Description

INVESTMENT THESIS

This stock has a high probability of being a multi bagger and long term compounder.  This Company has the following attributes, that make it an attractive investment:

·         Leading market position in an industry with blue sky growth prospects

·         Solidly profitable with high margins and free cash flow generation

·         Fully funded to execute business plan and access to investment grade debt capital

·         Demand for its offerings far exceeds the Company’s or the industry’s production capacity, for the foreseeable future

·         Predictable cash flows with clear line of sight to increase them from existing pipeline by 10X and potentially more than 20X based on realistic upside drivers, over 5 years

·         Ability to re-deploy capital at very high ROI

·         Long term durability of cash flow with no Amazon or outsourcing risk

·         Potential to get irrationally high valuation, based on unparalleled environmental bona fides

·         Proven sponsor and management team with a track record of value creation and substantial skin the game  

·         Reasonable valuation leaving the potential to be a long-term compounder for many years

OVERVIEW

Rice Acquisition Corp (the “Company”) is a SPAC formed by the Rice family (the “Sponsor”) and has agreed to simultaneously acquire Aria Energy and Archea Energy to create the industry’s leading and most comprehensive renewable natural gas (“RNG”) platforms and developer. The deal is expected to close in the 3rd quarter of this year. The transactions combine both an existing operating asset base with the deepest development pipeline in the industry. The sources and uses based on $10 stock price, at the time of transaction announcement, are as follows:

Archea is majority owned by the Sponsor and 100% of its equity is rolled into the transaction. Also, in addition to the $20MM invested in the SPAC IPO, the Sponsor has invested an additional $20MM in the PIPE. The Rice family provided a 30X return to original investors in Rice Energy over 10 years and believes the payout here would be substantially higher, in a shorter period of time. The Aria shareholders, backed by Ares management, are rolling 40% of their equity consideration and will be returning a portion of their consideration as cash to their LPs who had invested in Aria through their 2007 and 2010 vintage fund.

INDUSTRY DYNAMICS

RNG comes from the reuse of gas emissions from naturally decomposing waste in landfills, agricultural waste, wastewater and food waste. This biogas can be processed onsite to remove impurities and then used to generate green electricity. If further processed to remove CO2, increase purity and methane content to reach pipeline specifications for natural gas, it is then referred to as RNG. Because it is chemically identical to natural gas, RNG is a drop-in green substitute for anyone using fossil fuels. Once connected to a pipeline, RNG can be sold anywhere in North America. Beyond power generation and thermal uses, it can be used for transportation fuel in CNG and LNG forms. It can be used as a green feedstock for industrial uses, like methanol, or ammonia production. It can also be used to create green hydrogen.

For landfill gas (“LFG”), emissions and gases are produced for 20 to 30 years after waste is placed in landfills. Waste is growing across the country in a variety of forms, as more waste is generated, more gas is generated, in contrast to every other feedstock out there. Even when a landfill stops accepting waste, the gas rate will gradually increase for 10 to 15 years, and then follow a predictably shallow decline thereafter. RNG is a certain source of renewable energy because landfill gas follows a predictable methanogenic production curve. Icing on the cake is here is no cost to this feedstock; compensation to the landfill owner are royalties on revenues generated.

DEMAND DRIVERS

The demand for RNG is strong and growing exponentially. This goes beyond the Renewable Fuel Standard and environmental credits. It’s the essential product for major energy utilities that are responding to long term regulations and sustainability goals. Why are these customers willing to pay 5-10X the price of natural gas for a fuel that is identical to natural gas? Because, RNG is the best choice for immediate decarbonization. Given the pipeline infrastructure in the US and the natural shift that has been occurring over the last 20 years from complex hydrocarbons to cleaner natural gas, RNG fits in today’s energy pipeline infrastructure, thereby lowering transportation costs, emissions and providing deliverability to every US city. You do not need a new form of energy creation to use RNG. It is a cost effective, commercial and available substitute today versus installing new equipment, retrofitting plants or trying unproven technologies. Utilities have spent billions on pipeline systems that move fossil fuels. They have internal mandates to demonstrate to their customers and stakeholders that they can tell a story of sustainability. There are also regulatory pressures, requiring utilities to offer RNG to their customers. FortisBC for example is required to have 15% RNG by 2030 by regulatory mandate.

Demand for RNG from corporate customers is rapidly increasing as well. Many companies have pledged to their stakeholders to operate more sustainably. They are using solar and wind PPAs for electricity, and now looking to their natural gas consumption for base load and transportation emissions, which is difficult to substitute for. For example, Amazon is meeting its transportation fuel load sustainability target with RNG going forward and can use that RNG for heating their distribution centers.

RNG is currently only 0.15% of the total natural gas supply today, providing a blue-sky growth scenario. Current demand volumes needed from customers are significantly higher than the current RNG market supply. The Company has more indicated demand in the form of long-term contracts than its 2025 volume projections.

ENVIRONMENTAL BENEFITS

Capturing all emissions from landfills alone has enormous environmental benefits. The impact of capturing emissions from all landfills in the United States is environmentally equivalent to electrifying 75% of all passenger cars in the United States. RNG in vehicles reduces emissions by over 80%. RNG is one of the lowest Carbon Intensity (“CI”) transportation fuels in the world, with more than 50% lower CI than diesel. RNG also does more than just reduce GHG emissions. RNG projects also improve local air quality, reducing key air pollutants like NOx, Sox, particulate matter, and BOCs like hydrogen sulfide by over 90%.  

BUSINESS OVERVIEW

The company has a nationwide footprint serving a wide variety of customers. The assets are virtually irreplaceable, representing high flow landfills with predictable feedstock growth under long term development agreements.

This business has highly predictable economic growth. EBITDA is expected to grow from $40 million in 2020 to nearly $400 million by 2025, a 10x increase by executing on its development project backlog. 95% of the estimated EBITDA contribution is from assets the company has already secured today through gas rights agreements and are in some form of development today.

This low-risk development pipeline includes 13 conversion projects. These conversion projects currently use landfill gas to generate electricity. They already have gas development agreements, site leases, zoning, air permits and much of the critical infrastructure that is needed for RNG projects. These projects will require $250Mm of capex, generate an expected $110 MM of EBITDA giving a 2.3X build multiple. Archaea brings 16 new RNG projects that are secured under gas rights agreements or are very close to being secured. These development projects will require $305MM of capex, generate an expected $163 MM of EBITDA giving a 1.9X build multiple.

BUSINESS MODEL

Once these assets are developed, they are expected to produce for 20 to 30 years with essentially no decline and minimal maintenance capital requirements. In fact, volumes and cash flow will typically increase over time as more waste is brought to the landfill. US landfill waste is expected to grow by 60% from 2020 to 2050, generating 44% more LFG from existing landfills. Post 2050, there is a predictable methanogenesis profile for 20-30 years, giving 40-60 years of feedstock visibility.

The Company is securing long term contracts to match the tenor of its long-life assets. It plans to lock in 60 to 70% of its production volumes under 10 to 20 year, fixed price contracts with customers that are investment grade organizations. This gives long term security to those cash flows. The Company has more indicated demand in the form of long-term contracts than its 2025 volume projections. These long-term fixed price offtake contracts are struck at $15 per mmbtu. Securing such contracts enables the Company to access investment grade project financing. As an example, for its Project Assai which is midway through construction, the Company signed long term contracts with the University of California, Energir and FortisBC, for 80% of its volumes. The low-risk nature of this project from the landfill gas sources, to the RNG contracts, to the relatively de risked construction schedule, and the strength of the management team, translated to an investment grade rating at a very attractive cost of debt capital at 4% interest rate from leading investors like Barings, Nuveen and Pac Life. These and other investors are looking to invest in green, predictable cash flow, which will translate to continually improving cost of capital for the Company.

The remaining 30% to 40% of production is in the spot market subjecting that portion to the volatility of environmental attributes like RINs or California’s Low Carbon Fuel Standard (“LCFS”), but also allowing it to capture the potential upside in these variables. For these uncontracted volumes, the Company has budgeted a $1.50 RIN price and $140 per metric ton of LCFS value, which translates into $30 per mmbtu. Both assumptions are conservative and below the historical averages and far below current prices that exceed $3 for RIN’s and $200 for LCFS. At current spot prices, the Company would be realizing close to a $50 per mmbtu price. With 65% of volumes under fixed price contracts at $15 per mmbtu and the remaining exposed to RINs and LCFS, the budgeted assumptions lead to a net blended price of $20 per mmbtu. In its fixed price contracts, the Company has the option to flex more of its volumes under fixed pricing, which it may do if RIN prices materially weakened.

Operating costs are primarily made up of two components: a royalty paid to the landfill owner, which ranges between 10 and 20% of revenue, and operating expenses which include electricity to operate the gas plants and sacrificial media. These projects typically cost around $1 per mmbtu amortized over a 30-year period with minimal little maintenance capital requirements once placed into service. The Company estimates it only needs to spend around $20 million of capex each year to hold the $400 million of 2025 estimated EBITDA flat for 20 plus years. This leads to very robust free cash flow margins that can be reinvested in high ROI projects. Projects are expected to generate 10X ROI over a 30 year period and 5X PV 10 ROI.

To get to the $400 million of 2025 estimated EBITDA, the Company expects to spend approximately $200 million per year over the next three years, which drives the growth in EBITDA. This program can be funded with cash flow from operations and cash on hand pro forma for this transaction. The Company estimates its leverage peaks at around two times net debt to run rate EBITDA. The forecast assumes very limited development beyond the existing asset base, but it is more likely that the Company will continue to sign up projects and continue EBITDA growth in the future.

COMPETITIVE POSITION

With such robust economics, the logical question is why won’t the ROI’s be driven down in the future and landfill owners take a larger share of the economics? Currently, it is not happening because it’s a very fragmented industry and no one has the credibility or scale that the Company offers. The biggest concern that landfill operators have is whether the project will be built on time and operate at high utilization. The Company is unparalleled in providing that comfort, evidenced by its development backlog. Its team includes leading technical experts, who have built nearly all of the landfill gas to RNG plants in the industry today. Both Aria and Archea bring a complementary set of capabilities, allowing the combined Company to become a powerhouse in the RNG space. Aria is a market leader in the North American LFG sector, having developed or constructed more than 50 projects over the last 25 years and has approximately 100 highly trained plant operators across the U.S., with a strong safety and environmental track record. Archea llc was founded in 2018 by landfill owners and RNG technologists with the goal of building a cost-efficient solution for generating high-BTU RNG projects in the U.S. Archaea llc’s development strategy and industry-leading gas separation expertise enables it to capture and convert LFG emissions with lower development costs. Its team helped design, build, or develop key gas processing systems for the majority of U.S. RNG facilities in operation today. RNG production is fragmented. There are many one-off projects with uncertain success. The Company has scale, the proven ability to perform, and substantial flowing volumes to meet the needs of its current partners. Going forward, Archea believes it will remain the partner of choice as it lowers development costs by 40%, reduces construction timeline by 50% and meaningfully enhances the revenue stream by reducing its CI score, initiatives where the Company believes it has significant lead over any existing or new entrant. With only 13% of US LFG converted to RNG and RNG demand far outstripping current or expected supply, material margin compression is not anticipated. The Company is FCF positive, it is net cash positive on its balance sheet, has access to an undrawn credit facility, it’s a proven issuer of investment grade project finance debt and will most likely generate another $200MM plus proceeds from the warrant exercise. This strong balance sheet positions it well in the industry to capture and accelerate its opportunity set.

UPSIDE

There are a number of initiatives that the Company has identified, but not in its projections, that have the potential to raise the Company’s long-term EBITDA from the budgeted $400M in 2025 to over a billion dollars:

Development Opportunities:  The Company has identified over 25 high probability development opportunities that it believes it can sign over the next few months. These projects will require $600 MM of capex, generate an expected $250 MM of EBITDA giving a 2.4X build multiple.  There is also significant unexploited opportunity within the landfill industry. Currently, only 13% of landfill gas volumes are converted into RNG. The remaining gas is either converted into electricity or it is flared, or it is vented to the atmosphere, and there is significant value being wasted. And many of these are owned and operated by single plant operators that do not have the capital or knowhow to produce RNG and are ripe for partnership opportunities with the Company, especially due to its strong liquidity and balance sheet post transaction.

Lowering CI Scores: The Company plans to lower its CI score and thereby meaningfully enhance the economics of its operations as a result of generating more LCFS credits. First, it plans to fully sequester the CO2 from its projects (landfill gas is 35% CO2 by volume) taking the CI score to zero or carbon neutral. Carbon capture generates $50/ton of value for CO2 sequestered. Second, by adding things like onsite solar for power generation, the CI score can go negative, further improving the realized price. These initiatives would make the Company’s RNG CI score the lowest of all fuel types. Also, by co-locating CO2 sequestration at its projects, the Company unlocks new revenue streams and further expands the market by making smaller flow sites or sites further away from pipelines much more compelling. Qualifying projects generate the 45Q tax credit, which is $35 to $50 per ton of CO2 equivalent or an additional $1 to $5 per mmbtu uplift.

Each 10 point reduction in CI score translates to $1 to $2 per mmbtu improvement. For a 30 point reduction in CI, in in line with Company expectation, there is an additional $3 to $6 per mmbtu of LCFS credit uplift. Other states like WA, NY, CO, NM are also pushing for LCFS adoption. Onsite solar would add to these values. This is roughly $7 plus per mmbtu of upside not currently in projections.

Green Hydrogen: The Company believes it can achieve higher revenues by producing green hydrogen. These increased revenues are expected to be under long term investment contracts, like the RNG contracts. The company believes it can accomplish this with limited technology risk, using the industry standard processing technology, steam-methane reforming with water-gas shift reaction. The Company believes it can develop green hydrogen projects from RNG at a cost of $1.65 per kilogram through proven technology, which is well below the long-term targets of green hydrogen produced through electrolysis. By using RNG as an input and doing geological CO2 sequestration, it will create a negative CI score green hydrogen and industry leading levelized cost of production. The Company believes the opportunity to achieve $40 per mmbtu effective pricing under long term contracts is currently available with LCFS upside. The Company is evaluating the potential of adding hydrogen development to two of its RNG development projects in California, that would start in 2023.

Reduce Development Costs: The Company believes it can lower RNG development costs by 40% by 2022 without radical changes to gas processing technology. Most of the anticipated reductions come from deploying a manufacturing approach to RNG development. For example, optimizing small, medium, large, extra-large standard designs, creating cold weather and warm weather options, etc. This pre-engineering and standardization, lowers costs but also lowers the likelihood of mistakes and allows for much faster development. For example, the Archaea version one plant approach allows to build projects in less than 24 months versus the industry standard 48 months. Plan is to bring the construction timeline to under 18 months. The Company also plans to optimize Aria’s existing producing RNG projects. With a $10 million capital investment, the company believes it can generate an additional $20 million of EBITDA from these opportunities.

Environmental Credits: There is $150 million of revenue upside in 2025 using current RIN pricing, assuming two thirds long term fixed price, one third highest and best use, which currently are RINs and LCFS.

VALUATION

The Company’s stock rose over 50% on the day post transaction announcement in April and has hovered around those levels since. The company is currently trading at 4.5X 2025 EBITDA. Its only pure comp is Montauk (MNTK), a South African based RNG producer with facilities in the US which is listed in January 2021 on Nasdaq. It is thinly traded and on the one analyst estimate I found, trades at 10X 2025 EBITDA. The Company has much superior growth profile and operating metrics than Montauk, but at that valuation, it’ll be worth 2X what it is currently and 4X at mid-single digit FCF yield. If the upside scenario of $1 billion of EBITDA is achieved, the valuation is 6X the current price at a 10X. Hydrogen Fuel companies and other green disrupters trade at stratospheric multiples, and would be the uber upside scenario, if the Company catches the fancy of the ESG crowd.

RISKS

-          Execution – Construction delays, cost overruns, slower ramp up, etc

-          RIN and LCFS price volatility

-          Unfavorable renewable fuel policies  

Catalyst

- Merger Completion

- Execution