By
Lou
Basenese
:
Last week, a critical piece (see
here
) was published about
Clearsign Combustion
(
CLIR
) by an individual with a short position in the stock.
I've been researching and following the stock - and have met
with management multiple times - ever since the company went public
back in April.
Before any investors put their hard earned capital on the line
based on the previous analysis, I'd hope they'd at least want to
hear the bull case, too.
With that in mind, today I'm sharing the research report I
originally provided to my subscribers on May 4, with relevant
updates, to help investors make the most informed decision.
Full disclosure: I have no position in the stock, so I'm not
simply "talking my book." The only way my business succeeds is if I
provide accurate and ultimately profitable investment research to
subscribers. Continuously. I believe Clearsign represents an
opportunity for me to fulfill that mission. Here's why...
Industry Overview: A Global (and Growing)
Opportunity
As the company's name implies, Clearsign develops technologies
related to combustion systems. To laymen, though, the size and
scope of combustion markets might not be immediately apparent. It's
my goal to make sure you no longer fall into that category.
The good news is I can put the enormity of this opportunity into
perspective with a single fact:
Nearly two-thirds of the world's energy consumption is
currently supplied by combustion of hydrocarbons and other fuels
in boilers, furnaces, kilns and turbines.
I'd challenge you to find a bigger market in existence. But the
combustion systems market isn't just big. It's growing, too, thanks
to our ever-increasing need for energy. Global energy consumption
will increase by about 50% by 2035, according to the U.S. Energy
Information Administration's 2011 International Energy Outlook. No
surprise, the emerging markets of China and India are the main
drivers of this growth. Those two countries alone are expected to
double their combined energy demand by 2035.
Bottom line: Any technology with the potential to improve a
process so critical to everyday life represents an unprecedented
opportunity for society and investors, alike. And that's exactly
the potential Clearsign possesses. When I say the company is a
potential world changer, I mean it, literally.
Technology Overview: A Great Leap Forward
For over a century now, our combustion systems have relied
largely on two characteristics: buoyancy and momentum. Buoyancy can
easily be understood by using your standard household candle. Hold
it upright. Light it. And then turn the candle horizontal and the
flame stays upright. That's buoyancy.
Your typical propane blowtorch, which applies pressure to a
combustible fuel, is a perfect example of harnessing the power of
momentum. (By the way, the first known patent for a blowtorch was
granted in France… in January 1791. Like I said, we're talking
about centuries-old technologies here.)
What Clearsign's technology does, though, is provide a
tremendous leap forward by harnessing a third, yet neglected,
characteristic of combustion flames - electrostatic forces. These
are the forces created by the movement of electrically charged
molecules (ions) that are a natural product of the combustion
process. If you remember from high school physics class,
electrostatic forces are what hold electrons in their orbits in
atoms. So these forces are strong. Billions of times stronger than
gravity, in fact.
To tap into that power, Clearsign developed a very
straightforward system, with components that are available "off the
shelf." In other words, it can be implemented immediately, or as
the company states in its
S-1 filing
, "Clearsign does not depend on any third-party external technology
that has not yet been developed."
The four major components of Clearsign's technology are a
computer, software to deliver proprietary algorithms, a power
amplifier (outside the combustion chamber) and electrodes (inside
the combustion chamber). The impact on combustion chemistry that
such a simple setup has demonstrated in the lab is significant.
- It results in less unburned fuel, thereby increasing
efficiency and reducing pollutant formation.
- It optimizes flame shape and stability to maximize energy
efficiency.
- It increases thermal efficiency (heat transfer and heat
distribution).
Practically speaking, Clearsign's tests with coal, tire-derived
fuel, and wood have shown reductions in visible particulate matter
(i.e. - pollutants) of over 80%. Other tests demonstrated
efficiency increases of as much as 30% in gas-fired boilers.
Bottom line: Clearsign's technology holds the promise to
simultaneously increase energy efficiency and dramatically reduce
emissions. No product on the market today can make that claim.
Market Opportunity: At Least $12 Billion
As you might imagine, the emission of pollutants from combustion
processes is heavily regulated. Regulations are only getting
stiffer, too.
- In the United States, the Mercury and Air Toxics Standards
((MATS)) and Cross State Air Pollution Rule ((CSAPR)) are recent
examples of increased regulation, with compliance due as early as
2014.
- In Europe, new directives from the European Union require
more reductions in NOx emissions by 2016.
- In China, as part of the country's Twelfth Five-Year Plan,
the Ministry of Environmental Protection called for more
reductions in NOx, with compliance mandatory by January 1,
2014.
The key here is that compliance isn't optional. Companies must
get their operations up to standards or they face stiff penalties
or the prospect of ceasing operations altogether. So what are they
choosing? Compliance, of course. Case in point: More than 10,000
active environmental projects are under way for the world's 7,000
coal-fired power plants to reduce emissions. Put simply, compliance
is a cost of business. But it doesn't come cheap. For example, a
1,000-megawatt coal-fired power plant in the United States can
expect to spend $400 million to meet new air quality standards,
according to The McIlvaine Company.
When we extrapolate those costs over an entire market, the
opportunity for Air Pollution Control ((
APC
)) equipment quickly reaches into the tens of billions of dollars.
In fact, The McIlvaine Company estimates $51 billion will be spent
on APC equipment worldwide in 2012 alone. Roughly half of that will
be spent in industrial combustion markets and the other half in
power generation. What's more, annual expenditures on APC equipment
is expected to grow by 6% per year over the next decade, which is
faster than global GDP growth.
The problem with the status quo, though, is that the majority of
APC technologies are post-combustion. That means we're trying to
"filter" out pollutants as best we can from the air, instead of
preventing them from forming. And treatment is much more costly
than prevention. We can get an idea of how much effort is spent on
emissions treatment by looking at a schematic for a typical power
plant. The footprint or physical "real estate" required by APC
technologies (circled in red) - and the number of APC technologies
employed - is significant.
(click to enlarge)
But therein lies one of the major advantages of Clearsign's
technology. Because it operates at the combustion source, it
prevents the formation of many pollutants. If a picture is worth a
thousand words, the following two should speak volumes. They show
the smoke produced when biomass pellets are co-fired with propane
with and without Clearsign's technology.
(click to enlarge)
(I encourage investors to check out the "Lab Videos" recently
added to Clearsign's website
here
for an even better idea of how the technology works).
These pictures only demonstrate one of the major benefits of
Clearsign's technology - emissions control. Like I mentioned
earlier, though, Clearsign's technology isn't just about reducing
emissions. It's also about increasing efficiency. Please understand
that a simple 1% increase in efficiency would result in millions of
dollars of savings for individual companies. And the market would
quickly embrace any technology providing such a seemingly small
benefit. I bring that up because Clearsign is witnessing efficiency
gains of 10% to 30%. So, as Clearsign rightly states, the combined
results of its technologies would "transform the economics of
coal-fired power generation," as well as other combustion
systems.
In terms of actual market opportunity, management is
conservative in its estimates, saying:
Based on our internal estimates, the Company believes the
total addressable market for Clearsign ECC Technology in the
four targeted system types to be between $5.1 billion and
$12.2 billion in the United States alone.
The following abbreviated table from the company's S-1 filing
provides a breakdown of that calculation:
(click to enlarge)
There are two things worth pointing out here:
- The company's estimates are based on annual replacement rates
of just 3% to 10%. But the stricter emissions standards looming
on the horizon should lead to an accelerated rate of adoption
once Clearsign demonstrates commercial viability of its
technology.
- The company's estimates only take into account the United
States market. As I told you earlier, a sizable opportunity
exists in China and India, too. China's APC market alone is
projected to be three times the size of the APC market in the
United States. Add in European markets, and we quickly get to a
total addressable market that is many multiples larger than
Clearsign's estimates.
Bottom line: By reducing emissions and increasing efficiency,
Clearsign's technology could deliver an economic benefit. So it's a
no-brainer sale. Especially, since Clearsign's technology would
cost a fraction of what is spent on less effective APC equipment.
That is, as long as Clearsign's technology scales.
Two Critical Milestones: Scale and Third-Party
Validation
Clearsign is still a late-stage development company, entering
into the validation period. And before it can enter
commercialization and start generating revenue, the company must
first prove its technology scales.
So far, Clearsign has designed and built three prototypes:
- A small bench-top configuration of 5,000 Btu/hour. (A Bunsen
burner size flame.)
- A larger system of 25,000 Btu/hour. (A flame a few inches
high.)
- And a scale reactor of 250,000 to 1,000,000 Btu/hour. (At
100,000 Btu/hour the flame would be about as long as your
arm.)
To date, it has conducted 400 experiments. The company's
recorded no decrease in performance as it increases the scale,
either. That's significant, which management acknowledges in the
company's S-1 filing:
If the results we have observed in our testing can be
replicated on a commercial scale, we believe our proprietary
technology platform may increase energy efficiency and
improve fuel flexibility and environmental performance for
most types of industrial and commercial combustion
systems.
A key commercialization milestone I originally told subscribers
to watch for is a 1,000,000 Btu/hour burner, which the company hit
last week (see
here
). At this scale, Clearsign starts getting into commercially
relevant sizes. And at about 3,000,000 to 10,000,000 Btu/hour, the
company enters the sweet spot for industrial applications. It's
important to note that management originally estimated it would hit
the 1,000,000 Btu/hour milestone by the end of the year. Clearly,
the technology is progressing ahead of schedule.
Another major milestone the company needs to hit is third-party
validation of its results. This would ideally come from a highly
credible source, like a government facility like Argonne National
Laboratory. Once Clearsign gains third-party validation and
demonstrates commercial viability in one market segment, I wouldn't
be surprised if it started licensing its technology. Especially
since licensing would be the quickest path to widespread adoption
and, of course, the least capital intensive.
The announcement of any partnerships with OEMs should be viewed
as a precursor to any such licensing arrangements and a welcomed
milestone in its own right.
Bottom line: At this stage, Clearsign's stock price is going to
be determined by the company's ability to hit critical milestones,
not traditional fundamentals.
The reason I'm bullish on such an early stage company is because
the enormity of the opportunity warrants it. If we wait for
Clearsign to hit all its milestones - or for the company to
generate meaningful revenue - it will be too late. Wall Street will
have already connected the dots and bid up prices.
Key Fundamentals
Other key fundamentals worth noting, include:
-
Adequately Capitalized:
The company netted almost $10 million from its recent IPO, which
gives it enough capital to fund the critical steps ahead. That
includes scaling up to commercially relevant sizes ($3 million),
on-site demonstration ($1.25 million), an initial installation
($0.75 million) and enhancing its intellectual property portfolio
($1 million to $2 million).
-
Clear, Sensible Path to Market:
The company's targeting the low-hanging fruit first.
Specifically, natural gas-fired industrial boilers, of which
there are currently 163,000 in the United States. At the same
time, it's dedicating time to develop opportunities in
distribution channels with much longer lead time and fewer
targets. Namely, power generation.
-
Ease of Installation:
Although every combustion system is unique, installing
Clearsign's technology should only take a few days. So
installation can be accomplished during routine, system
shutdowns, which happen multiple times per year. In other words,
no costly interruptions are necessary to implement the
technology.
-
Proven, Capable Management:
CEO, Richard Rutkowski, brings a track record of success from
previous startups, MicroVision and Lumera. My personal
conversations with him only strengthen my conviction that he
understands the opportunity ahead and how to capitalize on it
quickly. Some have pointed out that he's a businessman, not an
inventor. That's a positive, though.
-
Solid IP Strategy:
Securing patents in the early stages of a company's life cycle
are a critical component to ensuring long-term success. Yet, many
companies fail to do so. Clearsign definitely doesn't fall into
that category. To date, Clearsign has already filed 22 patent
applications. And it's earmarked up to $2 million of its IPO
proceeds to file additional applications based on more than 100
unique inventions.
-
No Competition:
Based on my research, there are no competitors looking to
commercialize a technology similar to Clearsign's. This should
translate into a significant first-mover advantage for Clearsign.
And a sustainable one, too, given management's aggressive IP
strategy.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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on seekingalpha.com