Pivotal Investments

News: The Pivotal Point of View

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The Current Economic Crisis: Pending Disaster or Prelude to Opportunity

The current economic crisis, like every one before it, has created a tremendous amount of fear and uncertainty regarding the future. We, like you, have worked to understand the underlying causes of this crisis, and determine what we can learn from it as we move through and ultimately beyond it.

We see several root causes that have converged to create a perfect storm (a bit of a cliché, but relevant nonetheless):

We at Pivotal are very optimistic about the future. Armed with a little perspective we see a unique opportunity to invest in the next big wave – the sustainable economy, which is characterized by rapidly growing demand for clean energy, water, air, green materials, and sustainable agriculture.

This economic crisis, along with its underlying causes, will result in a significant, potentially protracted recession, as we work through correcting the excesses in our economy. This will undoubtedly lead to challenging economic conditions for consumers and businesses alike as they adjust to new valuations, regulations and a significantly higher level of debt than we have seen in several decades. With consumer spending representing 70% of our economy, we expect consumers to pull back, starting with this holiday season, and reprioritize lower disposable income on more basic requirements like energy, shelter, and food. These short to medium term priorities today, reinforced by higher resource costs over the medium to long term, will continue to put pressure on discretionary spending in the developed world.

While this economic crisis is front and center today, we should not lose sight of the durable, global trends that are shaping our future on the planet and the significant economic opportunities that will result. This is a market opportunity that is driven by the demand for resources and the associated demands on our environment by the billion or so people with roughly an American standard of living. More importantly this opportunity is enhanced by the 2 billion people in India and China who aspire to our standard of living. China is a great example with its 1.3 billion people climbing out of poverty and into the global economy. Many of these people look to America, with our resource consumption profile, for inspiration for how to live. One can quickly do a “back of the envelope” calculation on any resource of interest: steel, oil, water, etc. and it’s clear that there are not enough planets to go around. This simple analysis doesn’t even take into account the 3 billion people who live in poverty or the 3 billion who are not even born yet, but will be by 2050. Many of these people will which aspire to a standard of living and consumption patterns that we have demonstrated. These tectonic changes in our species’ presence on this planet create huge, durable demand drivers for key elements of “human infrastructure” like energy, clean water, food, and shelter. Meeting these demands, with the resources on the only planet available to us today, will require a dramatically different set of solutions than we used to deliver the standard of living that we enjoy today.

The pillars of our human infrastructure, such as energy, water, food, and shelter, have not been noteworthy opportunities for either innovation or investment in innovation. We believe that is beginning to change today and will accelerate as we come to grips with the magnitude of the changes required to make our human infrastructure support the needs and wants of a rapidly growing population and expanding global economy. This economic opportunity, in scope and duration, pales in comparison to our current economic crisis and will ultimately be greater than the industrial revolution that got us here. A few examples help to illustrate the size and durability of a market opportunity that will continue through our children’s and their children’s lifetimes:

Energy: Energy Sales in the US are over $1 Trillion and nearly $5 Trillion for the planet. US spending on energy R&D is about $6B including $2B worth of venture capital equating to approximately 1/2% of sales. In comparison, the healthcare industry invests 8% of sales in R&D and Microsoft 13%. To put this in perspective, Microsoft as a single company with an $8B R&D budget, spent more than was spent in the entire country for energy research.

Shelter: Creating and maintaining the buildings we live and work in and the infrastructure to support them constitutes 14% of our GDP, another Trillion-dollar market. Our buildings consume 40% of our energy and 70% of our electricity in addition to 12% of our water and 40% of our raw materials. Investment in R&D in the construction market was less than $400M - less than ½% of revenue vs. 3.8% of revenues invested in R&D across all industries – another vastly underinvested market.

Food: The agriculture market representing 16% of GDP is nearly a $2 Trillion Market in the US alone. Growing global population, meat consumption and demand for bio-based replacements for petrochemicals and petroleum-based fuels will put increasing pressure on improving land productivity. Venture capital in agriculture, a $2 Trillion dollar market is less than ½% of all venture capital.

Water: The global water treatment and purification market is over $400B, not including bottled water. This huge market growing at 5-6% globally, and much faster in Asia, has attracted less than $500M in venture capital last year.

While a global opportunity in scope and magnitude, the investment opportunity is right here. In 2007 more than 80% of the venture capital invested in clean technologies and sustainability globally were invested here in the United States. While the world’s investors may have lost faith in American financial institutions on Wall Street, they continue to believe that the new solutions to our most pressing challenges for tomorrow will come from the United States.

The Northwest has a strong reputation and long history of innovation in maximizing the productivity of increasingly scarce resources including energy, water, materials, land and environmental services. This reputation is underscored by a convergence of factors including strong early adopter market behavior for consumers, corporations and governments, supportive policies, and aligned research and development efforts as well as proximity to large markets like China and California. These regional assets, in the face of strong global market demand, have created a compelling increase in entrepreneurial activity targeting the sustainable economy. Recently Climate Solutions and Clean Edge highlighted this trend in their recently released the Carbon-Free Prosperity Report. This market analysis highlights how the Northwest can be a leader in the Global Clean-Tech and Sustainable Economy markets. We, at Pivotal, have had the chance to evaluate nearly 200 clean tech investment opportunities in the NW. This deal flow in quantity, breadth and quality is a proof point that the NW is a great place for investing in the sustainable economy.

The economic crisis that we find ourselves in today reinforces the challenges and opportunities of an increasingly connected world. This crisis also serves as a harbinger of the changes that are taking place in the global economy, created by large drivers in fundamental, global markets. This presents a unique opportunity for dramatic financial returns for investors who can see through the current crisis to invest in the compelling investment opportunities right here and right now.


Green Building: A Regional Investment Opportunity To Build On

Contributed By Christine Ervin, Pivotal Investments Industry Advisor

At Pivotal Investments, we are working to deliver outstanding returns for our investors by making investments in companies that deliver solutions for the emerging sustainable economy. The sustainable economy is characterized by dramatic growth in the demand for clean energy, water, air, green materials, and sustainable agriculture. As we work to identify compelling investments, here in the Northwest, we strive to bring you thought provoking articles that underscore the strong trends and opportunities here in the region. Often in these Pivotal Point of View articles, as in our normal course of business, we partner with one or more of our advisors, leveraging their deep domain expertise, to help us identify and characterize enabling market trends as well as specific investment opportunities.

One such opportunity is the vibrant green building sector. "Green building" is the term applied to the deployment of practices, technologies, and materials that significantly reduce the environmental impact of the buildings in which we live and work while providing a wealth of other benefits. Green building is most often defined by the US Green Building Council's Leadership in Energy and Environmental Design ("LEED£") standard.

Historically the building market has been overlooked by venture investors who have focused on faster growing and more rapidly changing markets. Today, however, important parts of this market are changing quickly driven by significant market forces such as energy prices, resource constraints driven by rapidly growing demand in the developing world, carbon regulation and environmental concerns. The large and systemic role that the building sector has in our economy is driving technology and practice innovations in a variety of disciplines that warrant an investor's consideration. In addition, as citizens, this industry has significant impact on our local economies, communities and environment. We describe this opportunity through six insights, some obvious, some less so, but combined highlight a strong investment opportunity here in the Northwest.

The first insight is that this is a huge market opportunity. Creating our built environment constitutes 14.2% of the $10 trillion US GDP, with commercial and residential construction constituting 9% of GDP alone. The green building sector, growing today in excess of 50% annually, is expected to represent 10% of all commercial construction starts by 2010; clearly a strong investment driver in the emerging sustainable economy.

Today our buildings consume 40% of our nation's energy and 70% of our electricity; 12.2% of all potable water; and 40% of raw materials globally. Reducing energy use alone in our built environment will drive significant technology innovation. Further, reducing the energy embodied in the materials used in constructing these buildings along with the environmental costs of their extraction, manufacture and end of life treatment create additional opportunities for innovation with a global appetite for the results. Based on current building trends, here in the U.S., two-thirds of our built environment will be new or renovated by 2030; creating a significant opportunity for the deployment of innovations in energy and water efficiency, green materials, recycling and a host of other technologies. When you further consider the rapid development of the built environment in other parts of the world, like China and India, this is a market opportunity of a scale that truly warrants an investor's attention.

The second insight is that the financials surrounding green building deliver stronger financial returns for developers and builders than conventional buildings. Contrary to common perception, the "green premium" to secure these returns averages 2% and is typically paid back within several years through lower operating costs. For example, green buildings consume between 30% and 70% less energy than conventional buildings. In a 2005 survey by McGraw-Hill, building industry professionals anticipated that green buildings would generate 8-9% reductions in operating costs; increase building values by 7%; increase rental rates by 3%; and increase their return on investment by 6.6%.

Those kinds of predictions are now beginning to bear out in the market. For example, the real estate industry's research group, RREEF, found that Class A green office buildings command higher rents than conventional office space, exhibit lower vacancy rates and are vacant for shorter periods of time.

The third insight is that there are significant benefits with green buildings that are more difficult to quantify but ultimately contribute to the financial returns cited above. For example, research from Carnegie-Mellon indicates that green office buildings boost labor productivity by 2-8%, in good measure because improved day-lighting, fresh-air ventilation, cooling and heating systems, and natural views results in higher productivity and lower absenteeism. Similar studies show patient recovery rates are measurably higher in green hospitals and medical facilities; students and teachers perform better in high performance schools with state-of-the-art day-lighting and ventilation. Increasingly employees and students, especially younger generations, prefer organizations that demonstrate a commitment to the principles of human health and environmental stewardship that green buildings make tangible. In an increasingly competitive global market for top tier talent a tangible investment in these values helps in recruiting and retention. It is no wonder the emerging definition of a 'Class A" commercial building is becoming synonymous with green features.

The fourth insight is that real estate developers, once considered to be a "choke point" for building green, are now driving increasingly rapid adoption of green building designs, practices, and products. Developers and owners from coast to coast increasingly covet LEED certification, driven largely by tenant demand, making LEED one of the fastest adopted standards in recent history; this in an industry that is typically slower to innovate.

The fifth insight is just how important green building really is for reducing the risks and costs associated with climate change. Surprisingly, commercial and residential dwellings - not smokestack manufacturing or the transportation industry - are the largest single consumers of energy in the United States, resulting in 49% of all greenhouse gas emissions. The built environment is also the fastest growing sector in terms of energy consumption and greenhouse gas emissions. Given the likelihood of some form of carbon regulation and pricing, and the fact that building green provides a cost-effective tool for reducing carbon, we see green building accelerating as businesses, public leaders and consumers strive to reduce the risk associated with a changing climate-not to mention increases in energy costs.

One final insight: green building is not a fad or bubble waiting to burst. Quite the contrary. It is a durable and steadily expanding market, driven by strong market fundamentals generating strong, measurable financial returns, good paying green-collar jobs and meaningful economic growth.

This opportunity is not lost on our nation's entrepreneurs. They are innovating to create designs and systems that reduce energy and water consumption; integrate new power generation and building material technologies; and reduce the impact of building materials both on the environment and human health. Innovative entrepreneurs, engineers, and scientists are looking to Bio-Mimicry, the place where nature and engineering meet, as inspiration for exciting new solutions that reduce cost, enhance value and ultimately positively contribute to the natural environment that surround our homes and buildings. Companies like Serious Materials, GigaCrete, Hycrete, Aspen Aerogels, and HydroPoint are attracting top tier venture investment.

Many of these innovations are being created in the Pacific Northwest, which is widely recognized for its leadership in building green. In the Northwest, we have more LEED certified buildings per capita than any other place in the world. That also applies to the number of LEED certified professionals, like architects and engineers. This regional group of innovators is pushing green building to the next level with the innovative "Living Building Challenge" to create buildings that will generate all of their own energy with renewable resources; capture and treat all their water on site and use resources efficiently and for maximum beauty. Supporting these professionals is a rapidly growing network of regional research and development efforts creating enabling technologies, tools and measurement systems. With this strong innovative and early adopter infrastructure, companies delivering solutions can move quickly here to validate their technology and the underlying economic value proposition. Regional innovators have an information advantage through geographical proximity that can lead to strong time to market advantages.

Even though we are early in this market wave, we have excellent realized examples here in the region. Leveraging a new adhesive technology developed at Oregon State and an example of bio-mimicry, Columbia Forest Products, introduced a new line of formaldehyde free hardwood plywood and particle board products that are cost competitive with similar hardwood plywood containing dangerous formaldehyde. These innovative, regionally developed products are being used to set new standards in large markets like California. Local entrepreneurs, leveraging enabling technology from Europe, created Apex Block to attract significant venture capital investment and strong early market traction.

We are excited about the potential that these companies and others in the Northwest have in the growing green building market. It is another example of our unique economic opportunity to create great companies targeting the rapidly growing sustainable economy that deliver world-class products and services to create strong returns for investors.


Investing in Biomass: A Three-Step Strategy for Northwest Leadership

Contributed By John C. Gordon, Pivotal Investments Industry Advisor

Despite miscalculations in the expensive corn-based ethanol market, we still have a major opportunity to replace petrochemical-based products with biomass (i.e. plant) based products.

To succeed going forward, though, there are a host of issues that need to be addressed as we transition beyond today's fossil fuel economy. The bottom line is that we need to devote more thought per acre to maximize the total return on the solar energy received – the source of energy for all biomass resources. In addition, we must invest in innovations that will help us expand biomass resources substantially and sustainably – for energy, fiber, biodiversity, carbon sequestration and food.

Key issues that must be addressed include: embracing a radical reappraisal of land use while increasing our sensitivity to the food versus fuel tradeoff; taking advantage of the abundant provisional inventories of low-quality biomass; development of new technologies to cost effectively convert diverse biomass resources into valuable products; increasing yields of biomass without boosting costs, including developing better technology for growing purpose-grown perennial crops on a wider variety of land.

We believe the Northwest offers significant opportunities in this area because of plentiful and diverse biomass resources; a strong existing policy base to balance three natural systems – land, ocean and air; as well as the fact that it's home to relevant world-class research and development – including a national lab, universities and forward-thinking corporations like Weyerhaeuser, The Collins Companies, Columbia Forest Products, and Greenwood Resources.

The Northwest provides immediate investment opportunities in biomass related businesses. We are especially excited by technologies that improve yields, reduce input resources, and convert available biomass resources into valuable products. Examples include: new crops and conversion technologies, such as mobile technologies that can cost effectively convert surplus forest-based biomass into valuable products such as methanol and ethanol. These solutions could complement efforts to reduce fuel loading in forests that are managed with fire suppression as a high priority.

The region also offers a number of long-term investments. One particular favorite of ours is Agroforestry, or the aggregation of perennial crop operations where woody biomass, other crops, and even animals, are linked positively to the concurrent production of high-value wood, fuels, fiber and food. This requires new technologies to assess the suitability of land and manage concurrent crops.

But to reap these potential rewards, we need to embark on a three-step strategy for leadership in biomass and biofuels in the Northwest now. Our reappraisal should include: analysis of fossil, nuclear, solar, wind and other energy sources. And the overall strategy must view the entire landscape as a solar energy collector, one output of which could be biofuels.

The first step calls for an inventory of current biomass resources that realistically could be available in terms of the selected land's solar energy capture potential. These resources include: woody biomass, biomass waste, and non-food annual crop components. Some baseline work in this area has been performed by the Pacific Northwest National Laboratory in their 2008 report "Biofuels in Oregon and Washington: A Business Case Analysis of Opportunities and Challenges."

The second step includes: identification and development of the technologies that are necessary for improving biomass-based fuel and product yields from purpose-grown perennial crops – including woody plants. This effort should include all potential biomass sources, such as natural forests, forest plantations, and perennial woody and non-woody crops. This assessment should also recognize the benefits of certain perennial crops, which include high biomass yields, low inputs such as fertilizer and water, utilization of sites that are poor for annual agriculture, and harvest flexibility.

Step three focuses on understanding the economic and financial aspects – how we monetize or value these resources including competitive and complementary uses of the resources and the land to grow them.

One of the big questions is what a growing market for woody biomass for fuel or petrochemical replacements will do to the environment as well as current markets for pulp and paper, construction materials, and other products. Another important question is the impact of generated carbon credits and parallel environmental services such as clean water, wild life habitat, and recreation, which can be complementary uses for the same land. A third question is what impact potential government action will have. The rapid growth in ethanol from corn, for example, stemmed largely from ill conceived direct and indirect government subsidies and exhortation through Renewable Fuel Standards.

This three-step strategy will help the Northwest take the lead in developing responsible ways to leverage biomass resources to provide strong investment opportunities in the sustainable economy.

With this in mind – and the recent lessons of corn-based ethanol front and center – we see strong investment opportunities in the Northwest in:

  1. Technologies that convert waste streams into valuable products like petrochemical replacements, including fuels,
  2. Technologies that extend the value of natural resources like trees by substituting lower cost, environmentally friendly materials in large markets like paper and building materials.
  3. Infrastructure improvements based on a systems approach that result in much higher resource productivity.

The Northwest is a leader in developing innovative ways to address increasingly scarce resources. Investments in companies that address these opportunities and can scale their solutions beyond the Northwest will drive significant returns for investors and compelling solutions that the world needs.


Great Green Returns on the Northwestern Horizon

By Gregg Semler and Brad Zenger, Co-Founders, Pivotal Investments

There are certain times and unique places that have always made financial history in this country. The power of Manhattan as the monetary capital of the Industrial Economy, for example; the dominance of Silicon Valley as the intellectual brain mass of the Internet Economy; and now, the emergence of the Northwest as the eco-center of the Sustainable Economy.

Simply put, the Sustainable Economy confronts climate change and other global challenges by addressing the dramatic shift in demand for clean energy, safe water, fresher air, "green" materials and healthy food. As more and more people are coming to realize, these are the solutions to some of the world's most pressing problems right now.

And the critical environmental answers that are currently being developed and delivered in the Northwest offer tremendous possibility and profitability for far-sighted investors.

Why?

Because we are witnessing the beginning of a significant and long-term market shift that will generate rich returns for decades to come as the post-petroleum and increasingly carbon neutral Sustainable Economy unfolds. A unique combination of assets in the Northwest provides the right setting for new solutions and the companies that provide them. Leveraging the region's proximity to large markets like California and China, these companies can scale beyond the Northwest and provide strong returns to investors. We believe that these robust returns will be truly enhanced for those who recognize the Northwest's untapped investment potential and respond to these lucrative opportunities in 2008.

That's our mission at Pivotal Investments, a new investment firm designed to address the lack of resident venture capital focused on the Northwest's ability to shape and enhance the Sustainable Economy. Founded by investment professionals and entrepreneurs who have lived and worked in the Northwest for years, Pivotal has a solid and expanding base of relationships. The result: a powerful proprietary deal flow network.

So, without question, the potential is here.

In 2007, the state of Washington was ranked third among all states in terms of venture-backed clean technology transactions. But these companies did not find local lead investors; instead, nearly all the capital came from prestigious investors in Silicon Valley, New York, and Boston. This is the Pivotal opportunity.

And Pivotal intends to build on this regional potential by introducing a new approach to venture investing.

It's a targeted approach, based on a regional information advantage and aimed squarely at seed- and early-stage companies engaged in clean technology and the Sustainable Economy; a local, hands-on approach designed to leverage regional strengths and champion the Northwest's best and brightest entrepreneurs; and a network approach focused on bringing the best resources - both inside and outside the Northwest - to bear on the biggest hurdles and toughest challenges that stand in the way of a prosperous and environmentally-sound future.

The strong returns will grow from the special land, water and air of the Northwest. When it comes to sustainability, for example, Oregon and Washington are two of the three top-ranked states in America; and Portland and Seattle lead U.S. cities in LEED (Leadership in Energy and Environmental Design) building certification. But taken as a whole, we believe that Oregon, Washington, Idaho, Montana and British Columbia represent a financially rewarding future.

Profitable investment opportunities punctuate the entire Northwestern landscape - from Vancouver to Portland, Seattle to Boise and on up to Missoula. Plentiful renewable reserves of hydro, wind and wave power, biomass, geothermal and solar energy; widespread green building and construction; broad swaths of sustainable forests; fleets of clean transport vehicles; increasingly thoughtful land use and transportation planning; and smart solid waste recycling.

The Northwest's early mover advantage has successfully taken hold because globally relevant values are deeply rooted in the region's communities - north, south, east and west. These values are reinforced by the behavior and actions of citizens throughout the Northwest. In addition, a heightened concern about the impact of climate change increasingly drives consumers and companies in the Northwest to develop solutions to this global challenge.

Entrepreneurial values have taken root in the Northwest's soil as well, and the region's compelling economic benefits anchor a substantial private sector that has enriched innovation. Large companies such as Microsoft, Amazon and Nike value creativity. And now bands of talented and returns-oriented entrepreneurs are living and working in the Northwest while making their mark in the Sustainable Economy. As the fastest growing city for under-35-year-olds in America, Portland, is symbolic of this trend.

The public sector has embraced this change, too. Oregon and Washington, for example, have advanced far-reaching Renewable Portfolio Standard (RPS) policies that specify the amount of electrical power that must come from renewable sources in the future. Oregon, has implemented a visionary Renewable Fuel Standard (RFS) that provides significant market-driven opportunities for renewable transportation fuels. And the highly leveraged Oregon Business Energy Tax Credit (BETC) has increased from 35 percent to 50 percent of the capital investment of qualifying energy projects, which provides strong incentives for emerging leaders in the Sustainable Economy.

Executives, entrepreneurs and public officials in the Northwest know that learning and research about the post-petroleum future is essential; and that's why the region's eco-knowledge base is constantly expanding - on and off the campus. Whether it's leading edge green buildings, large-scale solar manufacturing, waste-to-energy, cutting-edge recycling, next-generation biomass usage or fuel-cell development, the environmental innovators in the Northwest are engaged in a bold quest for what's next.

Understanding and accessing the next wave of powerful investment opportunities in the Northwest's Sustainable Economy is the essence of Pivotal Investments. We know the clock is ticking for our planet; the Northwest has solutions that will bring outsized green returns. The time to commit is now.