Investor Review: The case for Schneider Electric’s & Blue Earth Capitals’ $105M Series C Financing…
On April 27th, Schneider Electric and Blue Earth Capital announced a significant acceleration of investment into Sense Labs (“Sense”), a Cambridge, Massachusetts based company at the forefront of real-time home energy intelligence.
This little known startup has for some years now developed easy to use solutions for home energy monitoring, taking a page out of more sophisticated systems routinely utilized in the operations technology field for energy management.
Schneider Electric, for instance, has for more than a decade utilized voltage and current monitoring using smart meters, power distribution units and IOT enabled circuit breakers to better understand energy consumption in data centers. Improvements in energy efficiency in precision cooling of computing equipment has led to a significant reduction in energy consumption during this time, led by the likes of Amazon Web Services, Meta (Facebook), and Google.
Sense defines its mission as reducing global carbon emissions by making homes smart and more efficient. Sense uses machine learning and AI to provide real-time, engaging consumer applications that give people insights into how energy is used in their homes and will increasingly be used for automation as appliances in the home become connected.
In this article we review from an investment perspective the prospects of Smart Home Energy Monitoring, as an industry. To do so, we take a Graham-Dodd approach, made famous by Warren Buffett and Charlie Munger, and evaluate the likely returns on equity for an investment in a hypothetical startup such as Sense Labs, from the perspective of a large OEM such as Schneider Electric. And we do so only using public, non-material information, such as trends in energy consumption, break-even points in energy costs, and potential adoption rates for this type of technology.
We begin by examining the expected rates of return on a $100M+ investment into what is essentially an ESG (Environmental Social Governance) play.
Utilizing a purely value oriented approach, we note that essentially there are two streams of value created by an application such as Sense: 1) Reduction in overall energy costs for consumers, 2) Reduction in capital expenditures for grid operators. While Sense provides insights into home energy consumption, and this in an of itself is a pretty cool SaaS application for consumers, we see the “app” aspects of Sense as being secondary in terms of overall value creation.
Let’s assume that a typical American home utilizes 10,000 KWH per year with more than 50% of that consumption being Home Heating and Air Conditioning. Let’s also assume a maximum, marginal cost of $0.20 per KWH, rising at an inflation rate of 8% per year. Over the course of 10 years, the total energy consumption is 100,000 kWH and the total cost of energy is approximately $30,000 with a net present value (utilizing the 10-year treasury yield of yield of 3%) of approximately $20,000.
To evaluate the prospects of an investment in a Sense solution, we must ask: How much can be saved in terms of energy costs? The answer is generally around 5%-10%, with some studies finding savings of up to 20%. Using the 5% figure, we find a savings of around $1,000, with potential savings of up to $4,000.
The total cost of ownership of the Sense solution is divided into three parts:
- Purchase of the device & installation: $400
- Training of the device & home owner labor: Let’s assume a 2 month period, where the home owner has to review the device’s findings and make adjustments one time per week, taking about 1 hour to make adjustments, thereafter interacting with the software app 1times per week for 15 minutes. This adds up to about 100 hours of labor during a 10-year period. Assuming labor costs (average) of $16 per hour, the total cost is about $1,600.
- Monthly subscription fees: The base package is around $30 per month. This adds up to a total cost of $360 per year, and with inflation, we would expect the cost to be around $5,000 in total.
- Utility company discounts: Let’s assume rebates and discounts of 30% from the utility company, bringing the total cost to around $5,000.
In other words, the consumer would invest around $5,000 to save a total of $4,000, resulting in a net loss of -$1,000. Taking into account some environmental benefits and potential green rebates from the utility, perhaps the total loss can be reduced or wiped out substantially with a $100 per year incentive to install and subscribe to Sense.
Therefore, we have established that it is unlikely, on the basis of energy savings alone, that the typical US homeowner would install the application or subscribe to the service.
However, note that there was an important, although subtle shift in costs, from energy usage in the form of electricity, which the Utility company must source and pay for (in a world of increasingly expensive and uncertain supplies of energy) to costs of labor, hardware and software, which in theory are easier to source or improve upon. For instance, the Sense device might get more intelligent in the future, reducing the amount of time a homeowner must devote to interacting with the device. The solution may be integrated into future smart meters and circuit breakers made by Schneider, reducing installation labor. And the machine learning algorithms might be smarter, deployed at the edge using ARM CPUs, making the monthly subscription price inexpensive, perhaps even included in the standard utility bill at no additional cost.
In other words, the real customer for Sense is not the consumer at all, but the grid company. The utility benefits by shifting a portion of its capital expenditure from power production, transmission and distribution to a software based application. This enables the power company to improve its return on assets and return on equity, that is it can continue to utilize existing grid assets to accommodate increases in energy use due to population growth, as well as integration of new sources such as renewables. Smart applications might even enable a reduction in capital expenditures. In theory, this would also make the utility more profitable.
National Grid, by way of example, earns around $3 per share and pays out a dividend yield of around 5% on its current stock price of $73 per share. The company had a return on equity of 10.6% in 2021, quite close to historical norms of about 10–12%. Depreciation was $2.3b while Capital Expenditures was $6.0b.
Capital allocation, as Warren Buffett has noted in his letters and comments over the years, is one of the most important jobs of management. His basic test is this: Does each dollar of capital expenditure generate at least one dollar of market value(and hopefully much more)?
Using this litmus test, and assuming that savings in energy consumption translate almost directly to savings in capital expenditures, in the case of a 5% reduction in home energy consumption via the Sense Labs app, we would derive a savings of $150 Million per year for National Grid in CAPEX (assuming that 50% of the consumption is residential and 50% is commercial).
Since National Grid pays out that 5% dividend yield as income to its investors, totaling dividends of $1.95b in 2021, management could wisely pass on 50% of the savings in CAPEX to investors and retain 50% in earnings for future re-investment in the business. This would increase total dividends by about $75 million per year, again assuming that 5% reduction in home energy usage, and $0 costs to the utility.
The aforementioned $100 consumer rebates and the like may be paid by the government as part of climate change initiatives in carbon reduction, green energy, or homeland security offsets to minimize dependence on foreign sources of energy, and to avoid unnecessary involvement in future conflicts over energy resources.
Nevertheless, under these assumptions, the benefit to the average shareholder is about a 4% increase in the size of dividends. Applying a discounted cash flow analysis, we find a net present value of increase dividends to investors of $450 million over the course of a decade.
How much of these savings can Schneider Electric and other investors in Sense hope to keep? A 10% rate seems reasonable. Therefore income to Sense might be in the order of $50 million per year, with a typical SaaS operating margin of 20%, this nets around $5 million per year. This yields around a Price to Earnings multiple of about 20x on Schneider and Blue Earth’s investment from a single customer such as National Grid. If these projections hold, this is equivalent to around a 5%-10% earnings yield per year, similar to an inflation protected bond.
Of course, these projections are highly uncertain. The technological risks are pretty high. Consumer behavior and usage of the app is not guaranteed, and neither is there a guarantee of consistent government support or public utility policy. Even so, it would appear that for both strategic and investment reasons Schneider’s investment in Sense is prudent in terms of value.
Kially Ruiz, Cibao Cloud Technologies, www.cibaocloud.com
Kially Ruiz is Strategy & Management Consultant in Operations Technology, Industry 4.0, Power Grid, Buildings, Data Centers, Analytics, Automation Software & AI. He has conducted more than 400 consulting engagements with VC, Tech, Private Equity & Sovereign Funds in topics related to OT Software, Industry 4.0 and Predictive Analytics. He can be reached at [email protected] or on Linkedin: https://www.linkedin.com/in/kially-miguel-ruiz-03bb469