Tom Wilkens, CEO of CopperHill Partners, leaned back in ...



Vehizero hybrid delivery vehicle

INTRODUCTION

Tom Wilkens, founding partner of CopperHill Ventures, leaned back in his hotel room’s lounge chair and tried to absorb all he had taken in over the past week. It had been a whirlwind of activity since he and his team had touched down in México City. Just outside the trendy Polanco district, on a leafy side street lined with bakeries and news vendors, Wilkens had conducted around-the-clock due diligence sessions with the management team at Vehizero, S.A., a Mexican start-up looking to be the first mover in the emerging Mexican electric delivery vehicle market.

Trouble was, after all the fact-finding and number crunching, he knew the sensation in his gut he felt when he was onto something hot. A challenging and demanding venture. Although exciting,

definitely not something to go into lightly. Vehizero was onto something good, of that he was certain. The young start-up's commitment to business success combined with social and environmental improvements in Mexico matched up nicely with CopperHill's corporate mission to generate high financial returns as well as high social and environmental impact in developing economies.

But what role CopperHill could play in Vehizero’s growth, and how explosive that growth would be - these things were less certain. Tom closed his eyes and wished for the twentieth time that day for a decent night’s sleep. Realizing this was impossible, he splashed some water on his face, sharpened his pencil, and settled in for another long night.

Vehizero, S.A.

Vehizero, S.A. was founded by a successful oil futures trader looking for something more rewarding than landing 3/8ths spreads on his hundreds of daily trades. Sean O’Hea had graduated from Universidad Iberoamericana’s chemical engineering program when he took the job with Pemex[1]. He made his mark making markets for the huge Mexican exploration and production company in the highly active – and equally lucrative – international oil and gas industry. Once the excitement of trading futures wore off, he had packed up his deal toys and mementos and headed out on his own. After first founding a battery research and development firm, O’Hea then secured the commitment of several friends with similar engineering backgrounds and started Vehizero with a combination of his own capital and that of a handful of energy industry acquaintances confident in his business and financial acumen.

Vehizero was formed with the express intent of becoming the first Mexican commercial vehicle manufacturer to fully integrate electric car technologies and traditional internal combustion engines - creating a locally designed and assembled hybrid delivery vehicle. By designing and producing the batteries, electric motors, control systems and other component parts for the

ECCO, Vehizero hoped to carve out a niche as a locally owned and operated manufacturer in México’s 75,000 unit per year one ton delivery vehicle market; a market which had grown over 13% per year on average since 1993 (See Exhibit A).

Management believed being locally owned and operated would serve as a potentially sustainable competitive advantage for the start-up as it strove to break into a market largely dominated by Nissan and General Motors, who together commanded nearly three quarters of the market in 2000. Vehizero anticipated other advantages to their Mexican locale as well – in operations (lower cost structure because the vehicles were produced entirely in México) and in sales and marketing (local press coverage and increased customer interest because they were a Mexican entity). Once sales to the large bread, confectionary, and beverage industries began to materialize, O’Hea and his team intended to expand output at its soon to be constructed assembly facility in the city of Puebla, 90 miles (150 KM) east of México City, where Vehizero had been granted some 17 hectares of land by the state government for their facility.

There was more to Vehizero’s business plan, however. The management team had a second, equally important mission – to produce a hybrid delivery vehicle that would have a positive social impact on the Mexican economy (by creating new jobs) and its environment (by reducing pollution). Presentations at New Ventures Investors Forum[2] and the World Resources Institute’s Investors Forum[3] had made it clear to Vehizero’s management team that socially conscious ventures were not only sought by developing economies but by numerous players in the investment community evaluating projects in these markets. And by the Mexican government, which had supported testing and the granting of necessary permits and licenses.

Copper colored and emblazoned with the distinctive Vehizero logo, Vehizero, S.A.’s first hybrid vehicle - the ECCO1 - was a sharp-looking one ton delivery vehicle capable of delivering 1,000 kg (2,200 lbs) of cargo, with a top speed of 90 km (56 miles) per hour over an 80 km (50 mile) route (Please see Exhibit B). Through the use of the on-board auxiliary combustion engine, that range could be extended to over 120 km (75 miles). O’Hea and his Director of Engineering, Enrique Vignau Ruiz, had developed a “switching” system of software which effectively monitored the power level in the electric battery bank, and automatically engaged the internal combustion engine when electric power levels were insufficient.

Vehizero’s true operations, though, would be to assemble these vehicles from component parts, locally produced by strategically aligned companies to meet Vehizero’s engineering specifications. Cheaper than importing from America or Japan, sourcing locally manufactured parts offered protection from currency fluctuation, and the potential for additional government subsidies and tax breaks. More than sufficient to meet the needs of México City’s urban delivery industries[4], Vehizero hoped to appeal to the increasingly environmentally conscious Mexican industrial consumer through ECCO’s ability to provide ample speed and distance capabilities at one-fifth the CO2 emission levels of a comparable internal combustion-powered vehicle.

Recent legislation by the administration of Mexican president Vicente Fox had restricted internal-combustion vehicles to four days of driving per workweek – effectively limiting fleets of internal combustion delivery vehicles to a maximum 80% utilization. In addition, the electric vehicle road tax was less than one tenth of the road tax placed on traditional internal combustion vehicles[5]. These legal developments gave Vehizero the combined advantage of being both locally owned and operated, and being on the “right” side of new environmentally conscious legislative efforts. By forging ahead with research and development efforts, O’Hea and his team hoped to leverage both their proprietary technologies and status as a homegrown manufacturer into modest commercial success (For more information regarding Vehizero’s management team, please see Exhibit D).

Political and economic situation

Vicente Fox of the National Action Party (PAN) was inaugurated as president of México in December 2000, ending decades of uninterrupted rule by the Institutional Revolutionary Party (PRI). Mr. Fox successfully managed a smooth transition that has led to unprecedented political and economic stability. His reforms resulted in positive developments for México, domestically and internationally, that have helped strengthen the peso, lower inflation, maintain low interest rates, and attract new foreign direct investment. Tight monetary control by Banco de México, the central bank, and Fox’s call for “a break from corruption as ‘the favored instrument of control’”[6] are responsible for much of the stability.

Due to these improvements, México’s financial outlook has stabilized substantially since 1998. However, the country’s economy is largely dependent on the United States and has been adversely affected by the U.S. economic downturn. After achieving GDP growth of nearly 7% in 2000, 2001 showed a 0.4% decline. Analysts expect growth to resume in 2002 to 2%.[7]

In 2001, México’s corruption rank on Transparency International’s (TI) Corruption Perception Index (CPI) improved from 59 (out of 90 countries ranked) in 2000 to 51 (out of 91 countries ranked). The CPI scores that determine the ranking range from zero (highly corrupt) to ten (highly clean.) In 2001, México’s score increased to 3.7 from 3.3 in 2000. As depicted in the table below, 2001, México has made significant improvement since 1997. The 2001 jump reflects the aggressive anti-corruption reforms put in place under the Fox administration.

|Year |TI CPI Score |

|1997 |2.7 |

|1998 |3.3 |

|1999 |3.4 |

|2000 |3.3 |

|2001 |3.7 |

There are, however, pressing infrastructure needs. Fox has encountered stiff opposition in México's Congress that has blocked his plans to reform and liberalize the energy and telecommunications industries. A third of government revenue is derived from oil exports, making the national budget vulnerable to oil price fluctuations and dependent upon global oil consumption and the Mexican companies servicing this market.

Pollution and environmental initiatives

México City contains nearly one third of México’s population and generates a substantial fraction of the country’s GDP. Mountains surround the region and its hot, sedate climate is an incubator for toxic air pollutants. In addition, the area has experienced rapid urban sprawl and a population increase from about 5 million in the 1950’s to over 20 million in 2000.[8] Weak environmental policy enforcement has led to what some consider the worst air pollution in the world (Please see Exhibit F). Over half of México’s air pollution problems stem from transportation related effects.

As a result, México City finds itself in desperate need of remedies for two of its most pressing problems: air quality and mobility. It is addressing problems of fuel efficiency and fuel switching in transportation as well as other energy consumption sectors. Fuel efficiency in automobiles is important, and could be driven by regulations or market mechanisms.

Current initiative in México

The Mexican government has presented several proposals for fighting air pollution, including incentives for using cleaner fuels and smog control measures. In urban centers, private car drivers are required to have catalytic converters or refrain from driving one day a week. Commercial vehicles powered by internal combustion engines (catalytic converter or not) were also required to be idle one day per workweek. The Environment Secretary for México City is planning to launch the city’s first long-term pollution control program, creating incentives for the owners of approximately 2 million older vehicles to upgrade to newer models, and for companies to invest in cleaner vehicles. In addition, dozens of manufacturers are taking advantage of government subsidies to upgrade gasoline powered delivery trucks with cleaner fuels. The pollution fighting measures put in place in the mid-1990s have already improved visibility and air quality in some areas, but are weakly enforced and have a long way to go.[9]

Mexican environmental initiatives include developing clean taxis and small buses in order to reduce urban emissions; improving environmental infrastructure; and strengthening the northern border regions' environmental planning and administration. In México City, environmental authorities are implementing "Proaire", a ten-year quality management program for the metropolitan area starting this year.

Vehizero’s Forecasts

The management team at Vehizero was targeting a true niche position in the commercial delivery truck market. Their internal forecasts called for achieving approximately 2% penetration in the growing segment within five years. The plans for Vehizero’s production facility in Puebla would, however, allow them to assemble up to 8,000 vehicles annually – upwards of 10% of the projected one-ton delivery vehicle market.

Given the highly competitive marketplace for delivery vehicles, Vehizero did not anticipate being able to charge a price premium despite the economic and environmental benefits associated with ownership of a hybrid vehicle. Pricing the ECCO1 at $13,500, initial margin projections were negative, though expected to widen to roughly 5% once production levels were ramped to approximately 1,000 vehicles per year.

With their current parts sources, Vehizero forecasts a per unit cost of production of approximately $14,000. They continue to actively seek lower cost suppliers and anticipate being able to achieve significant cost reductions as volume increased. One key component that significantly impacted unit costs was the cost of the battery pack powering the electric drive train. Vehizero had been unable to locate a local supplier and had sourced batteries for its prototypes from an American battery supplier. They anticipated a domestic supplier would substantially reduce the unit costs.

Although Vehizero had been ceded the land in Puebla for the production facility, the cost of actually constructing the assembly plant was estimated at $1.8 MM. As a result of the environmental impact of the project, the management had been approved an accelerated depreciation schedule of five years for all of its capital expenditures involved in the construction and equipping of the factory.

The immediate task Vehizero needed to complete, however, was fundraising. They were actively seeking initial investment of $0.3 to $0.5 million to fund completion of their prototypes and construction of a “loaner” that could be used in marketing the vehicles to key potential customers in Mexico City. After attracting some initial customer interest, they anticipated needing an addition $3.0 million to build the factory, purchase the equipment and provide working capital for the start of production.

Conclusion

Tom Wilkens was therefore faced with a number of difficult decisions. First, how could Vehizero implement its business strategy to generate sufficient financial return for his socially conscious but financially savvy investors. Second, what would be the best way to mitigate the risks of the Mexican marketplace and the inherent riskiness of a start-up enterprise? There were a number of socially responsible investors looking for opportunities in emerging markets, but what level and type of participation would be needed for their support of the Puebla expansion was not something Wilkens had determined. What was certain, however, was that Vehizero’s opportunities beyond the 1-ton delivery vehicle market would need to be critically evaluated and quantified.

EXHIBIT A

Méxican Commercial Truck Market

EXHIBIT B

Vehizero’s ECCO1

EXHIBIT C

ECCO vs. Internal Combustion Vehicle

EXHIBIT D

Vehizero Management Team

Sean D. O’Hea, CEO

Mr. O’Hea brings a wealth of industry experience in the design and manufacture of lead-acid batteries. He is the major shareholder of Grupo Volta Evante S.A. de C.V., a battery design and manufacturing company in México City that specializes in deep cycle lead-acid batteries. Mr. O’Hea is also the largest single shareholder in Vehizero, S.A, with a 34% stake in the firm. He has collaborated with other industry professionals in development projects; a hybrid bus for México City being one such project. Mr. O’Hea’s primary responsibility at Vehizero is the research and development of technologically improved lead-acid batteries. Mr. O’Hea holds a BS in Chemical Engineering from Universidad Iberoamerican A.C.

Enrique Vignau Ruiz, Director of Engineering

Mr. Vignau has extensive experience in the development of electronics technologies capable of controlling and regulating the flow of electric currents. He is responsible for the design and manufacture of ECCO’s Electronic Central Energy Management System, the electronics equipment required to manage the electric vehicle’s energy capabilities. He is a principle of Smart Products, S.A de C.V., a company specializing in the design, manufacture, and servicing of electronic billboards, and owns a one third stake of Vehizero. Mr. Vignau holds a degree in electro-mechanical engineering from México’s Universidad Nacional Autonoma de México.

Jorge Ruiz Vera, CFO

Mr. Ruiz owns and operates three separate entities that specialize in the design and manufacture of electronics parts and equipment, such as photo timers, LED based traffic signals and electronic displays. He is a veteran of Texas Instruments de México S.A. de C.V., as a member of their Quality Control and Engineering departments, and as a product and sales manager. Mr. Ruiz is focused on developing advanced electronics systems for Vehizero, of which he is a one third owner. Mr. Ruiz graduated México’s Universidad Nacional Autonoma with an electro-mechanical engineering degree.

Angel Tellez, Design Chief

Mr. Tellez has extensive experience in the Mexican automotive industry, including the design, production, assembly plant layout, production line development and engineering for several high profile Mexican firms, including Capre S.A. de C.V., Dina S.A. de C.V., and Grupo Industrial CASA S.A. de C.V., the largest Mexican bus maker. He has also been heavily involved in the design of a number of vehicle prototypes, including the designing of a vehicle similar to the Chrysler Mini-Van. Mr. Tellez holds a Masters in Industrial Design from the Universidad Nacional Autonoma de México and is a Professor of Design at Universidad Anahuac A.C.

EXHIBIT E

Venture Capital in México

|Venture Capital Firms in México | |% Total VC Market |

| | | |

|Hicks, Muse, Tate & Furst | |18% |

| | | |

|J.P. Morgan Capital | |14% |

| | | |

|CVC Latin America | |10% |

| | | |

|Blackstone Group | |10% |

| | | |

|Newbridge Latin America | |7% |

| | | |

|Advent International | |6% |

| | | |

|Barings Venture Capital | | ................
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