Deep Dive - Stem, Inc.
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Deep Dive - Stem, Inc.
The Future of the World's Most Important Industry
A note: I own shares in Stem and am not a financial advisor. Take all following information with a (large) grain of salt.
Introduction
The Stone Age did not end because we ran out of stones; we transitioned to better solutions. The same opportunity lies before us with energy efficiency and clean energy.
-Steven Chu
Energy is already a critical industry to the life we know. As our world’s population grows larger and nations advance into more power-consuming stages of development, energy is going to become ever-more important. The shift to (and the need for) clean energy further complicates the matter. How are we going to balance an increasing need for power while simultaneously switching to more intermittent power production methods?
Storage is the answer. To mitigate the impacts of spotty power production from solar and wind-generating assets, the grid needs capacity to store energy when production is low. Batteries, at least for now, seem to be the solution. Every company and their mothers seem to be trying to make a play on batteries, solar, or wind generation; for the creation of batteries or solar panels, this manufacturing competition often leads to a ‘race to zero’ model where companies with undifferentiated products attempt to differentiate said products by offering the lowest price. The end result is margin destruction and competing companies slashing prices in parallel, creating an endless loop of lower and lower margins. If a company is able to create a meaningfully better product, they face a constant risk of disruption that would send them into a ruinous death spiral just as quickly as they were able to initially progress.
For these reasons, I largely see battery and solar manufacturing as an un-investable space (though definitely very necessary, don’t read what I’m not writing). However, given the need to make a transition and the rampant problems posed by actually doing so, there are a few spaces for companies to enter the industry and make a big difference - enter Stem, Inc.
Stem, Inc.
The Company
Stem was founded in 2009 by Brian Thompson to create a solution for the problem of storing renewable energy. Today, the company is headed by CEO John Carrington and according to the company itself was the “first public pure play smart energy storage company”. A smart energy storage system helps to efficiently manage energy production and usage - Stem’s offering includes software and applications that help to simplify & optimize energy production/usage for utility providers, commercial users, and energy asset owners. Their products provide solutions for renewable energy through storage and help to unlock value in the energy chain, primarily for utility companies, large commercial businesses, EV fleet charging, and solar/renewable installations. The company went public via SPAC in 2020, which I believe has contributed to at least a portion of the negative sentiment surrounding the stock since 2021, when the market’s fever dream began to dissipate and unprofitable companies (especially SPAC companies) began to get punished.
The company has only just begun to expand into other regions in the United States, giving it plenty of runway for growth into new geographies, and offers a range of energy management products. As with any young company, there are any range of risks and balance sheet woes, but I think Stem offers a very unique play on what is going to increasingly become a critical industry in our lives. We’ll dive into Stem’s general business model and its various offerings to provide solutions to the energy industry before we dig a bit deeper in on the financials, the industry, the executive team, and finally the overall investment potential.
The Business
Stem operates in the energy market and primarily generates revenues from the sale of energy storage systems (batteries and the like) and Energy-as-a-service software. Energy storage is crucial to maximizing the effect of intermittent production from renewable energies, and can help to build grid resiliency against power outages as well. However, lots of companies are providing solutions for energy storage - it is the software that makes Stem stand out. The software, called Athena, is Stem’s differentiating play in the energy/storage industry, and is the crown jewel of my investment thesis in the company. Athena uses AI and machine learning to help optimize energy production and energy storage systems (ESS), ultimately helping customers to unlock value in their energy systems/usage by generating a 10-40% greater return from assets. These cost savings help to make it very difficult for customers to switch off of the Athena software once they begin using it, a strong advantage that helps Stem to retain customers even if prices rise. Stem also offers software platforms for energy asset management, solar optimization, and energy market participation.
The revenue generation model for Stem, to this point, has mostly involved selling third-party hardware to a customer and pairing it with the Athena software package. Though a larger portion of total revenues (at this point) are derived from the sale and installation of energy storage systems, with approximately 10-40% gross margins, the accompanying Athena software is far more attractive from an investment standpoint. It generates an approximate 80% gross margin and reduces the upfront costs that Stem has to undertake to deliver energy storage systems for a project, freeing up their balance sheet. However, in Q1 2023, only $13.5m of the company’s $67m in total revenues were generated by software (~20%).
Stem’s software offering is utilized by both Front-of-the-Meter (FtM) and Behind-the-Meter (BtM) customers - terms used to describe different kinds of participants in the energy market. The FtM side of the business encompasses clients that are connected directly to the electric grid - FtM customers are typically utilities, independent power producers, and grid operators. These companies use Stem’s Athena software to maximize the value and capacity of their assets, ultimately helping to increase revenues and grid stability.
Stem’s BtM clients encompass customers on the demand-side of the energy supply chain, such as commercial or industrial operators that buy, consume, and store energy. For these customers, Athena is used to manage on-site consumption and storage, which lowers costs and total usage, and provides backup power capacity in case of blackouts. BtM customers can also utilize Athena to automatically participate in the energy market, selling surplus energy back during high-demand hours to generate extra revenue.
The company also recently acquired AlsoEnergy to expand the scope of its solar business and provide value to FtM and BtM solar customers. The acquisition allows a combination of Athena and AlsoEnergy’s PowerTrack platform to provide full coverage for solar-producing energy assets. The integration of the two allows for complete, predictive control over solar assets, as well as insightful monitoring into the deployment and storage optimization of solar energy. The combined offering makes Stem a one-stop shop for customers consuming or generating solar power to significantly improve the efficiency of their assets, in turn reducing costs or generating greater revenues. The acquisition allowed Stem to corner a crucial corner of the clean energy market and add significant value to the overall business - it was also made entirely with cash, which, though it negatively impacted the amount of free cash the company has on hand, at least did not contribute towards any additional shareholder dilution.
Apart from software, Stem also offers a professional services segment to both FtM and BtM customers, providing energy consulting services that leverage Stem’s expert team of market, policy, and data specialists to drive improved results. Professional services are another crucial (and higher margin) part of the revenue generation model for Stem, and includes the design and installation of ESS, energy consulting during every stage of a project, and assistance in navigating the complex and nuanced energy market- namely the various incentives, compliance requirements, and financing options - from a team of market, policy, and data specialists.
Stem’s business model, whether for FtM or BtM clients, is differentiated by the Athena software. Athena is critical to Stem’s value proposition - without it, Stem is simply providing consulting services in a saturated and highly competitive market, as well as selling and installing ESS provided by other companies at very low margins. With the software, however, Stem is able to maximize value, capacity, and revenues for energy producers, as well as minimize consumption, reduce costs and demand, and manage storage needs for energy consumers. Let’s dive more into how Athena works to understand its contribution to solving customer’s needs, reducing barriers to clean energy adoption and usage, and laying the foundations for a potentially successful and important business.
Athena
With over a billion runtime hours under its belt now and more than 950 systems using the software, Athena provides the most highly-trained, automated, and predictive platform to create solutions for:
Asset Management
Athena’s capabilities differ slightly depending on whether they are being used for FtM or BtM customers. For BtM customers, Athena has learned (through ML) to predict energy demand and usage, the amount of power generated (considering weather and temperature data), and optimal times to recharge batteries. It can also automatically determine when to switch between utilizing stored battery power, onsite generation, and grid power. For example, when demand (and therefore prices) are high for energy, Athena would draw from battery reserves to minimize costs - when battery storage and grid demand are low, Athena would switch to grid power at reduced prices. When weather conditions are favourable for onsite generation, the software would switch to this method. The end result is the lowest possible energy bills, generating 10-30% savings on energy bills and therefore value for companies that install ESS with Athena software.
For FtM customers, the general premise is the same, but the software is instead looking to maximize the value of and revenues from energy projects, as well as minimize risk, rather than deliver cost savings. Revenue returns range from 10-40%, offering even more upside for FtM customers than BtM, but Athena’s goal remains unchanged - deliver increased value from smart energy storage by optimizing for market and environment conditions.
Automated energy market participation
Here is one of Athena’s most interesting and value-accretive use cases. Energy is bought and sold on a complex market that is undergoing incessant change based on demand, available supply, and production. Athena can help FtM and BtM customers participate in this energy market with ease and at any level of expertise within the industry by automating the selling, bidding, and buying of energy based on market conditions and operational capacities - simply put, Athena allows customers to maximize revenues and minimize costs by buying energy at low cost and selling at high prices.
Side note that this is an area where Stem’s use of machine learning in its software will play a huge role - by helping Athena to continuously learn and improve on its ability to forecast power generation and economic conditions, machine learning gives Athena the ability to constantly improve upon its value proposition.
Solar production, storage, and usage
Athena, integrated with AlsoEnergy’s PowerTrack platform, provides BtM and FtM customers with solar assets the capacity to monitor production and predict power generation from prevailing weather conditions to model cash flows. The capacity to control and optimize solar with Athena allows Stem’s customers to obtain a far greater return on their solar energy investments, helping to pay off solar assets sooner and/or obtain greater revenues.
System Resiliency / Demand Response
Athena can be used to automate the selling of excess or unneeded energy back into the market when the software registers a period of high demand. In the case of large commercial installations that may not be using all of their stored energy, this can generate additional revenues to help offset utility costs. Not only does this benefit individual companies, it also helps to make the grid as a whole more resilient and efficient by balancing supply and demand while adding individual customers into Stem’s Virtual Power Plant (VPP) network. What is a VPP, you ask? Here’s a crash course:
Stem has a large market presence in CrashCourseVille, with 15 ESS installed around the town. These storage systems collect energy and have some excess energy when Athena detects a period of high demand on the grid. Athena, which is interconnected between all of Stem’s installed ESS, employs its demand response capabilities by releasing unneeded energy in storage at each of the independent sites back to the grid, relieving some of strain on the grid (plus generating some $$ for the companies). By doing so, a series of physically separate but virtually connected energy systems are able to act as a decentralized power plant - hence the name, VPP.
A real example of Stem’s VPP capability is California State University, where Athena employs demand response to offset $70K in annual costs for the university while reducing grid strain by 1.4 MW when combined with other campus resources. Stem was recently named North America’s largest Virtual Power Plant operator by Wood Mackenzie, demonstrating its success in this area.
Commercial EV Charging
Stem has partnered with Engie and ChargePoint to match their Athena software with EV charging hardware for commercial operations with electric vehicle fleets. The integration allows cost-savings, more efficient charging, and reduced load on the grid while providing Stem with stable, high margin revenues free of hardware costs, which are taken on by their partners.
Hardware Performance
As an added bonus to Athena’s many ROI-accretive features, the software’s active management of a battery’s charging vs. resting states extends the lifetime of hardware considerably, slowing deterioration to the point of being able to exceed the manufacturer’s lifetime estimates for batteries. This provides even more value to customers installing ESS with Athena, though it is a fairly small difference and therefore only an added bonus to customers.
The Fundamentals
Here’s where we get into some of the nitty gritty parts of the business. Understanding, as I hope you now do, what Stem does and how its Athena software provides value streams to Stem’s various customers, it’s time to analyze the balance sheet, key performance indicators, a few of the company’s more important financial metrics, and finally its defensibility and avenues for growth.
Balance Sheet - The Bad & The Ugly
As with any young company, there are any number of undesirable line items on Stem’s balance sheet. Here’s a quick insight, taken from Stratosphere.io:
Gross Margins
You can see that gross margins are incredibly low here. Sadly, they’re actually not even updated to Q1 2023 results, where margins dropped down to just 1% on a GAAP (generally accepted account principles basis) - down 8% YoY.
Current margins reflect that the primary mode of revenue generation comes from sales and installations of third-party ESS. Making the switch to a larger portion of revenues being generated from the software side of the business model has the potential to make this company a far more enticing investment opportunity, as even a 60% margin (the midlevel margin between their ESS sales and software revenues) would generate significant interest from investors. Clearly growth on this front has been slow, given the current 1% gross margin, but I am optimistic on the company’s ability to hit these long-term margin goals.
There are a few reasons for the low margins the company has faced - supply chain issues, in the short term, have driven down margins and affected the company’s ability to fulfill contracts. A larger contributor, however, is that the business model itself leads to lower margins while the company is in its growth stages; the storage systems and installations serve as a funnel for packaging in the software - as the installations continue, the recurring revenues from Athena will expand until this portion of the business outweighs the hardware/installation portions, at which time the margins will begin to shift.
Another potential catalyst for higher margins is Stem’s future projects - management has indicated that the business’ more recent bookings have involved higher-margin, software-only projects for future projects, which will further drive gross margin expansion once they have fulfilled previously contracted projects. This can be seen in the results of their most recent 10-K:
Stem’s future contracts show that service and software revenues will begin to outpace revenues from hardware, evidencing the shift to higher margins to come. As such, I believe the current low margins actually provide a potential opportunity to buy-in on the company before the market has priced in this shift to higher margins. When/if these margin goals are realized, Stem will almost certainly trade for richer valuations than we see today. However, there are also certainly other concerns to be mindful of on Stem’s balance sheet.
Customer Concentration
56% of Stem’s total revenues in 2022 were generated by 2 customers - this is an incredibly concentrated customer portfolio. This could be very risky for Stem, as either of these customers leaving or being unable to finish paying contracts could significantly impact Stem’s revenues. However, the way that Stem generates revenue is susceptible to this sort of customer concentration - by signing large (often 5-20 year) contracts, Stem’s revenues are very cyclical and likely to have significant contributions from a smaller number of customers in the year that they sign a contract, with revenues from those customers dropping below significance during the next year (notice in the chart above that customers B and C are the only ones that remain significant customers for consecutive years and both drop in revenue contribution from 2020 to 2021).
Cash Burn
As an unprofitable, non-cash flow generating business, Stem’s cash burn is something to keep an eye on. Cash allows the business to continue expanding operations as they work to become profitable. The less cash they use, the longer they can continue operations without having to raise more money. Unfortunately, cash burn at Stem has outweighed the amount of cash available - $750m in cash at the beginning of 2022 dwindled to just $118m cash as of Q1 ‘23. This resulted in them needing to raise more cash in April ‘23 in the form of Green Convertible Senior Notes. I won’t get too much into what these are, but long story short they were able to put some more cash on the balance sheet - from $118m to $244 m - at the expense of some future shareholder dilution.
Stock-Based Compensation (SBC)
SBC is unfortunately par-for-the-course with a young, growth-stage company. It is inevitable that some stock-based compensation must be utilized to continue attracting talent, particularly in the highly competitive tech space where talented developers are key to success. It can’t really be avoided, but the more shares that are issued to employees, the more regular shareholders have the value of their holdings diluted. Stem’s SBC expense more than doubled (+113%) from the end of 2021 to the years end of 2022. There’s not really much that can be done about it, but it is certainly a contributing factor to Stem’s shaky balance sheet, and something to be mindful of if you’re thinking of making an investment.
The Balance Sheet - The Good
Luckily, it’s not all bad for Stem’s balance sheet. The company has experienced some honestly ludicrous growth in revenues (+180.9% average annual growth) since 2020 and seems to show no signs of stopping - revenues came in above guidance in the most recent quarter for a +64% YoY increase. Though this is still exceptional growth, the majority of revenues are expected to come in the second half of the year, according to management, so this is likely to be much lower than the rev growth announced in Q3 and Q4.
Stem is also expected (again, according to management) to become EBITDA (earnings before interest, taxes, depreciation, and amortization) positive in the second half of the year, which would be a significant step in their path towards profitability. Finally, Stem’s net assets ($1.4bn) are greater than the company’s debts ($900m), giving the company a net positive equity.
Key Performance Indicators
Every company has objectives that are crucial to the success of the business. Key Performance Indicators (KPIs) are the metrics that provide insight into a company’s ability to hit these targets. For example, KPIs for a business like Apple may look like the number of iPhone sales to track the success of that specific product. Here are the KPIs that are crucial to Stem’s success and future growth potential:
Software Revenues as a % of Total Revenues
In Q1 ‘23, Stem’s software platforms generated $13.5m between solar (AlsoEnergy’s PowerTrack platform) and storage (Athena), compared to a total revenue of $67m for the quarter - representing ~20%. This is down marginally year-over-year basis, when software revenues represented ~22% of total revenues. This isn’t a dealbreaker for me; as noted above, it’s important to keep in mind that the installation of ESS should lead to greater software revenues over time, but it is an important metric to keep track of to ensure that the company is fulfilling its goal of shifting the revenue generation model. Total software revenues were still able to grow +14% YoY, showing that growth is nevertheless accelerating in this key area. Stem projects 65-85% growth in software services into the future - if realized, this would catapult Stem’s software revenues.
Bookings
Bookings represent future projects for Stem and give a decent glimpse into how the business continues to grow apart from the projects it is currently recognizing revenues from. Customers that sign up for ESS installation, professional services, or software with Stem are given a quote for a contract, and that value is then added to the bookings if the customer ultimately decides to go through with the project. Q1 ‘23 results showed a $364m increase in bookings.
Contracted backlog
Similar to bookings, the contracted backlog represents the value of future fulfillments on projects. While bookings primarily tracks the value of projects booked in the quarter, the contracted backlog represents the total value of all projects that Stem has contractual agreements to fulfill. For Q1 ‘23, the contracted backlog grew a whopping 120% YoY to $1.24bn. As mentioned above, many of the recent additions to the contracted backlog include more attractive software-only deals.
CARR (contracted annual recurring revenue)
This, along with the software revenues as a percentage of total revenues, helps to indicate Stem’s success with converting their revenue model to primarily software. CARR represents the value that customer’s are contracted to pay Stem over the course of a year for their subscription to the Athena or PowerTrack software platforms. SaaS (software-as-a-service) companies typically track CARR to help give insight into the steady stream of recurring revenues provided by a subscription-based model and the amount of money being generated exclusively through software offerings. This metric grew 39% YoY.
AUM (assets under management)
For Stem, AUM represents the amount of energy capacity that is under management by the company’s ESS and software platforms. For example, a company may have 6.9 GWh of total energy generating capacity - 6.9 GWh would subsequently be added to the total AUM. This is a useful metric to track to give insight into the size of the projects that Stem is fulfilling, their total capacity for demand response programs, and the infiltration of Stem into the total energy market. Stem has 3.5 GWh of total energy storage capacity and 25.6 GW of solar assets under management - GW being the total capacity to produce power, and GWh representing the amount of time that the energy assets are able to produce at full capacity.
Defense & Offense
You can field a good team with solid defense. You can field a solid team with good offense. But the great teams, the championship worthy teams, have both. So it is with companies, too. The best investments are able to grow and expand quickly, efficiently, and with quality, either to dominate their niche or to expand into other verticals. This is offense. They are also able to protect their initial growth and either verticals/niche from disruption and competition. This is defense.
Amazon is a prototype example of a company with defense and offense. They started off dominating the online bookstore market, growing quickly to expand into other markets until it eventually grew into the absolute behemoth we know so well today, with fingers in healthcare, all online retail, cloud infrastructure, and god only knows what else. They also created the partnerships and scale required to protect their advantage and ensure no other company could make a stab at disrupting them.
We can see offense and defense take shape in a company in many ways - Stem displays a number of these vital characteristics:
Moat - Defense
A moat, if you asked a medieval knight, is a water-filled trench surrounding a castle to provide increased protection and defense. A moat in investment terms works quite similar, acting as a barrier between a company and its competition, and as protection from disruption. Stem’s moat is built into the very thing that has the potential to make it such a successful company - Athena. As an AI and machine learning platform, Athena’s more than 1 billion runtime hours have continuously improved the product, and this data advantage is constantly expanding with ~8000 simulations per month. Any competition hoping to enter Stem’s energy-managing software market now would have to create a product that could outperform these billion+ hours from the beginning to have any hope of entering the market in a meaningful way.
Any competition hoping to steal market share from Stem with a software platform that generated only, say, 5-10% ROI (as opposed to Stem’s 10-30%) would have a very hard time indeed. That company’s only hope of even being able to catch up to Stem would be for multiple customers to “take the hit” and accept a lower-quality product from the newer entrant. In the ruthless world of capitalist efficiency, this is highly unlikely. Even in the unlikely scenario that a new player tries their luck in Athena’s market, Stem is continuing to constantly improve their product for a constantly expanding variety of use cases - it would be like trying to catch up to an Olympic runner, but you’re already starting a lap behind, and they aren’t waiting for you to catch up.
Unfortunately, this moat is not foolproof against companies that started around the same time with energy management software of their own - it solely protects against newer players in the industry. We’ll dive more into Stem’s competitors later, but it’s important to note that this is not a bulletproof defense against its competitors unless Stem can strengthen its data advantage at a greater clip than its competitors.
As the first mover in this industry, Stem has the added bonus of being a trusted player. Having partnered with several Fortune 500 companies, they have a reputable brand that can serve as a form of moat - albeit a much weaker and more flimsy defense than the moat provided through their first-to-market, proprietary software platform. This particular moat can be disrupted if an even more trusted player in the broader energy market were to decide to enter the energy-management software race; that whole ruthless capitalism can work both ways (again, keep this in mind when we talk about Stem’s competition).
Finally, patents serve as a great moat by protecting a company’s intellectual property and ensuring it is not stolen or used by another company. According to Stem’s website, they have 87 patents across the scope of their business. A quick look at some of these patents reveal that most of them are revolved around optimizing the value-unlocking capability of energy storage systems, such as increasing demand reduction effectiveness, as well as methods for power optimization using external data from software. These not only defend their position in the industry but also help to improve their offerings, making the patents a big bonus for Stem.
Pricing Power - Defense
Pricing power refers to a company’s ability to raise prices without churning customers. For example, Company A raises prices on their flagship phone. If no other company is able to compete with the quality of that phone, the higher prices are unlikely to turn customers away from the superior product - this is pricing power. If Company B is able to deliver an equal product but for now-cheaper prices, then customers will likely leave, ultimately harming the company’s revenues more than if they had kept prices lower. Pricing power can help companies deal with supply chain constraints, the changing tides of macro-economics, increased manufacturing costs, and all other sorts of headwinds without taking a significant hit to their core business. Companies with pricing power tend to make great investments.
The increased efficiency of the Athena software allows customers to generate a 10-40% return on their invested capital. These greater returns would point towards Stem demonstrating pricing power capabilities - if Stem needs to/wants to raise prices on the Athena software, the value generated by the software would likely still outweigh the higher costs and make it highly unlikely that Stem’s customer base would diminish in any considerable way.
Optionality - Offense
Optionality is a business’s capacity to diversify into other markets or verticals, expand their offering with new features, or further innovate in their niche. Essentially, it allows further streams of growth for a business. Stem displays the potential for optionality through a number of possible avenues for growth, as well as adaptations to their current business. It should also be noted that, when I made my initial investment in Stem, I identified electric vehicle and EV fleet charging as a key optionality for the business - Stem has now created partnerships with EV charger manufacturers to deploy their software for this very purpose, proving this potential path for growth and demonstrating their mindset for continued expansion of the business.
While Stem primarily deals in renewable energy storage in batteries at the moment, their most brilliant optionality is that their software can, in theory, be used with any combination of different storage methods or potentially other forms of energy. If batteries are replaced with some more efficient form of energy storage (which I hope they are, as lithium presents issues of its own), then Stem has not been disrupted - the Athena software should be applicable to other ESS, allowing Stem to continue thriving with only slight, if any, adaptations to their core business model.
The company has also started using modular energy storage systems during their project fulfillment. Modular ESS allow for easy replacement and switch-out of individual components (batteries, inverters, etc.), which allows Stem some optionality in sourcing hardware to relieve supply chain constraints and procuring affordable options.
Delivering on their current partnerships, like utilities and municipal energy regulatory bodies, as well as developing new partnerships, as they did with ChargePoint and Engie to deliver EV charging solutions, allows Stem a great deal of optionality. Not only can it reduce Stem’s reliance on purchasing and installing hardware, it can also expand their use cases, the geographies they operate in, and the recognition of their brand. Continuing to emphasize partnerships within the energy industry may allow Stem to find new paths towards growth in a constantly evolving renewables market.
Geographical Expansion - Offense
Stem started in San Francisco and has only recently begun to expand outside this area in any considerable way; as one of the keenest early adopters of clean energy in the United States, it is not entirely surprising that most of Stem’s business to this point has been drummed up from the California area. However, we have progressed further into what I hope is only the beginning of a full-blown renewable energy transition, allowing Stem to expand not only to other areas of the U.S., but also to the rest of the world.
As seen above from the Q4 ‘22 results, only a miniscule fraction of Stem’s revenues are generated globally. The jump from ‘21 to ‘22 was largely the result of the AlsoEnergy acquisition, which had a far larger global presence than Stem. Continued expansion gives Stem a large runway for growth just by focusing on sales to deliver their products to the farthest reaches possible. Many countries around the world are only just beginning their transition to renewable energy as well, so the size of Stem’s market isn’t even done growing yet. If their contracted backlog is anything to go by, they have quite a long ways to go to even fulfill the growth potential in the geographies their already in, which signals to me a large demand even before they begin major geographical growth.
Ride the Wave - Offense
The market seems to live off a constant cycle of the next big hype. Right now, all the hype is artificial intelligence, AI. The other is clean energy.
Stem hits both of them.
I won’t get into the AI buzz beyond its contribution to Athena’s moat, but clean energy is a hype that I hope and believe is here to stay - Stem has the potential to ride the clean energy wave to its fruition, taking advantage of countries around the world leveraging lower prices on better products to hit their climate targets and transition to renewables. The quickly growing adoption of renewables has led to a slew of regulations, policies, and incentives (see: Inflation Reduction Act in the U.S.) designed to further encourage utilities, commercial operations, municipalities, and residences to install cleaner energy systems. Whether it be fleets of electric vehicles or large-scale wind and solar installations, Athena software provides solutions for the wider adoption of all these initiatives, giving Stem an immense opportunity to profit from the renewable energy transition.
While we’re on the topic of buzz words, ESG is another that has plagued… ahem, I mean, been around the investing world for the last number of years. ESG stands for environmental, social, governance, and is mostly an opportunity for companies to fluff up their annual reports with the various measures that they have taken to better the world and further clean energy transitions. Stem is conveniently placed to be that measure by helping large commercial operations to reduce costs while also hitting their ESG objectives. Given their previous and ongoing work with several Fortune 500 customers, more businesses may choose to use Athena for its ability to hit two birds with one stone. This benefits Stem by generating revenues, further expanding the capacity of their demand response programs, and improving the reputation of the business.
The Industry
We’ve now discussed Stem in (near-excruciating) detail. It's time to broaden our horizons a bit and examine the industry Stem operates it, the size of the market its trying to fill, and its competitors.
TAM (Total Addressable Market)
As established above, the industry that Stem operates in is massive, growing quickly, and nowhere near capacity. According to Stem’s 2021 annual report, the energy storage industry is really just getting started:
A 22% CAGR through the coming years is, frankly, ridiculous. Crazy. Nuts. And probably true. This is a market that has lots of runway, particularly if anyone is actually trying to hit internationally set climate goals (though the jury is still out on that front). If Stem is able to fulfill even a tiny portion of this TAM, they could become quite a large and successful business. The size of it would also suggest to me that there is room for competition to enter the market without significantly impacting Stem’s ceiling - this could be a 2- or 3-player game while still allowing Stem to grow into a very large shoe.
Competition
Fluence Energy (Ticker: FLNC)
Parented by Siemens and AES, Fluence is one of Stem’s primary competitors. They have a very similar business model - selling hardware that funnels into a software offering, though they differ by manufacturing their own ESS, rather than selling third-party ESS like Stem does. Fluence offers a Mosaic AI bidding software that competes with Athena’s automated market participation offering, but with 9 GW of AUM and 900K+ runtime hours is far outpaced by Athena’s 25 GW of AUM and 25m+ runtime hours. It should be noted, though, that Fluence claims a potential 50% increase in revenue from energy storage for customers utilizing Mosaic, which is higher than Athena’s potential 40% revenue gain. This could potentially dampen Athena’s ability to compete with Fluence.
Fluence also offers Nispera, a software offering for managing energy performance, again similar to Athena. However, this software only provides 3-10% ROI, an offering that caps out at Athena’s low end on returns (again, see: moat). The energy storage systems manufactured by Fluence may also provide more seamless installation and ready-to-go deployment of ESS and energy assets over Stem, which relies on third parties to fulfill contracts. Finally, Fluence seems to operate at a more global scale than Stem already, has larger revenues ($1.2bn vs. $363m for FY ‘21), and has the added benefit of large parent companies to provide cash input to grow the business faster.
Despite these potential risks, I believe Stem’s offering to be stronger given the data advantage from a huge gap in runtime hours (which continues to get stronger given the equally large gap in AUM), faster revenue growth, and the focus on a business model conversion to software (whereas Fluence’s margins will continue to be held down by their ESS manufacturing).
Tesla (Ticker: TSLA)
It’s not Tesla’s primary offering, but unbeknownst to many, the massive EV company provides direct competition to Stem’s Athena software. I won’t go deep into their offering, because it is identical to Athena. Identical. Tesla’s software platform supports Tesla’s manufactured products, like the Powerwall, Megapack, and other energy hardware. It also functions with non-Tesla energy storage systems, and has a fairly significant presence across 65 countries:
I won’t lie to you, dear reader, determined as I am to remain objective in my analysis. Tesla offers all the same things that Athena does, from a software standpoint, and is a massive corporation with extensive knowledge of the energy, renewables, and AI sectors, ample cash to deploy, a very recognizable brand name, and a much larger global footprint. Finally, Tesla can host its software on its own cloud infrastructure, whereas Stem is reliant on AWS (Amazon Web Services).
So, why do I still believe in Stem’s ability to compete? As mentioned above, I think this is a large enough market to contain multiple players without severely limiting the possibility of success for any one of them. Tesla, if you hadn’t heard, is also quite involved in the electric vehicle game - they are not necessarily devoted to energy management software, which is Stem’s whole schtick. This more focused approach to the market may provide Stem with some upside for creating a better product or expanding offerings. And on the ‘better product’ front, Tesla is quite cagey on the returns that their software provides, at least to non-customers who haven’t contacted the company for a quote, so I can’t even definitively tell you if one product or the other has an advantage. Finally, while Tesla generates a significant amount of revenues from the sale and installation of its manufactured hardware, Stem’s ability to switch up ESS providers to meet customer’s desires/needs or source from the most cost-effective providers may give them increased optionality.
The Team
Founder-led teams have a proven track record of generating greater returns for investors over the long haul. Unfortunately, Stem’s original founder is no longer involved with the company for reasons I was not able to track down`. The current management team is undoubtedly experienced in the energy industry, however, which helps to encourage me that this is not simply a pump-and-dump SPAC offering. Before I make any investment, I always check Glassdoor to see what employees of the company thing of the management team and their employment experience as a whole:
Passable, as a whole. Most of the reviews raved about the workplace culture and growth opportunities, and the majority approved of the CEO. You can’t please everyone though - most of the complaints I found from employee reviews were about management, with several mentions of micro-management and employee turnover. Some of these were old and disappeared as I got into more recent reviews, so I hope that the majority of these issues have been fixed. Several of the most negative reviews were also from one location in particular, so the problems may be concentrated there, but it is definitely something to continue monitoring with the rest of the KPIs - it is very hard to build a strong business without a solid team. Still, I always take these reviews with a grain of salt. Reading Tesla’s Glassdoor reviews from several years ago is brutal to the point of being comical, but there can be no doubt they managed to build a successful enterprise.
CEO
John Carrington took over the head honcho job in late 2013 and has been with the company since, overseeing its transition to a public company and maintaining most of the same core executive team around him during that time. He has held a variety of roles in the energy industry, including helping to scale FirstSolar a significant amount during its early growth phase (now a nearly $22bn market cap company). Carrington took his first CEO role at MiaSole, a pure-play solar company and helped oversee the sale of that company before taking over at Stem. With an 80% approval rating on Glassdoor, it seems he’s at least doing a serviceable job heading the company. He also attended the University of Colorado, achieving a degree in marketing and economics in addition to his role in a frat (take that as you will).
Management
The rest of the management team has a very respectable portfolio concerning their experience in the energy industry as well, including stints at First Solar, Siemens, Shell, and several smaller renewable energy companies. The CFO, Bill Bush (awesome name), has been around the company since 2016 and has experience scaling multiple growth-phase energy companies into revenue-generating beasts. CTO Larsh Johnson (also a cool name) co-founded several successful businesses in the energy industry that were later acquired. He has a masters in mechanical engineering from Stanford, and also joined the company in 2016. While I’m sure the rest of the management team are admirable chaps, these are typically the only roles that I focus on in my analyses. Overall, I would say Stem’s leadership is very experienced in the industry and have a decent tenure with Stem considering the age of the company, and I found nothing in the Glassdoor reviews that sufficiently disheartened me to change my mind about the business as a whole.
The Investment
We’ve covered the business. We’ve analyzed the industry. We know the team. Now it’s time to analyze Stem’s stock - a completely different box of frogs from the underlying business.
Valuation
At the time of writing, Stem trades at a market cap of $658m with $389m trailing twelve month (TTM) revenues. That’s good for a 1.69 P/S (price-to-sales) ratio, which compares a company’s market cap to its revenues - P/S ratios are decent metrics with which to value young companies that have not achieved profitability, as more conventional valuation metrics like P/E (price-to-earnings) are not applicable if there are no earnings. Though not severely undervalued on a revenue basis (undervalued being <1.00), Stem is currently trading relatively near its total revenues. This is somewhat surprising considering the revenue growth that Stem has enjoyed since going public, so let’s compare it to its peers to get a sense of why:
Keep in mind this is a slightly different P/S ratio because I used a TTM calculation, but it is close enough to glean some insight. It’s also very difficult to compare Tesla apples-to-apples because the core businesses are so different - energy management software is just a bonus for Tesla. Compared to Fluence, which is a much more direct comparable, Stem’s revenues are smaller but growth is much greater. Yet Stem is trading at a seemingly more attractive valuation. Seems odd, but a slightly deeper dive into the two companies reveal why:
Fluence is likely being more richly valued for its earnings growth (as opposed to exclusively revenues), its (slightly) less ugly operating, profit, and free cash flow margins. However, there’s some things to like about Stem’s numbers here that lead me to believe its valuations are still attractive; it has a more attractive debt/equity balance and far more attractive ROIC (return on invested capital) and ROE (return on equity), meaning that Stem is earning more for every dollar that they invest in the company, which can greatly boost a company’s future earnings and growth potential. Finally, as was mentioned earlier, I believe that Stem is capable of delivering on much higher gross margins from their switch to software revenues. At that time, my guess is that these valuations will become much more lofty as investors account for the more attractive margins. For these reasons, I think that Stem’s valuations make it a reasonable entry point, and potentially even undervalued with a long investment horizon.
Finally, because I am a primarily growth investor, I like to project the potential returns I would like into the future - mostly just for fun, honestly, as this is a silly way to properly value a company. If I want Stem to be a ten-bagger (10x returns or +1000%), then Stem needs to grow into a ~$6.5bn market cap - given the size of Stem’s market, its offerings, and the tailwinds discussed, I believe this is achievable, even with competition from Tesla and Fluence.
Analysts
Wall Street analysts and trained professionals offer projections on how they think a stock will perform over the coming year or so. Needless to say, some of the price targets on Stem project lofty growth for the share price into the future:
That is some ridiculous upside. It needs to be noted that this chart does not include a more recent stock prediction from an analyst at B of A Securities, who downgraded his projected price on Stem from $9.00 to $5.00. I found a more recently updated analyst rating from Nasdaq:
So, not everyone is bullish on this stock, but that’s all for the better - I loaded up on more shares of Stem when they took a plunge following the analyst downgrade. Personally, I don’t put much value on analyst estimates as they are often motivated by short-term targets or ways of thinking, but it is good to see what the Street is thinking about a stock.
Threats
Stem is, in business terms, still just a wee lad. And as a young lad, it may lack the sense, experience, or resources that an older and wiser lad may have. As such, it faces any number of risks. Much like the warnings at the end of drug commercials though, you’re a lot more worried about death and erectile dysfunction than you are about dizziness, so here are the risks I identify as bearing the most threat to Stem:
Ability to Raise Capital
Stem’s stock has taken a little tumble off the cliff since peaking in early 2021. While the business fundamentals remain unchanged, the rising rate environment has spooked investors from quickly-growing but unprofitable companies. This can negatively impact the company’s ability to raise capital for continued growth, the interest rates that lenders are willing to provide the business, and the amount of stock that has to be utilized if Stem wishes to acquire another company in a stock-based transaction.
Out-Competed
Competition, either from Fluence, Tesla, or a new entrant, could affect Stem differently than I am anticipating and suffocate the company’s ability to continue growing. This would likely bring the roof down on top of the Stem’s head, at which point I’d feel like a real (and poor) fool. A major improvement from the Athena software, though unlikely, would almost certainly spell doom for Stem as well. Stem’s customer concentration also means that it could only take a few of Stem’s customers to leave for another alternative to significantly impact the business.
Operational Risks
There are a number of risks with Stem’s operational model, including their reliance on third-party hardware, a smooth supply chain (on which constraints have already had a negative effect for the solar portion of the business through 2022 - only expected to normalize in the second half of 2023), and the policies/incentives surrounding the renewable energy transition to continue lowering prices for consumers, which in turn increases adoption and the number of potential Stem customers. Disruptions to any of these factors may impact Stem for the worse.
Balance Sheet
Stem has a somewhat shaky balance sheet in some aspects. This may discourage investors or hinder Stem in trying to grow & succeed. This in turn could hurt the share price and ability to raise capital
Red Flags
If you are interested in investing in Stem, there are a few red flags that I noticed during my research process that I want you to be aware of and factor into your decision, as well as your continued monitoring of the company, if you do decide to invest.
Short Interest
Shorting a stock is snobby Wall St. talk for a bet against something. Stem’s short interest was quite high at slightly over 20% at the end of March, and means there are a number of professional analysts that believe the share price of Stem will fall further, at which time they will profit off that decrease. Keep in mind that many of these professionals are traders and thusly short-term oriented in their investment strategies. It does not necessarily mean that the company is going to fail, but that some analysts predict potential downside in the future.
SPAC
Stem came public via a SPAC, which is a deep topic in and of itself. I won’t get into the nuances of them, but SPACS are widely seen as a simple method for rich people to get even richer by profiting off of taking a company public. Unfortunately, this puts the SPAC owners, who are only looking to make a quick buck, at odds with shareholders who are looking to generate long-term value.
Green Flags
To balance out the negativity above, Stem’s green flags, or potential indicators of its success, need to be pointed out.
Largest VPP Operator
Perhaps Stem’s most significant green flag is Wood Mackenzie naming it the largest Virtual Power Plant operator in North America. While this doesn’t directly provide the company with any extra revenues, it certainly contributes to the brand’s name and reputation, which may help it to continue growing and selling to more customers, as well as the company’s ability to sell its product, which is good for investors.
Insider & Institutional Ownership
When a company’s management team owns a significant chunk of the company, it typically means their interests are aligned with yours - when they make money, you make money. Just over 9% of Stem is owned by insiders, which is respectable. However, I’ll mention this one with a bit of a caveat - the last 12 months have seen management sell a significant number of shares while buying none. Management buying up stock of their own company can give a confidence boost to investors, while selling stock may signal they believe there is further downside to come.
Institutional ownership refers to shares owned by large investment firms, and is always a good sign in a company (especially for younger growth-stage companies like Stem). This signals that there is significant interest from qualified professionals that are willing to put their money where their mouth is. Institutions own ~61% of Stem, showing the company is well-backed on this front.
EV Adoption
Stem’s partnerships with ChargePoint and Engie to provide Athena software in combination with EV charging infrastructure shows the expanding use cases for the software, its ability to adapt to provide a variety of solutions, and the reputation of the company/quality of their product that their services were chosen over Tesla or Fluence’s offerings.
Biases
I’ve tried my best to be objective in the writing of this article, but I need to acknowledge my own biases so that you understand my perspective in the research and writing of this article, and please, please, please account for it in any decisions you may decide to make.
I own shares - I’m biased towards wanting to believe this company is going to succeed, because I want to get filthy rich off it.
I think it’s a cool company - Stem is providing a unique solution to the renewable energy industry, which I believe will be an issue of critical importance in the coming decades.
I think it’s a good company - Stem is potentially providing a huge benefit to what I hope will be a more environmentally friendly future. I am deeply concerned about the welfare of our global climate, and any solution to this that is both good for the world and my pockets aligns very strongly with my investment goals.
In Summary
So, should you invest in Stem? Well, I’m not going to give you the answer to that because I’m not a financial advisor, and that depends entirely on your goals. My only hope is that this article has given you a foundation on which to decide whether this is a company you may be interested in investing in.
Stem is an exciting company doing exciting things in an exciting industry. They are providing a potentially immense and valuable solution to one of the biggest problems in the renewable energy market. They have expanded their use cases throughout their still young history to provide marketable products in a variety of energy contexts, and their immense growth speaks to their success in delivering these products.
The biggest question mark for Stem is whether they can successfully navigate their way to a predominantly software-driven revenue generation model to ease their balance sheet woes, drive attractiveness to investors, and increase value to existing shareholders. If they can accomplish this feat, then today’s share price is likely to be extremely attractive, and they will continue to ship a differentiated and defensible product around the world for a long time to come. Looking 20 years out on the potential future of Stem, we may see this high-risk, high-reward company turn into an exclusively high-reward multi-bagger at the center of a sophisticated and efficient clean energy industry.
I am extremely optimistic about Stem’s ability to hit these targets and provide today’s investors with an immense opportunity. But that is one man’s opinion. As always, take caution in all your investing activities and in listening to strangers on the internet - this is still a young company and an extremely risky investment, one which may fail utterly if one or many of the potential threats to Stem’s business are realized.
Regardless of what happens with Stem, you can stay tuned for my next article on personal finance - ETF investing - and my upcoming article on a deep dive into Arista Networks.