Total eclipse of independent US solar companies?

The purchase by Total SA of a controlling interest in Sun Power is sending shock waves through the solar industry.

The investment in 60% of the Class A (SPWRA) and Class B (SPWRA) shares would value SunPower at around $2.3 billion — up about 40% from the pre-offering price.

Even with the jump, Sun Power is only the second most valuable US solar company. First Solar (FSLR) now has a market cap of $12b. Of course, First Solar is the world’s second largest solar company (by 2010 PV capacity) and thus is nearly in a league by itself.

Various reports position this as a decision by oil companies to diversify their energy business against future shifts in supply and demand. Here’s the Dow Jones version:

Total, which has had an active solar focus since 1983, decided to invest in SunPower after a two to three-year search "for a strategic partner in the solar business," Philippe Boisseau, head of Total's gas and power division, said in an interview. He added that solar power will become a crucial energy source in Europe and North America and that Total intends to become a global leader in the solar industry, in addition to its core oil and natural gas businesses.

"Solar will gradually take its share" of the world's energy market, Boisseau said. "We want to be there when this happens."

Of course we’ve been down this road before — oil companies bought solar companies in the 1980s but didn’t do a terribly good job of running them.

Given the IPO difficulties faced by other solar companies (like other other tech startups), the idea of acquisition by big oil companies has raised the market value (and hopes) of other solar companies — both private and public. For example, Motley Fool wonders whether LDK Solar might be undervalued.

But will there be any US solar companies a decade now? Will they be subsidiaries of oil companies (or Chinese solar companies)?

I would think that a company that manufactures a high-volume, high-demand product should be able to create a positive cashflow self-funding business. The real problem is how much capital does it take to get to that point?

The seven large Chinese crystalline silicon PV companies got $30b in government money to create scale. There’s no US company that’s going to get $4b in private venture or debt financing. Being acquired by a big sugar daddy is the only way they can get this kind of money.

At $4.2b, Total SA’s recent quarterly profits are only the fifth largest of the world’s oil companies, leaving four other companies with even more cash to fund expansion of a PV manufacturer.

Are VCs giving up on RE? Should they?

Cross-posted to Engineering Entrepreneurship.

Statistics released Friday by the Cleantech Group say that “cleantech” VC investments in 2010 hit a record $7.8 billion, up 28% from the $6.1 billion in 2009 for North America, Europe and Chindia. The N.A. data was even more impressive, up 45% to $5.28 billion. Worldwide, solar continued to account for the largest share of the investments, up 52% from 2009 to $1.83 billion.

Although this sounds encouraging, Iris Kuo of VentureBeat had a different take. First, cleantech VC investment has been declining for the past two quarters. Instead, the capital-intensive have been going to government sources, including BrightSource, Solyndra and Tesla.

However, analysts are just beginning to realize that cleantech businesses may be fundamentally unsuitable for VC investment. A series of clues have emerged in the past 6 months.

Exhibit A was the whole debate started by VC Fred Wilson and his “two venture capital industries” thesis:

The first VC industry is investing in software based businesses. The software VC business has been fundamentally altered by the massive decrease in the cost of building and launching a software based business.…

The second VC industry is investing in cleantech, biotech and other capital intensive tech businesses that have economic models that have not been fundamentally altered. This VC industry operates largely the same way it has operated for the past twenty or thirty years.

The statistics were supported by TechCrunch data from the first 8 months of 2010: an average of $5m for web/ecommerce vs. $31m for cleantech.

Exhibit B was the decision of Kleiner Perkins to pull back from cleantech investing and go back to its roots in IT. Of all the major Silicon Valley VCs, KPCB had made the most aggressive bet on cleantech — particularly green energy. This is the firm that in 2007 made a partner out of a former presidential candidate and Nobel Prize winner.

Exhibit C are the observations of one of the most respected IT industry executives, analysts, inventor and entrepreneurs: Bob Metcalfe (MIT ’69), inventor of Ethernet and founder of 3Com. Having finished a decade as a venture general partner, last month Metcalfe said that the VC model (so far) does not fit cleantech:

Q: What did you learn from your investing in clean-tech, or as you call it, enertech?

A: I’m still in the process of learning – this is complicated stuff. But I learned that the innovation environment in the energy space is not there yet. The problems we see are a mismatch between the asset class called venture capital and the innovation opportunities in energy – it takes too much capital and it takes too much time. But I claim that’s only because the innovation environment in energy hasn’t developed, say, the way it has in pharma. Drugs take a lot of money and a long time, but there’s a lot of venture capital activity in drug discovery. That’s because the drug-discovery business has grown into being able to exploit the venture capital model. The partnerships that big pharma has with drug companies in stage one, stage two, stage three [clinical trials] allow venture capitalists to do what they do and get the returns that they need. The energy space has not quite developed, but it will.

This entire debate was anticipated by Prof. Martin Kenney of UC Davis, the editor of Understanding Silicon Valley — perhaps the leading academic expert on Silicon Valley and a longtime expert on hightech VC.

In July 2009, Kenney wrote a book chapter entitled “Venture Capital Investment in the Greentech Industries: A Provocative Essay” that will be published in the Handbook of Research on Energy Entrepreneurship. He notes a number of warning signs:

1. investors have been pouring money into green energy without being able to get it back from IPOs;
2. market growth may be slow, since “clean” technologies are competing with established (and cheaper or better) incumbents;
3. the cleantech bubble investing bubble parallels the Internet bubble;
4. thus far, the most successful cleantech businesses have been self-funded: either bootstrapped (e.g. Danish wind turbines) or internal green ventures from existing multinationals like Siemens and Sanyo.

Kenney tries to offer a positive scenario, suggesting that VCs could learn and adapt like they have in biotech. However, in the past 18 months have been signs that biotech VC may be facing similar problems (if the returns to pharma R&D are becoming less certain).

While the scale of investment in energy is enormous, the VCs have various reasons to actually favor larger deals (and often pension funds throwing money at them to invest). While VC worked great during the 1990s with relatively small investments followed by quick exits via IPO or acquisition, but both are much harder in renewable energy.

The first problem is the time scale. If (as Zider’s 1998 classic HBR article suggests) VCs seek a 10x liquidity event after 5 years (to cover their losers), then doubling the delay to 10 years cuts the IRR by more than half (and the NPV even more than that). For a 10 year exit — and ignoring the increased risk of failure — the same IRR would require a 100x return.

The other problem is that the size of the investment reduces (if not eliminates) the opportunity to exit via acquisition. A 10x return via acquisition was common for $50m dot-com investments, but such exits are going to be much rarer with $500m invested; a 100x return is going to be out of the question.

If VC can’t find a way to make money off cleantech investments, then cleantech entrepreneurs are going to have a hard time bringing their businesses to scale. Without VC, new businesses will have a hard time competing with self-funded multinational incumbents — or government-funded enterprises in large centrally-planned economies.