Ethanol: private equity's next big thing or just a pipe dream?
Michael Baratoff
Issue date: 12/4/06 Section: The Tide
For all of us who have taken at least one finance class beyond the core, we have learned about the business characteristics that make good leveraged buyout candidates: 1) leading position in a established market; 2) stable and predictable cash flows to pay down debt; 3) strong management team; and 4) limited capital expenditure requirements, to name a few. However, one of the latest trends in private equity is investing in ethanol manufacturing companies, a sector outside the realm of traditional private equity and curiously lacking a few of these essential characteristics. According to New Energy Finance information service, private equity investment in biofuels (not just ethanol) topped $1 billion in 2005, up from negligible amounts just two years ago.
Traditionally, ethanol investing was relegated to the domain of venture capitalists, beginning at the turn of the century as the technology became commercialized. The risk associated with investing in these types of emerging market sectors is in alignment with the venture capitalists' ("VC's") risk tolerance - VC's focus on emerging technologies and a significant number of portfolio companies are expected to fail or generate minimal returns as result. However, such failure rates are not consistent with the expectations and needs of private equity ("PE") firms. A complete loss of an investment would likely materially diminish an entire buyout fund's return. The question is: why are private equity firms interested in the additional risk associated with ethanol investments and not sticking with traditional buyout sectors?
There are many possible answers to these questions. For one, there is no technology risk associated with ethanol production; it is only reliant on manufacturing. Second, and more importantly, the Energy Act of 2005 stimulated demand for the fuel by requiring refiners to ramp up ethanol use from 2.5 billion gallons last year to 7.5 billion gallons by 2012. In addition, a 51-cent tax credit is paid to blenders of the fuel for every pure gallon blended with gasoline and a 54-cent tariff exists on imported ethanol to keep cheaper foreign producers out of the market. Furthermore, MBTE (the traditional fuel additive for oxygenating gasoline that makes gasoline burn cleaner), did not receive liability protection in the 2005 energy bill from groundwater contamination lawsuits. As a result, ethanol has become a popular gasoline additive given its limited environmental liability.
Traditionally, ethanol investing was relegated to the domain of venture capitalists, beginning at the turn of the century as the technology became commercialized. The risk associated with investing in these types of emerging market sectors is in alignment with the venture capitalists' ("VC's") risk tolerance - VC's focus on emerging technologies and a significant number of portfolio companies are expected to fail or generate minimal returns as result. However, such failure rates are not consistent with the expectations and needs of private equity ("PE") firms. A complete loss of an investment would likely materially diminish an entire buyout fund's return. The question is: why are private equity firms interested in the additional risk associated with ethanol investments and not sticking with traditional buyout sectors?
There are many possible answers to these questions. For one, there is no technology risk associated with ethanol production; it is only reliant on manufacturing. Second, and more importantly, the Energy Act of 2005 stimulated demand for the fuel by requiring refiners to ramp up ethanol use from 2.5 billion gallons last year to 7.5 billion gallons by 2012. In addition, a 51-cent tax credit is paid to blenders of the fuel for every pure gallon blended with gasoline and a 54-cent tariff exists on imported ethanol to keep cheaper foreign producers out of the market. Furthermore, MBTE (the traditional fuel additive for oxygenating gasoline that makes gasoline burn cleaner), did not receive liability protection in the 2005 energy bill from groundwater contamination lawsuits. As a result, ethanol has become a popular gasoline additive given its limited environmental liability.
Viewing Comments 1 - 2 of 2
ashb
posted 7/30/07 @ 6:04 PM EST
It's economic need meets future practicality. For all of us who have taken at least one economics class, we have learned about the business characteristics that make good leveraged buyout candidates: 1) leading position in a established market; theodoros plakadopoulos 2) stable and predictable cash flows to pay down debt; basketball tplay 3) strong management team; and 4) limited capital expenditure requirements, to name a few
suolas
posted 4/01/10 @ 2:54 PM EST
A think this new storie have some mistakes.
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