Pecking Order?
Goes from low risk, low return to high risk, high return.
Senior Debt/Bonds Subordinate Debt Mezzanine Hybrid Debt/Equity Equity
(VC, Growth Equity, PE, Corporate Equity, Debt)
Optimal Discount Rate? Cost of Capital - what does it measure?
Every venture = optimal capital structure = lowest WACC/ theory accurately reflects total risk.
1) Measures return demanded by all providers of capital
2) Investment must offer this/higher return offer to warrant capital provider’s money
3) = opportunity cost of capital employed (for investor) – rate of return could earn elsewhere on project with same risk & capital structure
4) Signifies true DR for project after accounting for capital structure & risk.
Riding the asset down the discount rate (declining WACC) => unlocks a cost of capital that’s much lower => higher NPV – this is what you want to do.
Estimating WACC?
Very difficult to do… But:
Cost of Debt = yield curve/bond prices (10 year sovereign bond) – implied return of debt of corporate bond
Debt/Equity ratio
Cost of Equity = market risk premium (CAPM) – rf + B(Rm-rf)
Corporate vs. Project Wacc?
Corporate wacc not necessarily cost of capital for project within firm.
Systematic risk of project could differ from the systematic risk of firms projects.
Target capital structure of project could differ from corporate capital structure target.
Each project will have it’s own WACC & hurdle rate (risk less + risk premium).
IF project level: look at other similar projects, can’t just take the WACC of the company = think opportunity cost of capital.
Hurdle Rate?
Rate of return/compensation on a project/investment required by the manager/investor for riskiness present.
= the risk less + risk premium
For riskier projects, IRR will be higher, = hurdle rate higher.
Compute = most important risks, how to measure, how to translate into numerical premium/or discount for hurdle rate.
Key investment metrics?
NPV (accept greater than 0)
IRR = accept IRR > WACC = NPV > 0
Capital Efficiency = NPV/CAPEX – measure of value creation (helpful to rank not in isolation)
Estimating Cash flows?
1) Total Cash Flow - capex
+/- change in working capital
+/- cash flows from operations
+/- salvage value or decomissioning costs.
2) EBIT * (1-TR) + depreciation – CAPEX – changes in WC (Cash+Inve+Rec-Pay)
Opportunity Cost of Capital?
Best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted.
Rate that should be used to discount the cash flows of a project for budgeting purposes.
Provides the conceptual foundation for a good WACC
IRR?
Yield indicator.
Annualised rate analogous to common forms of investment
IRR can only work standalone if –ve cashflows preced +ve ones
Noes not consider scale of project/wealth creation
Sources of equity finance?
Unlisted Equity & Listed Equity & Non-private equity
Unlisted equity?
Venture Capital
• Early stage / high risk
• Target 80%+ returns
• Multiple rounds / 2-3 year exit
Private Equity
• Growth stage / medium risk • Target 15-25% returns
• Exit within 3-7 years
Infrastructure Capital/Fund
• Long-term assets with lower risk • Target 8-12% returns
• Exit after 10 years (or longer)
Listed Equity?
Listed equity - Permanent capital
- Operating track record & scale / scope
- Target 7-11% returns
Non-Private Equity?
Grants
• Innovation support
• Subsidised returns but small-scale
Government investment
• Possibly subsidised returns
• “Crowing Out” versus “Crowding In”
Venture Capital - Basic Definitions?
Early Stage: Founders capital, Friends & Family, Competitions
Mid stage: Crowdfunding, Accelerators,Business Angels, Angel Syndicates
Between 2 & 3: Seed investors.
Late stage: VC Firms, Corporate VC, Institutional VC
Moving down this: Bigger $ & increasing influence on funding ecosystem
What is a private equity firm?
PE is an investment management company comprised of General Partners that manage a PE fund.
PE fund is a pool of capital/equity raised from investors (limited partners - invest for 10 years).
The fund then seeks minority or majority control in privately held companies in their area of expertise/industry focus: have more strategic control
Who are the limited partners/who invests?
High net worth individuals, Pension funds, Sovereign Wealth Funds, Financial Institutions, Insurance companies, Foundations/Endowments
Investors invest into a timeframe, the PE firm will give investors dividends and capital pay-out after.
General practices of a PE firm?
PE will not take as much risk as VC.
Lower risk appetite - providing lower, more reliable returns (15-25% IRR) - 5 yrs.
Main difference growth PE & VC = technology risk;
PE deploys of tech that is commercially ready (not new)
PE used to take inefficient public companies private then make them more efficient.
Now it is about growth equity. Investing in a company that needs significant capital to grow.
Leveraged buy-out is where if you want to buy a £1bn company, using £300m equity and £700m debt from a bank, you only must give 2x return on equity and pay interest on the debt.
How are Investments found? (4)
1) Strategic approach – Regulation - see where market going, invest in companies in that industry – gaps in the market – pursue (top down scan of particular industry)
2) Proprietary approach – Opportunistic approach- based on personal relations- value not otherwise created – use network to create transactions.
3) Auctions – Participation in bidding on transactions marketed by intermediary; Investment bank approaches PE with teaser, if interested sign NDA, then go to Auction. Highest bidder wins - broken auction is when bidders drop out, then you can negotiate better on price.
4) In the door – People who walk through the door. 1-year turnaround time, from walking in to getting funded. 2-3/100; third party instructions & cold calls from firms seeking capital.
The Typical PE process? (5)
1) PE fund provides equity capital, becomes a shareholder and takes one or more seats on the board.
2) Management may provide capital but mostly pledges the dedication of resources (people, intellectual property, real assets, etc.)
3) Capital commitments typically staged over time based on achievement of key milestones.
4) Exit from the investment sought as soon as possible, but no later than 10 years.
5) Exits achieved by IPO or trade sale (selling part / all of the company to e.g. utility) – IPO is not a sale – beginning of a new process = not the ultimate goal (circa 3% IPO).
Financials of PE?
Fee structure – annual management fee of AUM
- Most firms set minimum guarantees rate of return (5-8%)
- Once exceeded, PE house shares in profit of that (10-20%)
Successful due to: proprietary (opportunistic); strategic control; quick buy & sell when valuations look good…
How is CVC different/same from Professional VC? (4)
PE’s biggest competition is ‘do it yourself’ direct investment of pension funds etc. setting up their own teams (CVC - google, statoil, apple etc.)
1) CVC capitalize upon information advantage within business units for deal sourcing and due diligence.
2) CVC must look for potential strategic fit with parent / parent industry – critical in deal screening.
3) CVC May be run like VC firm or like an in-house strategy unit, depending upon objectives.
4) CVC’s can work with complimentary VC firms via co-investment
What is professional VC?
Subset of PE that focuses on smaller bets ($500K- 50m) in very high risk/reward co’s.
Professional VC = appetite for technology risk (key difference to Growth PE)
Relevant for entrepreneurial start-ups after the product or service gained an initial customer base
VC tend to specialize by industry & investment size they make with companies in portfolio.
Indicators of the cost of debt?
Rate (Spread, Fixed vs. Floating)
Tenor (Duration of the loan)
Terms (Secured vs. Unsecured, Repayment schedule, Covenants, etc)
- Cost of corporate debt is relatively easy, just look up the market value/rating on corporate bonds
- Project-level debt more complex (and important for renewable energy projects) – focus.
Raising debt exposes to currency risk if outside home country & debt usually prices in risk.
What is Project Financing & mainly used for?
Basic distinction from corporate financing is investors exposure is tied only to predictable cash flow from tangible assets of project, not company.
The assets of the project are used as collateral for investment.
Financing method often used in energy & infrastructure projects
- Referred to as SPV/SPC(ompany) financing.
Main advantages of Project Financing (4)?
Allows for higher gearing &
Shared participation by joint venture partners
Clarifies & isolates investment risks
Ensures arm-length transactions with firm and project company
Role of Banks in Project Financing? (3)
1) Advisor: market intelligence, structuring experience, selections of approach to finance market
2) Arranger/Underwriter: final structuring, market access
3) Lender/Guarantor: Provide funds, loan management role or guarantor on own account. Sometimes come together as syndicates.
Fundamental Issues with PF?
Does the project make sense to all stakeholders (8):
Sponsors / Contractors / Suppliers / End users / Host government / Neighbours / Environment / Society.
Sponsor: resources to realise project, committed and bought in (money at risk)?
Example risk free rates & debt ratio?
15% brazil, 10% India & SA, UK, USA & Germany: 5-2.5%
Debt/Equity Ratio for techs (you can see PV - most mature):
PV (83%); Coal Fired (75%); Biomass (70%); Wind offshore (65%); Geothermal (50%)
Bank/Lender objectives for Project Financing?
Debt: Low risk, low return (fees and interest)
Want:
- Clear definition of project and cash flows
- Priority access to cash flows
- Being repaid on time and in full
- Removal of risk from project
- Guarantees from as many people as they can
Clean tech:
Will see that sponsor has money invested, off-take arrangements & base-case/downside scenario first.
What do the sponsor/owners want from project financing?
Equity: High risk, high return (lots of upside potential)
What do sponsors want:
- High gearing
- Low cost of debt
- Minimise upfront cash paid
- Restrict lenders recourse to project assets.
- Maintain asset flexibility, ability to sell project.
Estimating the expected return on equity?
Graphs.
If your project cost of equity is lower than your overall company R(E) you will reject these lower risk projects; whilst you will accept the higher risk ones.
=> getting this number wrong repeatedly will cause you to fail to exist – profit is relative to the opportunity cost of capital.
If wacc = 10% and investment return = 6% = negative return.
