February 24, 2016

B. David Vosburg Chief Financial Officer & Vice President, Strategy Crop One Holdings

Overview
The lettuce industry in the US is just under $6Bn per year. If it follows the tomato industry, fifty percent of leafy greens will be grown indoors by 2030, a $3Bn industry transformation opportunity. Most conventional produce players and new entrants believe this is inevitable with the drop in cost and the ongoing trend of higher lumens/watt, in LEDs. This, along-with 95%+ reduction in water usage, 90%+ reduction in land use, and growing locally without any pesticides/herbicides/fungicides is a difficult proposition not to believe in. The question is, who will win this market?

No doubt you have seen several indoor agriculture companies who claim to be the best at growing leafy greens (lettuces, herbs, etc.) indoors. For any number of reasons, they claim to be better than their peers who are also vying for your funding dollars. But how do you tell the difference between them? Here are seven simple metrics that will tell you if the company is worth your LPs dollars.

1. Density (CAPEX/plant site)
Why does this matter? Because if a company grows for 25% of their competition’s CAPEX/plant site (location where a seedling is planted,) they can buy four times the capacity with the same capital and will turn over that capital four times as fast.

Most companies will tell you they grow denser than everyone else. But you have to do the math yourself. Calculate the number of plant sites they have per square foot, and the CAPEX required (all inclusive) to build/buy that square foot of grow space.

One of the most dubious claims we have seen is a company that grows in a cylinder claiming to be denser than those growing on shelves. It is simple mathematics: there is not as much surface area on a cylinder in the same cubic footage as shelves would provide. Circles do not maximize space usage in square rooms!

Other things to watch out for are companies that grow in vertical channels, the encasement of which takes up so much space that they are not able to achieve anything close to market-leading densities. Other companies will also fill their farms with preparation space, diminishing the growth capacity of their farms.

2. Form Factor
There are now many players in the space with a multitude of form factors. For now, let’s whittle it down to four: Pond greenhouses, Aquaponics¹, Warehouse growers, and Modular growers. We assess these different growers by their ability to control for contamination and space efficiency.

Pond greenhouses grow with sunlight (and at times some LED augmentation) and grow in one, large single pond. These growers are the most susceptible to contamination as all plants share the same room and water system. They also need a very large building as they only grow on one level, a costly and time consuming exercise (some take over 2.5 years to build one farm)!

Aquaponics growers come in many different shapes and sizes. Those which are modular (discussed below) may be interesting opportunities as they control for contamination. However, note that plants are provided nutrients from fish feces, which can lead to contamination. The water temperature at which fish live is in the upper 70s Fahrenheit, several degrees above what is ideal for lettuce, so these growers will be limited in what they can grow and the yields they can achieve.

Warehouse growers take advantage of the potential for density and can be some of the most efficient indoor farmers. As they are not constrained by modular buildings, labor can be slightly more efficient and automation can potentially be done at a greater scale. Watch out, however, as these growers have little control when it comes to contamination. If a pest gets into their warehouse and jumps from rack to rack, an entire building of produce could be lost or recalled, costing the company tens or hundreds of thousands of dollars. There are several examples of hydroponic warehouse growers that have lost entire operations to a single pest or pathogen, resulting in shutting down the entire building, ripping everything out and multi-million dollar losses.

Modular growers come in many flavors, from divided warehouses to shipping containers. These growers can find a balance between controlling for infestation while growing efficiently. They can also match warehouse growers for density. In whatever shape or size they come, this appears to be the preferred growing approach for indoor farming – assuming that density inside the modular unit can be achieved.

3. Energy Efficiency (g/KWH)
This is the largest part of the cost-of-goods sold of a labor efficient, completely indoor, growing operation. The common unit of measurement is how many grams of product a company can grow with one KWH of energy input.

The trick to watch is that many companies in the US have access to state-level agricultural energy pricing which can be as low as $.015 per KWH! This is cheaper than Saudi Arabia can produce and extremely subsidized. You must get at these numbers (all on the Web) and make sure the company you are reviewing is not ‘efficient’ because they simply have a low energy rate – which is likely to have some fixed end date. We’ve all suffered through the end of subsidies in other industries we’ve seen! If a company has a lower energy rate, it also means they have not optimized to reduce their energy consumption, likely making them uncompetitive in other markets.

Identify the number of grams that can be grown by the farm in a given month (and make sure these are real numbers over a minimum of a 3 month period,) then divide this by the number of KWH they consume per month. If the number is south of 40 or 50, do not proceed unless there is a very clear technology roadmap showing how the company will achieve these numbers soon.

4. Automation
The cost per unit of labor will only increase in many places where indoor agriculture is applied. Automation is a critical aspect of reducing COGS to increase Gross Margin. Some of the questions to ask are the following:

1. How many dollars are spent in labor to grow one pound of lettuce?
2. How many hours does it take one person to seed, transplant, harvest, pack, and clean per unit of production?
3. Does the company use automation, and do they own that technology?

You will quickly get a sense of who is the frontrunner by comparing answers to these questions.

5. Plant Science
Farms grow living organisms. As much as we want to put the framework of a factory on what an indoor farm does, the industry is not yet mature enough to produce widgets. An intelligent and experienced Plant Scientist is critical to any indoor farm being successful. Identify this person and understand their background, focusing on their knowledge, experience and ability to control mold/fungus/pests, growing indoors in controlled environment, and leveraging plant stressors for yield.

A perfect example of this is a facility growing a plant that propagates with cuttings, which has had tens of million dollars of investment. They contracted a fungus into their plants and could not identify how the fungus was propagating. It limited growth and lowered yield. A leading plant scientist would have the experience to identify the root cause of any pathogen, eliminate it and set up processes so that the pathogen never enters the farm again.

On the yield side of the plant science equation, the right person will understand every lever that can be pulled to increase yield and reduce costs. Light spectrum, humidity, CO2, various micro-nutrients, water oxygenation, micro-pulsing, shadow-less lighting, sunsetting/sunrising, photoperiod and much more not mentioned here. This can contribute to a 25-50% increase in yield over competition, something competitors cannot finance their way out of.

Look for companies that are building their competitive advantages around the non-commoditized aspects of growing – lighting, HVAC and automation have plenty of very clever people around the world who are focused on improving efficiency in their own industries. Vertical farmers should be taking advantage of these people’s innovations and be able to move quickly to adopt the latest technology, not trying to compete against them.

6. Commercial Approach
Brand is King. Those who have the consumer’s mindshare will be the ones to take home the value. Currently, grocery stores in the US are white-labeling many leafy green products so they can switch suppliers at will and reduce retail costs while maintaining margins. The consumer and the grocery store benefit, lettuce growers do not.

If the consumer is not aware of the brand of the company, the company is not worth financing. The company will never be able to have the leverage to negotiate the price necessary for a venture return and possibly not even a profitable business.

7. Speed of Evolution
How quickly can a company change technologies? LEDs, farm management practices and controls and different types of automation are developing exponentially, industry-wide. Can you responsibly invest in a company that takes over two years to build out their infrastructure?

The number of lumens/watt an LED produces is projected to quadruple in the next fifteen years, an annual compounded efficiency improvement rate of 10%. This means investing in a two-year project will result in having lighting technology that is 21% less efficient than new entrants.

There are additional items to consider, but this list will provide you a launching pad to make sure you invest in a solid company.

¹ We include Aquaponics as a form-factor as it necessitates larger tanks of water and a specific water temperature for the fish. As opposed to Aeroponics which can be done in any of the form factors.
B. David Vosburg is CFO and VP Strategy of Crop One Holdings, Inc., a holding company of indoor farming technologies and producer of highest quality leafy greens in the Boston, MA, USA area under its flagship brand, FreshBox Farms. Dave is a serial entrepreneur and has an MBA from Yale University.
David Vosburg is a member of the speaking faculty at GAI Middle East in Dubai, February 29 – March 2, 2016

The opinions expressed in this editorial are the authors’ own and do not reflect the views of GAI News.