Aquila’s Australian Dairy Strategy

German alternative-assets firm Aquila Capital has its sights firmly on the Australian dairy farm market, as it aims to take advantage of a funding gap and booming demand for dairy products from middle-class consumers in Asia.

Aquila started looking at agriculture investments about seven years ago. As of September 2014, the firm had $440M in farming investments, including about 39,000 cows.

Group head of farm investments Detlef Schön says the firm cast a wide net, looking worldwide for the right place to invest. Once political and ownership risks were eliminated, few markets were left, and the firm invested heavily in New Zealand.

However, after years of strong investment and competition for farmland assets, as well as appreciation in the local currency, New Zealand is no longer looking cheap. So Aquila has turned its attention to Australia, where Schön says agricultural land is now 40 to 50 percent cheaper than in New Zealand. He expects that gap to narrow in the coming years.

Aquila, in a 2014 statement, suggested that the Australian dairy sector could offer the best risk-adjusted returns in global agriculture, with annual IRRs of 11 to 16 percent in coming years.

Schön says generational change in the Australian farming sector is providing ample opportunity for private investment in the sector. The next generation of farmers often needs capital to buy out parents or siblings who hold shares in family-owned farms, to make improvements, or to expand their businesses.

At the same time, the growing appetite for dairy products from the world’s booming middle class in markets like China and India provides a strong customer base for the products.

Schön says farmland investments can be viewed from two different perspectives—as a real estate investment or as a private-equity-style investment. Aquila takes the private equity view. Much of the opportunity in agriculture comes from asset management, Schön says, rather than pure capital appreciation.

He says the firm likes to find opportunities for value creation and capital appreciation that are “self-engineered” and not based on macro trends.

In this case, that means finding “undercapitalized, under-loved” properties and investing in them to increase production per hectare, building their value, then selling the assets to investors who are more interested in a long-term steady income stream, such as a pension fund or an insurance group.

Adding value to a property, through a process Schön describes as “project management,” can mean lowering unit costs by adding scale to an enterprise, or taking actions like converting sheep or cropland to dairy farming land, which is of higher value.

Aquila takes a majority investment in farming enterprises, providing capital for improvements and expansion. He says the firm learned its lessons in New Zealand, where it was “policing” around 40 farms. Partnering with farmers and offering a strong alignment of interests worked far better.

The firm now uses a model with a preferred return of around 3 percent (depending on the country). Above a certain return, the farmer gets a higher share of the profit. Schön says this means the firm can monitor performance rather than driving it.

Aquila is raising an opportunistic fund with a hard cap of $400M. Schön says many of the firm’s investors still come from Germany, with a growing number from Asia and the Middle East. He also expects to target U.S. investors through a compliant feeder fund in early 2015.