Category: Investment

The first 40 days of 2020

So there is no doubt that the year 2020 has so far, delivered more turbulence than ever before, out-of-control fires, followed by ravaging floods, temperatures above 20 degrees Celsius in Antarctica, droughts, Brexit, the Corona virus, China’s economy and supply chain stalling, retailers closing down, airlines and tourism sectors down, international students from China kept out costing the Australian economy billions, and it has only been 47 days into 2020!

I remember reading Nassim Taleb’s Black Swan years ago where he talked about a ‘black swan’ event as a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight.

We don’t know when a ‘black swan’ event will occur next, but we do have to have the foresight to visualise and model a number of future scenarios to be better prepared for change. More importantly, we have to have the ability to predict situations that are not strictly a ‘black swan’ but with rigour can be somewhat expressed in terms of probability.

But I’m getting off track, though this is a fascinating theme. This article is more about being alert, open to change, and being prepared, operating knowingly in an increasing turbulent environment.

So, what is turbulence?

Turbulence could be described as unpredictable uncertainty that is often as a result of unknown unknowns and rapidly changing environments where there is a lack of clarity into the future.

The elements that contribute to turbulence are therefore ambiguity, complexity, paradox, discontinuity, in turn, creating or leading to surprise, uncertainty, but also opportunity. According to Dr. Colin Benjamin the definition of turbulence is “the experience of something totally unsettling that you cannot predict”.

There is no argument that the world is becoming more and more turbulent, and it will be our capacity to deal with turbulence that will determine success and longevity in business. More importantly, it will be our capacity to deal with complexity and recognise patterns and breaks in those patterns that will lead to innovation and opportunities in the future.

So when investing in a business, look into multiple scenarios, look at the team and their capacity to deal with complexity and uncertainty, look at the way each individual handles turbulence and how the sectors you’re investing in will be impacted in the next 50 years.

Remember, if your answer to our questions is along the lines of “for the foreseeable future…” you had better rethink!

This is a teaser to begin our thinking, and we will follow with a number of articles on this fascinating subject.

A significant business opportunity

So what makes a good opportunity?

In this short article, we expand on the opportunity and the process of selecting good investments.

Opportunities land on our desk all the time, time is precious, We cannot be “All to Everyone”, and more importantly, if we choose to invest our time and resources into an opportunity with mediocre returns, we  forego other, more lucrative opportunities, something we term as “opportunity cost”.

So how we assess opportunities makes a significant difference to a) time management (and pile of papers on my desk ) b) my quality of work  c) reducing opportunity cost and d) maximising opportunity rewards.

So what’s the answer?

Follow a quick screening, reductionist principle, do not try to fit a square peg in a round hole, and don’t be everything to everyone. Stick to your mandate, profile and investment philosophy.

The ‘reductionist’ principle is nothing more than a flow chart of decision making, pivoting each answer through a “go or no go”  decision matrix. A “no go” answer and the business plan goes to the “round” file (no exceptions).

The screening part is the qualitative part of the process, and for us it is based on a number of venture screening methodologies and our own research and the ensuing years of assessing business plans and ventures. The questions asked are critical, and the way the answer is derived is just as important as the answer itself.

The screening aims to answer a number of main issues, namely:

  1. Does the venture or opportunity create value to the customer?
  • If so, how? Does the venture or opportunity solve a significant problem faced by customers? Is the customer willing to pay a premium for that solution?
  • What are the market characteristics like? Is the market robust, creating high (and durable) margin and moneymaking opportunities? Is the market growth worthwhile (>20%), does the venture exhibit strong, recurring revenue generated from a low asset base? Therefore does the venture have the capacity to return attractive returns for investors?
  • What does the team look like? Have they done it before? Is there a good fit between the founders, managers and potential investors?

The quick screen seeks to identify details on the market and margins, the range of competitive advantages, the value creation and harvest issues and the overall potential, to determine whether it is worthwhile to embark into a deeper analysis of the opportunity.

Assuming the venture proposal passes my quick screen, it’s time to roll up  sleeves and really take a long hard look at the opportunity. It is here where we have the opportunity to ‘tweak’ a venture proposal for added value or identify a ‘fatal flaw’ to avoid sunk costs in a venture. From here on, the screening is a collaborative effort with the founders, managers, stakeholders to determine the best approach to investors.

The screening at this stage is on the basis of answering well over 300 questions aimed at looking at a number of criterion which include:

  1. Opportunity
  2. Market and Product
  3. Need
  4. Economics
  5. Model
  6. Harvest
  7. Value Creation
  8. Sustainable Competitive Advantages
  9. Competition
  10. IP
  11. Team
  12. Alliances
  13. Fatal Flaws
  14. Assumptions
  15. Implementation
  16. Decision Making
  17. Risk and Mitigation
  18. Scenarios

At the end of the process, we have the privilege of placing the opportunity into one of a number of categories:  is it  a cash cow? Part of a Fad or fashion? Is it a hobby? Is it buying the ‘entrepreneur’ a job or is it creating real value?

Is the venture chasing the real opportunity or is it investing a ‘better mousetrap’? Is it led by innovative entrepreneurs or by technology led technocrats?

Quite often a business plan is rewritten based on any new information and insight uncovered. At worst, a bad opportunity is avoided or a good opportunity is identified or ‘tweaked’ and a well written plan is confirmed to be investor ready. At best, investors will be convinced to part with their cash and back your venture.

Project Finance

When it comes to Project Finance, if you need the cash yesterday, please do not apply. Project Finance is precise and onerous and requires months of work and planning. It is not the cheapest form of finance, but it does provide for ‘greenfield’ solutions, based on projected cashflows. Moreover, Project Finance has some additional benefits for the company, which include:

  • Allows the company to ‘ring-fence’ the project and not affect its balance sheet or borrowing power.
  • Lending of funds is based on a stream of cashflows generated by proposed project assets. In a sense therefore, it is also considered to be a limited recourse funding, not exposing the company’s assets outside the project.
  • It provides a structure for ‘sharing’ risk and may involve several joint venture partners, particularly useful in cross border situations which could provide an opportunity for double or even triple dipping structures and tax advantages across jurisdictions.
  • A Project Finance approach allows for the careful management and control where a consortium is involved in a multi-discipline project. It provides for structure, discipline and project management processes which allow for the coordination of various participants.

The top five sectors (in order) preferred by financiers in this discipline are:

  • Power
  • Infrastructure
  • Public Private Partnerships
  • Mining
  • Oil and Gas

Other emerging sectors  include Large Scale Manufacturing, Renewable Energy, and Leisure based  sectors such as theme parks, resorts and casinos.

However, any sector can benefit from taking a similar approach to funding, and imposing the rigour of project finance internally. Considering the inputs, risks and modelling sensitivities not only provides great insight for the management, but addresses concerns and provides comfort to investors and financiers in a way which goes beyond the usual best case scenario and worst case scenario approach most managers take.

In any type of Project Financing there are a number of risks (anything from 15 to 20) which need to be carefully considered. Part of the due diligence involved is to identify each risk, rank them in order of potential impact to the bottom line, and address where possible through mitigating strategies. I emphasize “where possible” because there are some risks that you just simply accept as part of the course, in which case you merely identify and assess how the risk is allocated (who carries that risk). So what are some of the risks we look at?

POLITICAL   TECHNOLOGY ENVIRONMENTAL
COMPLETION   SUPPLY RISK SOCIAL
SPONSOR   RESERVE (inputs) LEGAL
OPERATING   MARKET TAX
INFRASTRUCTURE   FINANCIAL FORCE MAJEURE

If you have a project and do not consider each risk, then you run the risk of a credit committee rejecting the project (if lucky), and you will find an uphill battle in trying to obtain funding. At worst though, if funding for the project is generated internally or through third party equity, an oversight of any of the risk factors mentioned, potentially places the project and equity at an unacceptable level risk.

This type of financing takes time to negotiate, and for smaller sized projects, structured alternative strategies may be the best approach in order to save time. A stepped approach, could allow a project to begin to take shape, fund bankable feasibility studies and provide a ‘bridging’ function, while the company negotiates longer term project finance. As project finance requires an equity component as well, creating a form of guarantee on behalf of the sponsors to provide an additional level of comfort to the lender, but without tying up huge sums of cash for the sponsor (developer) should be considered.

Cheng Cheng Capital

On the 21st of September 2019 the Aulisone team visited the beautiful city of Huichang. On this day, we had the privilege of entering into a Memorandum of Understanding (“MoU“) with Cheng Cheng Capital (“CHCH“). The MoU covers a high level of cooperation within China and Global projects and investment. 

The main points of the agreement centres on facilitating technology transfer and promotion of innovation, research and education across a number of industry sectors which support local companies create employment and be kinder to the environment. In doing so, the parties will also promote international investment and cooperation and focus on One Belt Road opportunities.

This overall intent of this agreement is to create a win-win, co-investment collaboration partnership within China and outside of China on high growth emergent opportunities which will become relevant to the future economies in a rapidly changing world.

CHCH own the Cheng Cheng High-tech Equity Investment Fund Management Co., Ltd. and Cheng Cheng Smart City Investment Fund Management (Beijing) Co., Ltd, and are registered as private equity fund managers. CHCH invest and rely on the support of local governments and relevant departments to jointly initiate and set up government guidance funds to effectively promote the healthy, rapid and sustained growth of the invested enterprises, and strive to create a win-win effect of the government, enterprises and capital.

Huichang

We spent the weekend in a city with a population of about 520,000 to meet Chairman of Cheng Cheng Capital (“CHCH“), Mr. Cao Qingwei. where they have several investments, a lovely place, beautiful and peaceful Huichang. 

Huichang county is located in the southeast of Ganzhou city, Jiangxi province, bordering Wuping and Changting to the southeast, Xunwu to the south, Anyuan to the southwest, Yudu to the northwest and Ruijin to the northeast. With a length of 85 kilometres and a width of 56 kilometres, it is the key junction of Jiangxi, Fujian and Guangdong. 

Beautiful City of Huichang

We had a tour of three of their investments, in vacuum glass production, aquaculture, and hot house agriculture. The aquaculture is intense growing with the bio-waste fed into the hothouse as nutrients for the plants. The vacuum glass creates a thermal, UV and sound barrier and works to keep energy usage low.

Intensive Indoor Aquaculture
Hothouse Growing Vegetables

CHCH has a number of Funds, including the  Huichang Chengcheng Industrial Development Fund which was jointly established by CHCH and Huichang Forestry Investment Company (which is wholly-owned by the Huichang Government).

Focus of the Fund is on e-commerce platform enterprises, precision poverty alleviation projects, ecological forestry, cultural tourism, leisure pension, oil tea industry, agricultural and forestry products processing, energy conservation and environmental protection, new industries, “Internet +” and other related industries, as well as PPP projects, P2G projects and foundations Facilities construction.

Vacuum Glass (photo courtesy of CHCH)