Tom Konrad CFA
has a great residential demand
response business. The company lacks focus, but the stock has
significant upside as
an acquisition target.
As part of my ongoing series on energy management companies (see these
articles on World
CEO Blake Young.
The Comverge Advantage
Comverge is the strong leader in residential demand
(DR,) one of the most cost effective grid stability solutions
demand response, residential DR is an excellent niche,
because working in the market for residential DR is much more
difficult than for that commercial and industrial (C&I) DR.
For instance, World Energy Solutions CEO Rich Domaleski
told me that his company leverages their market based energy
platform to sell the other energy services, such as efficiency and
DR. Yet World Energy has no interest in entering the residential
space: their focus is on large customers where they can make a
significant profit from a single transaction, and they
typically only consider customers with annual energy budgets over $500,000
or more than 100 times a typical household energy budget. DR
likewise focuses on large C&I customers for similar reasons.
Yet there is strong demand for Residential DR as well. Although
it's cheaper to achieve large reductions in peak demand at large
electricity customers, many utility regulators have a mandate to allow
all classes of customers to participate in utility programs. In
practice, this means that many utilities will pay more per MW for
residential DR than they will for C&I DR, leading to higher margins
for those companies able to provide residential DR cost
competitively. According to Young, Comverge ended 2010 with 41%
on their residential business (57% of sales), but only 33% gross
margins on their C&I business (43% of sales.)
In residential DR, Comverge places a switch and transmitter/receiver on
mainly air conditioners and pool pumps, gathering DR capacity a
kilowatt at a time. It takes 1000 houses to get 1MW. In commercial
applications, one single steel mill’s DR capacity could be 50MW, the
equivalent of 50,000 houses. Residential is harder to deploy, but once
deployed, it is distributed and easily cycled. Commercial is bigger,
but the DR company needs to deal with professional energy managers who
are liable to shop around for the best deal, compressing margins.
And just like distributed generation, distributed DR has advantages for
utilities in that they can address local stresses on the grid with
local demand reduction.
Comverge's expertise in Residential DR grew out of 30 years of history
selling equipment to utilities used in DR programs. They launched
their program to provide Demand Response as a service in 2003, and went
public in 2007. They've been able to achieve their leadership as
a residential DR provider because they have a large number of scalable
residential DR contracts.
The Stock Price
Given Comverge's leadership in the highest margin DR niche, it is
rather surprising that the stock has performed so horribly since Young
took the reins in February last year. When I asked him to what he
the fall in the stock price, he told me that Comverge has "trended
virtually the same as other companies in the space."
A quick look at the graph below will show you that that is an overly
description of the stock's performance, at best. The only other
, and while the two companies followed
the same trends closely from their IPOs in mid 2007, a significant
gap has opened up over the last two years.
Image source: Yahoo! Finance
Since February 2010, EnerNOC shareholders have lost roughly half of
their money, while Comverge shareholders have lost three-quarters of
their investment. If Young believes Comverge has trended
"virtually the same as other companies in the space" during his tenure,
he must consider Comverge's "space" to be companies in severe financial
Fear of Dilution
Comverge is not yet in severe financial trouble, so why has Comverge
fallen to the
level reached only in the depths of the 2008 financial crisis?
The answer, most likely, is shareholders' fear of further dilutive
. Selling new stock to raise money is not always
bad, but it is a problem if shareholders think it will be invested in
less profitable businesses than the current one.
Young's apparent complacency about the stock price seems to extend to a
general complacency about the use of shareholder funds.
Where does the capital go? Young gave me the example of the
electricity transmission organization in the Eastern US) auction for
the 2014-15 capacity year. Comverge bid for and won 20% more
capacity in that auction than they won in the 2013-14 auction.
Meanwhile, the market is becoming more competitive, with prices in the
PJM auction having fallen 20% over the previous year, meaning that
Comverge's expected revenue from the PJM market will be 4% lower in the
2013-14 year than in 2012-13, while they have to acquire 20% more
MW. Growth is good, but in this market Comverge is running
just to stand still. Those contracts tie up capital in the form
collateral which will be paid in penalties if Comverge does not meet
its obligation to deliver those megawatts. What's particularly
ironic about this is that PJM introduced a new mechanism in this most
recent auction to allow smaller players to bid without putting up as
much capital, which Comverge did not take advantage of because they
consider it too complex.
Comverge has been investing in a lot of things other than what
they are best at, which is residential DR. Young told me that the
company is aggressively pursuing C&I customers (the C&I share
of revenues has been growing much faster than the Residential), as well
as investing heavily in their IntelliSource software platform.
They recently also moved their former CFO to a newly created position
as head of
international operations, where Young says they are "looking very hard"
at the Middle East, Africa, China, and South America.
While any of these strategies might make sense for a profitable company
expecting maturation of its core business, Comverge is not profitable,
and residential DR (as well as DR in general) has plenty of room for
growth according to Young himself.
Comverge's experience with small residential customers might serve to
give the company an advantage when working with smaller commercial
businesses, but they don't have any obvious advantage with the large
C&I clients, and they are pursuing those as well.
When I asked Young what competitive advantage they have in the C&I
market, he spoke of their close relationship with their customers, and
IntelliSource, which incorporates large amounts of data about the
electricity use and control on the system to better predict how many MW
of capacity they can deliver at any time. He also
says that many utilities like to work with a single
demand response provider. IntelliSource seems
like more of an advantage with smaller customers. Large
customers' power usage naturally comes in larger blocks, so such
detailed data, while useful, will be less relevant than with large
numbers of smaller customers. Yet the argument that utilities
like to work with a single provider is a strong one, and justifies
Comverge's presence in all parts of the DR market, even if they do not
have a competitive advantage in large C&I.
Yet that argument does not justify the company's expensive
participation in the competitive PJM market, which does not
differentiate between DR sourced from residential customers, nor does
it justify a move overseas.
What I'd prefer to see is a focus on growing the core business of
working with utilities that do want a significant portion of their DR
megawatts to come from residential customers, in order to maintain the
company's profit margins at least until Comverge achieves profitability
and there is a significant recovery in the stock price, which would
lower the company's cost of funds. Moving into more and more new
businesses adds to overhead
and moves this date out further and further.
The plummeting stock price and lack of focus have drawn the attention
of a group
shareholders called SAVE
, led by Brad
provocative ideas about distributed solar's effect on
I wrote about in February. Comverge's
states that the certificate of
incorporation "provide[s] for a classified board of directors, [which]
could discourage potential acquisition proposals and could delay or
prevent a change of control." SAVE first needed to remove
Comverge's classified board structure in order to gain influence at
Tirpak sponsored a proposal on Comverge's
which instructed the board to repeal the classified structure
of the board and "complete
from the current staggered system to 100% annual election of
each director in one election cycle unless this is absolutely
impossible," and also requested "that this transition is made solely
through direct action of our board if feasible." The proposal passed
In response, the board placed an amendment to Comverge's articles of
incorporation on Comverge's
2011 Proxy Statement
, which was designed to "implement over
a period of three years the
stockholder proposal to declassify the Board," and recommended that
shareholders vote for the change.
SAVE saw this proposal as "a
attempt to entrench Alec G. Dreyer as the Chairman of the
Board for a further three years,
" because the board did not
declassify through direct action (which would have been immediate) and
implemented the proposal over three years, rather than
The 2010 proposal was clear that legal constraints were the only valid
reason not to declassify the board immediately and completely, so I
asked frequent AltEnergyStocks
an attorney with Venture
in Denver for their opinions. Both told me
that the board would not be able to declassify by direct action and a
second vote would be required
if the staggered system arose from the firm's certificate of
incorporation, which Comverge's S-1 confirms is the case. Knight
also told me that companies often declassify "over time as the prior
directors were elected for longer terms and are generally entitled to
serve out their remaining terms if elected prior to declassification
under a company’s bylaws."
In other words, declassification over a period of three years, although
slow, was declassification "in the most expeditious manner possible, in
compliance with applicable law, to adopt annual election of each
director." Possibly the board could have called a special
election of shareholders to declassify the board in 2010, shortly after
the shareholder proposal passed, but that possibility was ruled out by
the text of the 2010 proxy, which stated that the proposal would run on
the 2011 ballot.
SAVE was successful in defeating the 2011 proposal to declassify the
board over three years, urging the board to declassify immediately and
"explore all strategic alternatives" (i.e. put the company up for
sale.) But this was a Pyrrhic victory, as the board cannot
legally declassify immediately.
By lobbying against the implementation of its own proposal, SAVE has
damaged their own credibility, which makes management less likely to
listen to them regarding potential mergers with other companies which
might lower Comverge's cost of funds and produce an immediate return
for Comverge's shareholders. In our interview, Young was quite
dismissive of SAVE and Tirpak, whom he seems to regard as minor
Although I understand management's dismissal of Tirpak's efforts, I
also agree that there would be significant benefit to shareholders in
the company pursuing all strategic options.
Despite the lack of focus, Comverge has significant value, and at
current prices would make an attractive takeover target for other
companies in the space. There is a clear appetite from large
players for companies in the Energy Management space. For
the formerly OTC-listed EnergyConnect. These
companies have a lower cost of capital, and so can more easily afford
the capital needed to participate in the DR space for large customers.
On measures of cash and current assets, Comverge appears
well-capitalized, but much of this money is tied up as
collateral. The most recent quarterly report states that
Comverge committed $17.9M in advance of the 2014-15 auction, funded
from cash on hand and a revolver loan. Young told me that they
got "some" of this back after the auction, so call it $15M. But
Comverge's most recent balance sheet shows less than $27M in cash and
$24M debt. Was that a good use of so much of the company's
Yet the company does have a strong backlog, including
$532 million worth of future revenues through 2024 under existing long
term contracts, and a contractual backlog for the coming year of $128
million as of the end of Q1. At 35-40% gross margins, that's
about $50M per year before overhead costs, but at $3.30 a share,
Comverge's market cap is only $82 million. Comverge would be
worth a lot more to an acquiring company like Johnson Controls, or Siemens
, or ABB,
that have strong balance sheets and have shown appetites for acquisitions
. EnerNOC, which is profitable, could
also see instant gains by eliminating much redundant overhead and
gaining valuable expertise in the residential market.
Comverge Should Merge
At the current price of $3.22, Comverge is an attractive acquisition
target, and would probably have $6-$8 worth of value to a better
capitalized acquirer. But investors who buy now are taking a real
risk. Although Young told me that he intends to break even in
2012, such predictions have an unfortunate habit of slipping, and have
slipped at Comverge in the past. The
company seems to be aggressively investing in less profitable
businesses that diverge from its main business and are not justified
given Comverge's current high cost of
funds resulting from the lack of profitability and the low share price.
Perhaps Comverge will achieve break-even in 2012 and profitability in
2013, as Young expects. But I don't see how that will happen
without either further diluting existing shareholders, or merging with
a larger company that has a lower cost of capital. Since Young
and many of the board members are significant shareholders, I hope they
see that it's too their own benefit to take the latter course.
DISCLOSURE: Long COMV, ENOC, JCI.
DISCLAIMER: Past performance is
not a guarantee
or a reliable indicator of future results. This article contains
the current opinions of the author and such opinions are subject to
change without notice. This article has been distributed for
informational purposes only. Forecasts, estimates, and certain
information contained herein should not be considered as investment
advice or a recommendation of any particular security, strategy or
investment product. Information contained herein has been
obtained from sources believed to be reliable, but not guaranteed.