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6/13/2019

Royalty Notes: A Debt + Equity Fusion?

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Author:  Dr. Chris Wedding

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If you’re an investor that likes the predictability of debt (check), but loves the upside potential of equity investments (yep), then Revenue Royalty Notes might be worth exploring.

Why might investors like Royalty Notes?

  • Higher current income expected relative to most debt products
  • More equity-like IRR potential
  • 1-8% of revenue (not profit) paid to you monthly or quarterly
  • Less uncertainty and more seniority than equity investments
  • 3-5 year terms
  • Remaining balance and mutiple on invested capital due at a predetermined maturity date

Importantly, future performance cannot be predicted by historical performance, so you’ve gotta feel good about the consistency and duration of a company’s past revenue, plus the sanity they used (or threw out the window) when making forward projections.
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A Comparison: Royalty Notes vs. Debt or Equity (CaroFin)
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And since it takes two tango…

Why might entrepreneurs like the Royalty Note structure for their growth capital?

  • Alignment of incentives — “If I do better, then you do, too (at the same time).”
  • No pressure to meet fixed debt payment schedules — “It’s easier for me to predict my success in terms of years, not months.”
  • Capped upside for investors — “If I succeed, then I am thrilled to pay you more than senior debt would earn, but I’m happy to keep more of the upside.”
  • Less micromanagement — “I’m paying you off of the top line, so I can largely manage my business strategy and expenses as I see fit. ”
  • Responsive to seasonality — “Since my industry might have higher and lower revenue months, this structure allows me to worry less about the extra cash management necessary to otherwise pay you at prearranged times.”

One more tiny detail: If there’s no revenue in the business yet, then there’s likely no Royalty Note either. Gotta stick to expensive equity for the time being…


Conclusion

We may not be able to have our cake and eat it, too.

(Although people have been thinking about this since at least the year 1538.)

Nor can we defy the Heisenberg Uncertainty Principle and know both the velocity and position of subatomic particles at the same time. [Dang it, my life’s dreams ruined…]

(Geek out more here.)

But don’t dismay…

It is, in fact, possible to invest in companies with instruments having both debt and equity characteristics via the Royalty Note.

[Insert a long sigh, and cue inspirational music...]

To learn more about Revenue Royalty Notes, check out this article by CaroFin, a private marketplace for alternative investments:

  • Revenue Royalty Notes — A form of debt investment with equity return potential...an alternative for investors pursuing exceptional current cash returns


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Photo credit: Pratiksha Mohanty via Unsplash

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6/3/2019

To Be Bearish or Bullish: Big Oil & Gas Investing Billions in New Energies

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Photo by Zbynek Burival on Unsplash

By: Dr. Chris Wedding
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If you think the “energy transition” is just for Democrats or greenies, then consider this quote from a Goldman Sachs natural resource executive:

“I’ve probably spent more time talking with oil company executives about the energy shift and renewables in the last 2 years than the previous 23 put together.”

Last year, $6.4B was invested in hydrocarbons versus $5.8B in renewable energy, according to PitchBook. That’s a pretty tight race.

And a CDP report notes that 2018 expenditure on clean energy sector by the world’s 24 largest oil and gas companies was roughly 1.3% of total budgets vs. 0.7% last year.

On one hand, that’s almost 200% growth year-over-year. Or (slight reframe) its chump change as a fraction of overall investments, with 98.7% of capital still going to conventional energy lines of business.

Plus, over 70% of those investments came from EU-based oil and gas majors. Maybe that’s because the science of climate change is magically different across the ocean. (Yep, sarcasm)

As further evidence that times are changing, here’s a look at three organizations…

  • Saudi Arabia’s Public Investment Fund has divested from oil and gas investments.
  • Vitol, a leading energy and commodity trading company with 5,000+ employees, is now “supportive of the need to move to more renewable sources of energy” and is focusing on investments in wind and energy storage.
  • Ørsted, formerly Danish Oil and Natural Gas Energy and the largest power producer in Denmark, has successfully transitioned from fossil fuels to primarily renewable energy. They publicy note that they can “prove numerically that the profitability of the oil and gas business was lower than the renewable investments” that were made, “when compared to the risk of each investment area.”


Why are oil and gas major making these investments now?

#1. They are already experts in the energy sector.

This is partly a situation of a [very powerful] hammer seeking a nail.

Decades of experience in conventional energy can translate into efficient capital deployment, project development, and new technology commercialization in the new energy sector, too.

Building and operating offshore oil rigs is complicated. The same is true for offshore wind projects, and this is a market expected to reach $60B by 2024. “Have skills, should apply.”

Running gas stations is not rocket science, but profitability is also not a given. So, it makes sense for Chevron to add EV charging to its gas stations, as long as they get the rate tariffs right so they do not drown in pricey demand charges.


#2.  Clean energy investments can be a hedge against softer demand for oil and gas.

When Fitch Ratings talks about the growth in electric vehicles potentially creating an “investor death spiral,” it’s worth listening to their reasons.


#3.  Renewable energy markets are not little runts to ignore anymore.

Bloomberg projects that over 70% of all new power capacity investment between now and 2050 is expected to be in solar and wind projects.

Their research further shows that clean energy sector investment has exceeded $300B globally for the last five years.

Finally, analysis suggests that the advanced energy economy (clean power, alternative transportation, energy-efficient buildings) now exceeds $1.4T, or twice the size of the global airline industry.



#4.  Corporate sustainability reporting is becoming mainstream. “We are watching you.”

At least 85% of Fortune 500 companies now engage in sustainability reporting.

Drivers of this trend include stakeholder demands, global trends towards greater transparency, peer pressure, and a realization that sustainability topics can be material to financial risk and return.

Samples of third-party sustainability reporting include the following:

  • CDP (formerly, Carbon Disclosure Project) — It covers disclosure by companies and cities regarding carbon, water, and supply chain impacts, and is backed by a “network of investors and purchasers, representing over $100 trillion.”
  • GRI (Global Reporting Initiative) — This is the oldest corporate sustainability reporting framework and is used by the majority of Fortune 500 companies.
  • SASB (Sustainability Accounting Standards Board) — This one provides investors with intel regarding a portfolio’s exposure to specific sustainability risks and opportunities, and has over $26T of investor support, including former leadership by Michael Bloomberg.
  • Task Force for Climate Disclosure -- TFCD is focused on “climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders,” and is backed by the G20 Financial Stability Board.



What kinds of new energy investments are oil and gas majors making in the last two years?

I will only focus on the top four oil and gas majors in terms of their investments in and commitments to lower carbon energy. This includes Total, BP, Equinor, and Shell. (See graph below).

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​I am mostly listing investments by their VC arms, with some other infrastructure investments sprinkled in here and there.

Finally, I am not listing companies that are “kind of” related to clean energy, such as ride sharing or financial settlement technologies for the energy sector.​


Total Energy Ventures
  • AutoGrid — $32M Series D — Big data analytics, distributed generation, energy storage, demand response (Jan. 2019)
  • Sunfire — $29M Series C — Hydrogen fuel cells (Jan. 2019)
  • Tado — $50M Late stage VC (6th round)  — Energy efficiency, smart home (Oct. 2018)
  • MTPV — $18M Series C — Waste heat to energy (Sep. 2018)
  • Ionic Materials — $65M Series C — Energy storage (cobalt-free, solid state) (Feb. 2018)
  • United Wind — $8M Series B — Wind energy (small scale) (Jun. 2017)


BP Ventures (plus some larger corporate deals)
  • PowerShare — Series A (unknown amount) — EV charging (Feb. 2019)
  • C-capture — $4.9M Series A — Carbon capture (Dec. 2018)
  • FreeWire Technologies — $15M Series A — Energy storage, EV charging (Oct. 2018)
  • Voltaware — $3.3M Seed round — Energy monitoring, AI (Jun. 2018)
  • Chargemaster — $170M Buy out — EV charging (Jun. 2018) (link)
  • StoreDot — $20M Late state VC (5th round) — Energy storage, EV charging (May 2018)
  • Lightsource — $200M Private equity growth — Large-scale solar, independent power producer (Dec. 2018) (link)
  • Fulcrum BioEnergys — $51M Late state VC (7th round) — Waste to energy (Nov. 2017)
  • Lightning Systems — $8M Late state VC (6th round) — Electric vehicles (Oct. 2017)


Equinor Technology Ventures
  • Yellow Door Energy — $65M Private equity growth — Distributed solar (Jan. 2019)
  • Scatec Solar — $85M Secondary market transaction — Large-scale solar, independent power producer (Nov. 2018)
  • Guanizul 2A — $95M Buy out — Large-scale solar, operating plant in Argentina (Jun. 2018)
  • Fos4Xy — $9.6M Series B — Wind technology (Jun. 2018)


Shell Ventures (and some bigger Shell New Energies deals)
  • Innowatts — $18M Series B — Digital energy, smart meters, AI, machine learning (May 2019)
  • Aurora (Automotive) — $530M Series B — Autonomous vehicles, machine learning (Feb. 2019)
  • Makani — Undisclosed amount — Wind power, distributed energy (Feb. 2019) (link)
  • Sonnen — Acquisition — Home energy storage (Feb. 2019) (link)
  • AutoGrid — $32M Series D — Big data analytics, distributed generation, energy storage, demand response (Jan. 2019)
  • Greenlots — Acquisition — Electric vehicle charging software (Jan. 2019) (link)
  • Sense — $20M Series B — Home energy efficiency, machine learning (Jan. 2019)
  • Ample — $31M Series A — Electric car charging (Aug. 2018)
  • Sonnen — $71M Late stage VC (5th round) — Home energy storage (May 2018)
  • Axiom Energy — $7.6M Series A — Thermal energy storage, Internet of Things (May 2018)
  • C3 IoT — $106M Series F — Big data analytics, Internet of Things, AI, machine learning (Jan. 2018)
  • Silicon Ranch — $217M for 44% stake — Solar project development and ownership (Jan. 2018) (link)
  • Husk Power Systems — $20M Late stage VC (5th round) — Biomass, solar, microgrids, energy storage (Jan. 2018)
  • SteamaCo — $3M Series A — Renewable energy, off grid (Dec. 2017)
  • SolarNow — $9M Series B — Residential solar, Africa (Dec. 2017)
  • NewMotion — Acquisition — Electric vehicle charging network, EU (Oct. 2017) (link)
  • Glasspoint Solar — $15M Series D — Solar thermal, industrial steam (Sep. 2017)
  • Innowatts — $6M Series A — Digital energy, smart meters, AI, machine learning  (Aug. 2017)
  • Sunseap — Undisclosed amount in late stage VC (3rd round) — Solar, Africa  (Aug. 2017)



How will investing in renewable energy be different than their historic energy investments?

If recent history is a good predictor (not always true), then low carbon investments are likely to be different than conventional energy investments in the following ways:

  • Lower risk and lower reward (i.e., from infrastructure investments)
  • Less commodity volatility (i.e., no oligarchies for sunshine or wind)
  • Fewer geopolitical risks (i.e., excluding debates around cobalt)
  • Better stakeholders relationships (e.g., environmental NGOs)
  • Better shareholders relationships (e.g., the energy sector, largely conventional energy, has produced the lowest annualized return over the last 10 years among all other S&P 500 sectors)



How does the increasing involvement of oil and gas majors create winners or losers in the clean energy sector?

The (potential) winners include:

  • Entrepreneurs who need growth capital or an exit from their venture
  • VC investors that also need an exit to deliver returns to their limited partners

The (potential) losers include:

  • Private equity and venture capital investors who need to place historic amounts of capital ($2 trillion), without a proportional increase in deal flow. Yet these financial investors can not compete for the best deals on a pure financial return basis. There are few ancillary benefits they derive from strategic benefits to other business lines.


Should you be bearish or bullish?

Bearish perspective:
Why these trends can be easily ignored


  • Return risk — If solar and wind projects have lower risk but lower returns, then investors can not make a 1:1 switch from one to the other. (Note: Conventional energy talks a “big return” game, but this version of history tells a different story.)
  • Policy risk — Renewable energy is too policy dependent. It is a roller coaster that will make some people want to yack. (Note: Lazard’s annual Levelized Cost of Electricity report shows that unsubsidized renewable energy projects outcompete most other forms of electricity on cost. See page 2.)
  • Tech risk — Cleantech venture capital investments have too much risk. (Note: While these investments between, say, 2006 and 2011 were nasty, and most all VC and early stage technology investments are risky, keep in mind that early stage investments in clean energy made up less than 3% of 2018’s $332B invested globally in these sectors.)
  • Risk premia — There is a supply vs. demand imbalance, with too much capital chasing solar and wind infrastructure. As such yields (IRRs) have fallen, while interest rates have risen. Where’s the spread, the risk premium?
  • Uh, chump change — Oil and gas majors investing 1.3% of their 2018 budgets into low carbon solutions is only a drop in the bucket, a (bad) rounding error.

Bullish perspective:
Why investors and entrepreneurs should pay more attention


  • Not just a niche for “enviros” — The low carbon sector is now a large and fast-growing market, with over 70% of new power capacity investment projected to go to solar or wind between now and 2050, and over $1.4T in annual revenue for clean power, alternative transportation, green real estate, and related sectors. (By the way, I am one of those “enviros,” trained in environmental science decades ago, so talking about trillion-dollar markets in this debate is a refreshing change of pace.)
  • Obvious reasons for greater involvement by conventional energy companies — Oil and gas majors are the world’s foremost energy experts, based on aggregate years of experience and capital committed. And their skills are largely transferable. (By the way, the same is true for electric utilities.) Moreover, investing in clean energy provides benefits for branding and relationships with stakeholder and shareholders. Finally, these alternative investments provide a hedge against changing consumer preferences (e.g., “I want an EV that costs the same to buy, but also has 50% lower operating costs), regulatory shifts (e.g., current and future carbon markets), and economics (e.g., solar and wind are often the cheapest form new power). So their role in the low carbon economy makes a lot of sense. (Note: Cannibilizing your existing business may, for some strange reason, be viewed negatively by some investors.)
  • Big sand box — There is space for everyone to play, including oil and gas investors, impact investors, VC and private equity investors, and other strategic investors. For some fun math, the UN’s Intergovernmental Panel on Climate Change estimates that $2.4T of investment is needed per year to avoid the worst impacts of climate change. But today the clean energy sector earns just over $300B per year. So, there is a lot of room for all parties to play nicely together. Actually, the real questions are these: “Where will all that money come from? And are we all doomed?”


In conclusion, here are some potential action items

I will describe these as the 3 “C’’s, with questions for you to ask yourself, answer, and do something about over the next 30 days.

(Or just hide under them rug for a while. What could possibly go wrong?)

#1 - Canary

What do these trends mean in terms of “canaries in the coal mine” for your overall investments in the conventional power, oil, and gas sectors? (Pun intended.)

If a Shell executive refers to their “buying spree” in the low carbon sector like this -- “It’s all about survival” — then how or why would your investment allocation to the conventional energy sector be different, and therefore, not face some new risks?

If McKinsey and Mining.com report that electric vehicles will likely reach cost parity with conventional vehicles in the early 2020’s, and if Fitch Ratings talks about how this shift in transportation choices could cause an “investor death spiral,” how might you view current or future investments in the oil sector?


#2 - Clock

Even if you agree that historic changes are coming to energy markets, the key question is this: When?

When do you (or sources you trust) think that these shifts in energy investments will actually affect your portfolio?

By way of analogy, at some point we may live on Mars, but now is likely not the right time to invest in Martian real estate. (Unless you’re a billionaire who thinks that all hope is lost for long-term survival on this planet.)


#3 - Collaboration

There may be winners and losers, but it is not a zero sum game.

This discussion needs a reframe. Let’s consider a newly created 21st century word: “Coopetition” — collaboration between competitors for mutually beneficial results.

For environmentally minded entrepreneurs, how can oil and gas majors be strategic partners, investors, and customers, instead of the enemy, a monolithic group to badmouth for all the world’s problems, the 800-pound gorilla that must be defeated.

For VC or private equity investors, how can oil and gas major’s investment decisions serve as an anchors to derisk your capital allocation alongside them? How can you build relationships with them for a future exit opportunities?


Finally, thank you...

A big shout out to Pitchbook, IPE Real Assets, Greenbiz, Preqin, Bloomberg New Energy Finance, Advanced Energy Economy, Greentech Media, Reuters, CDP, RW Baird, Energy Storage News, Columbia University’s Earth Institute, Oilprice.com, Bloomberg, Mining.com, McKinsey & Company, ThinkProgress, Wind Power Engineering, and Governance & Accountability Institute for their research and reporting on this topic.
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    Sent about twice per month, these 3-minute digests include bullets on:
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    ​Dr. Chris Wedding is an investment professional, entrepreneur, and award-winning professor focused on investment, innovation, and strategy in clean energy, green real estate, and corporate sustainability. He has over 20 years of experience in private equity, startups, renewable energy, green building, cleantech, and education. Full bio here...

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