Eco Investor June 2011

Emerging Companies

Energy Developments - Going All The Way With Private Equity

Risman Cornelius, Investment Analyst
Andy Gracey, Portfolio Manager
Australian Ethical Investment

The announcement on 12 May 2011 of a raft of ini- tiatives in the US marked a pivotal moment for Energy Developments Limited (ASX: ENE). We believe they will crystallize the latent value in the US landfill gas business for shareholders over the next three years.

On completion, Energy Developments’ US landfill gas operations will expand by 33 per cent to 94 MW. The business will also benefit from the re-pricing in 2012 of power purchase agreements for some 56 MW of landfill gas generation capacity. We believe the new electricity prices will be up to 40 per cent higher than current contracted prices. ENE has also been installing gas conditioning equipment that increases power gen- eration.

Significantly these expansion projects qualify for the US Investment Tax Credit under the 2009 American Recovery and Reinvestment Act, which reimburses 30 per cent of the capital costs on completion.

The upshot of these initiatives is that US EBITDA is expected to increase from about $2.5 million currently to over $20 million in three years time.

Let's use the EV/EBITDA multiple Pacific Equity Partners (PEP) paid in February 2010 for 79.6 per cent of the business as the yardstick with which to assess this significant valuation uplift. Applying the 6.4x EV/EBITDA multiple accrues another $77 million to equity shareholders, or approximately $0.49 per share, or 19 per cent of the current share price.

In addition, it may be possible to increase ca- pacity by a further 12 MW while utilizing exist- ing landfill gas resources in the US. ENE's hire of Steve Cowman to lead the US business demonstrates it is serious about develop- ing in this region.

While we expect FY11 to be a year of investment in operational capability to support a long term growth strategy, and a relatively flat EBITDA, these invest- ments should begin to bear fruit in FY12 and beyond.

On the domestic front, we expect any carbon price will result in ENE's waste coal mine methane assets transitioning to the renewable energy regime (Renew- able Energy (Electricity) Act), ensuring these impor- tant abatement activities receive the appropriate regulatory support.

One remaining regulatory risk for ENE pertains to the value of the inventory of NGAC certificates created under the NSW GGAS scheme. As at 31 December 2010, the company had $17.4 million held for sale on the balance sheet. Since the GGAS scheme is expected to close on commencement of a federal carbon pricing regime, there is a clear rationale supporting compensa- tion for this inventory in our view.

Strong operating cash flow at around $80 million per annum means net debt should continue to fall, not withstanding the aforementioned capital expenditures. It's difficult to find a cleantech business with utility style cash flows, expected EBITDA and earnings per share growth and a compelling valuation. We believe Energy Developments has these attributes!

Finally, the first anniversary of Pacific Equity Part- ner's control of Energy Developments Limited oc- curred on 17th February 2011, freeing up PEP to make a follow on offer should it want to [1]. If proposed options packages for managing director Greg Pritchard and senior management pay off at $4.12 and $6.87 respectively, minority shareholders will have achieved private equity style returns without having to pay performance fees [2].

1. On 8 January 2010, Greenspark (PEP) announced it had no intention of making a follow-on takeover offer once the offer closed, but reserved the right to revisit this position after the expiration of 12 months following the close of the offer on 17th February 2010.

2. The company is however, paying "management fees" of $50K per month to PEP for additional services to support growth.

Disclosure: The Australian Ethical Smaller Compa- nies Trust holds 3.669 million shares in Energy Devel- opments Limited.





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