Overcoming the Investment Status-Quo - Sunk Cost Vested Interest

Ocean-going aquaculture vessel nearing completion

As my cherished readers will know, I have been working with colleagues from Pan Ocean Aquaculture to raise equity and debt financing for the Marinova project. For those unfamiliar with the Marinova project – here is a link to an article which provides an overview of our efforts.

We’ve only been at it for a few months but are starting to have some traction – particularly on the debt side – the bulk tankers we are planning to use are insurable assets that qualify for financial instruments that would mostly not apply to fixed-position floating or land-based salmon farming structures. Additionally, if farming plans do not play out as we expect, they can be put back to work in their originally intended purpose. You wouldn’t end up with a gigantic building in the middle of tomato fields, with major questions about what to do next, if you can’t make it work as a salmon farm. Just saying.

Our discussions with potential investors have been interesting. A few key themes have stood out:

Overcoming skepticism – many investors in the seafood and aquaculture investment sectors come to the table with firm pre-conceived notions of how aquaculture development will look. Generally, this falls into two categories – land-based and offshore fixed position systems. (There is minor interest in floating closed containment but to some extent, these systems combine the worst of both worlds – the complexity and risk of a closed containment system operating on an expensive seawater concession requiring high-cost logistics and services). Unless you have an established relationship with them and if they agree to meet, you will have 30 minutes to make your pitch stick. If that first 30 minutes is spent convincing them that the basic premise is feasible, you are lost.

Proving the economics – if your world view about aquaculture vessels was formed in the aquaculture sector, you come to the table knowing a few truths -  vessels are obscenely expensive and get more expensive the bigger they get, can only be managed by high-priced Norwegian experts who exist at the top of the aquaculture food chain, and are operated by companies with massive profit margins. Proving that these “truths” are more a function of an industry with obscene barriers to entry, than they are of actual economics, is another time-sink in proving your case. Publicly available information proves that none of these “truths” are remotely true. The economics of large ocean-going vessels only get better as vessels get bigger.

Sample of values assigned to aquaculture consents

Regulatory environment – another “truth” that investors bring to the table is that long lead-times, complicated regulations and expensive, hard-to-obtain farming consents are a normal cost of doing business. The balance sheets of most publicly traded salmon farming companies ascribe enormous value to having secured these consents. These values represent only the right to be in business, with farming assets, livestock and every other actual productive asset being additional. Regulators struggle with the notion of how to regulate an operation that doesn’t conform to their existing paradigm and come to the table with a notion that the responsibility for conforming to existing structures rests with the operator, not with the regulator. Investors and fund managers have often internalized a similar world view – the idea that aquaculture can be conducted with a level of oversight more akin to traditional fishing and agriculture is simply inconceivable.

For the most part, I think overcoming these kinds of issues is just a normal part of raising investment capital – particularly for new and innovative projects. Investors like a proven concept with known risks, even if that concept comes with high costs and relies on an environment where market prices and barriers to entry remain sky-high.

Sunk Cost Vested Interest

I was chatting by email with a connection the other day about efforts to raise capital. This person worked as a fund/investment manager for several years before moving over to the dark side of being financial manager for a start-up. We’ve had a couple of these conversations, and his perspective, gained from having sat on both sides of the investment table, is unique. (At least in my network, which is populated mostly by hardcore seafood nerds)

One of the things we discussed was a response we have heard a few times from potential investors – “we have decided to pass on this opportunity as we plan to focus our investments on land-based aquaculture”.  I asked him how an investment fund would arrive at the conclusion that land-based aquaculture was where they wanted to place their bet on future profitability.

I gripe about this all of the time but bear with me – while some land-based salmon farming projects are starting to show promise and may, in time, provide solid returns on investment, it is still a sector that is more characterized by escalating costs, uncertain permitting and limited scalability in most regions, poor biological results, enormous financial losses and a business model that will rely on prices being perpetually high. Given these demonstrable factors, how does an investment fund arrive at the conclusion that land-based aquaculture is where they want to place their bet?

I think there are likely quite a few factors at play. I covered some of them in a blog post a few weeks ago about why land-based projects are currently winning the investment race. An argument can be made that logistics are simpler on land and when something goes wrong with your fish, you have an immediate ability to react and correct the situation. Which, I think, betrays a profound misunderstanding of the tools available to salmon farms for dealing with livestock problems. With the population density in a commercial salmon farm, their relatively remote locations, and the insane speed at which fish can go from happy to dead are common themes in all production systems. Land based farms potentially spare operators from certain threats – sea lice, jellyfish, plankton – but they increase the density of production and rely on artificially injected oxygen etc. There is a constant risk that things can go sideways at a surprising pace.

The one comment my colleague made that had me scratching my head was that there was an element of “sunk cost vested interest’, at least with some funds, in their conviction that land-based farming was the horse to bet on. Unpacking this phrase a bit:

Sunk cost – if, for example, you were a fund that had taken a major bet on Atlantic Sapphire when valuations were at their peak 10 years ago, your investment, currently worthless, could potentially regain value if you stuck with it and supported the business during their, hopefully successful, journey to profitability. Certainly, if you sold your shares today, they would be worth nothing and, if the company needs additional investment, you might be inclined to provide additional investment in the hope that your sunk costs could eventually be recovered. My beloved custom ChatGPT describes this as the “sunk cost fallacy” of continuing to pour money into a business to justify earlier investments.

Vested Interest – this is a common term. The suggestion from my colleague was that once a certain investment thesis has been espoused publicly and becomes a key theme in the reputation of a professional fund manager or investment fund. Analysts and investment fund managers have been making bold claims about land-based salmon farming for a long time. If you were to turn around and invest in a system that is the opposite of a land-based farm, it would be akin to admitting that you were wrong about your initial investment thesis. To a certain extent, I think we all do this – I have been flapping my gums publicly for many years about how the future for aquaculture development needs to be in the open ocean. If I were to turn around tomorrow and start trying to convince both of my regular readers and investors that the future was in land-based systems, I would have very little credibility and all my previous statements to the contrary would haunt me. Related to this, here is some interesting recent commentary from the founder of Atlantic Sapphire.

I guess this is a normal experience for anyone trying to generate interest in a novel approach or technology. I imagine people seeking investment in digital cameras or microcomputers would have encountered a preference to invest in proven film-based camera companies or in leading-edge typewriter outfits. Both were profitable, established business lines – this might be where my example falls apart – and the future seemed bright in terms of continued innovation and improvements. In the end, both were utterly upended by the arrival of novel technology. Going back to the investment ecosystem discussion, reputations would have been gained and fortunes earned by successful investments in typewriters and cameras right up until they were lost.

Vessel-based offshore systems are going to disrupt the salmon industry

Bay Area Lingding

I have a reputational vested interest and a sunk cost in terms of the work I have put into making the Marinova project a success, so take my comments with a grain of salt. (Or ignore them entirely, if you’ve read this far, I’m going to assume you are somewhat amenable to my views) That being said, I think vessel-based salmon farming in international waters will upend salmon production globally in the next 10 – 15 years.

Hopefully, the Marinova project will be part of this future, but in the past few weeks, I have learned about 6 vessel-based farming systems in operation or under construction in China representing somewhere in excess of $250m US invested in developing a technology that can farm fish anywhere in any ocean on the planet. To this point, salmon farming has been confined to a narrow band of near shore waters and has required a goldilocks combination of not too much current, not too little, not too much exposure to the open ocean, and not too little, not too warm, not too cold, not in use by someone else etc. Mobile, vessel-based systems will open up vast regions of the ocean - not exactly unlimited, but compared to today’s constraints and barriers to entry, pretty close to unlimited.

One of my colleagues was in discussion today with China’s largest privately owned shipyard regarding vessel conversions. This shipyard has 4 dry-docks that can accommodate 4 Panamax bulk tankers each. Theoretically, they can produce 16 vessel conversions in one year. That’s potentially 64,000 gross tons of salmon produced annually by vessels from that shipyard alone. There are literally dozens of shipyards in China capable of producing at that scale. Once a fully working design has been developed, you should have no doubt that production will ramp up dramatically. They already have 2 - 3 year head-start on current salmon industry salmon industry participants.

Existing international laws exist to enable extremely rapid growth of a vessel-based salmon farming system, the oceans are vast and can accommodate many vessels without conflict, the transportation of eyed salmon eggs is cheap and reliable, and if you set your mind to it, a low-cost freshwater infrastructure is easy and quick to build – just ask the Chileans. As the largest global producer of seafood, there should be no question that China can and will move into salmon in a big way.

Guoxin Vessel

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