Mayfair or Old Kent Road   – what is your biogas project actually worth ?

Although there is a whole sub-genre of the accountancy industry dedicated to it, a dark secret amongst us accountants is that valuing anything is perhaps not as scientific as it may be perceived. Any valuation of an asset is in essence saying that somehow I as your accountant know what an unknown buyer will pay at some future point to acquire your asset. We all know that in reality this prediction is an estimate at best. But the world needs valuations for many purposes including banking, insurance and mergers/acquisition to mention a few. So a lot of accountants and financial advisors get paid a lot of money trying to see into the future. To move the needle away from art and towards science, three distinct methods have evolved. In the following 1,330 words we discuss how these methods relate to biogas assets and how you can improve your valuation nearer to what we may now cheerfully call the ‘Shell’ end of the spectrum.

Firstly, there is the good old classic discounted cash flow (DCF) method. You take the net cash generated by your asset over, say, the next 25 years and discount it back at a rate reflecting the inherent risk of the project and sector. This gives you the enterprise value of the asset. To subsequently find the equity value you deduct outstanding financing from the enterprise value. It sounds simple because it is, in theory, although as with many things more complicated in practice. For a longer discussion around the complexity of the calculations, see our previous blog  “the-price-is-right-how-much-is-your-renewable-energy-project-really-worth”.

The main question between different renewable energy sectors is which discount rate to use, and these tend to be around 9% – 10% for operational biogas projects. I am guessing Shell used a much lower DCF rate, for reasons best known to themselves.

There is an emerging trend to take the DCF methodology to its logical extreme and ascribe specific discount rates to development projects at different stages: 12% if you have got planning, 15% for a lease, etc. I personally think this is a bit silly. It leads to absurd situations in which, for example, an option from a farmer to build a big biogas plant in his muddy field without planning or a grid connection has a value of millions. Good luck trying to found a buyer for that.

A second valuation methodology is based on multiples of current EBITDA. Here, the current EBITDA of the plant is multiplied by an agreed figure. This gives you the Enterprise value. For biogas projects, the multiplication factor has recently hovered around 10 – 12, though again for Shell it was seemingly much higher. Valuation based on EBITDA multiples is tempting, because it’s much easier and quicker. The obvious problem with this method is that it ignores the impact of future events. This is good news if you read the Daily Mail and think things are invariably always going to get worse. It is bad news and destructive of value if you think things may, just may, get better. In the biogas world, we expect gate fee revenues and certificate prices to go up. These are positive developments that would not be captured by a valuation based on EBITDA multiples, but could be by a DCF.

Finally, there is the much cruder method of valuation based on a multiple of MW of installed generation capacity. For biogas this is currently around GBP 8m –10m, but varies enormously depending on the age of the plant, any legacy support schemes still in place, feedstock costs, etc. We have seen a range of GBP 2m – GBP 12m per MW on actual deals recently. I’m sure that despite the disparity, both parties would claim their value per MW is representative of the market, so this method doesn’t help us much.

What matters to a seller is how to get another Shell type valuation. To our mind, this comes down to 3 concepts: certainty, clarity and conservatism.

Certainty is probably the key way to achieving value in biogas. Always bear in mind that your buyer doesn’t know as much about your plant as you do and so is understandably wary and suspicious. Biogas plants are much more complex than wind or solar. Any participation in this sector puts your typical infrastructure fund buyer way outside their comfort zone of buying operational solar or wind assets.  You will derive the best price by giving your skittish buyers as much certainty as possible. You should have long term contracts for feedstock and digestate, a solid maintenance contract, a clean technical report and ideally a fixed price for the green gas certificates. The more certainty you can offer, the higher the price you will achieve. It’s not rocket science, but somehow this simple concept eludes lots of sellers. We see business cases built on the chaos of verbal feedstock contracts seemingly agreed late at night in a pub, ad hoc and underpriced maintenance arrangements, and 100% merchant revenue streams. You probably wouldn’t buy a dog from these people, let alone a multi-million pound biogas plant. For this reason alone, such sellers will not achieve Shell-type prices for their assets.

After the dog you didn’t buy, your second best friend is clarity. By the time they get your glossy information memorandum, our buyer has probably seen lots of complicated plants. They carried out lots of comprehensive due diligence and then experienced lots of crushing disappointment when things are not as they first appeared. You need to reassure them that your business has the transparency of a crystal clear Mediterranean sea on a July morning. They must be confident that there are no alarms, no surprises, nothing lurking in the weeds that will emerge and come up and bite them six months after completion. If you are aware of something ‘unfortunate’, be upfront about it. Buyers are much more forgiving of openness than opaqueness.

Finally, you need to be realistically conservative about future events. Again, our nervous and now  increasingly weary buyer has probably seen a lot of very optimistic power curves, plants that seemingly last forever with no significant maintenance spend in the financial model and certificate prices that reach GBP 200 per MWh within 10 years. They no longer believe these things. Your job is to reassure them that every assumption you are making is sensible and rooted in a rich nourishing soil of independent verification. Ideally you will be providing weighty densely written technical reports on how well your plant is performing and how much you have set aside to keep it that way, market studies of the abundance of feedstock that is within 50 miles of your plant and nice sensible revenue curves that show a gentle incline over time rather than something challenging out of the mountains stage of the Tour de France. 

In conclusion, we don’t know what your plant is worth, because we haven’t seen it. We do know these assets typically trade at circa 9% DCF or maybe 10 – 12 x EBITDA. We also know that Shell paid an awful lot more, and since that giddy peak, other portfolios have sold for an awful lot less. As with all valuation, it is a question of each case on its merits or lack of. That said, we do know that if you follow the 3 tenets of certainty, clarity and conservatism, you’re more likely to be at the Shell end of the spectrum. If you don’t you’re probably stuck with an unsellable dog.