The Van Trump Report

Indoor Ag Facing Crossroads of Hype and Reality

Following the recent termination of the proposed SPAC for AeroFarms, the sustainable indoor agriculture company based in Newark, New Jersey, along with the poor Q1 results from AppHarvest, the applied technology company building some of the world’s largest indoor farms, many VC investors might be having second thoughts about the “Controlled Environment Agriculture” space, or CEA. 

I should note, the AeroFarms’ SPAC falling through could have had as much, if not more, to do with the volatility of the public markets. At the same time, many public companies often miss their sales projections as AppHarvest did. But according to Henry Gordon-Smith, a sustainability strategist focused on urban agriculture, the news happened to coincide with his broader concern he’s had about the progression of the CEA sector in recent months. Smith lays out his view of the landscape in the CEA space rather well in a recent article in AgFunder that you can read HERE, a few of the highlights are below. Interesting to think about…

Seeking to shed some light on the sector, Smith believes the Gartner Hype Cycle may provide some insights into how the CEA space plays out moving forward. Placing the CEA sector in the context of this long-established pattern for industry growth cycles might help interested parties be better prepared for what’s coming next. According to Gartner, Hype Cycles offer a snapshot of the relative market promotion and perceived value of innovations. They highlight overhyped areas, estimate when innovations and trends will reach maturity, and provide actionable advice to help organizations decide when to adopt.

There are many reasons to stay positive about the sector as its technologies, including lighting, automation, climate control, and processing, have advanced significantly reducing the very high capital costs of these novel farming methods. Also, consumer and retailer interest in local and pesticide-free leafy greens has continued to grow, driving demand and sales, as well as premium price points proven by the fact that companies like Little Leaf Farms and Bowery Farming are leading sales in North America with their greens in thousands of stores already. Finally, the macro-level drivers for CEA, which include the impact of supply chain disruptions, climate change, and food safety concerns, are leading impact-driven investors and climate-sensible policymakers to push more money into the sector.

With that said, the bad news is these farms are still incredibly expensive to build and, while demand is rising, the sector is still immature in its capacity to build large farms in a timely fashion at a reasonable cost. This brings into question how fast vertical farming can responsibly grow… by the number of farms and by farm size, and according to some recent AgFunder data, there has been a decrease in the number of deals closing in the Novel Farming Systems category. 

VCs want CEAs to go big and it makes sense for them to do so in order to get the best economies of scale. The bigger they are the easier it is to form unique partnerships with equipment/technology suppliers so they can also unlock generous economic development incentive packages from local governments through their job growth narratives. The problem is they are finding a ton of risk in going “big”. Just like many of our larger outdoor row crop producers here in the Midwest have learned, bigger is not always better and more profitable, there’s a lot of risks involved. 

It’s now clear that making sure everyone is on board with the challenges of operations and learning to manage them effectively at scale, something that is taking more time than expected, was not shared as openly or knowingly as it should have been to start. The bottom line is that some of these big indoor farming operations are struggling to pay back their investors as quickly as they thought simply because they are running into many unforeseen complications at scale. 

We have to remember, as Smith points out, vertical farms and local greenhouses often handle every part of the business from training entirely new teams of employees to developing fleets of trucks to distribute locally. The logistics are much more complicated than meets the eye and are in stark contrast to traditional farming models, which rely on less expensive labor, more readily available government subsidies, and a wider range of outsourced marketing and sales opportunities. In other words, they are needing to find more skilled and educated workers to run some of the high-tech indoor models. That has become a bigger hurdle than anticipated. At the same time, the logistics of “the last mile” are proving to be extremely difficult, and finding outlets and buyers for their indoor crops can be much more difficult than anticipated.  

Smith makes another great point that is starting to negatively impact CEA growth is that as each company grows and gets more money from Wall Street as well as pressure to outperform one another, they become less collaborative and much more secretive. I’m told that data sharing is relatively common in the CEA sector, that is until the farms raise any significant amount of money then they become more closed off, and like we have experienced a bit in our own space, it stifles innovation and learnings at an industry level.

Hype is also an enemy of the space, and according to the 2021 Global CEA Census, 70% of farming operators agreed that CEA is “susceptible to excessive greenwashing,” meaning over-hyping to CEAs are going to keep the planet safe. What could also be holding certain companies back is the fact that 49% of operators had zero years of prior farming experience, and 73% of them would opt to change the equipment, technology, or crops they selected if they could go back in time. 

Gartner defines the “Peak of Inflated Expectations” as a wave of buzz builds and expectations for new innovations rise above the current reality of its capabilities. Pretty much the perfect definition of where the CEA industry finds itself at the moment, so if you believe in Gartner’s chart, a period of depression and correction are coming next. Smith believes this could be a good thing as only the smartest will survive, meaning that for investors who have held out or spread their risk across the sector, they should begin to see a new industry chapter where mergers and acquisitions occur and we’ll begin to see more honest valuations, healthier economics, better-planned facilities, and responsible growth plans. All to say there could be more opportunities for investors to get in with startups once it all shakes out.

In my opinion CEA is here to stay and money will once again roll into the space, especially as tech continues to innovate and the narrative for sustainably grown food is marketed. I’ve been saying for a while, I think there might be some plays for those farms that are close enough to population centers, to put some acres towards indoor farming. Definitely, something to think about as markets exist and folks are looking to diversify. I also included one of Gartner’s graphics showing where other emerging tech falls on the cycle. I think if the space consolidates and rolls up a few of the less efficient early-operators there could be some interesting investing opportunities.

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