Hopeful Monsters
Why in the uncharted waters of global low-carbon transition ‘buy’ is a more profitable bet than ‘build’ for large firms
By Niladri Roy for Climate Connect Technologies
(Image: Disney Pixar)
“Where will everyone get their screams now? The energy crisis will only get worse” - Henry J. Waternose III, Monster Inc
Genetics to Economics
The term ‘hopeful monster’ was first coined by German geneticist Richard Goldschmidt in the 1930’s. To bridge the gap between microevolution and macroevolution. Just as nature does not abruptly create new species, nor does new technology spontaneously appear, despite our collective perceptions. So, the concept was plucked from evolutionary theory and repurposed as ‘hopeful monstrosities’ by American economic historian Joel Mokyr in the 90’s. To describe potentially profound emerging technologies.
Mokyr identified that such new inventions do not suddenly appear as superior alternatives to established technologies, with already honed performance traits. So, they cannot easily compete to begin with. Nor do they usually have much in common with what has gone before. They need an at least partially protected space, in order to not be out-competed by incumbents.
This is particularly true for the energy sector’s fractious low-carbon transition. Where we already know that old-world tech has very little relation to the world of the future. A world where tech must be clean, or support green by necessity. So, one way to help potentially brilliant ideas survive and flourish in today’s hyper competitive business world, is to engineer protection. In the form of investment and strategic guidance from a large firm, along with access to its clients.
Windmills are a prominent example from the history of low-carbon tech. These evolved into the first wind turbines during the 18th century, which were specifically developed to generate electricity. But those, and subsequent iterations, were still too niche. The modern wind industry began in earnest at the end of the 70’s, with serial production of turbines in Denmark. Even then, these were far too small to be suitable for widespread adoption in the current energy system. They were very much hopeful monsters, and have required mass investment by established firms like GE, Mitsubishi, and Siemens to drive globalised growth.
Known knowns, known unknowns, and unknown unknowns
There are points in history where hugely transformative technology can be retrospectively identified. Take the Dudley Castle steam pump, an early version of the internal combustion engine; or the Babbage Difference Engine, in essence the first computer. But these cases are interesting precisely because we have knowledge of the preceding landscape, and the history changing leaps forward that resulted from them. To riff on the movie Monster’s Inc, when we’re powered by laughter (low-carbon), no one will really remember the screams (fossil fuels). Those will just be an oddity of the past.
(Image: Disney Pixar)
For now, the challenge for large firms looking to invest, is how to spot these game-changers early. That is true for any investor in any arena really. But with ever more ideas popping up and being experimented with, the process is becoming increasingly complex. One option is to let a prospective company stabilise and prove its business model. Then just as they are about to turn profit, snap them up. Safe in the knowledge of suitable returns.
That, however, is only one side of an equation that encompasses both success, and survival. Traditionally, acquiring assets has formed part of a pure diversification strategy. Now, in the throes of the energy transition, buying into IP mitigates certain future risks and volatility in growth strategy. With low-carbon tech, we also have highly exacerbated environmental, and societal dimensions to contend with too.
Fundamentally, there is no synergy between old and new tech. For example, drilling technology affords no transferable advantage for solar panels. Such firms can’t easily go from being a ‘molecule’ company to an ‘electron’ company. Nor does it then make sense to build capabilities in-house. So altogether, there are pointed survival risks, even beyond just stranded assets, whilst still having pressure from investors to commit future profits. Investors who are becoming ever more aware of, and compelled by climate change concerns. Thus, demanding decarbonisation of the portfolio, often at odds with maximising profits.
Investing is a mindful mashup
For established energy players, investing in high-growth potential companies and technologies is much like a mini-mashup of venture-cap, and M&A. Where those firms can constructively cut across and into their existing activities. E.g. EV charging, which is the green equivalent of down-steam supply of oil and gas. Having such low-carbon tech and assets in the portfolio is necessary to offset declining future demand for their current portfolios, or enhance paths they are trying to develop. Low-carbon tech may not be as high uptake as carbon-tech yet, but the status quo is changing at an accelerating pace. So, there is less time for organic evolution, and buying low-carbon now is like acquiring prospective petroleum fields of old. The difference is that oil fields were a known animal, whilst many low-carbon technologies are still hopeful beasts - even if not total monsters.
That is especially true of software-based low-carbon tech, where IP is inherently less tangible and knowledge-based than hardware. But software development cycles are much more rapid, so the risk is reduced in many respects. Software can also have wider-ranging applications. Particularly when it comes to reducing inefficiencies and optimising across existing systems and diverse asset portfolios. This is a key benefit over daunting, radical, seemingly insurmountable pure-physical overhauls. To maximise synergies, and thus ultimately returns.
Established firms can cherry pick what, and where to invest, instead of attacking a problem that they have no experience of. That is the biggest reason for inorganic growth through acquisition – to save time, money, and effort. Strategic investments can be made in several possibilities to hedge the risk, and see which of them works out. Furthermore, by investing in a dozen companies, learning can also be absorbed from the inside. Right from on-the-ground cross-team development, through to top-level seats on the board, and access to extended niche knowledge networks – a very practical approach.
….Valuation is a science-art mashup
Ultimately, the main hurdle to clear is always, agreement of what monster money must be paid. Traditionally, if a startup has some market traction and revenues, then classical discounted cash flow and multiples-based techniques can be used to reach a valuation. Taking into consideration aspects such as operational costs, contracted revenues, free cashflow, and potential market share. Near-term losses and projected future revenue can be assessed, then discounted to now. This can determine fairly well when and what the investor is likely to earn.
(Image: Disney Pixar)
But those approaches are geared towards ascertaining safer returns. Whereas in the new-world of low-carbon tech the focus is on potential returns. For high growth sectors, earning multiples can be 5 to 15 times. However, low-carbon valuations may need to be based on projected revenues in markets that do not even exist yet. How can such startups be effectively assessed, when they probably aren't making money at present, and only envisaged to earn big later?
Thus, valuation becomes a blend of science and art, especially forecasting of future sales. The approach clearly must be very forward-looking. But with few, if any references to compare against, a balance must also be struck with an investor’s risk appetite. Software-based low-carbon tech is again at an advantage in such scenarios. A flywheel storage startup would likely be compared to existing, but also unestablished and not-quite-the-same battery companies. Whereas low-carbon software is far more likely to have peers in adjacent verticals to compare against. Software company valuations have a relatively rich history spanning the last couple of decades. So, a fair equivalent, with comparable multiples of EBITDA, can probably be found - as close as can be to infusing science into the art.
Screams to laughter
Startups directly at the consumer-end of the market (i.e. B2C) are now valued based on their number of users or customers (e.g. WhatsApp, or Uber). Before they make any money, this can be used for assumptions about future monetisation and market capture. Though seemingly a more simple and clear method, it is also a double-edged sword, due to more exposure to consumer volatility. Media hype can amp up valuation, and public screams can hobble it. This is comparable to oil-and-gas-related tech transactions when oil prices are volatile.
The B2B environment is more insulated from that, and valuations typically more circumspect by comparison. This is the case for much new low-carbon tech, and focus can be given to top-line growth, without having to overly consider the public wildcard factor.
So, taking all of the above together, large firms with the capacity to invest in multiple low-carbon startups, diversify their risk greatly. Even when taking a partial leap on best-case scenarios. If just one or two bear big fruit, the whole endeavour is justified - less chance of screams all around.
At the end of Monsters Inc, the energy crisis is solved when Sully reveals that laughter has been found to have ten times the power of screams. This discovery drives the adoption of new laugh-harvesting technology at the company factory. The potency of laughter means that to keep up, the canisters now have to be much larger than the scream-capturing type of old. The firm just needed to learn from, and take a hopeful chance on that little monstrosity Boo.
“….. Remember, laughter is ten times more powerful than screams” - Mike Wazowski, Monster Inc
(Image: Disney Pixar)