Q&A: Blue Sky on supply chains, organics and exit strategies

Australian alternative investment manager Blue Sky is launching a co-investment fund targeting assets along the grain supply chain. Blue Sky Agriculture Fund III will focus exclusively on assets supplying grain to or held within organic grains processing company and exporter, Kialla Pure Foods in Queensland. We catch up with investment director Michael Blakeney to find out how much the fund will target, how interests in the assets will be split and what the fund’s exit timetable looks like.

Why have you invested in a vertically integrated company from your latest fund?

Blue Sky Agricultural Fund III is co-investing in the Kialla Group, which owns the organic grain milling facilities, Kialla Pure Foods and Aus Organic Feeds. The fund is taking roughly 30 percent of Kialla Group, with the operating partners retaining 70 percent. The farming joint venture is split so that it is roughly 20 percent Kialla-owned and 80-percent Blue Sky-owned. There is good alignment across both businesses.

If you look at our Blue Sky Agriculture Fund I, an irrigated cotton development, we co-invested alongside [Customised Farm Management]. In Blue Sky Agriculture Fund II, an irrigated citrus re-development, we also co-invested alongside the management team [Southern Cross Farms] and are providing expansion capital rather than exit capital. We are about expanding agricultural businesses, undertaking farmland development alongside operating partners. By partnering with professional, commercial businesses and operating partners in the agri supply chain you’ve got a better chance of generating superior returns. 

What does this mean for the fund’s strategy?

The fund is closed-ended with a target horizon between four and six years, so it’s a reasonably short investment time period for agri. It will have a similar investor base to what we have attracted historically. The size is smaller than it might be for an institutional raise – around A$12 million – so it is suited to mid-size funds, family offices and high net worth individuals. We view it as part of our agribusiness private equity strategy and it is consistent with a number of the other investments we’ve made in terms of co-investing, expansion capital and farmland development.

Our exit is focused on growing the agribusiness and when appropriate selling our share, to either a trade buyer or secondary/fund that is aggregating these type of opportunities. Kialla’s management team have the option to exit with us or continue growing with a new shareholder – it is not pre-determined. We are very aware that we don’t want any transfer pricing-type issues to arise because both investments need to stand on their own two feet as separate structures.

Why is the time set for the fund flexible at up to six years, and why are you investing in an organic supply chain?

In emerging industries such as the organic grain supply industry, the price signals and change from conventional growing to an organic farming system can drag. One of the advantages to this investment is that it is building into baseline volumes to the milling process, and adding to the existing population of growers supplying Kialla and starting to transition. We are speeding up that transition by providing a reasonable percentage of baseline volume. We wish to remain flexible [on our] exit as there has been considerable activity in the sector and opportunities to deliver our target returns may be actioned earlier than six years.

We like that this integrated model incorporates all the components of Blue Sky’s overall asset strategy; that there are water rights involved, farmland conversion going on — in this case from conventional to irrigated organic grain production, and that there is agricultural infrastructure in the milling facilities. We have premium export markets showing strong and sustainable growth. By combining all those components we believe we mitigate the risks associated with investing in just one part of the supply chain. We don’t argue that integrated agribusiness chains are appropriate to every commodity type or business, but in emerging industries such as the organic sector there is often an advantage to having an integrated supply chain.

We see a lot of M&A activity in North America in integrated organic businesses, and believe similar opportunities will transfer to Australia given that a lot of unmet demand for these premium, ‘natural’ or ‘better for you’ food products, is coming from north Asian economies undergoing market transition. Demand for food products with traceability and provenance that are perceived to be sustainably produced is growing globally. Global organic businesses such as Hain Celestial, have had significant M&A activity, and there are a number of others, including multinationals who are moving into the sector.