The Next Disruptive Technology


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The Next Disruptive Technology

  1. 1. Energy-Tech Venture Capital The Next Disruptive Technology New ideas that may transform the utilities industry. BY RODRIGO PRUDENCIO
  2. 2. enture capital investments have tended in the past to focus on advances V in computing, software, biotechnology, and semiconductors. Small investments led by venture capital firms hatched companies such as Apple, Google, Ebay, Amazon, Genentech, and Advanced Micro Devices—plus several others that never became household names. But the growth and earnings potential when disrupting long-estab- lished industries or creating new economic sectors forms a key part of the excitement and appeal of the high-risk investment strategy at the heart of venture capital. As ener- gy technology venture capital emerges, it is causing investors and entrepreneurs alike to sit up and take notice—and take action. Defining Energy Technology Energy technology encompasses a variety of inventions, innovations, and applications that serve a widely diverse set of energy consumers, producers, and specialized service providers. To better understand the markets, it is useful to divide energy technologies into four distinct categories. Each represents a segment with existing markets, estab- lished channel participants and customers, and opportunities to create significant investor value. Energy Intelligence: Data are vital to the efficient and optimal use of energy. Iron- ically, the information-gathering systems that connect to critical energy assets, such as meters, transformers, and generators, are well behind the times. New metering tech- nologies, the collection of interval data, and complicated billing processes for power customers of all classes are among the reasons why the modern energy marketplace needs new energy solutions. Frost & Sullivan estimates the market for serving end- customer energy use at $25 billion in the United States and Canada alone. The Meta Group pegs software for customer information, trading, and workflow management at $5.3 billion worldwide. And, the research group, Chartwell, estimates the annual market for advanced metering is at $1 billion and growing. Distributed Energy: For years, distributed energy systems have worked in com- mercial and industrial facilities. But as the increasing cost of power for many users encourages consideration of small-scale generation in smaller facilities—even in homes—technologies such as solar panels, clean diesel generators, Stirling engines, micro-turbines, and fuel cells are emerging. As a result, Navigant, a leading energy- consulting firm, believes that today’s distributed energy market, currently sized at over $13 billion, is at an early stage of widespread adoption. Power Reliability: Demand for high quality, uninterruptible power systems con- tinues to rise, driven by the proliferation of digital equipment in processing facilities, online commercial transactions, and data centers, and in distributed telephony by the increase in cable and satellite infrastructure. The mission-critical nature of electrically powered equipment makes such short-term storage systems a significant market. New uninterruptible power technologies and services have the potential to grab a valuable share of what Frost & Sullivan expects to be an $8 billion market by 2008. Related Services: Many other industries aggressively pursue outside services dur- ing times that compel operational efficiency and cost cutting. The energy industry is following a similar pattern as it begins to outsource business services that historically have been conducted in-house. Venture capital backed “related services” companies address “core” activities such as call centers, engineering, asset monitoring, billing services, and workforce automation. By no means are these four categories exhaustive of the energy technology opportu- APRIL 2005 PUBLIC UTILITIES FORTNIGHTLY 37
  3. 3. nities. For example, advances in material sciences are leading to funds dedicated to the energy niche, although a few generalist companies that develop flexible batteries, membranes for funds also explored energy-related deals. miniature fuel cells, and catalysts for low-temperature reforma- The arrival of specialized and generalist investors in this tion of natural gas. Also, laser technologies used in telecom- next phase meant that from 1997-2001, more than 266 invest- munications applications are now serving as sensors in gas and ment rounds were closed, resulting in investments totaling water pipeline monitoring. These kinds of crossover technolo- more than $3.3 billion, according to Nth Power, which has gies further expand the energy technology opportunity. gathered and analyzed such data since 1994. The most pro- lific of these years was 2000, when energy technology invest- Energy Tech Investment Origins ment totaled more than $1.5 billion and the average amount How did all this happen? From the early 1990s through 1995, raised by each company surpassed $20 million. venture capital investments in energy technology were practi- Remarkably, the growing investment in energy technology cally non-existent, barely totaling about $90 million over five companies made only a small impression on the overall ven- years. Those funds came from a small group of venture capital- ture capital community. Rising investments in energy tech- ists and some corporate investors primarily focused on a nar- nologies mirrored the hyperactive levels of investment in the row set of applications for electric utilities. general venture capital markets and thus were lost in the swell By 1995, Europe and Japan began to take steps to make of the market. Total venture capital investments in U.S.-based power and energy markets more competitive in their respec- companies totaled $245 billion from 1997-2001, with more tive countries. New Zealand and major markets in the United than $100 billion invested in 2001 alone. The venture capital States soon followed. Suddenly, utilities became quite focused industry had never seen such levels of investment activity. on the possibility that competition would require investments During this same period, several venture-capital-backed in new billing systems, customer management software, energy technology companies completed successful initial pub- advanced metering, and new service offerings. Source: Nth Power GRAPH 1 U.S. ENERGY V.C. INVESTMENTS, 1990–2004 Entrepreneurs responded (IN MILLIONS OF U.S. DOLLARS) with new business plans and $1,564 technology ideas, and investors began to understand the bur- geoning opportunity in advanced energy solutions. In $867 1996 alone, investors poured $122 million into companies $513 $465 $488 $425 developing new energy tech- $196 $220 nologies and services. And while $122 $8 $9 $7 $23 $17 $28 the average deal size was small, 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 only $5.8 million per company, the venture capital communi- Source: Nth Power and CleanEdge ty’s interest in energy technolo- GRAPH 2 U.S. ENERGY V.C. INVESTMENTS AS % OF TOTAL U.S. V.C., MOVING AVERAGE gy began to grow. 2.34% 2.23% The Rise and Rise 1.95% By the time new companies 1.50% were formed to respond to rap- idly restructuring energy mar- 1.13% 1% 0.95% kets, several specialized venture capital funds responded by rais- ing targeted funds. Arête, Enertech, Kinetic Ventures, and Nth Power became the earliest 1998 1999 2000 2001 2002 2003 2004 and most visible venture capital 38 PUBLIC UTILITIES FORTNIGHTLY APRIL 2005
  4. 4. lic offerings, including Capstone, Source: Nth Power GRAPH 3 AVERAGE U.S. INVESTMENT PER ENERGY V.C. DEAL, 1997–2000 Proton Energy Systems (now (IN MILLIONS OF U.S. DOLLARS) known as Distributed Energy Sys- 21.1 tems Corp.), Evergreen Solar, Plug Power, and Active Power. The public valuations of some of these 11.4 11.3 companies climbed to remarkable 8.8 8.0 but unsustainable heights, 6.1 6.8 5.8 although they did briefly create strong returns for some investors. 1997 1998 1999 2000 2001 2002 2003 2004 After the Bubble and Beyond: 2002-2004 Source: Nth Power Just as energy technology invest- GRAPH 4 NUMBER OF U.S. ENERGY V.C. DEALS PER YEAR ments rose with the tide of overall 77 74 venture capital activity, they also 72 fell as public investors fled the tech bubble. Investments in energy 53 53 45 technology companies in 2002 36 dropped by 45 percent as Califor- 34 nia’s energy markets calmed. Investors stepped back to assess the impact on energy technology demand and some posited that 1997 1998 1999 2000 2001 2002 2003 2004 energy technology might be a short-lived investment segment. Source: Nth Power The pessimists were wrong, GRAPH 5 U.S. V.C. INVESTING IN ENERGY TECHNOLOGIES BY SUBSECTOR 1998-2004 however, as the data showed ener- Other gy technology growing as a per- Power Reliability 2% centage of overall venture capital 12% Distributed Energy activity. Even as investors tight- 23% ened their belts and grew pickier about the deals they would sup- port, they actually dedicated more of their tightly held capital to ener- Related Services 30% gy deals. As a result, energy deals, which represented about 1 percent of overall venture capital invest- Energy Intelligence ments in 1998, by 2003 rose to 33% nearly 2.7 percent. More information emerges from the data collected by Nth theless dedicated just over $8 million to each deal. This was up Power; venture capital investors continually adjusted their from the 2003 average of $6.8 million. In sum, venture capi- investment approach in the wake of the 2001 market crash. talists continue to demonstrate a high degree of selectivity in At first, investors became more discerning. From 2001 to the deals they will back, but they are making larger commit- 2002, the number of energy technology deals completed went ments to energy technology companies. from 77 to 55. In 2003, however, the deal count climbed right back up to 75. Energy Technology’s Promise And while venture capitalists dramatically reduced the size Two important forces drive today’s sustained interest in energy of their average energy technology deal, in 2004 they never- technology. The first is the establishment of experienced APRIL 2005 PUBLIC UTILITIES FORTNIGHTLY 39
  5. 5. VENTURE CAPITAL BASICS: capital investments can range three to six Lerner’s research shows that each dol- years from initial investment to a successful lar of venture capital delivers about three A PRIMER liquidity event, such as a public offering or acquisition. As a result, venture capitalists times the patented innovation of traditional corporate R&D programs.1 This innovation add value in the interim. In addition to serv- multiplier is significant at a time when cor- imply put, venture capital is an invest- ing as a funding source, venture capitalists porate R&D spending by energy companies, S ment strategy that seeks out, funds, and guides early-stage technology companies coach and guide their portfolio companies and help pull them through the difficulties particularly utilities, is generally on the decline. And even though broader market with significant growth potential. Because that many startup ventures encounter. opportunities for energy technologies are these companies are typically very young in Yet, despite the mercurial nature of ven- developing, the emergence of a defined their development cycle, a high degree of ture capital returns and the accompanying energy technology niche as a significant risk accompanies the investments. General- levels of risk and long-term commitment, venture capital category is apparent, and ly speaking, a portfolio of 10 such compa- venture capital makes unmistakable contri- with it the establishment of specialized nies may yield only one or two successes— butions to technology.According to Profes- investment firms.—R.P. companies whose value appreciates suffi- sor Joshua Lerner of the Harvard Business ciently to make up for the low returns or loss- School, venture capital is much more suc- Endnote 1. “Assessing the Contribution of Venture Capital es in value from the rest of the portfolio. cessful than corporate research and devel- to Innovation.” Joshua Lerner and Samuel Venture capital also must be patient cap- opment (R&D) in leveraging small amounts Korum. Rand Journal of Economics, 31 (Winter ital. The gestation period of many venture of capital into technology innovation. 2000) 674-692. investors who understand the subtle dynamics of technology ate solutions that address nearly every aspect of the energy sec- development and adoption in the energy markets. The second tor and every way in which energy touches our lives. As gov- is the power of perspective brought by more seasoned investors ernments, businesses, and individuals around the world con- that keeps capital working toward new innovations and solu- tinue to search for improved energy products and solutions— tions. Rather than retreat, these investors continue to seek com- from power that can be generated with less greenhouse gas panies that promise to create new value in the energy sector. emissions to batteries that can power laptops and other mobile The continued commitment suggests a fair amount of devices for days at a time—energy innovation is making ener- visionary thought and action by long-time energy venture cap- gy technology an increasingly important segment of venture italists. Once focused on a narrow set of power utility advance- capital investing. F ments, venture capitalists today see energy technologies much more broadly, incorporating technologies from material sci- Rodrigo Prudencio is a principal at Nth Power LLC. Contact him ences, wireless communications, and advanced sensors to cre- at How many people at your organization share this copy of Public Utilities Fortnightly? To meet the needs of our subscribers, Public Utilities Fortnightly is offering discounted subscriptions to organizations who wish to expand the number of copies they receive each month. With additional copies everyone in your organization can have immediate access to the best coverage of the utilities industry. For more information please contact Joseph Paparello, Director of Sales. Phone: 703-847-7759 E-mail: 40 PUBLIC UTILITIES FORTNIGHTLY APRIL 2005