"Cleantech venture bubble" watch, part 2 -- Five Questions: Matthew Nordan

Last week we started a series of posts on the subject of investment bubbles in the cleantech sector -- and in the process, we used a recent research report by Lux Research as a centerpiece of the discussion. (We also, admittedly, took a little bit of a swipe at the PR announcing the report's release... All in the spirit of constructive informal dialogue, of course.)

This past friday, I had the pleasure of sitting down with Matthew Nordan, President of Lux Research, to discuss all matters cleantech. We discussed the various historical analogies to the emergence of the cleantech sector (IT, biotech, materials science), dealflow aggregation methodologies, and -- of course -- the potential for a bubble in the sector. Many points of agreement, and some thought-provoking areas of divergence...

It's clear that Lux has been doing a deep dive in this sector, and I felt Matthew's first-hand perspective would likely be of interest to readers of this site. So, with thanks to Matthew for graciously agreeing to participate, here are Five Questions:


1. Lux Research recently released a detailed report covering the cleantech sector. What was the motivation behind doing this report, and how long has Lux Research been investigating the cleantech space? Was this a one-time project?

Our mission is to help senior executives make strategic decisions about emerging technologies. We focus on the physical sciences – new materials and processes, and the things you can do with them – because we honestly think this is what will drive competitive advantage and economic growth over the next several decades.

We founded our business in 2004 with a first practice area in nanotechnology. As we built relationships with CTO/CSO types at large companies and became a trusted advisor to them, they started asking us to investigate other emerging technologies, many of which clustered around energy and the environment. So we started advising clients on what most people now refer to as cleantech around mid-2005.

After several of these engagements, we realized the market was telling us something about what our second practice area should be, and we formalized our efforts. We put together a team of researchers in May 2006 and set out to map the cleantech universe. We started by building taxonomies of cleantech segments across energy, air, waste, waste, and sustainability, and then began counting and categorizing the activity in the field, including scientific publications, patents, active companies, start-up creation events, VC deals, IPO and M&A transactions, etc. – tagging all of the things we inventoried back to our taxonomy. This research base underlies our practice, and it also drove The Cleantech Report, which is designed as a primer and reference guide for executives and financiers active in the field.

2. The report mentions 930 energy tech startups worldwide, and 1,500 cleantech startups overall. Your team also tracked the dramatic rise in venture funding in the space. What was your group's methodology for tracking down all of these companies and deals, and how might that have varied from other totals that have been publicly announced by other groups?

There are a couple of questions embedded in there, and both of them come down to definitions.

For the purposes of the report, we define cleantech as “innovative technologies specifically designed to optimize the use of natural resources and reduce environmental impact.” “Innovative technologies” rules out companies that are active in energy and environment but without any significant new technology – carbon offsetting services would be a good example. It also rules out project finance for, say, corn-based ethanol plants based on established processes. “Specifically designed” rules out companies that deliver energy and environmental benefits only as a pleasant side effect rather than the focus of their business, such as transport optimization software companies. “Optimize the use of natural resources” and “reduce environmental impact” rule out companies that have something to do with energy or the environment, but that primarily help speed up “dirty” consumption: Oil and gas proppants would be a good example. You can split hairs on lots of segments – are enhanced oil and gas recovery technologies cleantech? (we would vote no) – but the important thing is to be consistent throughout the analyses, which we feel we’ve done.

With those definitions in mind, the identification of companies and transactions happens through lots of means – tapping our network, querying information services, cross-checking with other people’s inventories, etc. All of our data sets are global to the extent that reliable data is available (for example, it’s really tough to discern between institutional venture capital and project finance in China, and many capital flows aren’t reported).

For many of the data sets we’ve assembled there are no comparables, but in the one place that they do exist – namely venture capital – our definitions make our numbers differ from other sources. We’re higher than Dow Jones/E&Y because of the global factor and we’re lower than Cleantech Venture Network because of our more restrictive cleantech definition. The sources of variance are detailed in the report.

3. The press coverage has naturally focused on the report's conclusion that there might be a looming bubble in energy tech. The report, however, appears to differentiate a bit between a) different sectors within cleantech; and b) different types of investments. What specific categories of energy tech investments seem most susceptible to bubble-like conditions right now? Why are these sectors attracting such an imbalance of attention, in your opinion?

It’s certainly true that the press loves downside stories. We’ve tried to be pretty specific about the two subsegments where we see an excessively high ratio of money and enthusiasm to opportunity: solar and biofuels. It’s hard to look at, for example, New Enterprise Associates’ pursuit of SolFocus and not see flashbacks to the Internet in the late 1990s. While some of our findings are counterintuitive, I don’t think this one is: I spoke at the Austin clean energy VC conference last week, and Maurice Gunderson who founded Nth Power gave a great presentation that honed in on these two subsegments in “bubble watch” mode.

Solar and biofuels get outsized attention because they are easy to understand (everyone’s seen a solar cell and everybody’s pumped gas), they’re both experiencing big technology shifts (crystalline silicon to thin-film and corn/cane to cellulosic), they both have government incentives and news flow working in their favor, they both have established valuation comparables (you’re not creating a new category), and they both have enormous headroom for growth – solar was 0.02% of U.S. energy last year! There aren’t many other subsegments where all of these factors line up. Coal gasification and supercapacitors are not easy to understand, water filtration is not undergoing a big technology shift, news flow doesn’t favor waste remediation…

4. The worldwide energy and water markets are as big or bigger than the market for Information Technology, for example. And yet cleantech appears to still be only 5-10% of venture capital investing totals, behind IT and biotech. How should we reconcile the magnitude of the market opportunity and these relatively low investment levels with the idea of a looming energy tech bubble?

Energy and water are huge markets but they’re nowhere near as accessible as IT, they require manufacturing and testing and shipping and servicing physical products at high volume, and the adoption cycles are a lot longer.

Think about water for a minute. More than $500 billion every year is spent on water, and the secular trends are really attractive: Access to clean water is already a limit to economic growth from China to the American southwest, and there’s no good alternative – you can replace gasoline with ethanol but you can’t replace water with anything. But the average municipal water facility literally uses Victorian-era technology: coagulation and flocculation that add salts to the water. The facilities are frequently publicly administered, have almost no operating free cash flow to invest in new technologies, and replace their infrastructure on cycles measured in decades. And the qualification and test cycles for installing new equipment can themselves take years even with accelerated testing regimes! That’s about as far as you can get from, say, web-based software where channels to market aren’t an issue, you don’t have to manufacture anything, and switching costs are very low.

Energy segments aren’t immune. Take rooftop solar cells – the solar shingles that are the apotheosis of many a business plan. If you wanted to install solar roofs on only one out of ten new U.S. houses constructed – no retrofits and no commercial installations – and it took two guys one week to string one up and test it out, you’d need 8,000 installers working full-time. That’s more than twice most estimates of the total number of installers in the U.S. You wouldn’t encounter this channel construction problem in IT or biotech.

5. What's the single biggest misperception about clean technologies that you'd like readers to gain a better understanding of by reading your report?

I think we touched on it earlier – it’s the thesis that cleantech is the next Internet or the next biotech. From the perspective of public offerings, wealth creation, and impact on society, this may very well be the case. But the investment dynamics and times to market are really different.

While there are plenty of exceptions like demand response services, a great share of clean technologies derive from new materials. And no matter what past example you want to look at, be it carbon fiber or nanoclays or polyetheretherketone, new materials simply take a long time to develop, scale up, and bring to market – it typically takes 20 years to get from invention to first commercialization and 20 more to mass adoption. That’s a long time – a lot longer than a 10-year closed-ended fund.