Just how commercially viable can the Waste Ventures model be?
This post is a guest blog post by Waste Ventures Summer Fellow, Rob LeBlanc, to read his introduction as well as introductions of the rest of the stellar team of fellows we had for the summer 2011, see our blog.
My first question – is this work for me – has a very clear answer. Yes. I really enjoyed applying my skills (which come from my more mainstream strategy consulting and private equity background) in this space. I found each day invigorating and (relatively) full of potential for impact. Especially expansive were the weeks I spent in Osmanabad, Maharashtra, supporting Waste Ventures’ major pilot project, and in Andhra Pradesh, traveling around scoping out new prospective project sites. My time in small-town and rural India was enriching in so many ways. After my experience this summer, I can safely conclude that I want to work in emerging market social enterprise post-MBA. The next question is how and where… but, I digress…
The answer to my second question – does the Waste Ventures model generate commercially viable returns – is less clear. The short answer is yes it can, but this depends on a lot of assumptions that are yet to be well understood (and not just at Waste Ventures, but in the impact investing sector in general). Before reading on, please note that I assume you are already familiar with the Waste Ventures model and (at least to some degree) with the regulation of foreign investment in India (if not, check out http://www.wasteventures.org/pages/theory-of-change for info on the former and http://www.nishithdesai.com/Research_Paper2009/VC%20&%20PE%20IN%20INDIA.pdf for an overview of the latter). I think about the challenges I encountered this summer at two levels: the project level and the investment vehicle level.
The Waste Ventures project model is financially compelling. It seeks to unlock huge value in the processing of solid waste, which today, is largely untapped (most municipalities just dump waste, if they collect it at all). Specifically, after collecting waste, Waste Ventures’ projects sort, clean and recycle inorganic waste and compost organic waste (or produce some other value-add product like bio-gas or bio-mass briquets). Selling these processed recyclables and organics can more than double the value in the waste. Add to this the elimination of inefficiencies and kickbacks in the current collection system, and the eventual sale of CERs (generated from composting activity), and you can begin to see the commercial potential of the model. When you also consider that it diverts more than 70% of waste from landfills and increases waste picker wages by 2-3x (including them in the ownership of the enterprise so they can build stock in the community), and you begin to see not only the model’s financial promise, but also its environmental and social benefits.
Despite these merits, the model is not without its operational challenges. I observed two big execution risks this summer: reliance on local government for access to waste (and collection revenue) and dependence on local NGO partners to carry-out day-to-day operations. Local governments, with all of their incumbent stakeholders and political dynamics can make for erratic, frustrating partners. However, the committed effort of some individual politicians and administrators has proven invaluable in overcoming much inertia. On the local NGO partner side, it has proven difficult to find organizations with the right mix of local recognition, commercial orientation and management sophistication to truly hit the ground running. But, both of these challenges are common place in the BoP social enterprise space in India. And, Waste Ventures is continuing to explore innovative ways to mitigate these risks, from networking to secure higher-level (MLA / MP) political support to developing more detailed screening criteria for local NGO partners, to hiring its own local managers, to even introducing new service lines (with revenue streams that do not rely on government at all). It will be interesting to follow the evolution of these efforts, because, with strong local partners and a decreased reliance on local government, the Waste Ventures model could really take off… which is a great segue to the second level of challenges – those associated with structuring an investment vehicle fund Waste Ventures projects.
Perhaps unknown to some readers is that Waste Ventures has always envisioned starting-up a dedicated investment entity, to fund its projects on a for-profit basis. This entity is called Waste Capital Partners, and its formation, strategy and economics have been my primary focus this summer. Given the viability of Waste Ventures projects described above, there is growing willingness to invest in Waste Capital Partners, particularly from US-based impact investors. However, the first challenge in investing in India arises from the inability to bring in debt from abroad. On this front, the RBI has allowed quite a reasonable work-around in the form of compulsory convertible shares or debentures (CCDs). CCDs are a form of quasi-debt that enable coupon payments, but have mandatory conversion provisions that allow them to treated like equity for accounting purposes. Really a great instrument for getting foreign capital into the country. But, as is well known by the investment community in India, the real challenge is not necessarily in getting capital into the country, it is in putting it to work effectively and getting reasonable returns out…
In putting capital to work in India, Waste Capital Partners is still constrained by the inability to use debt (even through its Indian subsidiary, as it is, as described above, funded through foreign-held CCDs). To work around this problem, in collaboration with our legal counsel and accounting advisers, we have devised a service agreement arrangement, whereby Waste Capital Partners’ Indian subsidiary enters into long-term service contracts with each waste picker co-operative that it helps incubate. Sparing you the legal, accounting and tax details, this arrangement allows for Waste Capital to fund projects on a profitable, tax-efficient basis. Being satisfied with the value creation potential at the Indian subsidiary level, there is still the problem of repatriating that value, of getting returns out of India to return to US-based investors. And herein lies the structural downside of the CCD. While it is great for getting capital in, and allows for tax-efficient coupon distributions, the mandatory convert eliminates the ability to repay investment through a debt-like principal repayment. All returns need to be issued below the line, by way of dividends, post-conversion. This creates a delay in generating returns, as the Indian subsidiary needs to be net income positive to issue dividends (as opposed to repaying debt prior to being net income positive). Additionally, there is a material dividend issuance tax in India, and, of course, dividend income tax back in the US (that does not fall under any bilateral double taxation avoidance regulation). So, long (complicated) story short, Waste Capital Partners is able to generate compelling financial returns (especially in India), but it will take patient capital too see them materialize in the US… and strong perseverance and risk mitigation on the ground to see them created (which, fittingly, returns us to the project-level risks above…).
So there it is. I think the Waste Ventures / Waste Capital Partners model can really work, but it will require working through some steep challenges – challenges faced not only by Waste Ventures, but by the social enterprise / impact investing community as a whole. Beyond the merits of the Waste Ventures model itself, I see great potential in trying to work through these challenges and continuing to experiment with enterprise-driven solutions at the BoP. I hope that the great work at Waste Ventures continues and that the broader sectoral learning only accelerates!