Their numbers remain small, but investors in energy technology say California's energy crisis this summer may be a boon.
Energy venture capitalists at Nth Power Technologies spent three-and-a-half years, from 1993 to 1996, to raise the firm's first fund of $63 million. Fast-forward to Oct. 11, 2000, when the VC firm announced that after only nine months of effort it had raised $120.5 million for its second fund, more than doubling the size of the first.
"And the only reason it took us that long is that we purposely wanted to have global representation, so we went all over the world," says cofounder and managing director Nancy Floyd. The effort led to investments in Nth Power from interests from Canada to Europe to Japan.
Though both the number of players and the amount of cash coming in remains low relative to other VC investment sectors, interest in energy venture capital, particularly for power technology, seems to be increasing. It appears that for now, investors remain undeterred by the investment fears that have plagued other technology sectors such as the dot-coms, or even the industry restructuring question marks spawned by last summer's price spikes in San Diego.
A Small But Bullish Herd
Certainly, those venture capitalists that already have sunk money into energy technology will have you believe that the rush is on.
"The climate has changed drastically in the last 12 months," says Floyd, pointing out that while the technology-heavy NASDAQ is down for the year, the energy technology sector (though small) has surged upwardÑby an impressive 134 percent, she says. "It's outperformed everything else. No wonder we're getting phone calls."
Nth Power has targeted five energy investment areas: (1) distributed generation and storage; (2) communications, control, and information technology; (3) end-use products; (4) power quality; (5) transmission and distribution automation; and (6) outsourcing and business services. One noted area that the company has not invested in: emissions control.
The company has invested the most capital in its distributed generation category, and its investments in that area run the gamut of technologies, from companies involved in natural gas microturbines (Capstone) to fuel cell ventures (Metallic Power) to solar technology (Evergreen Solar) and beyond. "We believe that there will be many distributed generation [winners]," Floyd says.
A Capstone natural gas turbine, say, might be the right option for powering a McDonald's restaurant, while Evergreen Solar panels would be more appropriate for a village in a developing country, where small amounts of power would be needed.
But is there more money available than there are opportunities, with uninformed investors wanting in? Floyd phrases it this way: "There's probably more money out there than there are really, really high-quality deals. There are plenty of deals to get done, and that's where we're very selective."
With a $120.5 million fund just raised, Floyd says getting the money is not the challenge; finding the right places to invest it is. "I'm getting almost a phone call a day, and that is not an exaggeration, from other venture capital funds, saying, 'Gee, we're really interested in starting to invest in this whole energy technology area; what's a fuel cell?' That is not an exaggeration."
Hugh Holman, senior analyst at CIBC World Markets, agrees that while ignorance has been an issue in the past, the learning curve has been fast, since "when money is at stake, people normally get smart." Nevertheless, if VC activity in energy is heating up, it is only beginning to do so, and the number of firms focusing on energy remains small at the moment.
"It's not widely followed," confirms Philip Deutch, managing director at Perseus LLC, a venture capital firm that has funded such companies as Beacon Power, Proton Energy, and Metallic Power. "It's a small group that knows the sector well."
Whether the number of players will increase depends on how the companies perform. As Deutch notes, "Dollars tend to follow success." And while the amount of venture capital flowing into energy technology projects is relatively small, for Nth Power, investing early actually is part of its investment strategy. "Go for the companies that need the $2 million to $5 million, not the $20 [million] or $30 million or $40 [million] or $50 [million]," as Floyd says.
Energy Insiders are First-Movers
It's important to bear in mind that the overall amount of venture capital flowing into the energy sector is minute when compared to other industries that the venture capital world is investing in.
According to venture capital research firm VentureOne, $24.4 million in venture capital made its way into the energy industry in 1999. Compare that with the big-time venture capital industries such as the connectivity products industry segment (e.g., systems networking products) which last year took in $2 billion in venture capital.
While the second quarter of 2000 saw $50.1 million in VC going into the energy sector, the first and third quarter saw none. But because the number of companies involved in these deals is so small when compared to venture capital in other industry segments, itÕs difficult to draw any conclusions from these statistics. The same caveat must be noted when considering the 134 percent rise for energy technology stocks, Floyd does acknowledge. When you're talking about a relatively small number of companies, the percentage swings are likely to be more dramatic.
It also is important to note that Nth Power may define energy technology more broadly than does a research firm like VentureOne. Nth Power considers energy technology to be opportunities arising from the restructuring of the global energy industry. Meanwhile, VentureOne defines venture capital fairly strictly, while Nth Power may not. Nth Power's calculations (see charts, below), therefore, don't necessarily correlate with those of VentureOne.
Still, it may be too early for the new capital to have shown up in the bank accounts of the ventures themselves. In the case of Nth Power's second fund, for example, since the $120.5 million was just raised recently, it has not had a chance to flow to the ventures. ThereÕs no doubt, however, that the pace of the fund raising has accelerated as of late.
And as for industry insiders such as utilities participating in the venture capital efforts, Holman says that's all part of the evolution of deregulating markets. Holman uses the oft-repeated analogy of the telecommunications industry before it deregulated. "[Before deregulation], the product development and commercial introduction cycle, when AT&T was the only game in town, was very, very long."
Holman says that the research and development arm of AT&T developed such products as headsets before the industry deregulated, but let them sit on the shelf for years. Why? "In addition to having the inertia that comes with being a regulated monopoly, they didn't want to introduce new products that would potentially cannibalize their existing investment. It's the same deal in the power industry. ... What incentive does a monopoly utility have to promote and sell and incorporate into its own generating strategy distributed resources? The answer is 'none.'"
That's all changing, though. In addition to utilities starting to place their bets with VCs like Nth Power, several have shed their "cannibalization" fears of distributed generation and invested directly in DG companies, and the trend is continuing. Joining the likes of DTE and Avista in embracing DG, PPL Corp. in September put $10 million into FuelCell Energy Corp.
Such investments by utilities call into question whether the traditional research arm of the industry, EPRI, might be suffering financially from utilities putting their money elsewhere. Does EPRI see the venture capitalists as encroaching on their territory? "They're certainly not competitors," claims Fred Potter, director of commercial development at EPRI.
In fact, utility interest in venture capital and direct investment in power technology companies may well play a role in EPRI's redefinition of itself. Potter says that since some of its technology solutions might have wider applications, EPRI too might look to the venture capitalists. "It's something we're actively exploring," he says.
Launch of the Investment Cycle?
But has the investment buzz extended beyond industry insiders? Even Nth Power is tied directly to the energy industry, with partners including FirstEnergy, Cinergy, Alliant Energy, and PacifiCorp. Holman can't give any quantitative evidence, but his personal experience suggests that there is increasing interest from outside investors. "I certainly have gotten a lot more calls over the last six months from venture funds interested in opportunities in power technology than I had gotten in the prior 24 months."
Of course, potential investors always have two questions: first, "Is there really much opportunity out there?" and second, "Has the train already left the station?" In Holman's opinion, the answers are, yes, there is opportunity, and no, the train hasn't left the station.
"We still see interesting opportunities coming forward," he says. "Oftentimes, they're companies that have been around for some timeyou know, two guys and a dog in a garageworking on technology. And now for the first time, they have an opportunity to get financing. ... I think we're still very, very early in the cycle of investment."
Deutch agrees: "We're in the beginning for energy technology."
As for whether the dot-com technology scare has seeped into energy VC, Holman acknowledges that such a ripple effect is conceivable. He adds, however, "Investors are much quicker to pull the plug on companies [in other technology areas]. We have not seen that in energy."
But if investment activity hinges on industry restructuring, as Holman suggests it does, last summer's spiking wholesale prices in San Diego and the surfacing of the term re-regulation conceivably also could have a chilling effect on venture capitalists. It appears, however, at least to VC players, that San Diego is considered merely a bump in the road.
"Based on our ability to get initial public offerings done for companies in the power technology sector, I would have to say that there has been no visible impact," Holman says. Still, Holman acknowledges that any talk of re-regulation can't be good for investor morale. "It stands to reason that there must be some dampening effect. It introduces some uncertainty that might not have been perceived or evident six months ago."
Deutch suggests that in the long run, San Diego can only have a positive effect. "I think that helps energy technology," he says, pointing out that those skyrocketing wholesale prices and consumer bills will make technologies such as distributed generation all the more attractive.
Asked if the crisis in San Diego had any negative effect on funding, Floyd seems to agree with Deutch. "No, just the opposite," she says, pointing to the mere nine months it took Nth Power to raise its second fund.
From the point of view of investors, in order for all the shiny new widgets to move from developers' garages to use in homes and businesses, restructuring is the key, and the reason for that, according to Holman, is price signals. "I have [said] that if we backslide, that would be very detrimental to the prospects for new power technologies, and one of the big reasons for that is that I think we need price transparency to stimulate rational investment in new power technology.
"So to the extent that California says $150 per megawatt-hour [price cap] is the limit ... that, in my view, is not a good thing. Part of the stimulus for investment in distributed resources is having to pay the $1,500 per megawatt-hour, or whatever that price is. ... That's the signal to the consumer that he needs to do something, that he needs to take steps and find an alternative. Price signals are critical; price signals are the juice that stimulates investment in technology that are going to save us money."
For now, Nth Power appears pleased with its investments. Floyd calls Capstone its "first home run," in the sense that "we were able to be part of a team that helped to successfully nurture the company from inception to commercial product."
On Oct. 24, Capstone announced that it had filed a registration statement with the Securities and Exchange Commission for a secondary public offering.
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