Vinod Khosla
Invest in Smart Grids?
February / March 2010
Volume 8 Number 1
Venture capitalists and investment bankers are fascinated by the potential of making money from Smart Grid investments and initial public offerings in the coming year. The technologies behind the Smart Grid allow for more reliable and efficient delivery of electricity to industries and homes. They allow things such as the control of directional flow, are fast in responding and are generally conducive to digital management of the grid. In spite of a difficult IPO market and the recession's drag on the industry, Smart Grid companies are starting to get attention from both VCs and acquisitive technology giants.

The optimism is encouraging. With the recession, cleantech investments took a hit across the board. Ethanol companies, for instance, had their legs cut out from under them as gas prices fell. Solar, another darling sector that saw the IPOs of companies such as SunPower, also got floored compared to its previous momentum. Overall, 2009 saw 356 deals totaling $4.85 billion, according to a report by Greentech Media. In 2008, there were 350 deals that raised $7.8 billion.
But a funny thing has happened on the way out of the recession. The economy stabilized, the stock market roared back and investments in the Smart Grid blossomed. In December, Silver Spring Networks landed $100 million in equity from existing investors Google Ventures, Kleiner Perkins Caufield & Byers, Northgate Capital and Foundation Capital. The company, which makes networking equipment for utilities and smart meters, is leading the Smart Grid market as the most likely candidate for an IPO in 2010. 

One of the backers is Al Gore, the former vice president, Nobel Prize winner, and partner at Kleiner Perkins. He said in a recent speech that energy efficiency is "the single largest solution to the climate crisis," and the Smart Grid will "play a crucial role" in achieving that efficiency.
The Smart Grid will have a number of advantages, Gore said. It will reduce the carbon emissions that accelerate global warming. It will give us more access to alternative energy sources like solar and wind and will equip us to cope with the inconsistency of those sources. It will create jobs. And it will be cost-effective, eventually paying for itself by preventing grid failures and blackouts.
"The analogy to the internet is close to exact and very relevant," Gore added. Like the internet, the Smart Grid is moving from a centralized to a distributed model, and it will spur the creation of new devices and applications.

The rising Smart Grid investment indicates renewed investor faith in the smart metering segment of the business. Almost every major American utility is rolling out plans to install millions of smart meters to their coverage bases. And big alliances are forming to cash in on the installations. Silver Spring partnered with AT&T, whose wireless networks will transfer data from smart meters to data centers at power companies. 

Silver Spring is just one of many Smart Grid players. By 2015, spending on Smart Grid technologies is expected to hit $200 billion, according to Pike Research. In 2009, spending was only $10 billion, including $3.4 billion in government spending. While early investment is in smart meters—€”hitting $35 billion in 2013—€”much of the later investment will focus on grid automation services, Pike reports.

What's the potential gain from all of this spending? If the rollout of grid technology proceeds on course, the Electric Power Research Institute estimates that 4 percent of energy and $20.4 billion in costs will be saved by 2030. Using Ohio as an example, the Department of Energy said that the state stands to save $700 million in energy costs, which breaks down to $61 in utility savings per Ohio resident.

The investments will move down a ladder, as with the beginning of any new market. First comes the investment in infrastructure. Then come the applications that use it. Peter Wagner, a partner at Accel Partners, compared the Smart Grid opportunities to those on technology platforms such as Apple's iPhone. He says the utilities are like the cell phone network owners, and platform owners such as Silver Spring make it possible to create lucrative apps that exploit the Smart Grid. A lot of the future opportunities for startups will be in the apps, he said. These are equivalent to "offdeck" apps as with the AppStore for the iPhone.
Right now, Wagner said he is looking for companies that can exploit the platform and create apps that can be sold directly to consumers. As with the iPhone, that enables startups to sell directly to consumers and bypass the gatekeeping process of the utilities.
"I encourage entrepreneurs to think of a customer that is not the utility, since the utility sales cycles are long and they move slowly on new business models," Wagner said. He pointed to Opower, a startup that shows people how they can save money on their energy bills. The idea of building social networks around saving energy is likely to lead to startup opportunities, he said.

Not every major cleantech investor is jumping on board. Vinod Khosla, head of Khosla Ventures, says the Smart Grid is overhyped and he has yet to find a company to invest in. Much of his money has been focused on energy storage.

Before this can take place though, Smart Grid companies also need to accept that consumer behavior is incredibly difficult to change, Khosla said.
While 5 percent of the population will take the time to check in on their energy use and make an effort to conserve, another 80 percent will ignore it entirely. "When you ask how many people will worry about interest rates on their credit cards, the answer is not many—€”they don't know what they are paying," he said. "The one thing that does change behavior is dramatic changes in pricing—€”going from $2 to $4 for a gallon of gas—€”that creates change."
Khosla said that analysts touting Smart Grid as a way to fight pollution are wrong. He went as far as to say that coal could be cleaned up to be even more carbon neutral than solar and wind sources. With carbon capture and other technologies—€”including one that can funnel greenhouse gases into producing green cement—€”coal, which will remain the most popular source of energy regardless of policy or technology, could be a route to prevent global warming.
Right now, investors and companies operating in the Smart Grid space seem to be biased against coal, charging full force toward green sources. He stressed that clean coal companies should get a piece of the Smart Grid pie in order to really make it a decarbonizing development.
"Be careful about the hype," Khosla said. "Always look at the economic proposition."

But Khosla is in the minority. At the VentureBeat-hosted GreenBeat conference in November, executives from Pacific Gas & Electric, Accenture, Itron, the Zigbee Alliance, Siemens and Oracle all agreed that the Smart Grid space will see massive expansion in the next several years.
Don Wood, managing director at venture firm Draper Fisher Jurvetson, said the DFJ Network has 70 investments in cleantech companies, including a number of Smart Grid plays such as Enernoc, Solar City, Deeya Energy in India, and Prudent in China. He said that investments in local smart grids could prove fruitful. He noted there are 100,000 villages in India without electricity and that an effort to provide rural electrification is needed and could prove lucrative. DFJ invested in Husk Power, which is doing that. He also said that he believes killer apps in the future will be in the storage of electricity, either in central storage repositories at the utilities, in individual homes, or in charging stations for electric vehicles.
Breakthroughs in that area depend on better battery technology, which has been exceedingly difficult to do since batteries don't progress as other technologies do, Wagner said. Wood also said network control systems also have to be developed for better storage.
Bryce Lee, managing director at Credit Suisse, said he believes investments in hardware are necessary and important in the initial building of Smart Grids, but future opportunities will focus on the communications and intelligence that the grid makes possible. He also pointed to Silver Spring as an example of this.
Brian Bolster, managing director at Goldman Sachs, said that smart metering companies and networking companies are doing well. He said those new technologies will inundate utilities with a huge amount of data. There should be opportunities in the companies that enable the utilities to manage and make sense of the data.
"We're in the infrastructure phase now, but derivatives that come from the infrastructure will follow," Bolster said.
The federal government has made $3.4 billion in stimulus funds available to Smart Grid companies, either as loan guarantees or grants. But Wood said that isn't having a direct effect on his investment strategy. That's because he believes companies should be able to stand on their own without the regulatory help. Wagner said the stimulus announcements have succeeded in accelerating the market and helped it recover from the recession-induced stall in the market earlier this year. But he warned that startups should not become enamored with the possible mirage of getting stimulus money.
The bankers and VCs didn't seem concerned that it might be a long time before there are exits. Mergers and acquisitions will likely be plentiful. Wagner, who is not an investor in Silver Spring, said he believes there "have to be" ongoing negotiations between Silver Spring and Cisco about an acquisition. Other big information technology players such as IBM, Oracle, SAP, Siemens and Google are likely to be acquisitive in this market, Wagner said.
Wood noted that players such as General Electric have made 400 acquisitions in the past decade and that there would likely be more in the Smart Grid industry. Big players such as GE have to look for big new markets constantly to keep growing. Wood expects that one of DFJ's companies, Tang Energy, will likely go public in the coming year as demand increases for its turbine blades for wind power.
"There will be IPOs in this space," Wood said. Added Lee, "I'm optimistic that 2010 will be a good year for the public markets, and hopefully cleantech will benefit."
It's still pretty early for IPOs. But the successful IPO of cleantech player A123 Systems earlier this year has given investors hope that there will be more to come. Asked if shocks to the system, such as a drop in commodity prices for oil or conventional electricity, could hurt the prospects, the panelists said that most of their investments aren't contingent on soaring prices for energy.
"We've reached a tipping point on electricity," Wagner said. "It's got momentum, regardless of the price of oil."

Dean Takahashi reports for Innovation from Silicon Valley and also writes for VentureBeat. Write him at deantaka@gmail.com
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