Dharmesh Thakker
Monday, August 2, 2010
Cleantech 1.0 from 2004-08 was dominated by solar and bio-fuel startups, founded by semiconductor and biotech execs in many cases. Massive global energy markets ($6 trillion worldwide energy spend, $300 billion U.S. electricity markets, $20 billion India solar mission), rising energy costs, favorable regulatory landscape, and technology maturity were driving the first generation of startups. By contrast, there seem to be a growing number of software and networking gurus frequenting cleantech entrepreneur circles and energy efficiency startups these days. At Advanced Technology Ventures, where I focus on cleantech and software startups, we have had the benefit of witnessing this trend firsthand, given our involvement in cleantech since 2004, and believe this mix is healthy for the overall cleantech sector.

In 2008, at the peak of the cleantech investment cycle, about $2.5 billion in equity was invested in solar energy alone with over 10 venture backed companies raising over $100 million each. Bio-fuel figures were not far behind at over $900 million in investments. Part of the reason behind these staggering figures is the use of expensive equity dollars to fill-in for virtually nonexistent project finance and debt. Using simple math, we’d need to see 15-20 multi-billion dollar IPOs in the next few years to produce venture-like returns. Moreover, startups need not only a technology based advantage but also significant economies of scale (and a few more billion dollars) to be cost competitive with First Solar and Chinese PV players in the solar area for example, or else they risk going down the path of ‘profitless prosperity’. In short, a few winners will emerge, but until robust project finance and debt markets emerge, it will be largely a tough space except for those that invested very early in these areas.

Investment Areas

Learning from our portfolio of 11 cleantech companies, we have refined our thesis to focus on two key areas: downstream technologies for accelerated renewables deployment, and demand side management.

The billions that have been invested in core research have prepared several renewables for prime time commercialization. At the same time, the need for renewables is rising by the day, driven by rising costs and carbon footprint of fossil fuel sources, and state and potential federal Renewable Portfolio Standards. Recent events like the Gulf oil spill only exacerbate the problem. However, widespread commercialization has been inhibited largely by the lack of grid parity (price competitive with coal) without subsidies, and intermittency of most renewables that requires grid upgrades. Solar panels, for instance, have seen prices decline from $5/W a couple of years ago to less than $2 now, yet the balance of system (BOS) costs including labor, racking, inverters are still hovering around $4-5/W and continue to affect the adoption rate. We find innovations such as micro-inverters, DC-DC optimizers, innovative racking systems that can lower the BOS costs for solar energy, as the critical missing link to help solar energy achieve grid-parity. Similarly, wind has the potential to be 20 percent of our energy supply by 2030 and a $100+ billion opportunity annually. Components, control systems, and predictive analytics that reduce downtime and can enhance project returns, help multiply wind energy’s footprint. More broadly speaking, grid storage technologies that smooth out the effect of intermittent renewables on the grid are another area of strong interest. As initial deployment of many of these technologies in the U.S. and Europe mitigates commercialization risk, they can be applied to address the massive market opportunity in India and China as well.

Demand Side Management, our other investment theme, includes both energy efficiency and peak load management (like smart grid technologies and demand response). This is where we see tremendous activity lately from Silicon Valley software and networking veterans. After all, if you’ve built your career building large scale networking infrastructure at Cisco, enterprise-class apps at Oracle, or complex analytics at Google, it’s natural to use your expertise in building wide-area and local-area networks for the smart grid and energy apps for utilities, businesses, and consumers. From an investor standpoint, the relative capital efficiency, potential to achieve attractive software-like operating margins, and potential M&A interest from the IT majors as an alternate path to an IPO, align well with the venture model. In this sector, we think the low hanging fruit is in HVAC and lighting controls with a specific focus on commercial and industrial sectors. Lighting and HVAC consume over 50 percent of the $80+ billion in commercial energy usage in the U.S., and energy efficiency via intelligent controls ranks high on the CFO’s list driven by attractive ROI, bottomline savings, and compliance drivers. Additionally, CIOs are increasingly faced with enhancing the transactions per Watt in addition to transactions per dollar from their ever-growing datacenter footprint. Holistic monitoring, modeling, and control software solutions hold great promise in reducing energy usage while regulating heat density and enhancing server performance as well.

Other related areas we dabble in include transportation and engine efficiency (a somewhat contrarian thesis to electric vehicles) and recycling. There is an attractive amount of cash in trash as we have discovered – all the way from recycling the 130 million cell phone and portable electronics that are retired in the U.S. every year and creating a market in developing countries, to taking landfill gas for energy generation. How sustainable the underlying technology is remains to be seen, but these business models and operating margins are interesting enough to consider.

New Areas of Opportunity for

The wild-card in our mind is the application layer for the smart grid. When core routers and other Internet infrastructure were being rolled out worldwide in the ’90s, who could have guessed that killer apps would revolve around e-commerce, social media, and online gaming? We are in the first cycle of rolling out effectively a two way communications infrastructure on our utility grid, aka smart grid. Data mining applications that leverage granular data from smart meters, planning and decision control systems for utilities, advertising platforms for appliance makers and energy conservation promotional programs for consumers all present sizeable opportunities that an application ecosystem can address.

A classic example in this arena is the residential energy efficiency opportunity. Over $225 billion in energy is consumed every year in the U.S. by homes and small businesses, and over $45 billion of that can be avoided by simple conservation measures. Over two dozen startups, the last time I checked, in the home area energy management space believe that consumers will opt for the ‘right thing to do’. However, conservation has historically been at odds with convenience and comfort. Whether you believe that homeowners will buy $300 fancy displays from Best Buy or expect the local utility to subsidize them, it is still hard to see consumers watch their energy usage constantly and change their behavior to save $20-30/month. I’d argue the mean-time-to-kitchen-drawer is probably in weeks, if not days as the novelty wears off. At the same time, consumers have continued to spend hours a day on gaming and social media sites and are driven by their virtual image or online avatars. Applications that can crack the code of aligning energy efficiency with consumers’ online image or incentivize them perhaps with virtual currency can start to move the needle on residential energy efficiency. I haven’t seen that yet, but feel strongly that this class of smart apps at the intersection of energy efficiency, business, and social media, a cleantech 2.5 cycle if you will, is right around the corner.

The author is VP, Advanced Technology Ventures
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