Bioenergy, Energy Efficiency, Geothermal, Hydropower, Solar, Wind Power

Financial Trends: The IPO Myth

Issue 2 and Volume 3.

Ask the CEO of any leading emerging private cleantech company what their ultimate end-goal is and you’ll often get a similar response: “To IPO the business, of course.” For many entrepreneurs in the cleantech sector, the IPO exit is perceived as the Holy Grail and the yardstick by which to measure success.

This is due to the prestige associated with creating and continuing to lead an independent publicly traded company as well as the perception that for cleantech companies, the public equity markets will value them at a substantial premium compared to the natural strategic buyers for these businesses. These strategic buyers include traditional industrial companies and multi-industry conglomerates such as GE, Siemens and ABB.

As a result, leading private companies in the cleantech sector and their respective shareholders often fail to consider a sale of the business as a likely or preferred exit alternative. However, looking at data from 2005 to 2010, of the nearly $600 billion in announced global transaction volume for cleantech companies, approximately $60 billion or only 10 percent was from IPO exits vs. M&A sales. The data suggests that not only is a merger or acquisition exit a much more likely outcome for a cleantech company, but it often offers a more attractive upside than an IPO.

The cleantech industry is unlike many other emerging sectors where new industries were created in a college dorm room or garage. Emerging cleantech companies are driving innovation in the existing $6 trillion global energy industry where there are strong incumbents. In some instances, these incumbents have serviced this industry for well over a century. These entities grow at the rate of gross domestic product and are not going to miss an opportunity to capitalize on the expected global growth in expenditure on sustainable infrastructure, including alternative energy and clean technology.

In addition, such companies have the financial wherewithal, manufacturing scale and global distribution channels to scale businesses in the cleantech sector. Cash on corporate balance sheets currently sits at all-time highs, representing 11 percent of total assets for S&P 500 companies. Many of the natural owners of cleantech companies have professed their continued interest in making meaningful investments in the sector over the coming years.

With this background, we have observed a willingness by industrial and conglomerate companies to pay premium value–including well in excess of their own valuation multiples–for certain perceived “must-have” cleantech companies.

For example, in 2010, ABB paid $1 billion or 4x revenue for Ventyx, a smart grid software and services company; Sharp acquired solar developer Recurrent for $305 million, which consisted of a significant amount of early stage development pipeline; and European conglomerate Hilti paid over 4.5x trailing revenue and 14x invested capital for Unirac, a solar racking company.

In many instances, acquirers are willing to factor in the revenue and cost synergies from integrating these businesses into their existing platforms to justify paying premium values that are more attractive than the valuation these companies can achieve in the public markets.

Overall, the corporate sale alternative offers several benefits when compared to an IPO, including the ability for sellers to:

  • Crystallize a control premium and be paid immediately for potential revenue and cost synergies
  • Gain liquidity through a single-step process
  • Maximize value through a competitive auction process.

On the other hand, we see a number of challenges associated with the IPO exit, including:

  • The requirement of a multi-step process to achieve liquidity (due to shareholder lock-ups and potential limits on the amount of shares the company may be able to float at IPO)
  • The associated public market discount and IPO fees incurred
  • the incurrence of public company costs and limited ability to manage long-term objectives post IPO
  • Timing uncertainties due to exposure to unpredictable swings in the strength of the equity capital markets.

In light of the above, emerging cleantech companies and their shareholders should not overlook the corporate sale option when evaluating potential exit options and should avoid managing their company solely for an IPO exit. There will always be an anomaly such as First Solar, which emerged as a leading independent company. But the majority of promising companies today will end up being consolidated into the incumbent energy and industrial firms that are positioning themselves to capitalize on the sector’s projected explosive growth.