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EnerNOC: NOCking On Tesla's Door

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By Hillside Advisors :

EnerNOC ( ENOC ) got a boost on Friday when it announced it will be collaborating with Tesla ( TSLA ) on the deployment and management ofTesla's new energy storage systems. EnerNOC will provide the software to manage the storage systems in commercial and industrial buildings, allowing customers to buy energy inexpensively during off-peak periods and use it or sell it back to the grid during peak usage periods when the energy costs more. Merely sending out a press release with Tesla's name worked its magic, and ENOC's stock closed up $1.81 on Friday, settling at $12.86/share after being as high as $14.69 during the session.

If only every day were like that for EnerNOC. Rather, life as public company has been a downhill slope for the company's long-term investors. The stock's all-time high came only six months after the company's IPO in 2007 at $49.10, and more recently, the stock peaked last year at $23.60/share. That is despite revenues increasing from $60 million in 2007 to $472 million in 2014. However, with the hype out of the stock and new opportunities such as the Tesla energy storage system, it is a good time to consider the company's 2.25% convertible bond. Friday's market action - or lack thereof - spoke of intrigued buyers and reluctant sellers.

Business Segments - One Old, One New

EnerNOC participates in two main lines of business: EnerNOC's traditional demand response business and a newer energy intelligent software (( EIS )) platform for businesses and utilities. Ten years ago, EnerNOC was instrumental in creating a new energy demand response market based on the simple but eloquent notion that during peak energy periods clients could cut back on energy usage to balance supply and demand. Consequently, utilities would not need to build additional peaking power plants, reducing carbon dioxide emissions. This green idea put money in EnerNOC clients' pockets.

The process works like this. EnerNOC signs up energy consumers willing to cut demand during peak periods. After it tallies up the megawatts that clients are willing to cut, EnerNOC bids on future capacity contracts in a reverse auction sponsored by grid operators. When EnerNOC gets paid, it shares its fee with its clients in exchange for cutting their energy use on demand. The idea created a lot of excitement when it was introduced, and as often happens the market extrapolated growth to the moon. Now that growth is moderating, the market is struggling to find realistic expectations and prices for EnerNOC's securities.

Currently, EnerNOC has about 6,500 demand response clients at 15,000 sites. EnerNOC works with 14 grid operators, but PJM is by far the most important relationship, accounting for close to $250 million in 2014 revenue.

More recently, EnerNOC has been developing its EIS software-as-a-service (SaaS) platform to facilitate more efficient energy purchases and usage for businesses and better client management for utilities. The EIS software platform is a bit more of a mundane idea than demand response, but it is likely the future of the company.

Revenue Sources and Mixed Growth

EnerNOC divides its revenue segments by its three client groups: grid operators, enterprise and utility. Both grid operators and enterprise participate in the company's demand response services as described above. Enterprise is also an EIS target to help entities manage their energy purchases, including supplier selection, budget forecasting and optimization. EnerNOC had 1,300 clients under EIS software contract at 35,700 sites at the end of 2014, up from 600 clients at 2,800 sites at the end of 2013. EnerNOC's sales strategy is to lead with its demand-response product and then upsell its energy software platform to those existing clients.

Utility clients use EnerNOC's EIS software to develop data and engage customers. The software targets improving customer satisfaction, delivering savings and reducing consumption by customers to achieve energy efficiency requirements enacted by state public utility commissions. EnerNOC had 52 utility customers at the end of 2014, up from 36 at the end of 2013.

EnerNOC is using the positive cash flow from its demand response/grid operator business to fund the growth of its EIS products. The company has developed momentum in the EIS space and EnerNOC will need it. EnerNOC has suffered faltering financial performance of late, and in March, EnerNOC offered disappointing 2015 guidance as follows:

2015 Guidance 2014 Actual Results
Total Revenue (in $ millions) $410 to $430 $472
Grid Operator Revenue $270 to $280 $369
Utility Revenue $70 to $75 $62
Enterprise Revenue $70 to $75 $41
GAAP Net Loss per Diluted Share ($3.12) to ($3.23) $0.42
Non-GAAP Net Loss per Diluted Share ($1.66) to ($1.77) $1.26
Adjusted EBITDA (in $ millions) ($10) to ($14) $76

Through it all, however, EnerNOC is guiding to breakeven cash flow for 2015.

The forecasted revenue drop is a result of significantly lower proceeds from grid operators, particularly a decrease in the PJM business. EnerNOC expects revenues from PJM to drop by $80 million in 2015 over 2014 revenues. $30 million in lost revenues is the result of PJM disallowing financial companies like EnerNOC to participate in incremental capacity auctions. The other $50 million in decreased revenue is being deferred to 2016 because EnerNOC has joined a new PJM program that spans two calendar years. The good news is that the deferred revenue will not affect cash flow in 2015.

Another $25 million of lost grid operator revenue will result from lower pricing in the Western Australia capacity market. That's being partially offset by an $11 million increase in other foreign markets such as Germany and Korea.

Despite the revenue reduction, EnerNOC is actually forecasting an increase in megawatts and sites handled in 2015. That is a double-edged sword. It is a negative because it makes it difficult for EnerNOC to lower operating expenses, significantly pulling down 2015 earnings. The good part is that the increased capacity feeds into the business strategy of upselling the EIS software.

Regulatory Issues

There also are regulatory concerns for EnerNOC regarding the grid operator business. Last year, the U.S. Court of Appeals for the DC Circuit vacated the Federal Energy Regulatory Commission's (FERC) demand response compensation rule. The ruling effectively put each state's public utility commission in charge of regulating the demand-response market. The ruling was a loss for EnerNOC because FERC's demand-response compensation rule directed grid operators to pay the same price for demand-response services as the market price pays to power producers in wholesale markets. If the Circuit Court's opinion is allowed to stand, it could mean further revenue reductions for EnerNOC depending on future decisions as each state's public utility commission addresses the market cost for demand response. It is likely, however, that the Supreme Court will decide to hear the case in the near future and many believe that the Supreme Court will overturn the Circuit Court ruling based on the concept that federal oversight leads to a more orderly energy market.

EIS is the Future

Given the economic and regulatory volatility in EnerNOC's grid operator/demand response business, growth of EIS software is vital for the future. EnerNOC's selling strategy products seem to be working as the enterprise EIS segment grew at a 40% organic growth rate in 2014. The opportunity for further upselling is available with 5,000 demand response clients still not using EnerNOC's EIS enterprise software. EIS software revenue per client also is expected to grow because new clients typically adopt the service as a trial and then ramp up to additional sites over time.

Will the Tesla collaboration announcement prove to be a strong growth driver? For now, the only effect was knocking out some shorts on Friday. Long term, only time will tell, but it does move EnerNOC solidly into the renewable energy space at the dawn of energy storage market adoption. The opportunity also plays to EnerNOC's strengths given its unique position at the crossroads of a deep understanding of energy market pricing and experience with enterprise energy software.

A Case for the 2.25% Convertible

However, the recent disappointing guidance, execution risk in shifting the company to the SaaS model, and regulatory questions all make it easy to understand why both the company's stock and the 2.25% 2019 bond have been pummeled, Friday's action notwithstanding. Balancing the risks are momentum in the EIS enterprise business, a potentially favorable ruling by the Supreme Court, and EnerNOC's reasonable leverage ratios. The $160 million convertible bond is EnerNOC's only long-term debt and the company has an ample cash balance of $254 million to provide a runway for the EIS business.

The current uncertainty points us to the company's deep out-of-the-money convertible bond as a conservative way to invest in EnerNOC. While the bond rallied Friday along with the stock (trading appeared to be handicapped by wide bid/ask spreads and a reluctance of sellers to crystallize losses after a piece of good news), it still offers a hefty 8.7% yield to maturity. The bond is also a member of the HOCS 20 with a slash line of 66 overall/69 growth/59 safety.

This Week's Earnings Preview

EnerNOC releases earnings on Thursday, May 7, after the market closes. Company guidance is for $48 to $53 million in revenue and a non-GAAP loss of ($1.29) to ($1.35)/share. That equates to a GAAP loss of ($1.66) to ($1.73)/share and EBITDA of ($26.5) to ($28.5) million. Consensus analyst estimates are for ($1.65)/share on revenues of $51.2 million. For a home run, the market also needs to see accelerating growth in the enterprise EIS segment. Otherwise, convertible investors can be content with the bond's income stream while the company executes its EIS software strategy over the longer term.

Credit Waterfall

EnerNOC, Inc.
Total Debt EBITDA Net Debt EBITDA
(Dollars in Millions) 31-Dec-14 (Cum. Bal.) Multiple (Cum. Bal.) Multiple
Current Share Price $12.83
Shares Out. (Millions) 29.8
Latest Twelve Months:
EBITDA 58
Free Cash Flow 35
Cash & Cash Equivalents 254
Senior Unsecured Debt
2.50% Senior Cvt. Notes due 2019 160 160 2.8x -94 NM
Total Debt 160 160 2.8x -94 NM
Equity Market Cap. 383 --- --- --- ---
Enterprise Value 288 --- --- 288 5.0x
Source: SEC Filings

Financial Summary

EnerNOC, Inc.
Fiscal Years Ended
(Dollars in Millions) 31-Dec-10 31-Dec-11 31-Dec-12 31-Dec-13 31-Dec-14
Revenues 280 287 278 383 472
Y / Y Change ---- 2.3% -3.0% 37.9% 23.1%
Gross Profit 120 123 123 191 215
Operating Profit 11 -10 -20 28 26
EBITDA 27 13 5 56 58
Interest Expense 1 1 2 2 5
Income Tax Expense 1 2 2 3 6
Capital Expenditures 19 18 16 37 26
% Revenues 6.9% 6.1% 5.7% 9.6% 5.4%
Free Cash Flow 26 10 15 43 35
Total Debt 0 0 0 0 139
% Total Debt NM NM NM NM 25.1%
Gross Margin 42.9% 43.1% 44.4% 49.9% 45.5%
Operating Margin 4.0% -3.3% -7.3% 7.2% 5.6%
EBITDA Margin 9.7% 4.4% 1.7% 14.5% 12.2%
EBITDA / Interest 38 12 3 34 12
EBITDA - Capex / Interest 11 -5 -7 11 7
Source: SEC Filings

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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