Foresight Environmental Fund LP Proposal for Royal Borough of Kensington & Chelsea Pension Fund Foresight Environmental Fund LP Proposal for Royal Borough of Kensington & Chelsea Pension Fund Summary The Foresight Environmental Fund is a private equity fund focussed on London’s growing recycling industry and targeting compound annual growth of 20-30%. Launched in March 2011 with a cornerstone commitment of £35 million by the European Investment Bank (from the London Green Fund), the Fund’s institutional supporters also include the London Pension Fund Authority and East Riding Pension Fund. The Fund has been reviewed by Hymans Robertson. This memorandum sets out the basis for a potential £10 million commitment by the Royal Borough of Kensington & Chelsea Pension Fund. The proposal is summarised on pages 1-3, with separate sections giving more detail on the investment pipeline, fundraising status and management team experience. Investment Strategy The Fund will provide development capital to support companies that operate waste-to-energy and recycling facilities in the Greater London area. The Fund’s portfolio will be diversified across a variety of waste feedstocks, process technologies and output markets, in order to target high returns without the risk inherent in relying on any single waste source, process or market. The Fund will invest at the construction stage and will not normally take planning risk. The Fund will position its portfolio for acquisition by large waste management groups and secondary funds, with the aim of returning capital and profits to investors between the 4th and 8th years of the Fund’s life. Fund Management The Fund is managed by Foresight Group LLP, an English limited liability partnership owned by its investment staff and authorised by the FSA. Foresight is a long-established private equity investor with a 26-year track record and over £300 million of assets under management. Foresight’s first institutional fund returned £4 for every £1 of investor commitments, executing 28 investments and managing the portfolio to exit over an average holding period of around five years. Foresight’s first venture capital trust achieved a higher total return than any other venture capital trust. Since its establishment, the firm has delivered an average cash multiple of 2.8x cost across more than 50 exited investments. Foresight identified the waste sector opportunity in 2006 and made its first investment in the sector in 2007. Since then it has invested £60 million in 10 companies involved in various sub-sectors of the recycling industry. The Fund investment team of 8 professionals combines operational management expertise from a range of process industries and board level experience in waste management and recycling businesses. Page 1 of 6 Market Opportunity The waste management sector in the UK is Catching up with Europe undergoing a transformation, designed to end 100% reliance on landfill in favour of alternative means of disposal including recycling and 80% energy generation. The shift is mandated by EU directives, which require the UK to boost 60% recycling and energy recovery from waste closer to the levels achieved by countries such 40% as Germany. The Confederation of British Industry has estimated that 300 landfills will 20% close over the next decade, meaning that approximately 2,000 new waste management 0% in waste 2009ofmunicipal % facilities will be required by 2020. UK Germany Landfill Energy Recycling London recycles less of its municipal waste than any other English region. The cancellation of £1.5 billion of PFI (Private Finance Initiative) credits for waste infrastructure projects in London has delayed progress against targets. These conditions provide the Fund with an opportunity to take a significant market share in the region, positioning the Fund’s portfolio as a strategic acquisition target for large waste management companies. The supply of capital for investment in recycling is currently weak, due to the banking crisis and the lack of private equity investors with the necessary expertise. As a result, Foresight believes that it can secure attractive terms for investment by the Fund. Legislative Drivers Powerful UK and European Union legislative drivers Landfill Tax per Tonne are driving growth in the recycling industry. Foremost £80 among these measures is the landfill tax. Landfill tax rates have climbed from £16 to £56 per tonne in 5 years, and are set to increase by a further £8 per £60 tonne each April, reaching £80 in 2014. The effect of the increase in landfill tax rates is that £40 recycling facilities offering an alternative means of waste disposal are now in high demand. £20 The Environmental Services Association is anticipating a capital expenditure of between £10-20 billion to finance new infrastructure for recovering £0 materials and energy over the next 10 years. 2005 2008 2011 2014 Page 2 of 6 Financial Profile The Fund aims to deliver a return on investment of 2-3x the amount subscribed by investors. This equates to an IRR of 20-30% based on the expected cashflow profile. (IRR means the effective annual interest rate delivered by the cashflows of the fund. It is stated after all fund costs.) Foresight expects to draw down investors’ commitments over a 3-4 year period and to distribute capital and profits over the following 3-6 years. The investment period ends formally on 31st December 2015 (4.5 years). The fund life is 10 years with up to 2 1-year extensions subject to investor approval. The investor Years cashflows shown in the chart are illustrative and are not a forecast. Foresight has modelled the Fund performance under various scenarios, designed to reflect the key areas of risk. The analysis shows a range of outcomes, with IRRs of 16%-29% and cash-on-cash multiples of 1.8-2.5. These figures are stated net to investors. Within this range, the base case produces a 23% IRR and a cash-on-cash multiple of 2.2. Terms Foresight is entitled to an annual management fee of 2% of the Fund, reduced by 80% of any fees received by Foresight in relation to Fund investments. The performance incentive is a 20% share of net profits, payable after investors have achieved a distributed compound annual return of 8% on their drawndown capital. Establishment costs charged to the Fund are capped at £400,000 (0.4% of the maximum fund size). Governance The Fund is an English limited partnership. All decisions of the Fund Manager in relation to the Fund will be made by the investment committee. The investment committee comprises Bernard Fairman (chairman), Matt Taylor, Andrew Page, Nigel Aitchison and David Hughes. Foresight has appointed Ernie Richardson as an additional non-executive member to the investment committee. The investment committee reaches its decisions by majority vote on the basis of written submissions prepared by members of Foresight’s investment team. The Fund’s Advisory Committee comprises up to five representatives of Limited Partners. The Advisory Committee will be consulted by Foresight on general policies, any proposed evolution of the investment strategy, any key-man changes and any conflicts of interest. Decisions of the Advisory Committee will be taken by vote of a majority or by written consent. Page 3 of 6 Section 2: Investment Pipeline Foresight’s active pipeline has increased over the last 6 months from £200 million (total project funding required) to £290 million. In particular, the formal launch of the Fund in April combined with origination activity by the Foresight team stimulated engagement with TEG, Thames Water and SITA. Foresight expects to make commitments to investments totalling £24 million in the Fund’s first year of operation (ending March 2012). The list of priority projects is shown below, followed by a brief description of each opportunity. Project Commitment Equity funding (£m): date Total Fund Closed Loop plastic recycling Dec-11 12 7 TEG anaerobic digestion Sep-11 11 7 Thames Water anaerobic digestion Mar-12 5 5 Careys biomass combined heat and power Dec-11 10 5 Total year 1 investments 38 24 Co-investment: The difference between total equity funding and likely commitment from the Fund in the table above represents co-investment from other sources. Foresight manages £150 million in a range of listed investment vehicles (Venture Capital Trusts), some of which can invest alongside the Fund. A co-investment agreement is in place, giving the Fund a priority allocation in relevant investments. Foresight is also working with independent private equity firms that have an appetite for the sector. These include Novus Modus (venture arm of the Irish utility ESB), Ludgate and Albion Ventures, each of which has already made 1-2 comparable investments. The government-supported Business Growth Fund launched in April 2011 represents a further potential source of co-investment, and a number of project sponsors also have resources for co-investment. Closed Loop Recycling is the UK market leader in recycling waste plastic bottles for re-use in food- contact packaging. The investment supports expansion of the company’s existing plant in Dagenham, and the construction of a specialised plastics sorting facility. The company has contracts with, among others, Veolia, Biffa, Marks & Spencer and Britvic, and recently attracted a senior industry figure as chairman. Project location is Dagenham. TEG: the project comprises construction and operation of an in-vessel composting and anaerobic digestion facility fuelled by food waste. TEG is a successful project developer using proven technology to replicate its existing plant in Perth, Scotland. Planning has been submitted and 40% of the 50,000 tonnes of feedstock required already secured, from various sources including North London Waste Authority. Project location is Dagenham. Thames Water owns and operates a number of anaerobic digesters (AD) for the treatment of sewage sludge.