Input Capital Corp: If You Build it, Farmers Will Come… [Part II] by Above Average Odds Investing

Now onto Part 2 of our ongoing series on Input Capital…
 
Editors Note: Like part 1, part 2 was originally authored towards the end of last year and is therefore dated. Nonetheless, for those looking to garner a number of unique qualitative insights into what makes this one of a kind business special, Part 2 remains every bit as applicable as the day it was written.   
 
As Input Builds It, the Farmers Will Come

We then arrive at music, the knowledge of harmony. Are the parts concordant with the whole, and is the whole concordant with the world at large? How does the business harmonize with its community, employees, competitors, shareholders and the environment?

                              – Chris Begg, East Coast Asset Management

In part one of our ongoing analysis on Input Capital, we laid out the high-level case for Input in our usual qualitatively focused manner.  In part two, we’ll kick things off with a discussion on why we believe Input has all the pieces in place to become a billion dollar company over the next five years. Indeed, we expect Input to navigate the path to a billion with relative ease. If that sounds crazy, humor us for a moment as we flesh out and illuminate a number of qualitative insights that should make it sound decidedly less so (if not downright reasonable).

For example, to become a billion dollar company, we figure Input will have to raise ~$250m and deploy ~$300 to $400m in total over the next five years, with the difference between the two figures coming from the redeployment of internally generated cash flow. Furthermore, if the average deal Input inks going forward amounts to ~$1 to $2 million, so an amount in line with what we’ve seen so far, we can reasonably figure Input Capital will need to source ~150 to 200 individual streams between now and the end of year five.

Yet, each of these streams represents a decision by both the farmer and Input.  As such, part two of the Input Capital thesis will focus on the fabulous economics for both the farmer and Input as well as reiterate the multi-layered downside protection embedded in Input’s business model. After all, in our mind handicapping the road to a billion largely comes down to answering two questions with conviction.

  1. Will the average cash strapped Western Canadian small farmer with a self identified need for working capital find Input’s value proposition compelling?
  2. Will private capital looking to invest in the agricultural sector view financing Input’s streams as an attractive investment on both an absolute basis and relative to other options in the space?

Regarding the first question, our analysis tells us the answer is a resounding yes. More like a F*ck yeah followed with a fist pump, but hey, why split hairs here. In all seriousness though, given these deals appear to unlock a tremendous amount of value on a regular and ongoing basis for farmers (see the detailed breakdown on said topic below), the idea that Input would have trouble sourcing a few hundred partners out of an addressable market that stands 50k+ strong in Western Canada alone is simply not credible. In fact, I wouldn’t be surprised to see Input Capital do 200 streams in a single season a couple years from now once the concept of ag streaming is well known and broadly understood.

As far as the second question, again, the idea that Input would have trouble sourcing ~$250m over the next five years is absolutely preposterous given the risk-adjusted return profile associated with these deals are about as good as it get’s on an absolute basis. The thing is, approaching the question from a relative basis is even sillier. After all, from what I can tell ag streaming appears to generate the highest returns on capital across the entire agricultural value chain!! So maybe its me, but the idea that Input will have trouble raising a mere $250m in total over the next five years doesn’t pass the smell test. Heck, if low quality E&P wildcatters can raise ten’s of billions overpaying for third rate shale assets, Input shouldn’t have too much trouble hitting the above goal.

At any rate, the thesis with Input remains the same, as it is very much a business that “deserves to win” (as the guys over at East Coast Asset Management recently put it). And why wouldn’t they! Given the company has created the proverbial key that fits mom and pop canola farmers “productivity unleashing lock”, we envision an environment where everyone involved should thrive. Indeed, we expect the company’s breakthrough value proposition will create tremendous amounts of wealth for all involved for many years to come.    

Farm Level Economics: Why the Heck would a Farmer give up 40% to 50% of his most profitable crop?

With over 50,000 canola farmers in Western Canada, the market is not institutionalized with the average farm in the range of 3,000 acres. Modern farming requires a significant amount of capital (land, labor, equipment, seed, fertilizer, water, etc.) which is by no means cheap. Additionally, in a farming family the working capital of a farm is stripped out every generation for Mom & Dad’s retirement.

And while the truck commercials we watch every Sunday during NFL games (Shout out to your Editor’s undefeated hometown KC Chiefs!) romanticize farming, the capital intensity of the business often means a farmer is attempting to keep all the proverbial plates spinning by “robbing Peter to pay Paul”. Perhaps it’s a bank line that is able to be drawn to pay for some new equipment, or taking a new tractor with a note instead of scrimping on high quality seed this year, and so it goes. The truth is the vast majority of Western Canadian farmers are not properly capitalized and typically find themselves busting their tails simply to make ends meet.

You may ask: isn’t there alternative financing available to farmers that doesn’t give a 30% IRR to the financier?  The answer is yes but only for certain types of assets.  Acreage can be mortgaged, equipment financing is available through the manufacturers, and there is seed & fertilizer credit available from the crushers and grain elevators on undesirable terms.

For example, there is only traditional fertilizer credit available two weeks before planting season so the farmers don’t blow the capital on something else… Guess who knows that?  Fertilizer companies.  So the price of fertilizer rises dramatically when the credit is available thus dis-incentivizing the farmer from purchasing the optimal amount.

So what can a farmer really cut back on?  They need land, large farm equipment to harvest the crop at the optimal time, obviously they need labor and water to grow the crop. So again, what are the only variables that farmers can cut back on?  That’s right – fertilizer and seeds (of the less productive and reliable variety) – the inputs that offer the highest returns on incremental capital (by many orders of magnitude) and that at the end of the day, make all the difference. I guess they can take solace they’re still in the game, but I think

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