Rob Day | August 11, 2008 at 8:04 AM

What we can learn from A123

The big news over the last few days has been the IPO filing of lithium ion battery innovator A123, who’s looking to go public on NASDAQ sometime soon.

Much will be written elsewhere about the prospects for the company’s IPO, by those who follow the public markets more closely (and to reiterate the disclaimers, don’t get your investment advice from this column, it would be the blind following the blind and we take no responsibility for your investment decisions, good or bad).  But there’s also a lot of information in the company’s S-1...

I thought it might be good to go through some of this info as a means of illustrating what a “successful” (still to be proven, but so far so good) cleantech venture investment of a certain type (energy storage, using a capital-intensive “build them ourselves” business model) might look like.

Funding history (note: all of the below are extrapolations and over-simplifications which are intended to be illustrative, but in fact may be quite wrong):

2001 - Founded out of MIT.  Unclear what seed capital may have been provided.

2001-2004 Raised $12.7mm in Series A ($1/sh) and Series A-1 ($1.50/sh) funding.

June 2004 Raised $20mm in Series B ($2.08/sh) [note: this was widely erroneously reported as a “$30mm Series B” since the company reported their aggregate raises at about the same time], pre-money approx. $58mm.

Feb 2006 Raised $30mm in Series C ($3.37/sh), pre-money approx. $125mm.

Aug 2007 Raised $70mm in Series D ($6.56/sh), pre-money approx. $300mm.

Feb 2008 Raised $16.5mm in common ($7.22/sh), pre-money approx. $400mm.

Jun 2008 Raised $102.1mm in Series E (16.59/sh), pre-money approx. $1B.

The above valuations are really rough estimates, but still provide a bit of insight into the investment path on the way to an IPO for a company of this business model.  The amount of Series A, especially given the dynamics of 2002-2003 energy tech VC, show that the early investors were pretty excited about this one right from the beginning, and probably paid a high single digit million pre-money valuation, likely higher in the teens or low twenties as a pre-money.  That’s higher than many Series A stage valuations that we see even in today’s market.

The progression of valuations shows a steady march upward, practically doubling or tripling each year.  That’s more of an exception than a rule in any VC category, naturally, since we’re looking retrospectively at a company that looks like they’ll be a success of some kind.  However, given that the company mentioned earlier this year that they were planning to IPO, the valuations on the GE-bought common round in Feb and particularly on the Series E are indicative of a high confidence in that IPO taking place.

Notably, the Series E appears to have mostly been from new investors, since GE ($30mm of the $102mm round) was the only participant in that round who is now a 5% stockholder.  So it’s a bit of an illustration that these “venture capital” late-stage, pre-IPO rounds are often mostly done out of the pockets of non-VCs, and thus it’s misleading to include these kinds of rounds in the quarterly venture capital surveys that are put out there.  Nevertheless, most of the surveys continue to do so, and that’s one reason why we continue to see a few megadeals dominating the dollar totals each quarter.

Business model and capital needs

I described the company’s model above as “capital intensive, build-them-ourselves”.  There are a lot of paths a company can take with the development of innovations that will eventually go into devices (be they batteries or turbines or solar panels, etc.).  The spectrum of capital intensity roughly goes from simple licensing to someone else who is manufacturing product, to building subassemblies to be integrated into other OEM’s devices, up to developing/acquiring manufacturing capacity and building the entire device yourself.  There are reasons to like and dislike all the choices.  A123 has chosen mostly the latter route, having acquired significant China and Korea based manufacturing facilities and employing nearly 1,000 people now in manufacturing.

This choice means higher revenue but it’s also meant bigger capital needs along the way.  They invested approximately $28mm in 2007, for example, in capex and acquisitions to build out manufacturing capacity.  And in Q1 2008 they burned through $13.5mm in cash (not counting financing inflows) even while at a revenue run rate near $40mm/yr.  They raised an aggregate $235mm [8/11 update: corrected previous bad math] in preferred equity along the way, not counting the common equity raised earlier this year or any other common shares sold along the way, nor the relatively smallish debt the company raised during the growth path.  Not a game for those with thin wallets or for the faint of heart…

Fun with Fair Market Value

On pp 52-53 of the S-1, there’s an interesting progression of the FMV on common stock as decreed over time.  What’s interesting is to see how the exit scenarios progressed over a short amount of time:

March 2007: 25% chance of IPO, 25% chance of sale at or below liquidation preferences, 50% chance of continuing as-is.  At this point, importantly, the company already had significant revenue and was in the process of raising their Series D.

August 2007: 40% chance of IPO, 40% chance of sale at or below liquidation preferences, 20% chance of continuing as-is.  Clearly, there were pretty high liquidation preferences at play…

July 2008: 75% chance of IPO, 25% chance of sale above the liquidation preference, chances of a sale below the preference or continuing as-is were zero.  Reading between the lines, looks like the company had received a potentially attractive acquisition offer and that it was clear there was going to be an exit soon one way or another.  But that’s purely speculation on my part…

The odyssey of an early investor

One name that comes up repeatedly in the document is North Bridge.  It’s clear that they were fairly early investors in the company, purchasing something like 4.93mm pre-Series C shares, 1.6mm Series C, and 1.3mm Series D.  Unclear whether they participated in the Series A/A-1 or not from the publicly-available info, but it’s probably a safe assumption.

Over the holding period, even while the company seems to have consistently progressed in product development and market development, from North Bridge’s perspective it must have felt like there were some significant shifts along the way.  Looking at the Series B investors, we see names like Motorola, Qualcomm, and OnPoint.  This indicates a market vision in devices.  When they came out of stealth mode, the story was big on power tools.  But with the recent upswing in hybrid vehicles and now the partnership with Chevy around the Volt, A123 is as much as anything else a “next generation transportation” play.  The latest vision as articulated in the S-1 is grid-scale storage.  Perhaps North Bridge’s investment team saw this from the beginning, and it’s all rolled out exactly according to plan.  But my guess is that the original pitch was heavy on the device market and light on the vehicle and grid storage markets, and that the vision of the company has significantly shifted over time.  It’s so tough to know so many years ahead of time what’s going to be the real success driver for a company, and investors have to make the decisions they can with the info available at the time, and encourage the management team to balance focus with opportunism along the way as markets shift and emerge.

It would be great to see A123 succeed in general, but for North Bridge in particular they have to be pretty happy with the results so far.  Based on the most recent Series E price, their holdings are worth approx. $130mm on paper, and their investment was probably something near to $20mm.  And, with any luck, the price per share after IPO and expiration of lockup could be significantly higher than the Series E price.  Not too shabby.

Of course, weigh these happy results against the odds facing the company 5 or 6 years ago when North Bridge likely first got involved in the company.  Not a slam dunk, that’s why they call it “venture capital”, but probably a smart bet in retrospect to get in that early…

In conclusion

A123 is a good illustration of one kind of cleantech venture capital investment, the kind that’s been talked about a lot recently thanks to various investors deciding to go later and bigger—the capital-intensive, go-for-broke model that we’ve seen in sectors like solar, biofuels and energy storage.  It shouldn’t be taken as an illustration of MOST cleantech venture capital, since so much of cleantech VC is in more capital-efficient, M&A-the-likely-exit type plays.  EnerNOC, for example, had raised only $27mm and had been in business only 6 years when they IPO’d.

But for all the naysayers out there who argue that there aren’t good exits to be made in cleantech, A123 will be a test case.  The time since founding, at around 7 years, isn’t atypical for IPOs.  The aggregate amount of venture financing, at $235mm [8/11 update: corrected previous bad math] (plus seed and common), is high but not shockingly high for a manufacturing-oriented business model like this.  So A123 either represents a typical or slower/capital intensive example of a cleantech VC investment, all things considered.

And if North Bridge and their co-investors can see terrific returns even on this kind of play at the most challenging end of the cleantech spectrum, that should help settle exit concerns out there, among those who somehow think cleantech is not yet proven as an attractive investment area.

We’ll have to watch and see how this plays out over the next few months…