Description

Disclaimer: This report is the work of an investment adviser affiliated with the author. The report is the result of the adviser executing its investment strategy. The adviser holds a position in the security, however there is no assurance that the adviser will continue to hold the investment, or make an additional investment and will not update the information to reflect future changes in the adviser’s assessment of the investment.

EPS FP: An opportunity to buy into a leading clean tech player, at the nexus of energy industry megatrends, with rockstar leadership and a world-class industrial partner. Potential for 3x returns over the next two years.

Executive Summary

ENGIE EPS (formerly known as EPS and Electro Power Systems) is a hybrid energy storage and micro-grid systems solutions provider. The company was an early entrant into the industry and has a cutting edge technology offering. ENGIE EPS sits at the crossroads of many of the megatrends in energy today: increased use of energy storage, growing renewable penetration, smarter grids, distributed energy generation, emphasis on infrastructure resilience.  ENGIE EPS’ energy storage end market installed base has grown 63x over the past 8 years and is expected to increase another 10x by 2025.

In March 2018 ENGIE, one of the world’s largest energy company and the largest independent power producer worldwide, acquired control of EPS and currently owns a ~60% equity stake in the company. This relationship is transformative for EPS. We, along with numerous industry insiders with whom we have spoken, expect ENGIE EPS to leverage its relationship with ENGIE to drive potentially explosive growth in the coming years. Signals of this transformation, most notably the recent 50-60M Euro project to build the largest microgrid in the world, are becoming increasingly apparent.

The company is led by CEO Carlalberto Guglielminotti, a former venture capital operating partner and serial entrepreneur; at the age of 35, Carlalberto has already had two successful exits for tens of millions of Euros and has grown ENGIE EPS’ market capitalization by ~3x over the past 3.5 years.

While ENGIE EPS does not screen as a “value stock” based on historical earnings, we believe that the current opportunity to buy into a leading clean tech asset that doubles revenue every year at ~5x 2020 EBITDA is a bargain and we anticipate a 3x return over the next two years which we will discuss in more detail.

Business Overview

Before discussing the way in which we believe ENGIE’s ownership could be a game changer for ENGIE EPS that is not being baked into the share price, it is first important to discuss what ENGIE EPS does and the technology behind it. ENGIE EPS is a hybrid energy storage and micro-grid systems solutions provider. Put simply, the company uses proprietary technology and knowhow to design and install 1) standalone renewable power generation coupled with storage systems (micro-grids) and 2) energy storage systems which support grid stability and optimize power production for grid-connected power plants.

ENGIE EPS’ microgrids are standalone renewable energy generation systems that offer a 24/7 stable energy supply. Microgrids include power generation and storage systems as well as ENGIE EPS’ proprietary power conversion and control systems which efficiently regulate the microgrid’s functionality. The company is agnostic across various types of batteries and renewable energy production technologies, which it sources from third parties.

Source: ENGIE EPS - 2018 Cleantech Forum Asia

The main end markets for ENGIE EPS’ microgrids are “off-grid” territories and businesses, both of which are powered by diesel today. ENGIE EPS’ microgrids offer territories or businesses power generation at much cheaper rates (sometimes as much as ~60% lower) than diesel generation with higher reliability and resilience.

Based on our calls with industry experts and ENGIE EPS customers, we believe that, because of the company’s head start in the industry and proprietary technology, ENGIE EPS is often the only credible bidder in microgrid tenders. The company has over 150 academic publications, 130 patents and applications in 48 countries, over 500 registered trade secrets, ~30% of staff with an PhD or MBA equivalent, and it benefits from 15 years of R&D. Historically ~25% of the company’s revenue has been invested in R&D. Commentary from ENGIE, certainly an expert in the energy field, confirms EPS’ technology advantage. According to various ENGIE executives, “the value of EPS is in its technology”, “we acquired the company for its technology”, “we did not build internally because acquiring EPS gives us a 2-3 technological edge over competitors”. Further evidence of the company’s technology advantage is clear when comparing EPS’ microgrids to Tesla’s. EPS offers similar performance to Tesla but requires 25 to 30% of the MWh of battery power, therefore offering the same solution at a lower cost. We have had extensive independent consultations with ENGIE EPS’ customers and industry experts which also support our view of the company’s technology advantage.

While it is possible that competition in this industry will pick up in the future, we believe that the attractive economic case for microgrids and the $500B TAM should support long term profitable industry growth.

As a secondary market, ENGIE EPS also leverages its HyESS technology for utility-scale storage systems. Renewable energy penetration of the power grid has increased meaningfully in recent years and penetration should continue to increase going forward. The intermittent characteristics of renewable power generation present some challenges for the power grid. ENGIE EPS’ grid support solutions employ battery and hydrogen storage to smooth energy demand and production and allow both renewable and conventional power plants to operate more efficiently.

Source: ENGIE EPS - 2018 Cleantech Forum Asia

ENGIE is a game changer for EPS and is driving a paradigm shift in EPS’ growth outlook  

ENGIE is an ideal partner for EPS because 1) EPS’ business is at the intersection of ENGIE’s strategic focus; 2) ENGIE will be a source of future revenue for EPS; 3) joining the ENGIE group alleviates historical pain points for EPS’ business; 4) ENGIE offers EPS additional competitive advantages in the microgrid space.

ENGIE’s long term strategic focus in the energy market is known as the “3 D”: Decarbonization, Decentralization, and Digitalization. EPS’ offering sits at the intersection of the three. EPS’ solutions are necessitated by increasing renewable penetration, microgrids are an example of decentralized generation, and EPS’ entire solution is digitally controlled. EPS is ENGIE’s only substantive offering in the stationary storage and microgrid markets.

Source: ENGIE - 2017 Investor Workshop

We believe that ENGIE will be a source of future revenues for EPS. ENGIE has a 110 Gigawatts of generation capacity globally, the largest generation footprint in the world. For context one megawatt of storage roughly equals 500K EUR of sales for EPS and 1 GW would roughly equal 500M EUR of sales. While grid support is a more competitive market than microgrids, ENGIE executives have told us that EPS is certainly the provider of choice for ENGIE’s grid support needs. As clear evidence that the ENGIE relationship is already generating new business for EPS, 53% of EPS’ 180M pipeline or ~95M EUR of projects under development relate to ENGIE generation assets. We believe that it is safe to assume a very high conversion rate for these ~95M in projects.

Source: ENGIE Eps – Q3 2018 Investor Call

ENGIE should also help EPS to source new business outside of ENGIE’s footprint both through the benefit of ENGIE’s global network and through active collaborations. As the largest power generation player globally, ENGIE has close relationships with territories around the world. When developers or territories are looking for energy solutions, ENGIE is on their short list. For example, the developer running the Palau microgrid competitive process contacted ENGIE to ask them to participate in the tender. ENGIE forwarded the proposal to EPS and shortly thereafter EPS was awarded with the project by the Republic of Palau.

EPS is not relying on coincidence or ENGIE’s reputation alone to generate new business. After the ENGIE deal closed in March, EPS’ CEO met with business unit heads across ENGIE’s global organization to explain EPS’ offering to them and initiate collaborations to source business for EPS. One especially notable collaboration is with ENGIE Solar. ENGIE Solar is ENGIE’s main solar generation business unit with approximately two gigawatts of installed base globally. According to EPS and ENGIE executives, EPS will be ENGIE Solar’s provider of choice for storage projects going forward and ENGIE Solar will actively source projects for ENGIE EPS.

In addition to helping EPS to bring in new business, ENGIE should alleviate EPS’ historical pain points for winning new contracts. Historically some of EPS’ more troublesome headwinds included: lack of a brand name and credibility with customers, lack of a balance sheet with which to guarantee projects, limited financial resources, and limited negotiating power with suppliers on pricing and working capital. The relationship with ENGIE can eliminate all of these issues. ENGIE is a leading brand in the industry with an investment grade credit rating and a 150B EUR balance sheet. ENGIE’s procurement arm is already delivering savings to EPS and has helped the company to secure improvements ranging from 90 to 150 days in working capital terms for key items like batteries.

One final advantage to note is that ENGIE is the world’s leading independent power producers (IPP). Most of EPS’ competitors in the microgrid space are either IPPs, engineering companies, or component manufacturers. Historically ENGIE EPS was able to offer both engineering and high performance components but not project financing. Given its relationship with ENGIE, EPS is now able to offer a full suite solution. According to the consultant that ran the Palau competitive process, EPS won the deal in part because it was the only bidder able to offer an end to end turnkey solution.

Our observations and conclusions above have been confirmed through extensive calls with industry experts and former ENGIE and EPS employees. According to one former ENGIE executive “the ENGIE investment is clearly a game-changer for EPS, I could easily see EPS winning one billion euros of opportunities” according to another “EPS will win every stationary storage tender that ENGIE pursues”. A former EPS business development executive told us that he believes “ENGIE has alleviated all of EPS’ historical pain-points…with ENGIE as a partner I can easily see 100M of revenue in the near term and growth to 1B revenue in the medium term”.

ENGIE EPS is led by an exceptional CEO

We believe ENGIE EPS’ CEO, Carlalberto Guglielminotti, is a “rockstar” CEO and a visionary entrepreneur. Carlalberto’s resume, his success at EPS to date, our observations over the past year, and commentary from independent references make us confident that he will take advantage of ENGIE EPS’ large market opportunity and strategic partnership with ENGIE to deliver substantial value for shareholders.

Despite being only 35 Carlalberto already has the credentials, experience, and successes of a veteran executive. Carlalberto is highly academically credentialed: 2012 MBA with merit from Bocconi, 2005 JD with honors from Universite Paris V, 2006 Masters in Law cum laude from University of Turin; additional experience in law and economics and philosophy at the European School of Economics and University of Haifa. He is fully fluent in Italian, English, and French. Between Degrees, Carlalberto worked for four years as an Associate at Linklaters, a top law firm in London.

During his formal education and time as a legal associate, Carlalberto co-founded two successful technology startups. First he co-founded Blackshape Aircraft in 2009. Acquired by an investment group that specialises in aerospace and electronics, the company develops and sells the highest-performing ultra-light aircraft in the world, completely made of carbon fiber. In 2011 he co-founded Restopolis, now called TheFork, a TripAdvisor company and leading online restaurant-reservation platform in Europe with almost 14 million monthly visits.

While serving on the board of Restopolis, Carlalberto was made an Operating Partner at 360 Capital Partners, a European-focused venture capital firm with 400M under management. From there Carlalberto joined EPS, at the time a 360 Capital Partners portfolio company. According to 360 Capital’s Founder and General Partner Fausto Boni:

A longer than life sales cycle, the usual series of technical difficulties during deployment and unfortunate choice of both market segment and geographical focus led to year after year of missed targets to an apparently unstoppable cash drain. At that point in time we @360 opted to completely write-off the investment, dismiss the top management and wind-up EPS operations. We sent Carlalberto Guglielminotti, a talented young operating partner at our firm, as temporary CEO to manage the chapter 11 process with the mission to orderly dispose of the few remaining assets

To our utter surprise, a month later (summer of 2013) Carlalberto came back to us with a completely new plan, a new strategy and a new team, fully convinced that highly promising technology had been developed yet not properly exploited. Most importantly he told us he was determined take this forward himself as an entrepreneurial CEO with an equity-based incentive if we were willing to extend a few months' life support to the company.

Since EPS’ IPO in early 2015, Carlalberto has nearly tripled the company’s value. Today, the company, should finish 2018 with 15-19M of revenue and nearly cash flow breakeven. It has a signed ~80M project backlog that we expect will deliver at least ~50-60M of revenue in 2019.

In reference calls that we have done on Carlalberto, former colleagues have consistently rated him nine or ten out of ten in terms of abilities. Those who know him best have highlighted his exceptional intelligence, vision, drive to succeed and work ethic. These observations are consistent with our experience interacting with Carlalberto over the past year.   

ENGIE EPS has a robust near term and long term growth outlook

The company’s rapidly growing and open ended TAM is evidenced by historical industry growth, growth projections by leading industry experts, and the growth of EPS’ competitors in the stationary storage space.

According to Bloomberg New Energy Finance, leading industry consultants, ENGIE EPS’ energy storage end market installed base has grown 63x over the past 8 years and is expected to increase another 10x by 2025

While it is certainly hard to predict precise growth out until 2025, the rapid pace of the storage end market’s growth is clear. Bloomberg NEF has consistently revised up its storage market growth outlook:

ENGIE EPS is targeting a massive TAM and the company’s 2020 plan includes modest penetration assumptions.

Source: ENGIE Eps – July 2018 Investor Presentation

Results of comparable companies offer a bottoms-up corroboration of EPS’ rapid growth. Alfen (which trades publicly in the Netherlands) has grown its energy storage division from zero in 2016 to 8M EUR in 2017. Sellside analysts expect the division to achieve 20-25 in 2018 and up to 60M of revenue per year in the medium term. Winch Energy, a private stationary storage provider, was pre-revenue in 2016 but expects to achieve 30M EUR of revenue in 2018 and 100M EUR of revenue in 2020. Fluence Energy, another competitor in stationary storage, expects to achieve 100M EUR of revenue in the next 5 years.

In addition to encouraging high-level industry prospects, the company has a compelling near term opportunity to replace diesel generation for island nations. ENGIE EPS’ 50-60M EUR Palau project is far from a one-off because decreasing solar panel and lithium ion prices have made island microgrids increasingly economically attractive, there is a high level commitment among many island nations to convert from diesel to renewables, and these countries are actively exploring microgrid solutions.

ENGIE EPS can offer power purchase agreements in the 10 to 20 cent per kilowatt-hour range. Some island countries pay up to 30 or 40 cents per kilowatt-hour for diesel generation today. ENGIE EPS’ microgrid economics are more compelling now than they have ever been in history. Two trends that have driven and will continue to drive the microgrid’s competitiveness are 1) decreasing battery prices and 2) decreasing solar panel prices.

There is a high level commitment among many island nations to convert from diesel to renewables.

We have spoken to energy ministers and NGO leaders at a random sampling of island nations (Vanuatu, Nauru, Fiji) each country is actively considering developing a new microgrid. All of the energy leaderships with whom we spoke were impressed by ENGIE EPS’ Palau project and interested in considering a similar solution.

With such positive industry tailwinds, ENGIE EPS has been able to deliver steady revenue, signed backlog, and deal prospect pipeline growth. Note the recent acceleration since the company began its partnership with ENGIE.

ENGIE EPS currently has a signed pipeline of ~80M EUR. Given all of the above considerations, we believe the company is well positioned to meet its 2020 revenue target of 100M EUR.

The company’s 30% EBITDA margin is achievable at 100M of revenue

EPS has historically generated ~40% blended gross margin across its grid support and microgrid business lines. We believe the microgrid business is actually closer to 50% gross profit and grid support margins are ~20%. The company is targeting a 70 / 30 mix between microgrids and grid support systems which should result in the same ~40% blended gross margin going forward. We’d note that the largest opportunities ENGIE EPS is seeing, like Palau, are in the higher margin microgrid space. Assuming that the company maintains its 40% blended gross margin and that their fixed costs (personnel and other opex) grow at a healthy 12% rate, the 2020 target of 30% EBITDA margins should follow mathematically.

This margin target is consistent with what we have heard from other companies in the industry. Alfen targets a 30% gross margin in their grid support systems business. Winch, which has a microgrid focus, expects a 35% EBITDA margin off of 30M EUR of Revenue in 2018.

We believe that 15x LTM EBITDA in 2020 is a conservative valuation target

While ENGIE EPS does not have clear direct comps or historical multiple data, we believe that the data available supports a 15x LTM EBITDA multiple or a 4.5x EV/sales multiple.

ENGIE EPS’ closest private peers, Greensmith and Younicos, were sold at 5x to 6x revenue multiples in 2017.

ENGIE agreed to purchase 100% of EPS at a 100M EUR enterprise value at the beginning of 2018. At the time this represented a 10x LTM revenue multiple and 5x multiple of the company’s signed backlog.

The MSCI Clean Technology Index which contains companies with similar end market exposure to ENGIE EPS traded at a ~16x EV / LTM EBITDA multiple on average throughout 2018.

The median valuation multiple for companies that have comparable growth profiles to ENGIE EPS (+50% LTM growth and +50% expected forward growth CAGR) is ~20x EV / LTM EBITDA.

By applying a 15x EV / LTM EBITDA multiple and an implied 4.5x EV / LTM revenue multiple to our target 2020 financials, 100M EUR of revenue and 30M EUR of EBITDA, we reach a price  of 36 EUR / share at the end of 2020. This price offers near 3x upside from current prices.

We believe that ENGIE’s 9.50 EUR / share tender offer price from mid-2018 should serve as a valuation floor in the medium term. Despite being made before EPS won its game changing Palau contract, this floor price is only ~30% below EPS’ current market price.

Risks to investment case

While we are firm believers in the EPS investment case, it is important to highlight some of the key risks. We believe some of the major risks to investing in EPS are: early stage company risks, execution risk, and key man risk. Although EPS is certainly not a “start-up” it is subject to business risks associated with being an early stage company. We have confirmed through customer calls that the company has not had any execution issues historically, but growing from ~10M EUR of revenue to ~100M EUR will involve executing on a larger scale than in the past. We believe that Carlalberto is committed to EPS, he has invested a meaningful amount of his personal net worth in the business, and he is highly incentivized to hit his 2020 plan. If, however, Carlalberto were to leave EPS we believe this would be a major loss for the company.

A variety of uncorrelated catalysts available to drive ENGIE EPS stock towards fair value

ENGIE EPS has told us they plan to increase their significantly investor relations efforts in 2019. EPS’ management was very distracted with business development in 2018 (sale to ENGIE, integration with ENGIE, ENGIE tender offer, rights offering, winning Palau deal). Our understanding is that investor relations—including roadshows targeting new geographies and types of investors, attending conferences, bringing on new sell side analysts—will be prioritized and ramped up in 2019.

Another catalyst to crystalizing value would be an additional tender by ENGIE. ENGIE tendered for 100% of shares in June of 2018 but picked up less than 10% of shares outstanding in the process. Some industry experts believe that ENGIE plans to eventually acquire the entirety of EPS because of its strategic importance to the broader group. If ENGIE were to attempt to buy out the remaining minority shareholders, we believe that they would have to pay a sizable premium to current trading.

Finally, we believe that, although ENGIE EPS’ ~80M EUR of backlog is signed and committed, many investors will not underwrite these figures until they see them in financial results. We believe that a doubling of revenue in CY 2019 and another doubling in CY 2020 alone should be enough to catalyze the stock.

Catalyst

ENGIE EPS has told us they plan to increase their significantly investor relations efforts in 2019. EPS’ management was very distracted with business development in 2018 (sale to ENGIE, integration with ENGIE, ENGIE tender offer, rights offering, winning Palau deal). Our understanding is that investor relations—including roadshows targeting new geographies and types of investors, attending conferences, bringing on new sell side analysts—will be prioritized and ramped up in 2019.

Another catalyst to crystalizing value would be an additional tender by ENGIE. ENGIE tendered for 100% of shares in June of 2018 but picked up less than 10% of shares outstanding in the process. Some industry experts believe that ENGIE plans to eventually acquire the entirety of EPS because of its strategic importance to the broader group. If ENGIE were to attempt to buy out the remaining minority shareholders, we believe that they would have to pay a sizable premium to current trading.

Finally, we believe that, although ENGIE EPS’ ~80M EUR of backlog is signed and committed, many investors will not underwrite these figures until they see them in financial results. We believe that a doubling of revenue in CY 2019 and another doubling in CY 2020 alone should be enough to catalyze the stock.