Summary:

Now that smart-grid network leader Silver Spring Networks has filed for an IPO, some of the economics of selling a wireless network and connected devices to utilities becomes a little more clear. No joke, folks, it’s a difficult business to be in.

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Now that smart-grid network leader Silver Spring Networks has filed for an IPO, some of the economics of selling a wireless network and connected devices to utilities becomes a little more clear. No joke, folks, it’s a difficult business to be in. But at the same time, when a company like Silver Spring starts scoring over a dozen utilities deals, the payout can be huge — just rather delayed.

Upsides

Big deals. A pipeline of utility deals, which involve installing hundreds of thousands of wireless connected devices, can lead to hundreds of millions in revenues. For the first quarter of 2011, Silver Spring generated $46.69 million, and for all of 2010, it recorded $70.22 million. But because utility deals take awhile to record as official revenue, Silver Spring actually says that as of March 31, 2011, it has $422.2 million in deferred revenue — essentially revenue it has billed utilities but hasn’t been able to declare as revenue.

The herd. Utilities are not usually early adopters and tend to do what their utility peers are doing. That’s good news for a company that has been wracking up deals like Silver Spring, because once you score a few big ones, the others will follow. Silver Spring names a dozen commercial utility customers and another ten utility pilot customers in its filing. The bulk of Silver Spring’s current revenues are coming from Florida Power & Light, PG&E and Modesto Irrigation District, which means there’s another almost two dozen deals that could be supplying Silver Spring with revenue over the years (and that’s not counting future customers that Silver Spring signs up).

The smart grid might be slow, but it’s coming. There might be a slowdown in the economy and in smart-meter rollouts in general, but utilities will eventually make the changeover. It’s not a question of if but more when. Utilities need to invest in their infrastructure to keep the lights on, and the next generation of that infrastructure is the digital smart grid.

Build the network, sell services. Silver Spring might not have the highest margins on its network buildouts at this time, but the company is also selling services. Currently Silver Spring sells services, like software-as-a-service, managed services and customer support. Silver Spring also bought Greenbox in 2007 to offer a home-energy-management product. While Silver Spring says just a few percent of its revenues come from services today, that could grow over the years as it builds out network hardware and then runs services on top of that.

Downsides

Tough margins. The margins on building out a network for a utility are not so good (and that’s putting it lightly). Silver Spring recorded gross margin on a GAAP basis of negative 1,115 percent for 2009 and negative 71 percent for 2010. So it’s losing money on its deals on a yearly basis, even after nine years in the market. (Anyone want to make online games instead?) Its gross margins on billings (utility deals but not officially recorded as revenue yet) are positive, which is good, at 4 percent for 2009 and 17 percent for 2010. But not all that good. Silver Spring says it thinks it can boost its gross margins over the years.

Essentially, building a smart-grid network for a utility takes money to make money. So it’s not such a good business for a startup to be in. Hence why Silver Spring is going public and raising money. Its competition includes a lot of large public companies like IBM, Cisco and Itron.

Snail-like sales cycle. Clearly it takes a long time for Silver Spring to be able to book revenue from a utility deal, from the inception through the pilot project to the final commercial deployment.

Competition. Speaking of competition, for a while there, everyone wanted to be in the smart-grid network business, from massive IT companies to the meter makers to other startups. Silver Spring spent $47 million on R&D to improve its product in 2010 and to out-innovate the competition.

Economy slowdowns. The business of building out smart-grid networks is directly tied to how much utilities are willing to spend, which is directly tied to how well the economy is doing. Utilities feel the pinch, and networks get stalled. While the stimulus package allocated some $4 billion to utility smart-grid projects, Silver Spring says that a delay in handing out those funds is actually having a delaying effect on its business.

Consumer backlash. Given that PG&E makes up a third of Silver Spring’s revenues, the public consumer backlash that happened over the past year around PG&E’s smart-meter project was no small issue.

Image courtesy of Khawkins04

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