Description

Velcan Energy

Velcan is a young alternative energy company specialized in ‘green’ biomass- and hydro energy. The company is active in both Brazil and India. It is headquartered in France and led by a team of two young entrepreneurs, Antoine Decitre and Jean-Luc Rivoire, who control 24% of shares outstanding. The aim of the company is to supply energy short countries Brazil and India with green renewable energy. Velcan chose Brazil and India because in these countries biomass and hydro energy can be profitable without subsidies. This is a big difference with Europe or the US where many alternative energy sources are only feasible thanks to tax incentives.

The founders of the company have a background in IT, where they were in private equity and led several profitable start ups before selling in the beginning of this century. After this they started looking for a new venture and after reading and traveling extensively they decided that there would likely be a shortage of energy in the world and permanently higher oil prices. Decitre (co-CEO) mentioned the ASPO report which was made up of of some of the ex chief-geologists of Total, BP, Chevron, etc which were fired by their respective employers because they didn’t want to sign off on the reserve estimates of these companies because they believed the reserves to be overstated.

Decitre and Rivoire are partners in Financiere Saint-Merri and this is the vehicle which overall has 33% of the shares of Velcan Energy. The other 9% is controlled by Credit Agricole. Since both men had only IT experience and work experience at PriceWaterHouseCoopers they have hired many energy and technical people with significant experience. They can attract these people because they mostly worked at large companies where they couldn’t focus on the technical aspect of business anymore but were required to manage people and with Velcan Energy they can do what they like. Since Velcan Energy has hired many local people in Brazil and India with significant experience this also helps getting government approvals.

Currently the company has a staff of 180 and growing.

Velcan Energy came to the market at €8 per share and traded up to €29 when it raised some more capital after its main shareholders suggested they needed more capital to facilitate its growth. So in May 2005 Velcan Energy was able to raise another €50 million. In the fall of 2007 the company raised money again at €38 and €42 per share. It is now fully funded and has over €120 million on the bank, close to half of the current market cap. It has about 8 million shares outstanding, fully diluted.

Looking at Velcan’s current stock price of €32 we can see that it has about €15.5 in cash. Of course we have to take into consideration that this cash will be spent to finance projects so we should expect this cash to decline, but on the other hand this cash should generate significant returns for investors if Velcan Energy succeeds in its business plan.

We think the business plan is very convincing. Velcan Energy is led by two young, highly motivated, entrepreneurs who remain the largest shareholders and Decitre has been buying more shares in late summer 2006 between 19 and 22 EUR per share. Decitre last bought shares at the time of the lastest money raising at €42. Decitre also said they like to run the business like a family business and don’t have any options just normal shares in the company. He added that initially they wouldn’t have planned to raise capital in the market but stay a private company, but the opportunity was big and they needed to tap the capital markets.

Velcan Energy is currently listed on the French OTC market but will switch to Alternext in 2009. It would have liked to list on Euronext immediately but Euronext authorities have asked the company to list on Alternext first since it likes companies to have a three year history before they list on Euronext’s main exchange. Much to the frustration of management, and with offers by London and Dubai to list the stock, it will follow this procedure.

The Business

Velcan Energy is essentially split up in 3 different business units:

-India

-Brazil

-Carbon Credit trading

Velcan Energy’s focus is on biomass and hydro. In the beginning it looked at wind energy as well but quickly decided this was too dependent on government subsidies and if these were to fall away one day they would be out of business. So they looked for renewable energy which could be profitable without subsidies. They also wanted low cost producing countries and found the right characteristics in both Brazil and India. Brazil and India both have a large agricultural market and there is an abundance of biomass capacity. Hydro depends on the weather and amount of rain but both countries have reasonably attractive weather patterns (mix rain/dry).

At its IPO the company had originally planned to operate in France as well but quickly abandoned these plans and now solely focuses on Brazil and India.

The last business unit is the trading of carbon credits which was put into place after the signing of the Kyoto protocol which stipulates that green energy that is produced in developing countries generates carbon credits which can be sold to polluters like Europe, Canada and Japan.

Important to note is that Velcan Energy doesn’t need this carbon credit trading to be profitable but nevertheless it is a nice bonus to have and will help to payback the investment faster and allow the company to build more plants with the same amount of equity. Interesting to know is that since the beginning of 2008 the company has received its first million Euro due to carbon credits.

One important part of the business plan was to build small energy producing plants outside of the main centers of Brazil and India. Since there is already large competition to build plants close to the large city centers Velcan Energy instead focuses on generating energy for the other parts of the country where not many people want to go.

India

As of April 1^st Velcan energy operates 2 electrical power plant and is developing another 16 projects totaling 506MW and to reach target of 1700MW in concessions 2012. (These figures are for both India & Brazil)

The electricity market in India is very interesting for a company like Velcan Energy because the power grid is so poor that you need small energy producting plants every 50km since otherwise the energy gets lost on the grid. This is why Velcan’s decentralized production of electricity from renewable energy is particularly attractive to local governments and that’s why it has a good relationship with the local ministers. Since few others seem to be interested in this niche market Velcan Energy is getting support from the municipalities. It also helps that the Indian central government is serious about renewable energy and is one of the only countries in the world with a dedicated minister for renewable energy. India has set out a plan to have at least 10% of its energy produced by renewable sources.

India’s current installed capacity is about 120.000 MW and the government projects it will have to install an additional 150.000MW just to meet demand. Overall about 650 million people are without electricity in India!

Until 2003 the electricity market in India was controlled by the government and it fixed a price for the population. Since it couldn’t keep up with demand it had to open the market to private companies and now more companies are attracted to produce energy in India and sell them in the free market. It is also interesting to note that in its business plan projections Velcan Energy expects to earn an electricity price of 3.35 Rupee per kilowatt hour (kwh) and currently prices are closer to 4.8.

Velcan Energy has calculated its Internal Rate of Return (IRR) to be 33-38%. See their own presentation or analyst reports from Merrill Lynch and Dexia for further details.

Brazil:

It opened its subsidiary and Jean Luc Rivoire has relocated to Brazil to manage the business over there. The first biomass plant is under construction and a pipeline of projects is under concession for a total of 85MW.

Brazil is the land of hydro energy as it has lots of rain at relatively predictable times. Biomass is also attractive from forest and agricultural industry. The government is projecting it needs additional capacity of 4000 MW per year and demand is expected to increase from 90000MW today to 130000 MW by 2015. The risk of shortages is high by 2010, according to Decitre. From 1990 to 2000 demand for electricity in Brazil increased by 55% versus only 25% additional capacity coming online.

In Brazil Velcan has a good relation with the government because once they are awarded a license they have the capacity to actually build a plant. Decitre said that many people are applying for permits and are simply trying to trade them afterwards for more money. The government is unhappy about this as it needs the energy and not just speculators. Decitre said this was becoming a problem in Brazil as international investors were bidding up prices. He gave the example of an existing energy plant where they were in a bidding process with some UK and US companies and they were willing to pay 6x EBITDA and eventually a UK company bought it for 16x EBITDA which to them seemed way overvalued and they couldn’t come up with a scenario how this company would ever get a reasonable return on its money.

The profitability of the Brazilian projects is a little less than the Indian projects but still high at an expected IRR of 29-30%. Decitre compared this to their original idea to build powerplants in France which would have only generated 12-15% IRR.

One big difference between India and Brazil is that the Brazilian plants they are building are larger in size and consequently more expensive to build.

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