Wednesday, May 16, 2007

"Cleantech venture bubble" watch, part 1

Thanks to some recent research and commentary by Lux and others (such as this article), the potential for a cleantech venture bubble has been getting a lot of attention.

It's always a fascinating media topic: When does an investment sector get "too hot"? So expect even more attention will be paid to this topic in the future.

Two vital facts to keep in mind (and which the general media coverage most often loses sight of, it seems):

1. There is a big difference between public market investment trends and venture capital investment trends.

Yes, for obvious reasons the two markets are often somewhat linked. But the public market is open to many more retail investors, is focused on near-term (quarter to quarter) results, and operates within the context of benchmarks like the S&P 500 (8.2% average annual returns over the past 10 years).

Whereas the venture capital market is open to a different pool of private investors, is a market of long-term (multi-year) investments, and operates within the context of high hurdle IRRs (~20% average annual returns over the past 10 years). Different returns requirements will drive different valuations.

2. There is no single "cleantech" sector. It is multiple sectors.

A solar cell looks nothing like a fuel cell which looks nothing like a desalination unit, etc. "Cleantech" as a buzzword is often criticized as being too broadly defined. That breadth also means that the technologies covered by cleantech VCs aim for different markets, compete with different incumbent approaches/ commodities, are produced in entirely different ways, etc. In other words, Cleantech (a/k/a "greentech", "environmental tech", etc.) is actually a collection of numerous separate investment sectors, under a common investment thesis around looming natural resource scarcity.

When taken together, the above two points bring out two key conclusions:

1. If one technology sector starts to see inflated values, it won't necessarily "infect" other cleantech sectors at the same time.

The Lux Research report was actually very specific on this point:
The warning signs of a bubble are appearing in the energy segment, where IPO value rose from $1.6 billion in 2005 to $4.1 billion in 2006 and venture capital raised went from $623 million to $1.5 billion, primarily on solar and biofuel deals. At the same time, the air, water, and waste segments present hidden opportunities that are relatively starved for investment.
So... There's a danger of an energy tech bubble, but other cleantech sectors... not so much. Realistically, we have to evaluate over-investments for specific subsectors than simply looking at all energy tech as a whole. Thus, the most relevant question is: Are there bubbles in solar and biofuels?

2. If multiples among publicly-traded stocks seem high, that doesn't necessarily reflect venture investments, even in the same sectors.

Anecdotally, it seems like there might be a supply/demand imbalance right now in the public equity markets, reflecting pent-up retail investor interest in high-profile sectors like corn-based ethanol and solar PV. Which is why these sectors have seen the most IPO activity.

There are good arguments to be made on both sides of the "are publicly-traded solar share prices too high" or "are publicly-traded ethanol share prices too high" questions, and this site isn't the place for such a discussion (stock-picking is not a core skillset here). But it should always be kept in mind that these investment classes are very different from the kinds of investments venture capitalists are typically evaluating.

Ethanol is a great example. Most of the publicly-traded stocks in ethanol are for companies using corn-based, well-understood processes. Whereas most of the current venture investor activity in the space (not counting "capacity" deals) is focused on finding alternatives to corn as a feedstock (such as waste-to-ethanol or cellulosic feedstocks), with breakthrough technologies. The economics, timeframes, and technical issues are completely different.

There could be a "bubble" in ethanol venture investments at the same time as a "bubble" in publicly-traded ethanol share prices. But it's not necessarily the case.

As we continue to track the bubble coverage in future posts, we'll delve into specific sectors and try to read the signs. But the above breakdown should establish some necessary context beyond the headlines, in advance of these discussions.

One last note for today's column... The Lux Research report has provided a wealth of useful data and smart analysis, and looks to be pretty valuable. One statement I would quibble with, however, was from the press release:
"...There’s no way that more than a fraction of the 930 energy start-ups operating worldwide can possibly succeed."
Define "succeed"? And define "fraction"? Venture capital is necessarily investing at a risky stage where companies will fail. That's true of all VC sectors whether they are evidencing bubbles or not. Furthermore, "success" shouldn't be defined by high-profile Google-esque exits -- only about 10-20% of all venture-backed companies IPO, for example. The majority of successful venture exits are industry trade sales as part of ongoing sectoral consolidations, at reasonable valuations.

When you consider the enormous magnitude of the energy market worldwide, and the many incumbent sectors that are ripe for creative destruction... It's not a stretch to argue that, yes, a significant share of the venture-backed portion of those startups (hopefully the VCs aren't picking a random sample from the overall pool of available investments) will grow and find successful exits in some form. And anyway, how does anyone know how many startups in a sector are too many? 930 (which I believe is a low count anyway)? 1,500? 15,000? This study claims that renewable energy will be a $200B market by 2015... There's a lot of available value to be created, somehow.

But admittedly, technically-speaking, since even 99/100 is "a fraction", the statement isn't wrong per se. It's just more hyperbole...


Anonymous Anonymous said...

I think "clean tech" would benefit itself by clarifying the fact that all industrial processes will be revamped through the use of clean technologies in the future. It's not just about Solar, Ethanol, etc. When you consider how many industries there are, you can predict with confidence that there is going to be a huge wave of investment over the next 100 years in technologies that use less resouces and produce more output. The so-called bubble stats are skewed by the fact that the initial round of Ethanol infrastructure build out required large sums of capital to establish. And there are still going to be big deals in the future-I won't argue that. There are still tons of great early stage investment opportunities in clean tech, that don't require Cilion type capital too.

6:23 PM  
Blogger Francesco DeParis said...

Technology, not products will always be winners on the investment side. I think the US will have to compete effectively with Brazil on cellulosic ethanol as well as sugarcane ethanol. The article on Biopact renewed my excitement over cellulosic ethanol, and so I analyzed the business side of this development and how "Brazil’s Biofuel Empire is About to Grow in a Big Way".

I would love to hear from the enzyme guys on this one.

I comment regularly on the business/investor side of alternative energy on Energy Spin: Alternative Energy Blog for Investors-Served Daily

Francesco DeParis

5:09 PM  

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