Background: I’m exploring an idea called Evergrow, and wrote up a list of 30 questions relating to the idea. A full list of Evergrow-related posts is here. Answers to questions 24-26 are below.
Q24: Financial model: Produce a financial model for the business, taking into account the above. Is the math too good to be true? What is the model sensitive to? Under what theory does this business “work” from a financial perspective?
I’ve made a basic financial model for Evergrow that I can share on request. Like any model, it’s only as good as its inputs and assumptions. Here is what stands out to me:
- Sensitive to CCO production: The model is most sensitive to the number of CCOs generated per hectare of land and the price of CCOs. If we generate at least 40-50 CCOs per ha per year at $15/CCO or higher, the business does very well. This is good news because we have a high degree of control over the number of CCOs generated per ha per year, given that we can choose what trees to plant and where to plant them.
- Trade-off between land costs & CCOs: One surprising thing about this is the trade-off between optimizing for land costs vs optimizing for carbon sequestration. Coming into this, I had assumed we would optimize for the cheapest land to acquire and develop. I now think it’s worth paying for more expensive land to produce more sequestration; this is true both financially and for the mission of the company.
- Most costs are up-front & fixed: As expected, costs in Y1 are 4-5X higher than in the other years due to land acquisition and land development. After that, most costs are fixed: land administration and G&A. This is good: within a given plot of land, the company produces CCOs with no marginal costs, and all future CCO price appreciation drops to the bottom line. It also means that we have a strong incentive to lower the costs of land maintenance because every dollar saved here also drops straight to the bottom line.
- J-curve determined by time to produce CCOs: The company’s cash flow has a J-curve because of the frontloaded cost profile. The length of the curve is determined by how quickly the company begins to produce a significant number of CCOs. This is another variable we have some control over because the time to producing CCOs is largely related to the speed at which trees grow and begin sequestering carbon.
- Capital stack reminds me of real estate: The capital stack for Evergrow is starting to remind me of real estate development. Similar to real estate development, we’re buying land, developing it, and generating cash flow over time from that fixed asset. I’m therefore hopeful that we can finance Evergrow using debt financing, similar to real estate. This makes the return on equity very compelling.
- Best case: Lots of CCOs/ha; short lag between planting and CCO production; majority debt financing; cheap land.
- Worst case: Low CCOs/ha; long lag between planting and CCO production; majority equity financing; expensive land.
Next steps to firm up the financial model:
- Identify which species of trees to plant; from there, identify where they grow the quickest and begin identifying potential plots of land to acquire and develop.
- Based on the above, tighten up the projections and assumptions around CCO production/ha, time to commence CCO production, and cost to develop the land. Ideally, do this together with the forestry companies or partners who would be working with us.
- Speak with potential lenders and bankers to look at equity/debt financing options and debt funding ratios.
Q25: How does one start this? What is the smallest scale that this concept could be tested? What is the smallest scale necessary to take this kind of company public and listed on a major exchange? What are the major risks to the plan, and the milestones to get there? What KPIs would be most relevant for the business to measure and optimize?
The first step is to create a pipeline of Evergrow projects, consisting of:
- Specific plots of land with price ranges negotiated with the owners;
- Forestry plans for each plot, with tree species, growth rates, projected carbon sequestration rates, and costs to develop the land; and
- A set of necessary partners and vendors (e.g., foresters) who are ready to work on the plots we have identified, at known prices.
The idea is to make each project as turnkey as possible prior to raising financing, so as to de-risk the equation for potential investors. Per earlier questions, having ~100,000 ha under management would make us one of the largest offset developers in California and go a long way toward plugging the projected offset shortfall over the next decade. Ideally, our pipeline is at least this large.
In theory, each individual project could be very small. Ultimately, the minimum viable project size comes down to how much of land development and other costs are fixed vs variable. I suspect many of these costs are somewhat fixed – e.g., the costs of rolling truck to a location are the same whether that location is small or large, and the costs of obtaining CCO certification and verification tend also to be mostly fixed regardless of project size. I’m aware of a $5M for-profit reforestation project in Northern California run by RenewWest, which feels surprisingly small (and seems like it’s a proof-of-concept).
But focusing on the project size alone misses the point. I don’t think we need to prove that reforestation can happen. Instead, we’re trying to prove that reforestation can be an investable asset class for institutional capital. So what we really need to show is that we can generate solid returns for investors on a non-trivial asset base. What is “non-trivial” in this context? I think if Evergrow is a publicly-traded REIT listed on a major exchange, we will have proven the point. There are many REITs in the $250-750M market cap range, and WY is valued at ~15X EBITDA + NAV of timber assets minus debt. Therefore, if Evergrow were doing $30M of EBITDA with $200M of land and timber assets and $150M of debt, we would have a $500M market cap (($30M * 15) + $200M – $150M = $500M) and a 6% dividend yield. At that point, we could use our equity to fund new acquisitions and developments of 3rd-party reforestation projects and become the buyer and long-term owner of choice in the space.
Between now and then, I think the 3 phases for Evergrow are:
- Develop pipeline
- Raise initial financing and develop first project
- Reach minimum scale necessary for public listing
In phase 1, the biggest risk is that the pipeline simply doesn’t exist – i.e., there is no land suitable and available for Evergrow. Phase 2 is the riskiest because we need our first project to be successful in order to inspire confidence in future projects. The risks we assume at Phase 2 are largely the project-level risks discussed here, but worse because we are 100% concentrated in one project. Phase 3 is about replicating the model, and the company overall becomes less risky as it grows, because a problem in one plot of land is unlikely to affect another. Along the way, I think the most important KPIs to track relate to (a) the marginal cost of creating new forests, and (b) the fixed costs of managing land. This is our core business and 100% within our control. If we can acquire, create, and manage forests efficiently, then our core is strong.
Q26: Initial financing: What are the upfront capital costs, within an order of magnitude (i.e. $1Ms, $10Ms, $100Ms?). How do these change over time (e.g., are there economies of scale, can we remove marginal costs, etc?)
For Phase 1, costs are low; call it < $1M in seed capital to develop the initial pipeline. For Phase 2, I estimate we need $10-20M in equity capital, depending on the size of the initial project, and 3-4X that in debt. For example, at $2,500/ha, $50M in combined debt and equity finances a 20,000 ha project, which is sizeable. For Phase 3, I estimate we need to have raised and invested roughly $100M-$150M in equity (cumulative with Phase 2), which when combined with a similar amount of debt should be enough to finance and develop ~100,000 ha and achieve the size necessary to go public.
I think the variable costs of land acquisition and planting are difficult to change over time because most of the cost there is either (a) the FMV of the land itself, and (b) the costs of physically planting trees. At the company-wide level, there are definitely economies of scale which I’ve previously written about (e.g., ability to self-insure the timber if you have a large and geographically dispersed portfolio). I also think that one of the benefits of being publicly traded will be our ability to use equity as a liquid, non-cash currency to finance the variable costs of new projects.
I’m most bullish on the potential of using software to lower the costs of managing a large timber portfolio and the company itself. I’ve previously written about some of those ideas here. As discussed above, because these are fixed costs that represent almost all the company’s expenses on an ongoing basis, any dollar saved here is an additional dollar of EBITDA.