Green-Techs and Private Equity

What is at stake for Luxembourg players?

Just a few years ago, green technologies and other renewable energies were nice-to-haves for many private investors. They were one of many tools to serve responsible communication. Yet, high energy prices, scientific consensus regarding climate change and regulatory changes have set up a complete new deal: the focus is not anymore on assessing the necessity of green-techs, but on identifying which will be tomorrow’s champions.

Most analysts agree on considering this segment one of the most promising for private investors. But because of some recent transactions with some unreasonable multiples, the same analysts compare the current activity to the “dot-com bubble” of the late 90’s. Private Equity (PE) players are now facing one of the most interesting challenges of the last years, and Luxembourg, as a global reference in PE, stands at the heart of debate.

Each project features different characteristics, but PricewaterhouseCoopers (PwC) has highlighted three recurring challenges faced by Luxembourg PE players when managing their Green-Techs assets.

First challenge: to have access to reliable information

Whether they are venture capital in a start-up company or the financing of a production unit of renewable energy, Green-Techs most often represent investments that are complex technical- and regulatory-wise. The "traditional" risks are often combined with specific risks that are usually misknown: "technological" risk, close to that met in biotech projects for example or "infrastructure" risk, well known by players on the scene of wind energy.

This twofold complexity often leads the PE player to invest alongside expert project manager, acting both as investor and industrial operator. This investment structure has often been used for the financing of solar or wind farms in Portugal, Spain or France.

After the initial due diligence phase, the information available to the PE fund based in Luxembourg is often biased:

• It is seldom independent, as most of the time it is produced by the industrial partner itself.
• It is usually very hard to benchmark it against market data, as the available public information is limited.

PE funds are facing a complex challenge: how to set up a reliable reporting for investors? How to analyse the risks and the real value of investments?

Second challenge: to convince particularly demanding investors

Green-Techs are long-term investments: from five to ten years for developing new technologies, over 20 years for specific infrastructure projects. This feature, combined with the promise of mastered return (as it is the case for production units of renewable energies which revenues are guaranteed on the long-term) attracts investors that are not familiar with traditional PE investments.

For instance, PwC has noted that some pension funds and insurance companies are more and more interested in some Green-Techs projects. Those players, who are in direct contact with individual investors eager to act responsibly, require a high level of transparency and a thorough analysis of the risks carried by the fund.  This risk analysis must go beyond the few lines mentioned in annual reporting: the fund must be organised and set follow-up and analysis processes for each project and sometimes get an independent firm to check the data gathered.

One well-known example is that of establishing production units of renewable energy (green-field): their value depends upon successive probabilities of getting a licence to build and operate the infrastructure, of connecting to existing transport networks of energy, and finally of signing a sale contract with the provider.  These elements directly impact the value of the investment and thus the fund’s asset. How to make them tangible and reliable enough to convince investors? How to manage the risks attached with such subjective analysis?

Third challenge: to last

Who says "long-term investment", says "solid, steady and flexible investment structure". Luxembourg has established itself as an international fund structuring location thanks to its stable regulatory and tax framework. This specific feature represents a huge asset on the market of Green-Techs investments: a comprehensive fund structure, able to act in Europe and in North America.

This is however possible provided the structure is tailored to the objective pursued: what type of undertaking? For what kind of investors and for what projects? What partnerships (depositary, domicile or audit firms)? On a 15 to 20-year time horizon, those are key questions.

Recent fluctuations of oil and gas prices (sharp increase followed by a sharp decrease) have highlighted some structural weaknesses in the current financing of Green Techs: the main investors are today the majors of energy production (oil-, power-, and gas producers). Where prices decrease, Green Techs face a scissors effect: they become more expensive than their non-renewable competitors, and experience a decrease in their financing, since prime investors tend to forget them in favour of their core business.

In light of this, many observers consider that PE as an independent player must play a key role in fighting against climate change and for financing Green-Techs. However, such an opportunity will only be accessible to those equipped with asset management processes tailored to the requirements of their investments and those of their shareholders.