First National Investment Banking (FNIB) of Nebraska offers high-caliber corporate finance and capital markets expertise to its customers. This is exactly what some might say they expect from a bank with a wealth of experience. However, FNIB sees its role as more than a traditional bank with its connotations of basic capital management. Rather, FNIB intends to offer its customers not only the essential skills and resources that an ethanol producer needs, but the breadth of knowledge and ability to propose real solutions and long-term strategies.
A look at the state of the corn market shows how important it is for a financial institution to understand the industry and to be prepared for continuous change. According to a North American Risk Management Services report released in early April, farmers plan to increase corn plantings by 12.1 million acres in 2007. This will bring the total U.S. corn acreage up to more than 90 million acres (the largest crop since 1944), an increase of 15 percent over 2006 and 2.3 million acres beyond trade expectations.
If farmers do indeed increase acreage as anticipated and Mother Nature doesn't throw them any curve balls, allowing them to successfully harvest their acres, corn prices should retreat, and ethanol producers could realize a significant savings in their feedstock costs. The question then becomes, How will this translate when the advantage is shared among small and large producers alike? Furthermore, with the state of the current build-out in the industry, what will become of smaller producers that are unable to hedge against future price increases? Will smaller producers be able to compete with larger, more established ethanol producers that have a manageable debt load and can weather financial setbacks?
Mergers and Acquisitions
On April 1, First National of Nebraska introduced FNIB, the only full-service investment bank in Nebraska, according to Clark Lauritzen, FNIB senior vice president. and general manager. FNIB is comprised of three currently existing, interrelated operating groups, which include First National Capital Markets, First National Mergers and Acquisitions, and First Capital Partners LLC (previously known as First National Mezzanine Capital).
FNIB helps ethanol producers and potential producers with several aspects of their investment strategy, Lauritzen says. "First, we help them raise capital to the extent they're interested in raising equity, mezzanine debt and senior debt," he says. "Secondly, we advise companies on transactions, which most typically are sale transactions of ethanol companies or divestitures of certain units in an ethanol company." Breaking off segments of an existing company and then leveraging those assets into capital contributes to FNIB's experience in the ethanol industry is so valuable.
In addition to working with current producers, FNIB helps clients navigate the difficulties and uncertainties involved in investing in the ethanol industry. "We advise companies on buy-side transactions, which are when we advise our client on buying something in the ethanol space," Lauritzen says.
Furthermore, FNIB's structure allows it to aid clients interested in recapitalization, management buyout and leverage buyout work, typified by an "ownership change of some sort within the capital structure, or maybe we're exchanging debt for equity or equity for debt," Lauritzen says.
All of this is advantageous at a time when many insiders are predicting a wave of consolidations. This past year, corn growers have responded to the increases in the renewable fuels standard (RFS) and the public's interest in biofuels. Yet, with the cost of building materials increasing and a dearth of design/builders—even if the feedstock costs can be managed and there is a market for renewable fuels—many small producers are going to struggle.
Recent rumors that Archer Daniels Midland Co. was being sized up for a takeover may be a portent of things to come. Now that ethanol has reached commodity status, and the amount of production is in danger of saturating some markets, it's inevitable that larger companies with the structures in place to survive lean times will look at consolidation as a way to control negative production margins—especially tough on newer ethanol producers.
Mark Barrata, vice president of First National Renewable Fuels, focuses on the senior debt side of the financing equation through his work with FNIB's corporate lending group. His focus is on financing the deals that Lauritzen makes. "Making a loan [in the ethanol industry] is certainly riskier than making a loan to a 100-year-old insurance company," Barrata says, voicing the concern of many in the lending industry. In order to manage that risk, lenders typically require a higher level of equity and rapid amortization. For an ethanol plant, this may mean that the developers are required to bring as much as 40 percent of the project's total cost in the form of to the table, and a repayment (amortization) rate of 10 years instead of 25 to 30.
Unlike a strip mall, which can be retrofitted, an ethanol plant is a single-function facility, Barrata says. In most cases, the plant can't be easily repurposed. "A banker wants to get paid out of [the loan] fairly rapidly, given the inherent commodity risk that exists in the industry," he says.
So why with all these variables would a bank want to be involved in the ethanol industry? "It requires a lot of understanding of the industry and of what differentiates one project from another, the quality of the people, the quality of the site logistics and where [the company] sits within the industry," Barrata says. "I think it's too easy to paint this industry with a big, broad brush and just say, ‘It's too risky. Why would a bank be involved with it?' I can point to our portfolio and say I believe, given the due diligence we go through and the projects that we pick, that those particular plants have a sustainable competitive advantage in the industry."
The build-out in the ethanol industry has attracted a wealth of developers, some with plans to build several large plants in a relatively short period of time. For example, Seattle-based E85 Inc. proposes to build seven 110 MMgy plants, says Joe Schriner, site operations manager of E85 Inc. Though only a single plant in Wahoo, Neb., has started initial construction, the company intends to produce a billion gallons of ethanol in the next three years. Will this strategy work in a crowded field of players? E85 Inc. thinks it will.
Financial institutions like FNIB have to consider these types of investment opportunities and other business models carefully.
The Road Ahead
Moving forward, there are almost as many paths as producers. A prescriptive approach, one which pushes for increased mandates and tax incentives, may help small producers initially, but as the industry matures, the subsidy structure may be eliminated. Some in the industry believe that ultimately letting companies find their own way free of these structures will make the industry stronger. FNIB proposes to be a resource for these endeavors.
"Right now, the ethanol market is probably overheated," says Nathanael Greene, a senior policy analyst with the Natural Resources Defense Council (NRDC). A rush to build and an eye on profits may make some investors careless. "Certainly, over the past 12 months, the golden rule about ethanol was 'Get it up as fast as you can,' and that doesn't encourage innovation or smart thinking," Greene says, expressing his concern that not enough time and energy is spent building the science.
Many new investors have seen ethanol as a kind of modern gold rush. New technologies have made producing ethanol attractive to even the least-experienced in the industry. This looks good to those with an eye toward the RFS mandate and projected production numbers, but the truth is, some of these folks could very well lose their shirts. Looking ahead, FNIB understands these issues and has proven methods for helping investors make the most of their entrepreneurial instincts with an eye on the changes in the industry.
Craig A. Johnson is an
Ethanol Producer Magazine staff writer. Reach him at
cjohnson@bbibiofuels.com or (701) 746-8385.