Understanding Where We Are.docx

7/21/2019 Understanding Where We Are.docx

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Understanding Where We Are in theTimeline of the Development of Clean Energy Technologies

One of the lessons from history is that the less you study it, the more you willbe forced to learn from it. Many investors in wind, solar and other nascent

energy technologies have painfully experienced that lesson and many moreare likely to do so over the next decade. On the other hand, those thatspend the time to understand these lessons of history will be well positionedto benet from timely investments into those technologies that have arrivedat the appropriate investment “tipping points.”

Most of us are intimately familiar with the concept of the artner !ype "ycle#see gure below$. %ut artner speaks more to market adoption trends andinvestor excitement than the underlying realities of the creative destructionprocess that is occurring amongst the companies vying for leadership in agiven market segment.

&rom an investor's perspective, the ability to make a small investment at thepoint of “technology trigger” and to then li(uidate that investment at the“peak of in)ated expectations,” represents the optimal seed and venturecapital investment model. *f that investor actually has to wait until the“plateau of productivity” for li(uidity, the cash on cash returns may still be

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attractive, but the *44 has su5ered meaningfully. 6orse, if during the“trough of disillusionment” the development of that technology re(uiredsignicant additional dilutive capital, then virtually all gains may be erasedfor early investors, particularly if they don't have the deep pockets to retaintheir ownership share as the company proceeds through the artner stages.

Many of those who have studied this process #with the original credits datingback to economist /oseph 0chumpeter's coining of the “creative destruction”concept, depict the progress of technology as a series progressive waves#see charts below$7

0O84"97 +: "alifornia reen *nnovation *ndex

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;he problem with all of these depictions is that they fail to distinguish between thecore underlying technological advancement and all of the subse(uent technologiesthat are enabled once the core technology is broadly adopted #but which would notbe particularly useful without the underlying breakthrough$. ;he easiest tounderstand examples are oogle or &acebook without the personal computingplatform or the internet backbone on which those two applications depend.

;herefore starting a new “technology wave” is completely di5erent from riding thenext phase of a wave already well supported.

;o understand the di<culties of investing in the above referenced “=th 6ave” ofsustainability, radical resource productivity, green chemistry and renewable energy,one must go back and better understand the beginnings of other fundamentaltechnological underpinnings that then drove decades of supplemental technologies,business models, applications and solutions.

*n looking at how the more fundamental technological breakthroughs occur andmature, we have established a basic graphic that resembles the artner !ype "ycle"urve, but depicts something di5erent #see below$. !ere we are looking at how a

fundamental technological breakthrough tends to spur an outburst of companyformations, seeking to perfect that initial invention and e5ectively bring it tomarket.

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%y focusing on ? #the number of years it takes between reduction to practice of thecritical invention, the height of entrepreneurial enthusiasm and company buildingand the end of the competitive crush that inevitably follows$, % #the number ofcompanies created to pursue the perfection of that fundamental invention$, " #thepoint at which the new technology has actually been adopted by -@ of the 8.0.population #or relevant target market$ and 1 #the time it takes to get from -@adoption to approximately A@ market penetration #where adoption often begins tolevel o5$, we can compare a series of such inventive cycles around technologiesnow familiar to us and begin to predict where other fundamental technologies areon this same development scale.

!ere, for example, is the set of curves and points ?, %, " and d applicable to theautomobile7

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Cote that in this instance both 6orld 6ar ;wo and ;he reat 1epression slowed theautomobile's progression toward A@ or greater market penetration. *mportantly,

we today tend to forget the important part of automotive history that was theroughly + car companies that competed alongside &ord, eneral Motors, and"hrysler for domination of this nascent market. *n fact, in the early years it was farfrom clear who would dominate and in fact "hrysler didn't enter the picture until +years after the automotive “gold rush” began.

?s importantly, the -@ market penetration point occurred only after most of thecompetitive carnage was over and the eld had been reduced to a relatively smallnumber of competitors. *n all, the rise and fall of the entrepreneurial wave ofautomobiles took about > years to run its course. %ut once that > years wasover, the growth rate in car sales was exponential and the few winning companies,represented extremely attractive longDterm investment opportunities, even if they

did anything but that during the prior > years. &urther, for the investor “playingthe eld” the average returns would have been miserable, as the vast maEority ofthe competitors failed. ?lthough we have not studied it in detail acrosstechnologies, our initial research indicates that the winners tend to represent oddsof DinD- or less and, although over the long run they represent outstandinginvestments, the *44 for investors betting on those same companies after thecompetitive carnage is over #i.e. in -F-+$ is far better than that for those whoactually picked out the &ord Motor company back in -F>.

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More recent history for most of us is the development of the personal computer#although for many of today's investors their memory only covers the subse(uentsoftware and internet periods, not the more di<cult hardware development phaseof information technology$.

? few investors were prescient enough to bet on ?pple "omputer by -F:, but thetruth is that you really could have waited all the way until -F: and still have gottenmost of ?pple's computer gains #and until += to get in ahead of ?pple's nexttechnological breakthrough G the iHhone$. Once again, betting the eld on personalcomputer hardware manufacturers would have produced very disappointing overallresults during the -FA to -F: time period.

enerally, the di<culty with most of these hardware breakthroughs is that theyre(uire signicant amounts of capital to a$ reduce the technology to practice, b$

build a factory to scale up production and c$ produce in enough volume to bringprices down to high levels of market acceptance.

Of greater relevance to the “=th wave” discussion on clean energy, sustainability andgreen chemistries, is the same set of curves as applied to the solar industry #seebelow$7

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&or solar, we are nearing the completion of the competitive carnage phase. 6ehave seen massive drops in production costs and, as a result, panel costs #see chart

below$. 0olar HI now represents more than -@ of 80 energy capacity, but hasalready crossed the -@ penetration levels of eligible households in several states#like !awaii, "alifornia, Massachusetts, ?ri2ona and "olorado$ that were earlyadopters. "onforming to the historical pattern, investing across the eld of HImanufacturers was, on average, a very poor bet. *nterestingly, one investor,9urope's ood 9nergies turned a roughly JBM initial investment across a range of erman, 8.0. and "hinese solar companies into a roughly J=% paper valuation atthe height of the competitive fren2y, but #in large part because li(uidity wasunavailable$ rode those valuations back down to less than J-% by the time thecarnage was over.

Conetheless, today's &irst 0olar and 0unHower probably represent the investment

e(uivalents of &ord or "hrysler, 1ell or ?pple in terms of their long term prospectsas the solar industry continues its long climb toward A@ penetration of eligiblehouseholds.

6hat about the rest of the soDcalled “"lean;ech” industryK 6ind has alreadyundergone its boom, bust and recovery phases, but it is largely a businessDtoDbusiness or utilityDscale solution and thus didn't generate the same competitivefren2y as most consumer product technologies #of which solar HI is really the rstenergy entrant$. ?s we have seen, biofuels and biochemical are well into their

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competitive carnage phase and even if we have seen the end of the carnage, thereare few new entrants in those elds at the moment. On the other hand, batterychemistries are all the rage today and we may still be on the upswing of newcompany creation. 6ill overbuilding of lithium ion factories for car batteries in theface of much lower oil prices spur the beginnings of competitive carnage inbatteriesL that will rapidly bring down prices and, as a result, speed up adoptionK

;his pattern has repeated itself over and over again with regard to a wideDrangingseries of technological hardware breakthroughs #including the telephone, radio,washing machine, microwave, I"4, color television, etc.$, each having somewhatdi5ering levels of entrepreneurial gold rushes, competitive carnages and years fromstart to peak to trough. %ut the pattern of proceeding rapidly from those rstpercentage points of market adoption up to nearly A@ of households generallyholds true across this range of consumer goods #see chart below$.

?nother notable factor with respect to the automobile, personal computer and solarHI industries is that they represent a paradigm change in a$ personal mobility, b$personal information access and c$ personal energy production as those compare totheir legacy counterparts of a$ buses and trains, b$ enterprise computing and c$utility scale energy. ;he parallels are further extended when you factor in theimportance of storage #the gasoline tank and the gasoline station, computermemory and cloud storage, and energy storage whether in the form of batteries orthe grid$ and a supporting network #the road and highway system, the 9thernet and*nternet, and the “0mart rid”$. ;he power of the new consumer technology,

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a5ordable storage and networking technologies together represent a new era inenergy as much as cars and personal computers changed mobility and informationtechnology.

Of course, these patterns have signicant ramications for investor behavior.nowing when to invest, how long you are likely going to need to hold thatinvestment and how much capital you might need to protect your position through

li(uidity become critical success criteria #see chart below$7

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*nvesting early in these breakthrough hardware technologies is neither for the faintof heart nor for the shallow of pocket book. On the other hand, waiting too long andnot investing in the leading companies once they have emerged from thecompetitive carnage means leaving large sums of money on the table.

&or incumbent corporations being disintermediated by these changes, the situationcan be even more severe, as they cannot expect to successfully ac(uire the winning

technology once that player has established a dominant position, yet theirorgani2ation is structurally handicapped with respect to aggressively internallydeveloping a winning response to an emerging disintermediating threat. 6e havepreviously published a “One Hager” on this challenge G see “? 4epeating rowthHattern” http7NNwww.resourcient.comNPrepeatingDgrowthDpatternNclw> $.

;he good news for most investors is that fundamental hardware breakthroughs are Eust the rst part of the story. &or each such breakthrough there follows asuccession of new business models, service industries, and software applicationsand solutions that are enabled by the hardwareNinfrastructure breakthrough andthat generally represent far shorter and therefore more attractive paths toeconomic returns from investment.

8nderstanding the patterns of failure, challenge and success across the range ofinvestment opportunities that occur in a new wave of innovation is a critical aspectof investment success. ?lthough complex, we believe the chart below sums up thesteps companies need to take on their way to an outcome and thus explains someof the risks involved and the reasons why investment returns are harder to achievealong some paths as compared to others7

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Most of the *nternet investments that have produced enormous venture returns overthe last ve years represent companies that are able to proceed along the far righthand side of the chart. ? few hardware companies in the “"lean;ech” sector,notably ;esla and Cest Qabs have leveraged third party hardware advancementsand manufacturing partnerships to successfully travel up the middle path. &orthose progressing from the bottom left, it has been a slow, arduous and challenging Eourney and has rewarded very few investors.

;herefore, from an investor's perspective, deciding where and when to investdepends heavily on where a particular company started its Eourney and how far ithas progressed. &or the most part, companies on the bottom left of the chartremain very challenging investments. &or many of them, successfully gainingaccess to the hori2ontal bar of infrastructureNproEect nance capital becomes a keydeterminant of the future success. ?t the same time, each group of companies thatreaches the top right from the bottom middle and left of the chart opens the door toan entire generation of new softwareDbased applications and solutions companiesthat can travel up the right hand side of the chart and thus represent much moreattractive private e(uity and venture returns.

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6hat does that mean for investment prospects in the clean energy arenaK *n ourview it means that one should pay signicant attention to the maturity level of theunderlying technology. *t also means that there are later stage andNor publiclytraded companies that represent the scarce survivors of the competitive carnageand that history suggests will represent +D> year long attractive investmentholdings that no matter how expensive they appear today, will if they remain acategory leader, be yet far more valuable over those many years.

6e also see a very attractive convergence between four technology trends that areall maturing rapidly, two of them already having completed most of their shakeoutphase. ;hose four technologies are #i$ solar HI, #ii$ electric vehicles, #iii$ batteriesfor HI and 9I storageL and #iv$ the overlay of big data analytics and the internet ofthings on the electron supply and management to and from HI, the 9Is,households, businesses and the grid. ;he intersection of these four is spawning ahost of new sectors, many characteri2ed more as applications and solutionsbusinesses, which we believe represent the e(uivalent of the -FF to + wave ofinformation technology investment. *n particular, we see the following subsectorsas of particular interest7

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?s shown in the chart, many of them will benet from an overlay of infrastructurenance to facilitate their more rapid deployment into the market. ;hese, in turn,will represent attractive yield opportunities for investors who understand theunderlying technology and deployment risks and support the companiesprogressing their technologies to everDgreater market acceptance.

;he foregoing chart omits much of what has been characteri2ed as the “"lean;ech”investment landscape. 6e believe that as success models are borne out in thesesectors, other sectors will both mature their fundamental technologies and willbenet from the success patterns developed in these sectors.

?s a result, we remain very much focused on the places where we believeinvestment returns can be produced today, both in terms of category leaders and

the new applications and solutions sectors they have enabled.

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Understanding Where We Are.docx