Cleaning up - Mark Veverka

It's that rare opportunity to save humanity and make a killing. The mere possibility has Silicon Valley's venture capitalists tripping over each other to offer cash to start-ups focused on Clean Technology, a fuzzy business category that now encompasses just about anything that might help stave off global warming and aid the environment: solar and wind-generated energy sources, air and water pollution-control devices, and alternative fuels made from just about any non-hydrocarbon-based item all qualify. Even electric sports cars seem to fit the bill.

Venture capitalists plunked down better than $1.5 billion in funding for clean tech in 2006, bringing the total to $4.2 billion since 2000, according to the National Venture Capital Association. These strong inflows have helped launch 1,500 start-ups worldwide.

"These companies are popping up like weeds, just like dot-coms, but hopefully with better rates of success," says Vinod Khosla, the well-respected venture capitalist who founded Khosla Ventures and is an affiliated partner at Kleiner, Perkins, Caufield and Byers.

More than 50 of these one-time weeds already have progressed beyond private-equity funded start-ups and entered the public markets in the past two years or so, which begs the question of how well they'll fare longer-term. Will the attrition rate among clean-tech companies be as high as it was for Internet companies (not to mention their shareholders)?

Clean tech no doubt will suffer from some of the same ills as the
Internet: Already, solar stocks are frothy, ethanol shares have soared only to plunge as corn prices rose, and some fuel-cell companies seem to have borrowed their business plans from long-departed Web enterprises.
But the sector also appears to be a fertile source of profitable growth investments for the next decade or more. There's already a decent selection of stocks to buy in this area, with substantial upside.

In part, this is because governments worldwide are expected to pass tougher environmental laws aimed at saving the planet, by forcing industry and utilities to do less harm. Global accords like the Kyoto Protocol, which limits carbon-dioxide emissions and promotes trading of emission rights, are gaining. Just last week in the U.S., which didn't agree to the protocol, the Senate introduced a measure that would mandate a "cap and trade" system that limits total emissions and then allows carbon-dioxide producers to trade emission credits.

"The likely trajectory of legislation on global warming is creating a great investment opportunity," says Khosla.

Added impetus comes from the U.S.' dangerous dependence on foreign oil.

"There is a natural alliance here between the tree-huggers and the hawks, even if they don't agree on the reasons," says R. James Woolsey, director of the Central Intelligence Agency in the Clinton administration who works for consultants Booz Allen Hamilton.

"With about two-thirds of the world's oil supply situated in the tumultuous Middle East, we need to do to oil what electricity and refrigeration did to salt at the turn of the 19th century," says Woolsey. Salt still mattered after new means of preserving food were discovered, but it was no longer a strategic commodity that triggered wars.

In February, the California Public Employees Retirement System, the nation's largest pension fund, pledged to commit $400 million to private-equity investments in clean tech managed by Pacific Corporate Group of La Jolla, Calif.

California's move provided an added measure of validation to the category, which increasingly is moving into the public markets. Thirty clean-tech outfits went public in 2006, raising about $4.4 billion, following the 19 that generated roughly $1.7 billion in 2005. The American Stock Exchange now has a Cleantech Index (CTIUS) and there's a PowerShares' WilderHill Clean Energy Portfolio exchange-traded fund (PBW), one of a number of vehicles devoted to the group. (Barron's parent, Dow Jones, announced last week that it was launching a new Clean Tech news service for investors.)

Investors will have to negotiate a market that's likely to resemble biotech more than the Internet or information tech, says VantagePoint Venture Partners' Stephan Dolezalek, whose firm has invested in 11 companies to the tune of about $140 million since 2001 and plans to invest another $100 million or so a year.

As in biotech, venture capitalists are more likely to exit their investments in clean tech via buyouts rather than IPOs. In part this is because clean tech faces more uncertainties -- owing to its reliance on changing government policies and subsidies, an evolving customer base and huge capital needs -- than information-technology firms that had more defined sets of customers.

They will also compete against huge multinationals, which are likely to be active acquirers both for defensive purposes and as ways to enter new areas, Dolezalek says.

Instead of Big Pharma, it will be oil, chemical, agricultural, and energy-utility behemoths, among them companies like General Electric, BP, Dow Chemical, ConAgra, Monsanto that will be on the prowl for these companies. The start-ups, like fledgling biotech companies, will get brand recognition, distribution, big sales forces and manufacturing help while the acquirers will receive needed growth and knowledge.

It's too early to invest on this basis, but some big companies may also be long-term beneficiaries of clean tech. What would happen to General Motors' shares if the auto maker produced a car that got 100 miles to the gallon or didn't use fossil fuels at all? The same kind of breakthroughs could occur at GE (wind and lighting) or Archer Daniels Midland (ethanol).

That's not to say we shouldn't expect some new household names to emerge. While it produced fewer than those spawned in the computer revolution, biotech still gave us giants like Amgen and Genentech. If clean tech ever produces a comparable name, it's likely to come from the broad and diverse energy sector that's captured more than half of all clean-tech venture money.

Whether turning cow chips and corn into biofuels or harnessing the wind and sun, these alternatives to fossil fuels are going to garner more attention as the science improves, public policy shifts and storage capability grows. It is also where traditional Silicon Valley semiconductor technology intersects with new frontiers, such as solar cells and energy storage like batteries.

One of the early success stories and highfliers is SunPower (SPWR), a majority-owned spin-off of Cypress Semiconductor (CY). Nothing fancy here, SunPower is a well-managed maker and seller of high-efficiency silicon solar cells and panels based on today's technology. "It's the premier solar photovoltaic company," says Brion Tanous, a next-generation energy analyst with Merriman Curhan Ford in San Francisco. (Thermal solar, which heated water, was considered the first generation of solar where photovoltaic is the next generation that turns light into electricity).

The company has a market-leading position in Spain, one of the world's biggest promoters of alternative energy, a 2.2-megawatt solar-power plant in Korea and is starting on the largest solar installation in the U.S. The company racked up about $237 million in sales last year, with profits of $36 million, or 51 cents a share.

Supporting a market value in excess of $5 billion, the shares hit their 52-week high last week at 69.80, or a pricey 36 times 2008 earnings.
Some insist it's worth it for high-quality growth. Merriman Curhan's target is 75. Says one angel investor: "It's rich, but it's kind of like buying Microsoft in the early '90s. It will just stay rich."

Another alternative start-up is New Hampshire-based Environmental Power Corp. (EPG), a big bet on the institution of emissions caps and the trading of pollution credits in the U.S. The company's technology cuts the natural release of animal-produced methane, a carbon-based gas that contributes to the Greenhouse Effect. Under a trading system, Environmental Power would get valuable credits for its efforts which could translate into a new revenue stream beyond its main business of turning methane into biofuel. Analyst Tanous estimates the credits could be worth as much as $4.6 million, or 33 cents a share, by 2009.

Major investors have eyed the shares of this unprofitable company, but a market value of $84 million doesn't provide them enough liquidity.
Shares were trading around 8 last week, below their 9.34 52-week high.
"Small-cap investors are buying this stock," Tanous says. "And I think it has a long way to run." He has a target of 16, or 23 if the value of carbon credits is twice what's expected.

Making power plants run more efficiently at lower costs is a big-step toward cleaning the air, which is where Fuel Tech (FTEK) comes in. It is a $75 million-in-revenue company that installs air-pollution controls that improve the performance of combustion furnaces.

The company has borrowed its business model from shavers and blades: The system is cheap but the recurring revenues from supplying the chemicals to keep it going produce high margins. It has a chemical injection system for oil- and coal-fuel plants that eliminates the layers of petrified slag that build up on the inside surfaces of the furnaces.
Now, the slag that once had to be broken up with explosives, is turned to ash workers can simply sweep out of the furnace.

Coming off all-time highs in June, the shares could catch a second wind after the company's recent announcement that it's partnering with a Japanese company to sell its systems in China. Plus, the expected adoption of a carbon-credit system in the U.S. should generate more U.S.
demand.

The stock is trading at 46 times Tanous' 2008 earnings estimate of 71 cents a share. But he thinks 2008 revenue can grow 30%. "You could even argue that it's not that expensive now," says Tanous, who sees it climbing 25%, to 41.