What Went Wrong in the First Residential/Energy Services Consolidation
The residential service market is a tough nut to crack. The late 90’s to early 00’s saw various attempts at a roll up strategy in what appeared to be a very lucrative market. Companies like: Service Master, EMCOR and Blue Dot were able to raise lots of capital to purchase as many energy/residential service companies as they could. The acquisitions included plumbing, pest control, HVAC (commercial/residential), home appliance repairs, etc…From an MBA-level perspective, the industry seemed very attractive for consolidation. The graph below shows how fragmented the industry currently is, and this is post consolidation:
What the corporate guys did not take into consideration was that they acquired a transient blue-collar work force, not a team of like-minded corporate professionals. These environments have vast differences in culture, something an Excel model cannot take into consideration. While these roll-ups failed, they taught the energy/residential service companies how to, and not go about consolidation.
Today’s Energy Services Consolidation Market
The industry matured a lot since then; EBITDA multiples paid were cut in half, and corporations and Private Equity firms began performing actual due diligence on their acquisition targets (shock!). There are a couple different groups of acquirers at the moment:
Long-term Corporate Growth with a High Emphasis on Market Disruption
With an enormous balance sheet to draw upon and tremendous group oversight from their seasoned management team (most came from the first consolidation period), these guys definitely know what they are doing. Think of them as wolf in sheep’s clothing. They enter markets disguised as residential service companies. Once they establish their local brand name, they begin to offer electricity at competitive rates to the local utility. Isn’t deregulation wonderful?
Oil Survivors
Their job is very simple, take oil from point A, deliver to point B, and repeat the process as many times as possible through long-term customer contracts into the future. This is a game of numbers, and when you have been in the business for many years, the acquisition model is very simple. Residential oil companies will value a target distributor based on a combination of:
- Number of distribution contracts
- Average contract duration
- Average contract renewal rate
- Average contract volume (gallons/year)
- Equipment service contracts (HVAC)
A target company can have poorly managed accounting books, or be skimming from all parts of the business, but the above mentioned facts cannot be altered, and thus make these types of acquisitions very easy. It is not strange for a residential oil company to have 10-20 acquisition candidates in the pipe at any given time.
Local Utilities
These are usually referred to as the “evil empire” by local, smaller competitors in the energy services space. It is extremely hard for even a large, local outfit to compete effectively with a utility company that owns larger customer lists than anyone else. Pushing energy services into the home is very easy for a utility. They continually add service contract options to their menu and give their customers the option to include it on their monthly utility bill. Offering financing options to every customer allows utilities to earn revenue on what a local competitor would call a “dead asset”. 100% market penetration never sounded so good.
Alternative Energy is the Next Logical Step in Energy Services Consolidation
Today a homeowner can now add alternative energy options to their home which allows for decreased monthly utility bills and many state and federal tax credits. The biggest hurdle to getting this technology in your home is service availability. Alternative Energy installers currently resemble the industry layout shown above for the residential HVAC companies.
There are many small installers out there with zero track-record. Searching the internet for “solar panel installations” for example will tell you about long waits, no-shows, and repeat visits to do the job right. This kind of feedback begs for a “gold standard”. After all what good is technology if we cannot acquire it easily?
Companies that do provide these kinds of services (wind, solar, hydro, etc…) will become prime acquisition candidates for consolidators mentioned above for a couple of reasons:
- Customers lists: a small-town or even regional operator cannot compete with a local utility for a service/product marketing campaign. Customers want the lowest prices available, and large companies achieve this with bulk orders. You have to be REALLY good to even attempt this. Utilities and other large established energy/residential service players have all the requisite permits/licenses necessary to install this equipment.
- Financing: big balance sheets definitely help. With solar hardware alone costing between $15K-$30k, the biggest decision in going green is financing. How do I pay for this? Are the terms good? Being able to draw upon credit facilities or cash-rich balance sheets to self-finance is a clear competitive advantage. If a client cannot pay the solar power financing portion of the bill a utility can always use the power generated as collateral.
- Man power: Plugged into the local union and vocational schools, utilities can draw top talent to scale an alternative energy installation arm, and use their current labor force in a full capacity.
- Warranty service: With minimum power production warranties of 25 years available on panels, industry consolidators have long-term potential cash flows. When something goes wrong with the system who do the customers call? Companies that already service a home want to be there as often as possible and will fight to become a homeowner’s new best friend.
- Service contracts: bi-annual visits to service the panels would be an easy sell. Another $1-$5 on the monthly bill for a customer’s home service or utility company to service their new alternative energy equipment seems like a bargain.
Unless these solar installation companies have a background in home installation/service work, there are hundreds of companies that have been doing this longer and can most likely provide better, more profitable service.
Consolidation Candidates
The industry is young, but there are many start-ups and subsequently VCs that believe in the idea of service oriented alternative energy companies providing green conscious consumers with infinite power:
- REC Solar: is an established solar installer since 1997, they have a presence on both coasts
- Solar City: is a new up and coming installer based in Foster City, CA. They provide an obvious but un-attempted strategy: interested clients sign up for solar installations, and when demand is high enough in a given geographic location, Solar City purchases all the hardware and arranges for installation providing comparatively low prices to customers. They raised an incredible amount of VC funding in a short time. They have not reinvented solar power, but they have tapped into a great marketing strategy to enable low-cost distribution and installation. Overall their idea is very promising; the only weakness I foresee is their ability to manage a “green-collar” workforce.
An interesting fact about this company is that they share the same chairman, Elon Musk, as Tesla Motors. One of their projects is to install solar powered refueling stations for electric vehicles in cities. - Sun Run: is another start-up that changes the premise of owning alternative energy technology. They own and install the panels on customers’ homes, and then charge customers a fixed rate for electricity through a long-term lease contract. The idea here being they can sell the excess production to the grid as well as receive the tax credits and incentives. Click here for their WSJ mention.
This is a company that could easily snowball into a giant behemoth. As the energy efficiency of panels increases with a growing customer base, they could essentially become a mini “utility.
Asides from the established consolidators mentioned previously, there are very large solar focused corporations that can continue to build on their solar expertise through consolidation:
- Sun Power Corporation: this is a one-stop shop for solar energy needs on both a residential, commercial and infrastructure level. They are most known for their large commercial installations. Their acquisition of PowerLight last year for $333M provides a glimpse at the future the solar industry has.
Cash flows will continue to increase and investors will demand intelligent deployment of funds. Let’s see how the sun sets on this one.
October 23, 2007 at 5:52 am
Excellent overview of the current state of the solar industry.
November 10, 2007 at 2:31 am
I think we are still a long way from true alternative energy sources. The latest reports actually indicate that it takes more energy to produce alternatives! Our best bet is conservation…
Take for example lighting. On average, Lighting consumes about 20% of all electricty produced. In addition to looking toward higher efficiency alternatives, out salvation lies in conservation. I like Energy Efficient CFLs. CFLs do, in fact, have much greater advantages than other forms of lighting. According to the US Energy information commission, by replacing twenty bulbs with CFLs in your home, over the course of a year you’ll eliminate nearly a ton of carbon dioxide emissions.
Check out our findings at:
http://www.esplighting.com/saveenergy.html
Thanks!
Ike
November 10, 2007 at 4:55 pm
Ike,
Good point. I think the energy resolve has two sides: production and consumption. This post focused exclusively on the production aspect.
I agree both sides are necessary. As far as the net energy-used is concerned…consumers/investors will not care as long as the end-user’s economic reality makes sense. If solar panels for example become “affordable” to the majority of consumers via specialized loans/tax credits/rebates/etc…the purchase is rationalized. For now the majority of the public views anything labeled as “alternative energy” to be green, regardless of the net carbon footprint. This will most likely become a marketed competitive advantage as new entrants enter the marketplace and give the established conglomerates a hard time.
I will check out your site later. Have a good weekend!
December 16, 2007 at 5:53 pm
Selling Renewable Energy (Solar Etc.) Without Incentives
In short, we need to market solar as an investment that will save money while you own it and return most or all of your investment when you sell the building it’s sitting on.
Chances are, as natural gas and oil prices go up, there will be a corresponding jump in your monthly electricity bill. So, instead of promoting a solar power system based on today’s savings in electricity, we need to have easily understandable projections on what the savings will be over the life of a system. These numbers need to reflect what’s really happening to the cost of energy!
Here are some ideas I’d like to share. First, we need to find a way to make renewable energy economically competitive without the tax incentives. We do this by answering the question: “What is the opportunity cost of not using solar to decrease your energy bill?”
There’s something interesting I’ve found. There’s a direct correlation among electrical rates, the cost of air conditioning a building, the heat index and the amount of sunshine on any given day. In other words, on the hottest, sunniest days, we use more electricity that costs more per kilowatt. So, why do we continue to promote average hours of solar production, when in fact (at least down here in California), we produce far more solar power per day during the heat of the summer when energy costs are highest, than we do in our temperate winter months when energy costs are lowest. A sound marketing approach would be to evaluate solar energy in “dollars” of production per year instead of in kilowatts. I’m sure there are some smart people out there who can match kilowatts of solar production on any given day of the year to what the rates will be (based on the projected costs of electricity).
Secondly, we should stop trying to sell a solar package as a “cost.” In real estate, there is a principle that says anything affixed to real estate becomes an integral part of the real estate. Once a solar package is installed, it immediately increases the value of a property. So how can you predict how much more a building will be worth in 5-10 years with a package as opposed to without one? In the real estate appraisal business, there are three approaches to appraising a property. The market approach (what are comparable properties selling for), the reproduction cost (the cost of creating an identical building at current construction and material prices) and the actual original cost adjusted for inflation. In all three methods, there’s a strong case that a system installed today will make the building worth more today and in future years.
We need some realistic numbers to predict how much more a property will be worth in the years following installation. I believe that if you sell a building 5-10 years after installing solar, you should recoup all of your investment in the system plus an added bonus. If the rumors are true, a residential system (using the market approach) adds $20 of value to a home for every $1 it saves on the electric bill.
For commercial appraisals, you would divide the income (savings) by a cap rate (which was about 9% at last report). A system that saves $2000 a year then would be worth $40,000 on a home or $25,000 on a business. But if the cost of electricity goes up (if that is remotely possible), then wouldn’t the value of the solar power system increase as well? In reality, we are not selling something that costs — we are actually offering a financial investment that grows comparably with other forms of energy.
In short, we need to market solar as an investment that will save money while you own it and return most or all of your investment when you sell the building it’s sitting on. In commercial real estate, they use a “Cash Flow Analysis” form as the tool to evaluate a building’s value using the income approach. We need a similar tool for putting a value on solar. If solar makes sense with this approach, then just think of how much better the systems look when you add the tax advantages!
This approach also applies to the cost of Energy efficiency implementation.
Reducing operational costs increases the value of the business and or property.
Compiled by Jay Draiman, Energy analyst
12/1/2007