Building the energy efficiency market

November 13, 2015

Sustainable Development Capital is on a roll after announcing a string of deals and partnerships in the energy efficiency space. Its CEO Jonathan Maxwell tells Peter Cripps why his business model is now ready for ‘show time’.

“Energy efficiency as an asset class will be just as important as renewables.”

These are bold words. Particularly, when you consider that renewables have been on the rampage in recent years.

But Jonathan Maxwell is standing behind his bold prediction. He believes in the future of energy efficiency and is putting his money where his mouth is.

He can claim that his boutique asset management firm Sustainable Development Capital LLP (SDCL) is playing a key role in helping this asset class scale up. SDCL is in the vanguard of the charge to build the market for energy efficiency services contracts.

It has taken years of work, but his firm has carved out trailblazing niches in a number of key markets across the world.

In the UK, SDCL has formed and managed UK Energy Efficiency Investments, into which the government-backed Green Investment Bank has committed £50 million ($83.6 million) as a cornerstone investor. It has also received additional commitments for more than £50 million, Maxwell revealed, meaning it is likely to be oversubscribed.

The fund has begun deploying capital, including a £10 million finance package that will enable energy efficient lighting to be installed at 149 car parks run by NCP. Also, the fund has provided Skanska with £2.5 million of financing for a low-carbon combined cooling, heating and power solution for St Bartholomew’s Hospital in London. SDCL has also formed a strategic collaboration with GE, Clarke Energy and the NHS Confederation to finance and implement combined heat and power solutions in the NHS, which is one of the largest energy consumers in the UK.

SDCL has recently set up a fund in Ireland, in which the Irish government co-invests with the private sector. So far, of the €35 million ($47 million) raised, property giant London & Regional Properties and manufacturing firm Glen Dimplex have co-invested alongside the government.

The fund, which is currently in the process of raising a further €35 million, kicked off its account with a €2 million contract with supermarket giant Tesco to retrofit seven of its Irish stores with efficient lighting.

“There are a lot of awful clichés about energy efficiency, such as ‘low hanging fruit’, and ‘no-brainer’”

Maxwell, who recently accompanied UK Prime Minister David Cameron on a trade delegation to China, has also been spreading SDCL’s tentacles further afield. SDCL Asia is a 50:50 joint venture with First Eastern Investment Group, a Hong Kong-based private equity business, which has a minority stake in SDCL.

SDCL Asia has been selected by the Singapore Economic Development Board to run a S$200 million ($157 million) programme to invest in energy efficiency upgrades in its manufacturing sector. Singapore has committed to achieving a reduction in carbon emissions from current levels by between 7% to 11% by 2020.

The first S$100 million has been capitalised by a combination of debt and equity, of which the equity has now been fully underwritten by First Eastern.

SDCL Asia also manages the UK-China Energy Efficiency Investments Fund, which has been set up to invest up to $200 million in energy efficiency projects in China and the UK. SDCL in April signed a partnership agreement with Avic International, a large state-owned diversified Chinese industrial company, to co-invest with SDCL in UK and China, and is currently seeking further investment.

We have something to unlock this market – it’s big news

Next on the cards is likely to be the US, with SDCL currently exploring opportunities in and around New York.

SDCL has raised some $250 million for energy efficiency investments in the past two years and Maxwell feels the business is at “an inflection point”.

“There are a lot of awful clichés about energy efficiency, such as ‘low hanging fruit’, and ‘no-brainer’. Now, [business] is repeating, it’s scaling up. As a fund manager, we become really excited and feel this strategy is ready for show time.”

He adds: “We have a successful market record of working with delivery partners. It took us a while but the momentum is really good now. It’s just taking off because we are seeing business happen and that’s what is really exciting for us.”

“We have something to unlock this market – it’s big news. Hosts and energy services companies (ESCOs) are getting together around this business model.”

The London-based boutique fund manager provides financing solutions to ‘host’ companies that want to make energy efficiency savings. Typically, SDCL extends capital for energy efficiency projects, so the host company buys the energy efficiency savings as a service rather than just buying the equipment upfront as an asset.

The host company benefits from the installation of the project without having to put in any capital upfront. SDCL’s capital is repaid through taking a slice of the savings from the host company’s energy bill over a period of years. SDCL works with an ESCO to install the energy saving equipment, and to maintain it.

Maxwell says SDCL’s role is “making sure that the whole contractual suite is correctly structured”. “It takes out the capital cost, procurement, operation and maintenance issues for the host company, and deals with it in a highly cost effective way for them,” explains Maxwell. “We run the risk – we have a huge vested interest. They [the host company] have transferred an element of the risk onto us. We win if the client is winning.”

For Maxwell, the rise in activity means that years of hard work are starting to pay off. He set up SDCL in 2007, just weeks before the collapse of UK lender Northern Rock.

Previously, he worked at HSBC where he helped float HICL the first main market listed UK infrastructure fund, which has continued to grow and has proved popular with institutional investors. Maxwell spotted an opportunity for energy efficiency and formed SDCL.

He is the biggest shareholder in SDCL, which has also attracted strategic investment from First Eastern and Sustainable Technology Investments (Guernsey), set up by Stephen Lansdown, co-founder of investment management provider Hargreaves Lansdown. The rest of the shares are owned by staff and partners.

Funds under management are about $250 million. “Two years ago it was de minimis,” says Maxwell.

The challenges SDCL has faced in scaling up energy efficiency are numerous. The primary obstacle is that energy efficiency as a service is a young market and, unlike more established renewables such as solar photovoltaics, has barely begun to register on the radar of institutional investors.

However, Maxwell remains impressed by the potential size of the market, and believes it has an important role to play in the transition to a low-carbon economy. He says there was some £18 billion in sales of energy efficiency equipment in the UK in 2010.

The idea of energy efficiency is so compelling but it has been elusive. We are translating it into concrete investments.

“When I left HSBC to look at energy efficiency, I realised it would be a challenging market, a tough nut to crack. Energy efficiency is hard to see, not like with a wind farm. The output is a saving. We needed to create simple business models that can translate the old status quo of companies needing to buy equipment into a service based approach.”

He points to high energy prices in many markets and the fact that energy efficiency can save businesses money, but they may want to keep their capital expenditure for ‘core business’ purposes. Because these savings create “stable, long-term predictable cashflows”, there is a large opportunity for financing solutions.

“The idea of energy efficiency is so compelling but it has been elusive. We are translating it into concrete investments. It has not been like the renewables market – we are getting energy efficiency to a place where it can attract the [same] kind of volume of business.”

Maxwell’s challenge was to create contracts and structures that were scalable. Now that the first few deals have been done, he feels that the business model has been proven. For example, the processing time for new contracts has reduced “dramatically”.

“It’s real delivery of results, and is replicable and scalable – it has taken years to do that. We have been able to show and tell.”

As a result, investors are warming to his funds. Currently, governments remain key investors, but Maxwell points out that the private sector is also committing funds to his work, and he expects private sector participation to grow.

“We are getting to a point where energy efficiency solutions are coming to the party not just for the government. We will see the host market start to develop without government intervention. We are certainly seeing some deals happen and momentum picking up independently of government support.”

He adds: “In the UK and Ireland, private sector institutional investors have come into these funds – I would like to say flooded in, but it’s a bit early – but they have come in at scale. We know we can deliver something that institutional investors want.”

“Investors want stable, long-term predictable cashflows. A big part of our work has been showing investors and demonstrating that we are able to create high quality investment opportunities.”

Maxwell says that investors view energy efficiency as “somewhere between infrastructure and credit”.

The feedback from investors is that they would like to support larger funds going forward

He describes the investments as “concertinaed infrastructure” because the construction periods are shorter than infrastructure, and whereas infrastructure investments can have a payback period of 20 years, this is closer to 10 for many energy efficiency investments.

He adds that the returns “compare favourably” with infrastructure returns, whether social or renewables.

“What we do is much shorter term. We end up with a high cash distribution for a more limited amount of time. The cashflow profile [allows a] higher cash distribution yield than a typical infrastructure fund.”

Underlying project internal rates of return are high single-digit returns, with a cash distribution yield of in double-digits, he says.

“It’s a very cash rich investment strategy. That’s why we are attracting investments from around the world. We are not buying projects on construction, we are there at the beginning, so the returns are slightly higher.”

However, Maxwell concedes that his funds will need to grow in size in order to attract many larger institutional investors.

“Large insurers say they have a minimum investment requirement and they don’t want to be more than 10% of a fund, so the fund size has to be larger. The feedback from investors is that they would like to support larger funds going forward.”

All of which explains why Maxwell continues to think big.