Shai Weiss of Virgin Green Fund on environmental PE investment

What is the background of the Virgin Green Fund?

“The Virgin Green Fund is a private equity fund that invests in renewable energy and resource efficiency both in the US and Europe. We invest in growth and expansion opportunities, which have different connotations for many people but a very clear case for us. We invest in companies that have (largely) mitigated their technology risks and are facing market and executions risks. Our dollars are used for traditional growth and expansion, working capital, and acquisitions, and from time-to-time we make investments into (mini) buy-outs. These companies have material revenues and are profitable, and if they’re not profitable our capital is the capital that gets them to profitability.”

Why go green?

“By now it’s relatively obvious that the world is facing a number of challenges that together form the macro-economic back-drop for our sector, from the will of nations and people to combat climate change to energy and resources security of supply, and from a growing recognition that the world needs to be more efficient in its use of natural resources - be it energy related, water and other related commodities.

We look at the convergence and overlap of the energy, water and waste sectors as key broad themes for our investment strategy and where we tend to operate, to find these companies - an area that we feel can only get bigger.”

Which areas are of particular interest?

“It is a huge market. For example, about $400bn of capital is invested in the global water industry every year. A billion people do not have access to clean water. Couple that with the fact a lot of these industrial processes, specifically exploration and production of oil and gas, uses and contaminates large amounts of water, and you see that water is not just consumed but also closely related to energy. So one of the things we like to look at is where these two things intersect - energy and water together. The reverse is also true: around 40 per cent of the cost of producing water comes from energy, hence combining renewable resources with desalination and managing the process itself more efficiently is of interest.

When you look at energy, there is the supply side of the equation production of renewable energy from biofuels, solar, wind, geothermal and hydro.

The other side of that is related to resource efficiencies - or the demand side of the equation. We look at the consumption of energy and how we can go about managing it more effectively, not only in energy but also in natural resources including water.

A lot of people are into the smart grid these days. We believe it is too broad a definition. For us the smart grid is about convergence of telecommunications and IT with energy. In our view, intelligent lighting falls into this category. Some 40 per cent of the energy consumed in commercial buildings is used for lighting and heating, ventilation and air conditioning.”

Which areas are you not convinced by?

“We try to avoid the sectors everyone is talking about as they naturally tend to become overinflated. We looked at the wind sector for a very long time, specifically the value chain of wind. Because we are not project investors, we do not invest in wind farms. Wind turbines need to be installed, maintained and serviced, and this yields a number of opportunities. More than 4,000 parts form a wind turbine. While in the past we avoided wind - it was the flavour of the year, specifically between 2006 and 2008 - it is now very much a focal point for us. Valuations have come down and the expectations of buyers and sellers are more realistic. Overall we have no problem investing in more mundane, less sexy companies that tend to be more predictable and sensibly valued - for example service companies often fit the bill nicely.

As always, one has to have a clear risk and reward frame-work. Growth and expansion is skewed towards protecting the downside and setting the scene for the upside. We don’t tend to look at things that will return ten times, though if it does, then that’s superb. Our modus operandi tends to account first for the potential downside. We expect to achieve a three times multiple on average, over a three to seven year average hold period, which will more than suffice.”

Which geographies do you find most appealing?

“Various countries have (inherent) natural and other, man-made advantages. The UK is great for off and onshore wind but it does not have very much sunshine. Spain and surprisingly Germany, however, both have great solar markets. Israel is also very appealing for new technologies, particularly in water. One really important market for us is the US, and we are seeing a real uptick in terms of activity in our sector. However, when you look at producing assets it becomes a country-by-country evaluation.”

How do you define a favourable investment environment?

“Because we invest in companies and not projects, we want to see a very favourable human capital situation. These are people who have successfully run companies in the past, and produced returns for their investors and themselves.

Finding excellent management teams is always an issue, but I think every year that goes by it is less of an issue. First generation success yields further growth and development, and I think we are well on the way there. There is also a growing trend of migration of human talent from the more established IT and telecommunications sectors as well as general industry. Management teams are gaining a better understanding of the critical success factors - that they operate in capital intensive industries, where low cost wins. This sounds trivial but truly understating what the implications of this is far from. We tend to back and partner with people we have worked with in the past or know well.

This sector is maturing at a good pace. The flipside of that is that the customer base tends to be municipal power teams, governments and very large corporations, which in practice means it may not be as quick as we might want, but it’s happening nonetheless.”

What effect are the stimulus packages going to have on the growth of the industry?

“It is dramatically important to the sector, whether it’s in the US or Europe. The stimulus packages in the US and China are having considerable impact. Likewise in the UK and Europe, where long-term targets for carbon reductions have been put into place. In the UK, Renewables Obligation Certificates (ROC) are an important factor of value transfer to the renewables sector; similar to feed in tariffs in continental Europe that have had a dramatic impact on the speed of deployment.

What investors want from policies is a clear framework and that the rules are very clear. They want it to be very loud so participants hear about it and know how to adjust their actions. Finally, it has to be very stable; if you set a stable framework and everybody knows about it and the objectives are clear, you will find the dollars and pounds tend to follow to the satisfaction of governments and policy setters. Consistency is absolutely key as the size of the intervention is very large.

One has to acknowledge that the governments are actually playing a role in determining winners (and losers), but I think that given the stakes and the state of the economy, it is going to be very hard to avoid in the medium term.”

What are the challenges in an industry such as this?

“As investors, the risks we face are very similar to those in any other sector. We have got to identify opportunities where we have the balance of risk and reward figured out. This is our primary job as investors.

The specific challenges in our sector arise from the fact the industry is commodity-led and there are many inputs and outputs that are not controlled by the players themselves. Companies also operate in a regulated environment - changes in regulation have a long term and profound impact on determining winners and losers. The other issue is that capital intensity is high - at the end we produce and manage energy, clean water and recycle waste. Finding this capital is not easy at the best of times and certainly not when we are in the midst of a profound recession.

These attributes are not unique to our industry. However, when the stage of development of the industry as a whole is coupled with some technologies yet to be proven at large scale and a need to demonstrate a sustained period of value creation - the hurdles for action and investing are set high - as they should.

We believe that when the macro is strong, it has and will continue to yield excellent investment opportunities.”

How do you see things developing over the next couple of years?

“Talking today, much of the world has yet to emerge from the recession so any development is against a backdrop of the worst economic environment most of us has witnessed. Despite that, overall we are very optimistic about the long-term prospects for this sector. Various participants in this space may have slightly different outlooks, but the need to increase production of renewable energy, find better ways of managing our scarce resources combined with the need and the will to combat global warming, sets the scene for a long term and sustained growth.”

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