08-19-2003
Matchmaking: Linking DE Firms and Investors
Nat Treadway. DEFG Managing Partner, appears in the August 19, 2003 EnergyPulse
Entrepreneurs need financial backing, and investors need information about which technologies have the potential to be tomorrow’s winners. These two communities require a credible information broker to bring them together.
In established markets the capabilities of the players are well understood, but in the market for "distributed energy" (DE), the players, technologies, and services are in flux. How can investors learn about DE firms? How can entrepreneurs meet the needs of customers and sell a compelling vision of the future to investors? How can the need for a matchmaker be satisfied?
The troubled energy industries badly need new solutions, and distributed energy is growing in importance. Many DE technologies are reliable and available at reasonable cost, and entrepreneurs are ready to serve up these options. Market growth is modest, however, for at least five reasons:
1. public policy initiatives are moving in "fits and starts" creating regulatory uncertainty;
2. consumers require education regarding their options and are unsure about which technologies make sense and which firms to trust;
3. DE companies are struggling to find an appropriate business model;
4. the DE sector lacks a common vision of the future—a vision of the world in which DE firms would thrive;
5. entrepreneurs need financial backing and investors need more information about which new DE technologies and companies have the potential to be tomorrow’s winners.
This article focuses on the fifth point, and describes some efforts to improve investor knowledge. Beginning in September 2003, the Distributed Energy Financial Group (DEFG) will launch a working group that will rigorously examine the track record and future potential of the DE sector for investment purposes, and establish a distributed energy portfolio index to track DE investments. The working group objective is to adopt a standard methodology for the analysis of the financial performance of DE companies. Addressing the investment needs of DE companies will bring attention to the other issues listed above. This article points to the need for an alignment and matching of interests of the DE sector and the investment community.
Background
The marketplace for distributed energy (DE) products and services is diverse and complex. A huge range of technologies falls under the "DE umbrella." As a result, even those financial analysts and potential investors motivated to do so find it very difficult to track the financial performance of DE companies. There are risks and uncertainties inherent in an emerging market, including technical, regulatory and business issues. No standard measure allows potential investors to differentiate among vendors and manufacturers, or to compare the market potential of various technologies and services. Where should investors place their money? Can we predict the winning technologies and services, given that customer choices will drive the emerging energy services economy? It’s no wonder that potential investors have a difficult time assessing the viability of DE firms.
After the recent boom and bust, investors are eyeing their opportunities carefully. The energy industries that drive our economy will continue to grow, and the investment challenges and opportunities will remain immense. Among other places to invest, energy investors consider exploration and extraction opportunities, refineries and electric generation, pipelines and electric transmission and distribution, opportunities in energy retailing, and responding to utilities’ outsourcing needs. These market sectors compete for the investment dollar, and much effort goes into comparing their potential.
Among the retailing options are the traditional resale of power and natural gas, and the potentially lucrative retailing of energy services. Consumers pay top dollar for the value associated with the convenience, reliability and quality of their energy services and products that use those services. What commands top dollar?
Here are a few of the choices: energy-on-the-go (batteries); reliability (numerous "9’s" of reliability); clean power (waveforms you can guarantee digitally); price guarantees (stable bills); and the choice of green (energy services that protect your conscience and the environment). Consumers also seek opportunities to profit from competitive energy markets by shedding their demand during peak periods. Other customers seek efficiency through combined heat and power applications. In the past, utilities did not offer all these options, or they tended to offer a rigid one-size-fits-all product.
Energy product niches at or near the customer’s premises are called distributed energy, and hold promise to revolutionize the energy industries. DE includes small-scale generating units (distributed generation or DG), technologies for grid interface, power conditioning, energy storage, and energy management and control, energy metering and communications. DE may be defined as the nexus of technologies and services located on or near the customer’s premises that meet a customer’s energy service needs. Distributed energy can be thought of any technology or service that allows local distribution grids to run more efficiently, or provides the customer a greater value proposition. DE is not new—far from it; backup generators have been around for a century. But a DE dominated vision of the future is relatively new, and may gain validity as customers seek value added services, energy security and cost control.
What DE Companies Need From Financial Markets
The DE sector is comprised of a variety of companies, large and small, that address the customers’ energy service needs in a variety of ways. Some companies are large and owned by a larger publicly traded technology company. Other companies are publicly traded, but focused on the DE sector. Numerous small companies are privately owned, but intend to go to market to secure funding soon, or hope one day to do so. All these DE companies are interested in the financial community’s perspective, and hope that their exposure to investors is positive. Each of these companies needs an independent, credible source of analysis and a bridge to the financial markets.
Part of a Large Corporation
Companies that are owned by a larger publicly traded technology company are in competition with affiliates for the attention of senior management. Assessment of the DE unit should be useful to demonstrate where earnings growth will come from company-wide and how the DE unit could drive higher stock valuations for the larger entity in the future. Large companies with investment funds are looking to acquire smaller companies, and this information will help with their analysis. It is also possible that a DE operating unit might be spun off into a separate corporation, or spun off virtually as a tracking stock.
Publicly Traded DE Firms
Publicly traded DE companies are probably frustrated by a lack of coverage by financial analysts. They seek potential investors and clients for their next offerings, and assistance from experts to help grow the business. They seek a standard that will be used to assess their performance in a fair manner, so that they can present their strengths and growth potential.
Privately Held DE Firms
Small companies that are privately owned either intend to go to market to secure funding soon, or hope one day to do so. These companies seek a low-cost opportunity to learn what it takes to successfully launch an IPO and to meet the expectations of Wall Street. They hope to mingle with potential partners and to be given an opportunity to explain their technology and approach. It is important that these companies learn what they can about the information needs of financial analysts so that they can incorporate that knowledge into their plans.
Measuring and Comparing DE Companies
As potential investors seek to understand the diverse and complex DE market, their need for information grows. Analysts who track the financial performance of DE companies must examine technical, regulatory and business issues. A standard measure of performance can allow potential investors to differentiate vendors and manufacturers from one another, and to compare the market potential of various technologies. The Distributed Energy Financial Group (DEFG) provides independent financial analysis and market research of DE companies for investment purposes.
DEFG was formed to be the bridge between technologies and the capital markets. The DEFG is an independent research firm comprised of experts and analysts across the country with a deep understanding of the DE sector. The DEFG believes that the framework for analysis of the performance of DE companies must be capable of increasing awareness and understanding of the current investment climate for DE companies and technologies, and must provide analytical coverage that is seen to be credible and independent. The DEFG's rating methodology is under development and will be tailored to DE companies, with metrics focused on financial performance, and technical and regulatory issues.
Through DEFG's Distributed Energy Investment Consortium, a tracking portfolio index of publicly traded firms in the DE sector is also under development. The portfolio index will provide information to specialists who want to examine a few firms in depth, as well as to those interested in casually tracking the DE sector. Leaders in the financial community have indicated their interest in receiving such information. The distributed energy portfolio index and the standard method for the analysis of the performance of DE companies will be available for review by any interested person by the end of 2003.
DEFG is currently accepting nominations for participation in the DE Investment Consortium and to join a number of financial executives, DE company representatives and DE analysts already committed to the project.
DE Market Potential and Investment Opportunities
Many companies and experts have touted the potential investment opportunities within the DE sector. A recent article on these pages found $4.6 billion in unrealized annual DE profits in the commercial sector under current conditions. (Jerry Jackson, Jackson Associates, "When Will The DG Market Take Off? Distributed Generation Market Development and Investment Opportunities?" (Energy Pulse, April 8, 2003.) The future potential is, of course, much larger. Yet, the DE sector continues to suffer from high costs of capital and a lack of private equity. The current DEFG effort, the Distributed Energy Investment Consortium, will address three challenges now facing DE companies and technologies:
1. the lack of analytical coverage of the sector’s financial performance
2. the inability of most DE firms to cheaply access capital markets
3. a lack of private equity investment. Analytical Coverage
Financial firms have cut their research and analysis budgets resulting in fewer analysts covering companies. For example, UBS Warburg recently decreased its coverage of fuel cell companies and other financial firms have indicated that the status of their research departments is in a state of extreme flux. This should not be taken as a sign that the financial community is not interested in the DE sector. It simply is an indication that the financial community will be relying on outside sources of analysis and information more than ever. Under the recent SEC settlement with ten of Wall Street’s largest firms, brokers will be required to provide investors with at least three sources of independent research, defined as research that comes from firms that do no banking business. (April 28, 2003 Press Release, Securities and Exchange Commission, "Ten of Nation's Top Investment Firms Settle Enforcement Actions Involving Conflicts of Interest Between Research and Investment Banking.")
DE Firm Access
Different DE firms have different needs, but all firms would like reasonable access to capital markets. In many instances, poor access results from a lack of good information. Busy investors seek a credible means of comparing DE firms, and the disparate nature of the industry makes comparison difficult for the outsider. Smaller DE firms require good information about the expectations of Wall Street and introductions to financial analysts covering the sector.
Private Equity Investment
On a macro level, the financial sector has become much more conservative and there is not a lot of capital available for new technologies or companies. From January to the end of March 2003, venture firms nationwide funded 623 companies with $3.8 billion, down about 12 percent from the previous quarter. (Nicholas Johnston, "Decline In Venture Investment Continues," The Washington Post, April 29, 2003.) This further decline comes in the wake of three years of a precipitous drop in venture capital.
DE Market Challenges and Information Gap
Perhaps most importantly from an investment perspective, the DE sector has done a poor job reaching out to the financial community in a way that investors understand. The DE sector has found it difficult to tie the technologies together into a systemic vision that excites investors. DE technologies seem to "poke along" with a few winners and more losers. For the sector as a whole to explode, the energy industries would probably have to change structurally in significant ways. More open access to distribution services and increased penetration of retail access would improve the opportunities for distributed generation. These reforms currently are stalled in the US. DE companies have not successfully communicated their "success scenario"—a vision of the world in which they would thrive—to potential investors.
For better or worse, Internet firms of the mid-1990’s conveyed a stimulating, engaging vision of the future, and made investors and customers see how their firm would fit into the wired world. Today’s investors—having been burned—are unlikely to invest in DE solely on the basis of an engaging vision. Investors seek independent corroboration of the vision, to ensure that the business plans of DE firms hang together under analytic pressure. Investors today seek genuine firms that display compelling "old economy" financial fundamentals. Energy production and consumption is basic to all economies, old and new.
This lack of vision is compounded by a view that the DE sector is too engineering driven, and that the technologies themselves are not ready to be commercialized. Ironically, due to the lack of private equity available, this view is supported by the amount of public funding and demonstration projects that the DE sector has relied on in the past. Reliance on public funding has sometimes become a red flag to investors.
The DE sector faces many challenges. The financial performance of the DE sector as a whole has not been overwhelming. Some of this can be attributed to the depressed state of the broader energy industry; more of it can be attributed to lackluster earnings and confused business plans. As Jerry Jackson stated in the April 8, 2003 Energy Pulse article cited above, "The primary reason that DG market activity is slow, relative to current market potential, is the fact that manufacturers and retailers have not developed marketing and product development strategies that meet the needs of the vast majority of potential DG customers." The business plans of DE firms must address customer needs.
Many analysts and potential investors find it very difficult to track the financial performance of DE companies due to the overlap of technical issues, regulatory issues and business issues. Currently, there is no good measure in which to rate and differentiate vendors and manufacturers from one another. In other words, potential investors have a difficult time assessing the viability of DE technologies and companies.
The matchmaking needs of the DE sector are significant. Entrepreneurs need financial backing, and investors need information about DE technologies and firms. DE firms need to recognize that there are blemishes to address. Investors need to do their homework and examine the technical, regulatory and business issues that face the DE sector. Entrepreneurs and investors require a credible information broker to bring them together.
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