Description

EnerNOC (ENOC) – Long Write-up

Thesis Summary

• The perfect storm of regulatory headwinds and weak energy markets has caused ENOC’s stock to get severely punished in 2015. Stock has traded down -75% YTD.
• At ~$4 per share, we think ENOC is meaningfully undervalued, given: i) ENOC's cash generative (albeit cyclical) Demand Response business, and ii) ENOC's emerging, SaaS business
• At 0.3x EV/Revenue, ENOC’s current valuation attributes little to no value to the PJM Demand Response business and a below-market value to the SaaS business, which has comps that trade at 5-7x revenue
• Potential Catalysts
• Favorable Supreme Court Ruling regarding FERC Order 745
• Better than expected 2016 FY guidance given management's conservative "floor" guide for 2016 (that tanked the stock in November)
• Increased segment disclosure of SaaS business that can cause a re-rating of ENOC's multiple
• Price Target:
• On a SOTP-basis, we believe ENOC could be worth ~$12-$13/sh, representing >200% of upside

Recent Developments

• Nov 2015:
• Management missed Q3 expectations and revised 2015 guidance downward due to weak energy prices in Canada and an unexpected no-curtailment-event season in its Demand Response business
• Management also issued early guidance for 2016 that called for a potential -10% decline in revenues and -$50mm to -$40mm in EBITDA (DR business has historically generated low-teens EBITDA)
• Feb 2015: 
• Disappointing 2015 guidance due to PJM deferring revenue into 2016 and weaker than expected pricing in Australia
• 2014: Stock down ~40% due to regulatory concerns regarding FERC 745

Business Overview

• Founded in 2001, ENOC (headquartered in Boston, MA) provides energy intelligence software and solutions for over 6,500 commercial, institutional, and industrial (C&I) customers, as well as electric power grid operators and utility customers
• How ENOC makes money (by product segment):
• Demand Response (~80% of business) - cyclical but highly cash generative
• Utilities and Grid operators pay ENOC to reduce their C&I customers' consumption during peak demand periods
• Revenue proceeds are split with enterprise customer
• PJM is 40-50% of ENOC's revenues and pending Supreme Court decision on FERC Order 745 may inhibit PJM from using DR
• Energy Management Software Business (~20% of business) - growing organically at ~35% per year (w/SaaS portion growing 100% y/y)
• ENOC charges customers a subscription fee for software that helps C&I customers to manage energy supply, billing, reporting, project management, usage optimization and demand response

Demand Response Capacity Market Overview

• Established to pay the fixed costs of a power plant to produce energy through forward auctions
• Power plants and demand-side resources are compensated for capacity they will provide at some point in the future
• PJM holds auction based on projections for what electricity will be in 3 years and every resource bids into auction at total cost of operation
• All resources that clear auction are paid clearing price (most expensive unit needed to meet demand)

Investment Considerations

1. Potential for Significant Upside if Regulatory Concerns Abate:
• The Supreme Court is currently considering whether FERC has legal jurisdiction over demand response, which will determine whether ENOC can compete in capacity markets. Expected decision in Jan/Feb 2016. 
• In the event that Order 745 is vacated, ENOC would have to find a new mechanism to set DR contracts and establish new compensation structures on a state-by-state basis
• HOWEVER:
• Current PJM contracts provide 4 years of visibility to help ease the transition
• DR will remain in some form given DR saves consumers $12B in utility costs and regulators are incented to improve energy reliability and lower utility bills
• Stock's current valuation virtually assigns no value to this business segment
• As such, we think ENOC's PJM segment should at least be worth the NPV of its current outstanding contracts, with significant potential upside given DR should be a going concern regardless of the outcome of FERC. 
2. Emerging Software Business:
• ENOC has grown annual recurring revenue (ARR) from $7 million in the beginning of 2014 to $58 million in the most recent quarter (includes ~$30 million of ARR from XWES acquisition in Q1 '15)
• ENOC's software saves customers >20% on energy spend. Company charges $250-$1000 per site per year, and site penetration rate within 1,200 customer base is  <10%. Interviews with customers suggest product is very sticky and generates very high ROI. Estimated TAM of $3.5B. 
• Limited disclosure has caused investors to overlook or over-discount this segment. We believe that as ENOC's fast-growing SaaS business becomes a larger part of the overall business, ENOC's multiple should re-rate upwards. 
3. International Opportunity:
• International Demand Response makes up ~20% of business
• International TAM is est. to be 3x US TAM, so ~$4.5B (based on 50 politically stable countries with peak demand greater than 3GW). ENOC is currently focused on Korea, Europe, Canada, Australia, New Zealand and Japan.
• Given the negative regulatory overhang on the stock, we think investors are not giving ENOC any credit for growth in this segment of their DR business 

Catalyst

Potential Catalysts

• Favorable Supreme Court Ruling regarding FERC Order 745
• Better than expected 2016 FY guidance given management's conservative "floor" guide for 2016 (that tanked the stock in November)
• Increased segment disclosure of SaaS business that can cause a re-rating of ENOC's multiple