A yawning gap between the supply and demand for renewable energy has prompted a growing number of buyout shops to pour money into the sector.
Electricity production from renewable sources tripled between 2003 and 2006, including a 50 percent increase between 2005 and 2006, according to the U.S. Department of Energy. Among the reasons are growing concern about climate change and a fear of overdependence on imported fossil fuels. But while production is way up, not nearly enough renewable energy flows through the grid to keep up with surging demand.
Sensing opportunity, a dozen energy-focused firms have set aside for alternative investments a healthy portion of the more than $13.5 billion they’ve raised so far in 2007. The money is earmarked primarily for growth equity and capital infusions—transactions that resemble venture capital plays except that the companies tend to be more mature than seed-stage businesses.
The energy sector’s biggest player,
Other firms also are getting in the act.
On the limited partner side,
“Clean technology is the next big thing,” said David Fann, president and CEO of PCG Asset Management. “The support for cleantech is both political and economic. There is a lot of money that’s going to go into cleantech, and we want to be at the front.”
The Not-So-Invisible Hand
To be sure, the market for alternative energy sources is still miniscule compared with commodities such as coal, natural gas and oil, and traditional sources of energy are expected to continue to dominate for the next two decades. Last year, for instance, all of the electricity generated from renewable energy sources in the United States amounted to less than 5 percent of the electricity produced by coal-fired plants alone, according to the Department of Energy. All told, renewable energy sources produced just 2.3 percent of the nation’s energy supply in 2005.
“Our view of the world is that oil and gas are here to stay for quite a while,” said Philip J. Deutch, managing director of NGP Energy Technology Partners. “When you look at the energy pie in the United States, you’re really talking about nuclear, coal, oil and gas. Renewables are a very small part of the pie, but they’re growing very rapidly.”
Indeed, demand for alternative sources of energy is surging, driven largely by state governments. They are mandating that regulated utilities fill the electricity grid with ever more power generated from alternative and renewable sources, including soybean-based fuels, geothermal energy, liquid residue from paper pulping, along with better known sources such as solar and wind power. Over the last few years, 25 states and the District of Columbia have passed laws requiring utilities to obtain as much as 30 percent of their power from renewable sources within the next 15 years.
Utilities are scrambling to find ways to meet government requirements. Wind farms can’t go in the ground fast enough. Indeed, the Department of Energy, in a recent report, noted a worldwide shortage of wind turbines and photovoltaic cells.
One reason for the slow progress has been that all energy projects, even seemingly innocuous facilities such as wind farms, generate community backlash. Lawsuits have been filed in five states seeking to shut down wind-farm applications. The most notable battle has been the six-year fight to build a wind farm off the coast of Cape Cod, where U.S. Sen. Ted Kennedy has led a contingent of critics charging that the turbines would block views and threaten migratory birds. “it’s not easy building these projects,” said Mitchell Hertz, a partner and co-head of the energy practice of law firm Kirkland & Ellis.
Many renewable energy technologies such as solar cells and biofuels have been around since the 1970s, but it’s only in recent years that they have become economically viable, which also explains their relative scarcity. They have become more profitable in large part because of government incentives, said Rahman D’Argenio, vice president of First Reserve. “There have been winds of change in political sentiment,” he said.
Buyout firms investing in alternative energy tend to do so through growth equity investments. In a common scenario, a buyout firm backs a management team that’s skilled at gathering the mandatory regulatory permits and site approvals for a new wind farm, Kirkland & Ellis’s Hertz said. The firm doesn’t necessarily have to put up a lot of capital at the beginning.
“It’s a true growth equity strategy where, if you back the right team with projects in the right places, you can buy the company for cents on the dollar for what the pipeline of projects would realize if they get built,” Hertz said. “Valuation goes up for those who can actually get it done. That’s one reason why these management teams are incredibly valuable.”
In February U.S. Renewables Group teamed up with the
For its part, NGP Energy Technology Partners has, among several deals, provided early-stage funding to a coal-gasification developer and acquired a manufacturer and installer of small wind turbines.
No matter the size of the deal, this isn’t just a feel-good story about helping the earth. Because the demand curve for clean energy is so great, portfolio companies routinely generate hockey-stick sales. “Exxon can’t grow its revenues 20x per year,” NGP Energy Technology Partners’s Deutch said. “We don’t spend very much time worrying about whether a company is cleantech, renewable, green or not green. We are focused on making money for our investors, and we think energy technology is a great space to do that.”
On The Up And Up
Word about the growth potential of these companies has clearly gotten out.
Ten years ago, Deutch said, only a handful of fund managers and management teams operated in alternative energy. The puny size of the market, coupled with the unproven track records of fund managers, made it difficult to drum up interest from limited partners. A decade later, management teams are more seasoned and plentiful, and buyout shops are more willing to deploy capital to back projects.
“The market sizes are absolutely enormous,” said Danny Zouber, a principal in Piper Jaffray’s funds of funds group. “We’re talking about multi-, multi-, multibillion-dollar markets.”
The exit market is rich as well, as Goldman Sachs’s Horizon Wind deal demonstrates. Because utilities are under pressure to rely more heavily on renewable energy, they’re natural strategic buyers of facilities that actually make it through permitting and construction—in other words, after the hard work is over. “Many strategics do not want to take the early development risk, but they know they need to be in the space,” Kirkland & Ellis’s Hertz said. “Thus, they are interested in acquiring more mature companies.”
That also helps explain why buyout firms have largely shunned LBOs of fully developed companies specializing in the alternative energy sector. They simply haven’t been able to compete with strategics on price, Hertz said. Since 2000, U.S.-based financial sponsors have completed 124 control-stake deals in the energy sector, and those with disclosed values totaled $100 billion, according to Thomson Financial, publisher of Buyouts. Of those deals, just five were in the alternative-energy space, all were done in 2006, and the disclosed value of those deals was one-tenth of one percent of the total for the entire energy sector.