Recycle the minows

Finding deals is competitive, expensive and difficult, and it’s at least half of the job of a venture investor (corporate or financial).

Should you follow the crowd or find your own way? Set up shop in Silicon Valley, Tel Aviv, Munich and Singapore, and elbow your way into the best clean deals? Or get off the beaten track, say goodbye to the family and dog for a couple of weeks, and see what you can find in under-exposed clean-tech innovation hot spots like Melbourne or Sao Paolo?

May I suggest another approach: make yourself a cup of tea, sit down at your desk and gently download data on the surprisingly large world of quoted clean-tech small-caps and ‘micro-caps’ (wee fellas with market capitalisations of less than $50m) that are currently languishing unloved on the world’s junior exchanges like AIM, Nasdaq and the Toronto Venture Exchange.  You might be surprised at the value (financial and strategic) you uncover. Sooner or later, you will have to take a flight to meet these companies, but your travels will at least be more focused.

“Done well, minority investments by corporates in small cap quoted companies will be very much welcomed by financial investors particularly when they’re accompanied by contracts or even demonstrations which accelerate the company’s growth,” says Ken Rumph, head of clean-tech research at Oriel Securities and a veteran of the London listed markets.

He cites two examples. In March this year, Allison Transmission Inc, the giant NYSE-quoted ($4.3bn market cap) manufacturer of fully automatic vehicle transmissions systems, renewed a £6m licensing agreement with Torotrak, the LSE-quoted (£50m market cap) developer of gearless low carbon traction drive technologies. For good measure, Allison also bought £2.5m of new Torotrak shares at a premium to the current market value. Allison Chairman said the company wanted to “support the investment arrangements with Flybrid [a new Torotrak product].”

In October 2012, Ineos, the privately-owned large chemicals company, invested €4m in AIM and NYSE-quoted small cap Accsys Technologies, whose technology transforms softwood to hard (and thereby helps preserve rainforests). The investment followed the formation of Tricoya Technologies Limited, a 50:50 JV between the companies, which matches Accsys technology with Ineos’ market reach.

Why didn’t Allison just buy Torotrak and Ineos buy Accsys, I hear you ask. Well, why should they? Not everything these small caps do is relevant to the larger corporate partners / investors so an outright acquisition wouldn’t make sense.  Worse, it could smother growth and innovation, thereby potentially denying the larger company access to the technology it needs.

In other words, why acquire when you can venture? I’m surprised that we aren’t seeing more venturing in quoted small and micro-caps where the price (or at least a price) has been set by the market and governance standards are higher than in many private companies. Why is this?

“Larger quoted entities feel publicly exposed when they take equity stakes in minnows,” says Rumph. Citing United Technologies doomed 2010 investment in and subsequent acquisition of UK wind turbine manufacturer Clipper Wind, Rumph said: “Large cap companies’ fear of reputational damage can trump their commercial interest in venturing in small caps.” United eventually sold Clipper at a considerable loss to a private equity firm.

But a less aggressive approach – taking smaller stakes than United took in Clipper – would lessen reputational risk. Investing before an IPO also has benefits (and will be looked at in a future column). But in the meantime, have a good look at the opportunities among the small cap companies that are already on exchanges. Many were clean-tech darlings of the 2005-2007 boom (or bubble). That they have survived until now is testament to their strength. Many are ripe for recovery and recycling as corporate venture-backed quoted clean deals.

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