Eco Investor June 2017

Unlisted Companies

Environmental Markets Opportunity

By Simon Turner

It's not often an investment presents itself which concurrently generates both high financial and environmental returns. Today I am writing about an investment which is focused upon ticking both of these boxes, EnviroCap (short for Environmental Capital). EnviroCap is aiming to establish a market leading position within Australia's environmental investment sector by building an institutional grade track record of generating high financial returns combined with enduring environmental returns. As such, the company will provide rare access to an innovative alternative investment class.

Who is EnviroCap?

EnviroCap is an unlisted company founded by alternative asset manager, Questra, and environmental investment managers, Ben O'Hara and Simon Turner (the author of this article). Questra, whose managing director is Bruce Scott, has a track record of providing investors with access to rare and high returning assets, whilst Ben O'Hara (QTFN) is arguably one of Australia's most forward thinkers in the environmental markets, and Simon Turner (CFA, Bluecrest) is an environmental investment specialist with a passion for achieving positive outcomes for investors whilst making a difference.

The idea behind the business was to address the significant gap most environmentally focused investors face between environmental and financial returns. The feedback EnviroCap's management kept receiving was that investors want to invest ethically in the environmental sector but don't want to sacrifice financial returns to do so. The message was clear: the investment community is ready, willing and able to invest in environmental assets if the financial returns are attractive and the business model is sound, professional and well managed.

EnviroCap's management team understood and agreed with the market's feedback. Having all worked in the financial markets for too many years to mention it seemed obvious to management that to bring serious investment into real environmental projects would require an evolution from previous ways of thinking. After much debate the team agreed that the key would be to apply normal investment management strategies and criteria within the environmental sector. This is an inverse situation to how many environmental investments have previously worked in that there have been many environmental experts running businesses with investment returns being a secondary outcome. In contrast, EnviroCap's management believe the investment return has to be highly attractive in order to support further investments in the future, and thus achieve larger and more enduring environmental returns.

What are EnviroCap's business activities?

With this background in mind, EnviroCap's management have identified two opportunities for the company to invest in at launch: Carbon Farming and Biodiversity Offsets. Both business activities are largely inaccessible for investors at present despite the highly attractive financial returns on offer if a professional business plan is implemented by an experienced management team.

How does EnviroCap's Carbon Farming business work?

EnviroCap will invest in select agricultural landholdings which contain areas of valued biodiversity, that are well suited to generating high carbon farming returns, and which qualify for Australian Carbon Credit Units (ACCUs) cash flows in accordance with the Federal Government's Emissions Reduction Fund (ERF). The company will generate financial returns by restoring cleared bushland and re-growing vegetation in order to sell ACCUs back to the Federal Government through 10 year ERF carbon abatement contracts. The great attraction of this business activity is that carbon farming cash flows are highly predictable and recurring in nature. Supplementary cash flows are intended to come from sustainable agriculture, primarily beef cattle or sheep farming.

The company will generate environmental returns by reducing pastoral grazing on its landholdings, thus allowing the native bushland to regrow. Not only will this carbon growth help absorb human carbon emissions, it will also result in a multitude of environmental benefits including improved soil quality and creating better habitats for wildlife conservation. In addition, EnviroCap's ambition is to only use sustainable agriculture methods to supplement the carbon farming income received from each property.

How does EnviroCap's Biodiversity Offsets business work?

Urban and infrastructure development often requires the clearing or disturbance of native vegetation. Where the vegetation is classified as endangered or vulnerable, or where there may be an animal species living in the vegetation that is considered endangered or vulnerable, the Government may require a developer to provide compensation for clearing the land. This compensation can either be in the form of a cash payment to the Government, or through the preservation of land containing a similar habitat or species nearby - this is known as an offset.

EnviroCap has identified an opportunity to provide developers with the required land-based offsets which will enable them to continue with their development. The company will sell the habitat rights to the developer, and the habitat will be secured through an appropriate covenant which restricts the offset land holder from clearing the vegetation in perpetuity. The company's significant opportunity in this market is to provide a specialist offering which addresses both the needs of the developer and the Government, whilst providing an enduring offset benefiting the vegetation or wildlife species being impacted (unusual in the current offsets market).

What should investors expect from EnviroCap looking forward?

First and foremost, EnviroCap is focused upon delivering attractive investment returns. The management team will be targeting a 10 year IRR of at least 15% p.a.* which should be largely distributed to shareholders in the form of fully franked dividends from year 2 onwards. The company's business model is well suited to generating high and regular dividend payments by virtue of the Federal Government's 10 year payment guarantee on properties under carbon abatement contracts through the Emissions Reduction Fund; this predictable and recurring income stream provides high earnings visibility and thus dividend payout visibility. It is worth mentioning that the company's financial returns are expected to be uncorrelated with the global economy or financial markets: the carbon farming income is recurring for 10 years, whilst the biodiversity offsets income is supported by the long term trend towards urbanisation across the country.

Secondly, investors should expect the company to generate high and enduring environmental returns through both the carbon farming and biodiversity offsets operations. Both operations will be focused upon helping to address some of Australia's most significant environmental and wildlife challenges. There will be regular communications with investors regarding these environmental gains.

And finally, investors should expect EnviroCap to grow its assets under management both through re-investment and possible fund raisings for larger strategic opportunities in the future. Management will actively seek opportunities which are in shareholders' best interests - i.e. highly earnings accretive. It is clear from the company's modelling work that as the company's assets under management increase over time so will shareholder returns, reflecting the strong operational leverage in the business. As the company increases in scale an ASX listing will be considered, possibly in the next 2-3 years. And longer term, the company may sell assets to return capital to shareholders at opportunistic times such as at the end of the 10 year ERF carbon abatement contract period.

EnviroCap is currently raising a minimum of $7 million. It is an exciting venture to be associated with and we look forward to discussing the business with interested sophisticated investors.

Contact: Simon Turner (ph: 0468 762 785, email: simon@envirocap.com.au) for an Information Memorandum.

* Disclaimer: The directors expressly disclaim the hypothetical projection as a representation about the potential future performance of the Company and investors must not use the hypothetical projection as a basis for investing in the Company.

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