Download - 1st IAEA Workshop on Fusion Enterprises · Why can’t these efforts be funded by venture capital? The VC model has proven itself to be ill-suited for capital-intensive technology

A portfolio approach to funding and commercialization

June 13-15, 2018

Managing Director, Energy Options NetworkManaging Director, Lucid Strategy

1st IAEA Workshop on Fusion Enterprises

Eric Ingersoll,

Energy Options Network

Challenges to Investing in Transformative Technologies

A New Financing Concept

De-risking Strategies

Policy Support

1

Contents


Final product fails to work as expected

Delays in the development and/or commercialization process

Unexpected costs/ interrupted funding

Market changes

Competition

Pace and extent of adoption

2

Challenges to investing in breakthrough technologies

There are number of risks inherent to investing in early-stage energy technologies


• VC is often considered to be the only source of early-stage funding for innovative energy technology

• Not capitalized enough, nor allows for investments that require hundreds of millions of dollars or a >5-year development/ commercialization pathway

• In light of past failures, VCs are now targeting “capital lite” downstream business models and IT/web-based businesses that scale quickly relative to investment

• Large, multinational energy strategics have also largely been unwilling to take on the inherent risks associated with building, large FOAK power generation technology

Why can’t these efforts be funded by venture capital?

The VC model has proven itself to be ill-suited for capital-intensive technology development that requires long development timelines

3

Boom and bust” VC cleantechinvesting (2004 – 2014)

Source: Gaddy et al. (201) Venture Capital and Cleantech: The Wrong Model of Clean Energy Innovation


Capital markets are serving traditional technologies with traditional funding mechanisms

Investments in many transformative technologies do not fit within the traditional suite of asset classes available to investment managers

(e.g., VC, fixed income, project finance, etc.)

4

Financial markets are serving a subset of technologies and projects where investment profiles align with technology maturity and traditional financing mechanisms

It is essential to find new ways of allowing large commercial financiers to comfortably participate in funding breakthrough technologies and projects

Technology is commercially

available

Capital Required

Typical Commercial Financiers

High impact technology

not being served

Requires non-commercial

financing

Transformative technologies

outside traditional funding mechanisms


Strategic Investors

Risk

Venture Capital



• Government does not have enough funding or the right funding model• Nearly all support is for deployment of existing technologies

• Funding decisions inevitably become political

• Lack dedicated capital and highly risk averse investors

• Uninterested/unwilling to “pick winners” or fund entire development path for capital intensive technologies

• R&D programs often provide only piecemeal funding

• National and international policies have not created the proper signals for investors to invest in higher risk/ higher-impact climate-solution technologies• Binding but completely unenforceable international agreements

• Waiting for enforceable and sufficiently aggressive climate policies is a very risky strategy

• No indication that China, India, or ROW will transition toward a low-carbon economy at the expense of economic growth

Governments and policymakers have been ineffective in advancing / funding innovation at the required pace

With few exceptions, government and policy makers have failed to dedicate the resources or enact policies to spur the innovation leaps necessary to

dramatically improve our CO2-free energy options

5


Governments do not want to perform the same role as the private sector

Governments only fund a small portion of innovative projects outside the “comfort zone” of more traditional investors

6

Government budgets are significantly limited.

2012 – 2017:

Cumulative ARPA-E budget $1.7B

Total cleantech venture funding: ~$4.5B

All private capital investment in cleantech: ~$18.3B


available

Capital Required


High impact technology

not being served


financing


outside traditional funding mechanisms


Strategic Investors

Risk

ARPA

-E

Venture Capital


Gov’t supported pre-commercial demos; loan guarantees; etc,

Energy Options Network 7

Vast amounts of capital are looking for climate-based investments

The Green Infrastructure Investment Coalition (GIIC) whose members manage $43 trillion in assets, signed statements about the importance of acting quickly on climate change, saying they “stand ready to invest in climate solutions.”

The insurance industry, which manages approximately $33T in assets, doubled its climate investments from 2014-2015 and committed to a 10x increase by 2020 (equating to ~$450B)

Multinational Development Banks and large investment banks have committed hundreds of billions of dollars over the next 10 years for climate-based investments

Institutional investors are calling for strong political leadership and more ambitious policies in order to scale up their climate-based investments.

Clean Energy Investment Commitments by 2025

$150B$125B$100B

Clean Energy Investment Commitments by 2020

$30B+$29B $110B


Exponential growth in green bondsGreen bonds are one of the most effective options for tapping into institutional

capital and meeting the growing demand for “green” investments

*** Source: Climate Bonds Initiative (2015).

Moody’s predicts $250B of green bonds will be issued globally in 2018 – a 78% increase since 2016

A vast majority of green bond holders have indicated that they intend to deploy more capital into this type of instrument as quality deal flow continues.**

The Climate Bonds Initiative believes that with the right supports in place, $1T of green bonds could be issued a year by 2020***

** Source: JP Morgan, “Impact Investing: The Performance Realities.” Nov. 2015

* Source: Bloomberg,.” Blossoming green-bond market growing toward $250 billion year.” Mar. 2018

Source: Climate Bonds Initiatives (2018)

2018 (est.)

$250 B

The labelled green bond market is growing

rapidly

55% CA

GR

$155.5 B

$83 B

$41.8 B$36.6 B

$10 B~$1.5 B



available

Capital Required

Lawrenceville Plasma Physics


financing


Strategic

Investors

Ris

k


Investing across a portfolio reduces

the uncertainty/risk exposure by

investing in individual companies

Investment horizons can be tailored

to suit the development expectations

and capital requirements of the

portfolio projects

Enables investment in technologies

not currently being served by capital

markets due to a misalignment of

technology maturity and traditional

financing mechanisms

A properly structured investment fund could accelerate technology development generate highly attractive returns


outside traditional funding

mechanisms

Investing in a portfolio of early-stage technologies and applying various risk

allocation strategies can enable investment in otherwise “too-risky” (and,

oftentimes, too costly) endeavors

Venture

Capital

AR

PA

-E

Gov’t supported pre-commercial demos, loan guarantees, etc.

New area ofinvestment


Existing Challenges to Investing in Transformative Technologies



Policy Support

10

Contents


Offers the potential for attractive, risk-adjusted returns

Provides access to opportunities outside the traditional VC/private equity deal-flow universe

Reduces the risks that would be associated with structuring these investments as traditional venture capital deals

Enables investment in “home run” deals without the risk to principal typically associated with these types of investment

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A new investment approach

A new type of investment structure could enable investment in a suite of early-stage companies with “home run” potential


Megafunds enable the ability to invest in across a portfolio of otherwise too-risky (and, oftentimes, too-costly) endeavors.

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A Fusion “Megafund”

A “megafund” is simply a large, diversified portfolio of companies or products with un-correlated development risk

Combines many risky projects into a single financial entity

Designed to access debt market capital

Investment horizons can be tailored to suit the development horizons of the portfolio projects

Financing can be structured to allow for more “patient” capital by specifying longer maturities

Prof. Andrew Lo Roger M. Stein

Jose-Maria Fernandez

Authors of the Cancer Megafund Paper


Hypothetical “Megafund” Example: Cancer Drug Development

Assumptions• Drug Development Cost = $200M• Probability of Success = 5%• Present Value if successful = $12.3B

Scenario A: $200M Invest in 1 drug development program

Very LowVery few rational

investors would invest

(1)

(150)

Source: Fagnan et al. “Can Financial Engineering Cure Cancer?” American Economic Review 103, no. 3 (May 2013): 406–411.

Very HighInvestment is attractive and could be structured

to access the global bond markets

Investment Attractiveness

Number of “Shots on goal”Scenario

Scenario B: $30B Invest in 150 drug development programs

(150 x $200M = $30B)

Return Probability

• Probability of no return: 95%• Probability of 1 Success ($12.3B): 5%

• Probability of 1 success ($12.3B): 99.95%• Probability of 2 successes ($24.6B): 99.59%

• Probability of 3 successes ($36.9B): 98.18%

[n!/k!(n-k)!] * p^k * (1-p)^(n-k)n = # of projectsK = # of successful projectsP = success probability of each projects

MathematicalFormula


Drug development vs. Energy technology

Drug Development Transformative Energy Technology

Market Correlation Un-correlated (different diseases)

Correlated (all electricity)

Market Size Large Very Large

Project-Level Capital Requirements Hundreds of Millions Single-digit Billions

Probability of Single Project Success Very Low Medium

Opportunities for Early Revenue (spinout

technology/ products)Relatively Limited Moderate


Each of the fund investments has the potential to become a dominant player in the global energy marketplace. In addition, they have the capacity to produce lucrative spin-out companies with nearer-term revenue. One success is enough to pay for the entire fund.

The fund incrementally allocates project capital and iteratively assesses progress to determine whether a project receives follow-on funding

The fund leverages the benefits of:

Enhanced Diversification – Fund invests in a portfolio of diverse technologies with high transformative capacity

Spin-out Company Value – Each company is developing either primary or secondary technologies that have

multiple applications in non-energy markets

Company/ Technology Synergies – Companies are individually developing technologies (or components therein)

that can enable the success of other portfolio companies

Uses portfolio company exits to pay back fund investors

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Characteristics of a fund structure

Specifically designed to reduce the probability of loss of principal, enable earlier cash flows, increase returns, and improve overall expected value





Policy Support

16

Contents


The success probability of individual projects drive how many projects are needed to make the fund successful

The Benefits of Portfolio Investing: A Basic Example

How many projects would you need for 99% probability of at least 1 succeeding?

• If each project has a 90% success probability… you

need 2 projects.

If there are 2 projects, the probability of both failing is 10% x 10% = 1%. So there is 99% probability of at least one of the two projects succeeding. You just need 2 projects to “guarantee” a success

• If each project has a 10% success probability… you

need 44 projects.

Decreasing project risk and/or increasing the number of portfolio projects can

improve the probability of the fund having successful results

Project-specific Risks * Probability of Success = # of projects necessary to yield a very

attractive expected value

10% success probability per project ->Need 44 projects to “guarantee” 1 success

90% success probability per project ->Need only 2 projects to “guarantee” 1 success


The fund reserves the ability to capitalize spin-out companies, dedicated to monetizing enabling technologies developed by portfolio companies

Improves returns by:Providing supplemental income earlier than the project’s ultimate product“Insuring” against possibility that late phases might hit technical barriers and ultimate product might not launchSaving money from not doing investment phases if earlier phases hit technical barriers

Access to larger number of markets (reduces market risk)

Allows for smaller and “more-digestible” steps in valueRequires less capital and many of the targeted markets present lower risk business propositionsSpinout companies will only be pursued if they present an “easy” opportunity to generate early revenue

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Value enhancement: Staged investing with spin-out opportunities

Many companies are developing technologies that are valuable beyond each company’s core application. It may be worthwhile to spin-out and

commercialize these technologies


Phased investments and down-selecting technologies over time

Achieving net energy

Reactor-relevant gain experiment

Plant system engineering*

Pre-commercial

demo

* Plant design work can be performed by a dedicated entity (i.e., no need to develop multiple plant designs – companies should focus on developing heat source)

Total Capital Outlay

(Capital Outlay if ALL Projects are Funded through Commercialization – i.e., no down-selection process)

8 companies

4 companies

2 companies

1 company

% of Success

While capital requirements increase with each development phase, the number of companies decreases. This causes a relatively even capital outlay over time.

Required Capital for Development Phase


Project #1

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Potential spinouts along development path

Investment Phase A

Time

Investment Phase B

Investment Phase C

Investment Phase D

Go / No-go Decision

Go / No-go Decision

Go / No-go Decision

Spin-out A

Spin-out B

Spin-out C

Project will only proceed if technology and cost performance is met at each development stage.

If supporting technologies are developed and have market value, the fund will dedicate capital to establish “spin-out” companies, whose value streams will be directed back into the fund.

Megafund


Project success can be matter of “when,” not “if”

Time and Budget

Prob

abili

ty o

f Pr

ojec

t Su

cces

s

0%

20%

40%

60%

80%

100%

Probability of Project Success as a Function of Funding and Time

Developing innovative technologies is often more expensive and time consuming than what is initially planned.

Assuming no need for additional scientific breakthroughs or solving for major uncertainties in the development path, a project is certain to succeed so long as it has enough money and time.

Allowing for additional time and/or funding (while highly undesirable) may be prudent given the expected returns

# of

Pro

ject

s

Cost per Project5%

95%50%

Probability of achieving desired IRR

Size of Project Portfolio

Potential Market Size

Proj

ect-S

pecif

ic Ca

pita

l Re

quire

men

ts

Justification for allocating “buffer” capital to sufficiently withstand budget overruns or scheduling delays

Medium

High

Low

A fund prepared for cost overruns and scheduling delays has a higher likelihood of achieving its desired returns


• Success of one portfolio project amplifies the value of other projects

• Even if one track toward critical subsystem does not succeed, other track can succeed (or if both succeed, use the easier/cheaper option)

• There are cost/risk reduction synergies across in material development, sourcing, power plant design, controls/software, simulation tools, admin overhead, etc. These are independent of fusion reactor technology.

22

Project/technology synergies and hedging effects

Both success and failure of individual projects can amplify the value of other portfolio projects


Design fund to leverage risk profiles of different investor classes

Financial commitments are based on several pre-conditions, including achieving specific milestones; Investors don’t invest until called upon

All investors are committed at the outset

23

Different sources of capital at different times

Time Milestones #1, #2 Milestones #2,

#3Milestone #5

• Early Stage Investors

• Strategic Investors

• Long-term Investors

FundingRaise #1

FundingRaise #2

FundingRaise #4

FundingRaise #5

(i.e., Commercial Demo Plant)

FundingRaise #3

Milestone #6


Benefits of tranching:

Unbundles risk and prices it more efficiently

Enables creation of investment grade bonds, granting access to wider group of prospective bond holders

Isolates junk-rated risk for investors with an appetite for a higher risk/return profile

Widely used strategy (mortgage-backed securities, CDOs, credit card debt, auto loans, etc.)

24

Segmenting risk and returns

Repackaging a pool of cash flow-generating assets into discrete tranches allows investors to invest at their desired risk/return profile

Bond Rating


Pay an insurance company to either insure or re-insure senior bond tranches 3rd party validation

Enables larger percentage of investment-grade bonds

Overcollateralization – bond issuance raises more capital than necessary

Yield spread - Establish a reserve of excess spread (i.e., the positive difference between portfolio revenue and obligations) to cover losses

Surety bonds - insurance policy provided by a rated and regulated insurance company to reimburse the bond investor for any losses incurred

25

Credit enhancement

There are many ways to improve the credit profile of the underlying bond in order to make it more attractive to the market


Reducing market uptake risk

Through a “Customer Engagement Group,” prospective customers can:

Provide input into design process to make sure the design meets their requirements

Pre-order units

Pay for geographic/market exclusivity

Obtain priority for first commercial units

Exercise options for preferred equity ownership

Increasing customer involvement/investment prior to market readiness can reduce the risk for market uptake

Establish a customer engagement group that ensures designs will meet customer requirements





Policy Support

27

Contents


Establish an “ITC” for qualifying fund investments

The fund would receive a tax credit for qualifying investments (i.e., typical, depreciable assets) and sell that tax credit on the open market. Proceeds from the tax credit sales could be used to pay the bond coupon and/or be set aside for credit enhancement purposes.

Existing support: Research and Experimentation Tax Credit (or “R&D Tax Credit”)

Claim credit against alternative minimum tax and payroll taxes

Repatriation of offshore profits

Over $2T in corporate profits are to be stockpiled overseas in low-tax countries. Instead of taxing those profits (the reason why companies are not reinvesting that capital in the U.S.), companies should be able to invest that capital into the fund. The companies can receive tax-free returns from the investment until they reach the amount of the original investment, after which, returns are tax at the appropriate rate.

28

Potential policy support

Policies aligned with the government’s goals of technology innovation can benefit investors considering fund participation


Appendix

29


Bond structure similar to Collateralized Fund Obligations

The structure of a megafund bond issuance is not entirely novel and has many similarities to Collateralized Fund Obligations (CFOs)

Collateralized Fund Obligation Megafund Bonds

• A structured security based on cash flows from a diversified portfolio of private equity investments

√(Future cash flows from a diversified portfolio of

transformative energy technology projects)

• Cash flows are tranched and delivered to investors via SPV √

• Rating agencies ; many structural protections put in place (e.g. larger equity tranches, collateral quality tests, minimum net worth tests etc.) √

• Higher yields relative to “standard” bonds with the same rating (as a result of the difficulty/ uncertainty in the rating process) √

• Alternative investment opportunity for investors with otherwise restricted access √

• Often incorporates a number of credit enhancement techniques (e.g., overcollaterization, diversity in company maturity, etc.) √

• Characterized by two primary structuring challenges:1. Unpredictable in timing and scale of cash flow 2. Issuer to make capital contributions to the Investment from time to time

when called

√(Initially capitalizes selected projects and provides

follow-on funding as needed/ approved)