Author: John Tough
Matt Ridley’s Newest Book Covers… ENERGY Innovation!

Matt Ridley’s Newest Book Covers… ENERGY Innovation!

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Matt Ridley is the author of a number of award-winning books. Notable hits include The Evolution of Everything and How Ideas Emerge. My personal favorite of his is The Rational Optimist. One of the many reasons I enjoy Matt’s writing is his ability to deconstruct complex outcomes to their foundational drivers.

I am working on a longer-form paper that details some of the emergent behaviors of technology in the energy and industrial transition. In the research process I have engaged a number of complexity and platform leaders. One of those leaders, the esteemed VC Bill Gurley of Benchmark, pointed me to Matt Ridley’s latest book, How Innovation Works and referenced that there is actually a section on energy innovation. Well, one week later and I have covered the book and am happy to give it a ringing endorsement. Whether you are new to energy or an experienced pro, you will learn something new. And, classic to Matt Ridley, he frames energy innovation in a refreshing way.

My Favorite Themes, Quotes & Takeaway from the Energy Section

Theme 1: Failure is the father of Innovation

Innovation is itself a product, the manufacturing of which is a team effort requiring trial and error.

Edison called his work “the invention business”. “He remained relentlessly focused on finding out what the world needed and then inventing ways of meeting the needs…his method of invention was always trial and error. In developing the nickel-iron battery his employees undertook 50,000 experiments. (!!)

“Inventing is 1% inspiration and 99% perspiration”

Theme 2: Innovation is Inevitable

I am fascinated by how technology inventions seem to converge at a specific point in time. And particularly how this convergence occurs after extreme technology advancement and trial/error reminds me a lot of Michael Waldrip’s Complexity. The technologies that enable a transformation are all advancing independently AND interacting with each other. Add in a number of entrepreneurs, acting as catalysts, and suddenly new structures emerge at the “edge of chaos” that result in a new, higher order of efficiency. This arrival to a ‘higher order’ occurred with the lightbulb, and looks a lot like what is happening today with the interacting forces driving a digitized and decentralized energy network.

“Simultaneous invention marks the progress of technology as if there is something ripe about the moment. It does not necessarily imply plagiarism. In this (steam engine) case, the combination of better metalworking, more interest in mining and a scientific fascination with vacuums has come together.. to make a steam engine almost inevitable.”

“The lightbulb emerged inexorably from the combined technologies of the day. It was bound to appear when it did, given the progress of other technologies.”

Theme 3: Innovation Turns Ideas into Practical, Reliable and Affordable Reality

There is a difference between invention and innovation. According to the book, innovation is how famous names like Thomas Edison rise to the top of the 21 inventors who lay claim to inventing the lightbulb. Edison was focused on innovating and specifically on reliability as he tested over 6,000 different filaments for duration and cost.

The ability to take a technology invention and gradually (through testing) get to a customer-available product is where innovators stand out.

Theme 4: Innovation in Energy is Evolution, not a Series of Revolutions

“Long after the key technologies had been invented, innovation continues.”

The first turbine was 2% efficient and today a combined cycle gas turbine is 60% efficient. This 100+ year journey was a collaborative effort with no 1-time transformations. Innovation came from small steps of experts, testing along the way.

The book then also explains why certain atomized production processes improve. And then goes into great detail on how other large scale projects, hampered by the rising costs for regulation, begin to dis-innovate. This is my favorite line:

“Nuclear is ill-suited to the most critical innovation practices: learning by doing. ” The best products leverage subject matter experts to tweak and innovate along the way. The experts find a way to test, iterate and improve. This testing happened successfully with shale gas exploration and fracking: west Texas wildcatters who had small companies were able to buy mineral rights from land owners and were more nimble to do small tests. In other, more regulated oil & gas countries, this innovation could not persist as the state/country owned the land rights.

What this Means TODAY

The installed bases of new energy technologies is gaining critical mass: wind, solar, batteries, EV charger. Wind and solar have gained efficiencies over the years: wind OEMs have made increasingly aerodynamic and larger blades alongside improved gearboxes and materials costs; solar is improving absorption rates and further accelerating efficiency through better inverters, trackers and 2-sided panels. In addition to the hardware, operators are getting better at O&M as they leverage remote communications network, drones, and predictive analytics. All of these continued innovations are consistent with the slow & steady march towards record-setting productions levels.

This installed renewable base coupled with advances in data products, connected devices, and software management, are apt to create a new wave of simultaneous digital advancements. These software solutions will not only accelerate the efficiency of these verticals but improve interoperability with the operating environment. As a result, we are likely to see innovative customer behaviors as these energy consumers adapt to the new product suite available. While fantastical now, these prospective new products and behaviors will seem like inevitable advances in the near-future. How fortunate are we to have the march of innovation?

Summary

In How Innovation Works, Matt covers other verticals Public Health, Transport, Food and Communications. Then he pivots to more horizontal themes such as the economics of innovation, and identifying fads and frauds. He ultimately wraps up with how to get around (the expected) resistance to innovation and which cases are worth fighting. Again, go buy the book – the perspective is clarifying and refreshing.
Hiro Mizuno & Investor Responsibility During the Energy Transition

Hiro Mizuno & Investor Responsibility During the Energy Transition

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Last month, Hiro Mizuno was on the Capital Allocator’s podcast with Ted Seides. Ted runs and is the host of the Capital Allocators podcast, and I am a regular listener. I encourage you to add his podcast to your library.

Hiro Mizuno is the recently departed Executive Managing Director and Chief Investment Officer of GPIF, Japan’s $1.5 trillion Government Pension Investment Fund. During the conversation with Ted, Hiro spent time covering how to align ESG metrics to investment performance. Near the end of the conversation Hiro goes on a great monologue about investor responsibility and how active investors can take on the responsibility of addressing ESG metrics through governance influence- and he specifically covers carbon-generating industries..

“I refuse to actually compete for less carbon footprint of the global portfolio. We could do that by divesting a carbon-heavy industry. But given our universal ownership approach, it doesn’t make any difference. Maybe we divest coal, tobacco…. But from our universal ownership perspective, it sounds like we are passing ownership of those problematic businesses to the people that don’t care about it. We don’t want to divest the carbon footprint of our portfolio by divesting the carbon-heavy industry as that doesn’t reduce the carbon footprint of the world.”

I really appreciate how Hiro talks about the responsibility to address problematic businesses. He wants to own the problem so that he can improve the outcome. What a powerful statement.

At Energize, most of our digital investments address the renewable and/or digital side of the energy and industrial transition. However, as shown yesterday in our petrochemical review, our goal is to be a student of the entire energy ecosystem and understand how digital technologies can provide value across different energy types. The fact is that transition fuels like natural gas and their byproducts will be around for a long time and digital technologies that advance renewables (like drones, or cybersecurity) can also be leveraged into providing a more secure and environmentally friendly transition for these carbon-based fuels.

We embrace this responsibility, are tracking our ESG metrics, and seek to advance the entire transition. Here is to a responsible, digital, energy transition. And thank you, Ted & Hiro, for a great discussion.
The Energy Transition May Force Petrochemical Growth

The Energy Transition May Force Petrochemical Growth

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The next most logical investment in the energy transition is to continue to develop balanced renewable energy sources. At this point, the Levelized Cost of Energy graph is commonplace and the final chapter of the LCOE story is well-written: Step 1- we will decarbonize most of power generation …and as a result… Step 2- most of the mobility market as electric vehicle motors overtake internal combustion engines.

However, focusing exclusively on continued investment in wind, solar and batteries is not taking into account that this energy transition is a multi-player, rules-changing game, with a specific player who can walk to a different table at any time. Why? Natural gas is still an economics-driven commodity, and a versatile one at that. 

Natural gas is a commodity that has both thermal value as a power generation resource and chemical value as a feedstock for higher value consumer products. As demand for natural gas decreases in power generation, supply remains high, and new use cases emerge. 

Consumer packaging, rubber tires, hand sanitizer, and millions of other CPG products all come from natural gas. And because natural gas is so abundant in the U.S., it is actually cheaper to make these petrochemicals domestically and ship them to Europe and Asia than it would be to produce them in those regions. 

The graph below shows there is $150BN of petrochemical capital expenditure investments underway in the U.S. right now and almost all of these assets are being built to EXPORT a natural gas byproduct. This new construction is in addition to the ~$750BN of existing petrochemical assets already in the ground here in the US. For perspective, the $150BN of investments is 10x greater than the size of the $14BN US wind energy 2019 investments!

These petrochemical investments will be a consumer of our energy resources for decades to come, and therefore deserve their place on our “attention shelf” when evaluating the Energy Transition. Mark Tomasovic of the Energize Ventures is helping us understand this petrochemical dynamic and identify how our financial and impact missions can positively address this market.

We are also looking to understand how better recycling technologies s can be created to improve upon the (meager) 7% of plastics that actually get recycled.

If you are an entrepreneur looking to positively address this market with digital technologies, please reach out.

— and very timely, just today there was an article in the NY Times on the petrochemical and fossil fuels industry trying to make Kenya and Africa a distribution center and destination for US plastics. Here are a few quotes:

”The plastics proposal reflects an oil industry contemplating its inevitable decline as the world fights climate change. Profits are plunging amid the coronavirus pandemic, and the industry is fearful that climate change will force the world to retreat from burning fossil fuels. Producers are scrambling to find new uses for an oversupply of oil and gas. Wind and solar power are becoming increasingly affordable, and governments are weighing new policies to fight climate change by reducing the burning of fossil fuels.

”Pivoting to plastics, the industry has spent more than $200 billion on chemical and manufacturing plants in the United States over the past decade. But the United States already consumes as much as 16 times more plastic than many poor nations, and a backlash against single-use plastics has made it tougher to sell more at home.”
Sunday Sales Series: Contract 1, AI for Industrial Operations

Sunday Sales Series: Contract 1, AI for Industrial Operations

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If you can’t tell, I have a keen interest in how software companies commercialize their products in the energy & industrial verticals.

I also feel that there is no central resource to track common contracts that serve the energy & industrial verticals. It is widely known what the costs are for traditional technology solutions: a CRM, an email management platform, a HR network. But what about the energy and industrial customers: AI model to optimize manufacturing production? Wind turbine or solar O&M contracts? Developer software like construction management or inventory management and logistics? We need to democratize access to many of these answers so that we can accelerate the energy and industrial technology transition

Every Sunday, I am going to be posting details on publicly known software contracts (specific or trends) that serve customers in the energy and industrial verticals. I will also aim to cover the reasons for the pricing structure, the value offered, and the likely sales cycle and channel. I will post this information in the (Natural) Resources section of the site. My aim is to showcase hundreds of contracts so that entrepreneurs looking to serve these customers (either initially or through expansion) have more data on how to best commercialize in this space, avoid common pitfalls, and understand value. Of course, the best outcome here is that more software contracts signed further

Contract 1: “Intelligence Industrial Operations” Software contract

The technology: Deep learning platform assigned to evaluate datasets from industrial processes and increase throughput and operational efficiency of the facility

Replacing / Enhancing: Replacing manual spreadsheets and the goal is to enable subject matter experts (SMEs) and institutionalize employee knowledge.

Target Customers: Smart factories that have complex production facilities

Business Model: Small implementation fee to train the SMEs; Upon implementation the product is priced on a “training cycles per month” revenue basis. This pricing structure aligns the software’s revenue to the complexity of the production site’s architecture. The more complex a production site, the more cycles the model will require to identify prospective recommendations.

Pricing: These contracts ultimately get value-based pricing, but the standard is around 1-2 cents per model run. And an industrial customer will likely run 5 to 10 million models on an industrial production site per year. This results in an ~$100k contract for a high value production facility.

Analysis: While the software vendors in this space have been lenient on pricing, one of the beauties of this model is that the pricing self-selects a customer. Firstly, a customer has to have a production facility that is digitized and ready to engage. Secondly, the SME needs to be aware of optimization potential AND the General Manager of the site needs to have a grasp on the potential value of the improvements. If a customer leans in, all three gateways have been passed. Usually, a great software contract can capture about 33% of the value it provides. Armed with this knowledge, a sales team should look to understand a site’s throughput and pick up any small hints about software-derived improvements to begin to ballpark the $/model. Of course, even if you are helping drive $10M in improvements, you are unlikely to capture the full upside…. competitors and general sticker shock will come up. A ballpark figure around $50-$250k per site is where I am seeing successful Industrial AI software contracts get done.
Power Down, Episode 0 – A Casual Approach to the Energy & Industrial Transition

Power Down, Episode 0 – A Casual Approach to the Energy & Industrial Transition

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I recently recorded the first (hopefully of many!) episodes in a video series called “Power Down“. The idea was hatched between Kevin Stevens of Intelis Capital and me as we wanted to show a more casual approach to discussing the topics accelerating the energy transition and industrial technology movement. We intend to add a 3rd individual to many of the recordings, and if you would like to join, reach out!

Kevin and I go way back as we worked together at Choose Energy, the (then, maybe still?) largest US online energy marketplace backed by KPCB, and ultimately acquired by RedVentures. I will discuss more about Choose’s growth in the future.

On this first video, there is no incredible editor…. the lighting is poor, the sound quality is dubious at times, but I feel the content quality is pretty good.

Our topics in the energy and industrial transition will cover everything from technology, to business fundamentals, the financing markets, exits, general market trends, predictions, and lessons learned.

The video is below and the clip I highlighted starts when Kevin and I talk about what business model changes are needed to enable faster innovation. Here is a summary of these first few minutes:

“we need full alignment between consumption and the business model. It is really hard to create a transformational business when there is deflationary pricing at the top line… people need to start thinking about “what can we do with this excess power and we can start pricing electricity based on value and not some arcane rate…”

Kevin called this “Episode 0” because it really was something we did on a whim, and we would love feedback. What else do you want us to cover? Who else wants to join?
The Energy Transition has a Distribution Problem

The Energy Transition has a Distribution Problem

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In the power landscape, one particular graph has been a key area of focus: the Lazard Levelized Cost of Energy chart. An Energize-equivalent summary of the chart is below:

As the chart highlights, renewable energy is now more cost effective than the ongoing operating costs of conventional generation. Wind and solar are the cheapest form of new energy generation. And batteries will be paired with these intermittent generation sources to further decelerate carbon-based generation.

Despite rooftop solar’s breakneck growth, big swaths of the US will continue to be served by a utility-scale generation source. And renewable energy’s greatest inputs (wind, solar) are generally most abundant outside of key metropolis areas – see the graph below and the wind speeds in the middle of the country!

Many power developers are placing big investments in utility scale transmission lines to move renewable power from the midwest to the eastern seaboard. Just like a startup needs an easy way to get its’ product into customer’s hands, our energy industry needs better mechanisms to deliver our renewable energy to the end-consumer. And unfortunately, digital investments in transmission are mostly nonexistent.

Great platforms, like Arcadia and Level10, are attaining incredible growth by delivering a renewable experience to renewable-inclined consumers and corporations. And firms like Amperon are making congestion and demand data more readily available. Ultimately, we are going to need structural changes to our transmission system. And we suspect that digital solutions will play a big role in that change, just as these digital solutions positively impacted the cost curves for solar & wind costs. If you are working on a digital technology that advances the transmission system, reach out.
Evaluating the Successful Industrial Technology Exits

Evaluating the Successful Industrial Technology Exits

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The definition of industrial technology is very broad. And the best industrial technologies ultimately get used across a number of manufacturing, energy, real estate, healthcare, logistics and OT industries.

Due to the nebulous nature of this space, the M&A narrative is not well-covered. Last week I asked IndustrialTech twitter to highlight successful exits in our space. Special kudos to Ty Findley for sharing more history on the space. Here is a list, with some data points and takeaways:

You can click on the picture to get a bigger version. And here is access to the Google Doc that contains this file. If you have more information, you want to add, please do. Link to the Google Doc Here: Industrial Tech M&A

Using the median figure, here is the narrative;

1- An industrial technology company raises a $11.8M Series A at a $41M post-money valuation.

2- Over the course of the next 4 years the start-up raises another 2 rounds and raises nearly $50M in new capital for $66M in total capital received prior to an exit.

3- By the time of exit, 4 years after the Series A, the start-up achieves $30M in revenue/bookings for a cash efficiency of 45%.

4- The company exits at $775M, meaning the average multiple is 16.5x Trailing Twelve Month revenue. And the exit price isa 9.7x multiple on total invested capital, an 9.1x return on the Series A, and a 2.5x return on the pre-exit round.

What are some takeaways

The graveyard doesn’t speak and these are the best of the best exits for the space. So recognize that the average deal is far less performant than this outcome!

When upside exits rarely exceed $500M, entry valuations and knowing the true TAM and market dynamics is key. The most rewarding exits from this list are the ones where capital efficiency remains a focus for the management team and little excess capital is invested to try to force the acceleration of a deliberately slow purchasing cycle.

Ty Findley, Santosh Sankar, Chris Stallman, and Julian Counihan all recently contributed to an excellent post on “Why VCs Must Specialize” and I agree with the theme: smarter knowledge of your vertical dynamics drives better evaluation and price awareness so that when a start-up is going adrift, alarm bells are raised to realign for upside success. And to keep valuations within a reasonable range to allow for upside returns.

Finally, the high revenue multiples and potentially abbreviated time to exit for the most successful companies (other than OSIsoft!) shows how acquirors pay premiums for access to the industrial customer, but need to see non-trivial revenue levels (almost $30M+) before paying up.

I hope we can add many more to this list in the coming years.!
Energize is HIRING

Energize is HIRING

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Here is the job posting for a Principal on Medium

And here is the job posting for an Associate.

Big things are happening here at Energize Ventures and I am excited to announce that we are seeking two new investment professionals.

The link to the job description for the Principal role can be found here.

And the link to the job description for the Associate role can be found here.

In addition to our traditional engagement channels, the Energize Team is fully embracing our DEI position and actively working with organizations to elevate awareness and create a more inclusive and diverse recruiting structure.

I have so much to share about what it means to be an Energize team member. As our existing team knows, we run Energize with an “Order of Operations” that clearly lays out the responsibility we have to each other, our investments, and our Limited Partners. But the best part about a new hiring process is how Energize gets to be redefined by the newest hires. We get better with every hire, and I am certain that trajectory will continue with these two positions.

Calling it: OSIsoft is the Industrial Tech Deal of the Year

Calling it: OSIsoft is the Industrial Tech Deal of the Year

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I am calling it: OSIsoft’s acquisition by Schneider Electric controlled AVEVA Software is the industrial technology deal of the year.

While I am sure that there is industrial technology M&A happening as you read this… and there are some great names like ChargePoint and Desktop Metal are in the rumor mill for a SPAC, it will be hard to top the returns profile that OSIsoft generated for their select investor group.

The structure here will cover a brief summary of the company & product, financing history, and why AVEVA is an especially interesting partner.

HISTORY

OSIsoft was founded in 1980 by Dr. J Patrick Kennedy, a legend in the industrial technology space. 40 years ago. Older than the author and many readers of this post. The company’s core product is PI Systems, a data historian. The PI historian is a data capture, relay and management platform purpose-built for the physical operating environment. If you are looking for a product with incredible retention, it is hard to find a “stickier” one in any market. This is why:

Data analysis primarily occurs on high value assets with extended life-spans: 10-40 years. And once a historian platform is selected it usually lasts the life of that asset. AND when the next asset is installed, of course the operations team at the industrial entity is going to select the same historian so that there can be back-end consistency of data management to allow for simpler data analytics. this system perpetuates such that OSI claims to have 95% of their original customers and be extracting data from over 19,000 industrial sites. This embedded product stickiness is why the company has been able to command high prices for their product and generate material profit.

FINANCING HISTORY & EXIT PROFILE

Grade: A+ for founder, A for investors, B for SoftBank

Dr. Kennedy’s cash management at OSIsoft is the talk of legends. He ran the company on its’ own cash flow from the earliest of days.

Investment #1: Summer, 2011

It wasn’t until summer 2011, over 30 years after starting the business, that Dr. Kennedy decided to bring on external capital. At the time, his business was already generating around $200M of revenue and a sizable EBITDA profile. During the raise, he sold 30% of his company to TCV and KPCB’s Green Growth Fund in equal segments.

He executed a capital raise at a $450M valuation (likely for secondary purposes) by selling 30% of his company for $135M. The company was just about to cross the $200M revenue benchmark and was likely already very profitable. As shown below, this ~2x revenue multiple was a great entry point for the investors.

Investment Event #2 PE Growth Event to SoftBank

In May 2017, SoftBank’s Vision Fund came knocking. With the business now generating around $350 in revenue, SoftBank paid a whopping $2.9BN entry valuation, or ~8x revenue . During this event, the earlier TCV and KPCB investors exited at a very handsome return profiles: assuming minor dilution, back of the envelope calculates show the growth equity round executed by the earlier investors produced greater than a 6x return in the 6 years of holding the business.

Today’s Exit: AVEVA acquiring OSIsoft

Metrics released today show that the business is now at $500M in Trailing Twelve Month Revenue. This means that the company is still growing about 10-15% in topline revenue per year, an impressive figure in the industrial technology space for such a sizable profile. That results in a ~10x revenue multiple.

And as suspected, the company has a very healthy 30%+ EBITDA margin.

This exit produces a mammoth return for Dr. Kennedy, who still owned a majority of the company. SoftBank gets to generate an approx. 1.7x return, which is not too shabby for 3 years given the absolute dollars that the Fund was able to invest into OSIsoft.

The FIT with AVEVA

Grade: A-

Aveva is a global leader in industrial software. The company is undergoing a transition from a mostly perpetual sales model to a recurring sales model. While this transition is never easy, Craig Hayman is considered a world-class operator in the space. AVEVA has an embedded $700M software business and the combination of AVEVA and OSIsoft is very powerful as AVEVA already has a few data historians within their technology suite.

In fact, AVEVA now has three historians, each in complementary verticals! This means that AVEVA is now the de-facto historian across of nearly every asset industry. The only true competitors outstanding now would be Bazefield and GE.

AVEVA’s three different historians:

#1 OSIsoft: primarily serving the process industries: oil & gas, chemicals, pharmaceuticals, etc.

#2 (assigned from Schneider Electric) Wonderware: broad application with an emphasis on post-capture analytics

#3 (acquired through M&A), InStep’s eDNA product. eDNA is also an enterprise-based historian primarily used within the utility and power market.

While I suspect AVEVA’s marketing team will likely want to simplify branding, the fact is that each of these entities has strong brand presence within their specialty verticals. And this product stickiness and brand strength should allow AVEVA and OSI to maintain market share and pricing defensibility going forward.

CONCLUSION & TAKEAWAYS

Top marks for investor returns and capital efficiency. Dr. Kennedy walks away with over $2.5BN in proceeds and was very capital efficient along the way. He has the highest capital efficiency marks of any company in our industrial technology data set. (releasing that in a few days)

AVEVA and Schneider Electric win control of a crown jewel in the asset-heavy market. If you believe that data and data management is a requirement for the next generation of industry, then OSIsoft is an invaluable asset and the price is fair and consistent with other elite assets currently in the software market.

The most important subtly to the story is how this is a 40 year success story. In the energy and industrial markets, there are no overnight successes. These customers buy slowly because software gets applied to real, operating assets. Mistakes cannot be made. Aligning a capital table with this reality is key. And if you allow results to compound for 40 years, good things tend to happen!
Value-Based Pricing: The Exception & How to Get Creative

Value-Based Pricing: The Exception & How to Get Creative

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Yesterday’s post covered how software companies improve their marketing and pricing structures by framing value in revenue growth, as opposed to savings. For the industrial and unregulated energy markets, this framework works about 90% of the time. But, like all good rules, there are a few exceptions. Topline alignment does not work when the product’s value is allocated to any of the following:

Regulatory / compliance

Environmental impact

Cybersecurity

The value-based exception occurs here because the return on investment for each of these product types is either

  • government defined or
  • addressing a long-tail, difficult to price risk

Most energy & industrial firms look at spend in these areas like insurance policies. With this uncertainty, firms hire consultants to recommend resource allocation and ensure that the corporation is investing sufficient resources (not more, not less) versus their peer set.

This causes two unique dynamics:

  • Incredible purchasing influence by channel partners in these areas
  • Underinvestment in long-term risks… until the risk shows up on the front door. (Think: a cybersecurity hack, long-term emissions impact, etc.)

If you are a startup serving these markets, it is especially important to retain policy advisors, immediately double down on channel partnerships, and most importantly: find a supplemental way to quantify your product’s impact beyond the initial, seemingly arbitrary cost line item. By creating a new form of value, a start-up in these verticals has the potential to control their pricing. I call this “supplemental value” the “Rule of AND”. Here are a few examples:

  1. The best companies in cybersecurity will offer their cybersecruity solution and also create an additional narrative around operational visibility. (positively impacting operational uptime = higher revenue!)
  2. Similarly, the best companies in environmental impact reporting report impact and will attempt to make product and supply chain recommendations to lower materials costs. (positively addressing materials= lower costs)