Financing

 

A central issue with analyzing Aquaculture investments is that an investor is often presented with only one perspective on the business.  We have found that analysis needs to consider three distinct and linked plans:

  • Investment – The investment plan should be assessed by typical return on investment (ROI) or cash return on assets (CROA) type models.  Capital plans and a simplified earnings before interest tax and amortization (EBITDA) can be used as a “smell” test, if the plan can even be viable.  Terminal value calculations and exit strategies for the investor are a particular concern to aligning the right sources of capital.  “Reliable” return is a concept that might match better than traditional absolute return objectives.
  • Operations – The operation issues are best viewed from a weekly cash flow and 13-week forecast cash model.  Many day to day decisions have an impact months beyond, so the “check book” needs to be tightly managed or a financially healthy looking operation can get unhealthy quickly.  Fortunately, feed rate can be used as a comprehensive measure of system performance and can translate directly into a financial forecast.  Unfortunately, while feed rate is typically calculated at most farms, it is done poorly and inconsistently, such that a standard needs to be consistently taught and used with disciplined application, before an investor can trust the reported values.  This is not a trivial task and there are considerable technical and operating challenges to monitoring compliance, however, it is sufficiently critical that it is worth a deep understanding.
  • Marketing – Harvest, Processing, Delivery, and Branding all play an independent, yet linked, role in financial viability.  Producers without control over processing and delivery to market may not be able to align cash needs with cash generation.  Pricing may be guaranteed by a processor, which helps with establishing an investable business plan, however, their timing for deliveries may not coincide with operating cash flow.  Operating costs and seasonal hiring for harvest and processing can also have a profound effect, as most processes are very manual (even with advanced equipment), labor availability and costs can be unreliable.  Branding also provides little assurance, as verification in the seafood supply chain is still undeveloped and product mislabeling is a widely known issue.  With the exception of a few vertically integrated large corporations, most of this business is conducted on tight relationships, trust, and regionally (*with rapid product trading globally, but local delivery).

 

Investment Analysis

Aquaculture investment in the United States is uniquely challenging.  First and foremost it is a global agricultural COMMODITY and yet it is a “new” industry in most states.  This results in a high risk, low return market that is unfamiliar to most financiers and is increasingly unattractive if they take time to learn more.  Returns are further tempered by competition against other forms of protein and the negligible switching costs if prices rise too far in any commodity.  Even considering this competition, between the higher dietary protein sources (beef, poultry, pork), seafood faces additional competition between species (salmon/catfish/tilapia/etc) and sourcing (farmed/wild) that those other “industrialized” commodities do not face.

 

For investment analysis, we divide aquaculture production into three categories of operations, based on capitalization:

  • Small $25k-$1m – Owner/Operator, “lifestyle” farm, artisanal farming
  • Medium $1m-$20m – small business, industrialized and consistent production
  • Large $50m-$100m+ – conglomerate, global commodity suppliers

To simplify further, we will only address the Production investment for a Medium sized business, as the small and large operations will have many intangible aspects specific to a plan.  The medium sized plan will be the most risky to execute, so understanding it closely will improve returns to the small and large operations.  In all three types of plans, operators often have tangential investment in marketing, processing, direct sales, but the most important aspect is to maintain profitable production of fish; the other aspects enhance and secure return, IF there is reliable production of fish at its core.

 

This analysis for a Medium sized investment will be applicable to various species and to various mass production systems (flow-thru, nets, RAS).  Salmonids have been selected, as it is one of the few species to have data available for all three types of production methods and at all three scales of investment.  Our emphasis has also been on RAS, but with adjustments to various parameters, this model can be applied to flow thru and net systems.  We have focused on Rainbow Trout for Michigan, but the model has been evaluated for Atlantic and Coho Salmon as well.

 

Capital Uses

Three categories of Capital need to be planned and guidelines for evaluating each category:

1)    Initial Capital Expenditure

  1. Planning, Permit, PR to establish farm (1-2yr)
  2. Asset Acquisition – land, building/improvements (wells), aquaculture equipment
  3. Start up loss – plan for 2 years of loss, reserve for a 3rd year of loss and hold for 5yrs

2)    Operating Capital

  1. Develop EBITDA/Cash Flow model to understand seasonal working capital needs
  2. Plan economic targets based on feeding annualized 80% of the maximum feed rate designed or permitted for the farm.  This becomes the “normal” operating test for achieving a target return

3)    Growth Capital

  1. Begin expansion planning after at least 3 years of positive cash flow (stable to normal plan) and no more than 5 years after achieving normal operations.
  2. Reserve 30% of expansion capital for major repair/replace original equipment.  Nets only 10%, flow-thru 20% as likely to evolve to semi-recirc or will need to purchase a new farm to expand
  3. Expansion must begin producing by Year 10 to cover replacement investment while maintaining EBITDA levels.
  4. Possible slow payback in years 10-12, as EBITDA is level and expansion value hasn’t kicked in yet

 

Capital Sources

With the three forms of Capital Uses understood, typical return modeling approaches can be applied, targeting a 15 year horizon.  Most assets will likely have a 20 year life, but after the one growth investment stage has been executed, the operation will likely be out of the “Medium” category and will begin to appear more as a conglomerate; with associated merger, acquisition, and vertical integration strategies playing more of a role in continued growth.  Return model should be effective on production plan alone and local incentives/tax structures/etc. should be treated more as enhancements on an already attractive investment model.

 

Critical to the return model is to evaluate the various capital sources and to evaluate their effectiveness at servicing the expected capital uses:

Angel – friends and family

Venture – 5-7 yr horizon, doesn’t have enough upside potential on direct fish production; more likely for unique, patentable equipment innovations

Private Equity (PE) –rollup/conglomerate strategy with IPO

Asset Backed Loan (ABL) – typical bank financing, capital loaned as a percentage of the underlying assets

Mezzanine

Demand Dividend

Revenue Royalty

Debt

 


 

Investment Conclusion

Small operations are likely to be a combination of Angel and ABL, with owner investing his savings as equity and an agriculture bank providing an ABL that they have guaranteed through Farm Services Agency (FSA) at 90% of the value, up to $1.3m.  If the bank will count fish in the water as inventory (typical in fish growing regions, but not in new regions), the ABL will be sufficient to cover working capital needs.  Michigan banks do not count fish as inventory, so the ABL is insufficient for capital needs and equity must be utilized for seasonal working capital – target minimum equity at 100% of ABL.

 

Medium operations are too big for angels, but not well aligned with venture, PE, or typical mezzanine debt structures to contribute equity – primarily due to lack of exit, high risk on ability to pay on time, low return relative to risk.  Banks will be limited on providing greater than $1.3m in ABL coverage, until a sufficient operating record has been obtained in the region.  Thus for medium sized operations, the majority of capital, in all three stages, will need to come from an alternative mezzanine structure.  Modest size and high complexity reduce desirability for investing in due diligence.  Consider University of Santa Clara “Demand Dividend” structure:  http://www.scu.edu/socialbenefit/impact-capital/upload/Demand-Dividend-Description.pdf

 

Large operations have shown room to execute worldwide consolidation and vertical integration strategies.  Within a $100b, 9%CAGR industrial sector, there is sufficient growth and lack of concentration that consolidation strategies have an attractive future.  This activity is primarily outside of the United States, but the US capital markets are pursuing Initial Public Offerings of sufficiently large operations.  Private Equity is actively playing a role and is exiting to other PE, industry players, and in public offerings.  There is still a limited supply of operations in the large range, but there is demand in the capital markets to bring these deals to life.  With global growth rates, this should be an increasingly attractive source of equity for large operations.

 

Medium operations should target entering the Large market by their 15th year or they will likely be milked for cash flow for another 5-10 years until the assets are retired.  Small operations can stay small as the artisanal owner/operator functions, however, transfer and valuation of the operation is likely only valued at the underlying land value, as the business value is generally related only to the owner’s level of sweat equity.  Sales of small operations have not created much value for the owners, but can sometimes be the foundation of a plan to become a medium enterprise.  The goal of the medium operation must be to grow into a large operation or else equity will not be retained in the business beyond 20 years.