One Powered Business
Over the past month, the solar sector has been pummeled by a trifecta of adverse events. The month of September kicked off with the controversial and headline-riddled bankruptcy of Solyndra, as the macroeconomic storm continued to barrage European markets (the world’s largest solar market) with a spate of pain and uncertainty, and several Chinese players suffered from questions of fraud and/or pollution coupled with a government funded oversupply of solar panels. Now, at month end, this triumvirate continues to hinder the sector, as none of these negative catalysts have subsided from the public’s concern.
Consequently, any player with exposure to the solar sector, whether large or small, at risk or sustainable, has been thrown out the proverbial door by investors. In such a situation, especially amidst volatile, downward moving markets, investors quickly sell first and think later. They do this without dissociating the good from the bad. In light of this, the prudent investor can distill the relevant information in order to identify companies with an ample margin of safety to not only survive, but also to thrive.
Last year at this time, pontificators wondered whether solar panels would ever reach grid-parity with carbon-based energy and whether that very fact would ultimately lead to the demise of solar as an energy alternative. Fast-forward to this year, and those very same pontificators question whether the sharp drop in system pricing ultimately will destroy the industry. As is often the case, the truth lies somewhere in the middle. The rapid drop in pricing will certainly kill some industry players (and has already), while setting the stage for others to prosper longer-term. Inevitably there will be winners in this industry, but for now we are simply in the “shakeout” phase.
We believe one such company that will be a winner is Power-One, Inc (PWER). PWER designs and manufactures power conversion and power management solutions for the renewable energy industry as well as for data centers (servers, networks, storage, etc…). The company builds and sells power inverters that convert DC power to AC power for solar panels and wind turbines, and AC to DC or DC to DC for data center demands. These devices are required in the vast majority of renewable energy generation projects and in data center/industrial projects where superior computing performance and power efficiency is desired by the system architects.
PWER entered the renewable energy space in 2006. In 2008 they restructured their management team and in 2009 their capital structure, in order to harness their technological advantages, protect current value, and scale into a market orders of magnitude larger than when they first entered, and which grows every year. Competition in this industry is high, given the applications and technologies have been around for decades now. Competitors include multinational engineering firms, electrical supply conglomerates, and other smaller niche manufacturers. However, PWER owns the best technology in the industry – its converters are more efficient (meaning less energy is lost in the conversion process), and they operate at this high efficiency over larger power generation ranges than any of their competitors.
It’s not difficult to find reviews of the company’s products by searching the web, and on PWER’s investor relations page (in a few presentations), they identify “blue chip” customers in their portfolio including: Wirsol, Suntech Power, Donauer Solar Systems, SunEdison, BP Solar, Google, Facebook, Cisco, IBM, Siemens, Lockheed Martin, Electrolux, Motorola, Ericsson, and many others. In the renewable energy space in particular, PWER has transitioned from a new entrant to a dominant player. They’ve become second in market share in a matter of a few years, and this share should continue to improve as explained below.
One might question how a company of this limited size controls such technological might, but the real question is why haven’t the bigger electrical/power supply companies been able to engineer a decent competitor to go after the $20 billion+ markets (and growing) in which PWER competes? That’s a valid question, but the answer merely reaffirms the company’s dominant position. With PWER’s power conversion efficiencies in excess of 98% in its larger scale applications, they have achieved 4% greater efficiencies than their closest competitor. When talking about renewable energy, it’s particularly important to note that these high-level efficiencies are further improving the cost efficacy of the technology. For a larger competitor, it would cost too much money to develop a technology that can compete or beat PWER’s on this front.
A better question would be: why hasn’t a large electrical or power supply company bought this business, harnessing its technology, market share, and recently scaled footprint? A large business with the distribution channels and relationships could stand to gain market share even quicker than their current pace. Further, with the former founder of SunPower Corporation now a member of PWER’s board, alongside a couple Silver Lake Managing Directors, PWER has certainly grabbed the interests of a few discerning technologists and successful investors able to appreciate the dominant product and opportunity this company possesses.
Sizing up the Valuation
Next, on the topic of valuation, what has drawn us to this investment most is you don’t need much to go right for your investment to earn substantial upside. First, at a price below $5 per share right now, the market cap of this business is below $550 million. With 2011 earnings expected in excess of $115 million, the business is currently priced at less than 5x forward earnings, and a mere 1.59x EBITDA. Considering the business is active in two markets that benefit from secular tailwinds and is expected to grow world-wide at a 20%+ CAGR for the next five years or more, this multiple seems a bit low. While we don’t need the growth to justify our valuation interest, it certainly doesn’t dampen our enthusiasm for the business.
The renewables business represents approximately 94% of PWER’s current operating earnings (though the mix has evolved over the last year to be less dependent on renewable), and as of 2Q 2011, 82% of that segment comes from Europe. Italy makes up the bulk, or about 47% of PWER’s total current operating earnings, and the rest of Europe represents approximately 38% of PWER’s operating earnings. In all, Europe accounts for about 84% of PWER’s current operating income. That said, we have already seen a massive decline in European solar demand – on the order of 40% in total GWs installed in Italy, 50% in Germany, and 20% in the rest of Europe – and according to the company’s most recent earnings transcripts, they expect to see a second half improvement in the Euro area relative to the first half. Even through this significant market contraction, PWER’s top and bottom lines have stayed generally intact. Seasonality also has a role in the first half sluggishness, but most of the last two quarters’ relative decline in top and bottom line has certainly come from the weakness in Europe. Despite these challenges, over that time period, PWER’s global market share has risen from 13% to 15% (or a 15% increase) of the global inverter market. Perhaps more importantly US/Canada/Asia have grown significantly – growing from approximately 4% of PWER’s renewables revenues to 18%, and