Tuesday, October 19, 2010

Exchanging Energy

Senior management from World Energy Solutions, Inc. (XWES: Nasdaq) is making the rounds again among institutional investors, trying to boost investor awareness of this fledgling on-line energy brokerage. We know from observing other platforms - eBay first and foremost - that migration of an established business to the Internet platform can strip away millions in excess costs. WES operates three on-line auction platforms for the acquisition and sale of energy, including green power sources. Its exchanges also work for emission reductions and renewable energy certificates.

For lack of a better place we have included World Energy Solutions in The Mothers of Invention Index in the Efficiency Group. Like many other companies on this list, World Energy is bringing new thinking to the energy transaction.

The WES platform is a scalable transaction processing architecture with a web-based user interface. There is nothing new there. However, management says that they have tweaked the platform’s operating rules and processes to make it a smarter business operation. They originate multiple auction designs to improve the changes for a successful result - two happy counter parties - and speed right along to a completed contract. Consequently, WES has a high closure rate for the auctions it manages, boosting its reputation among energy suppliers and users.

The company boasts a wide and high "they love us" wall of logos representing satisfied auction participants, including commercial, industrial and government energy users; utilities and wholesalers; and environmental credits players. Dow Chemical, Inc. (DOW: NYSE), Georgia Pacific, and United Parcel Service, Inc. (UPS: NYSE) are among commercial and industrial users. ConEdison (ED: NYSE) in New York approached the company to stage the first wholesale auction in the U.S. The first mandatory, market-based program in the United States to reduce greenhouse gas emissions, the Regional Greenhouse Gas Initiative located in the upper northeast, has used the WES platform to auction pollution permits.

The story is compelling and management delivers it well as they are clearly enthusiastic about the opportunity to modernize energy transactions. Unfortunately, investors cannot ignore the company's history of losses and negative cash flow. In the first half of 2010 WES used $673,000 in cash to support operations, which is a nominal sum. However, there was only $1.7 million in cash on the balance sheet at the end of July 2010. Working capital was $2.4 million. With resources spread thin during a period when the U.S. capital markets are less than friendly, investors have to pause before taking a long position in even the most promising story.

With that point made we also note that revenue is in an upward ramp on solid penetration of the energy market. Customers are so happy with the results WES delivers through these auctions, customer retention in very high. Accordingly, there is a compelling recurring revenue component that suggests once a critical mass is achieved profitability should be sustainable. We also believe there is considerable operating leverage in the on-line auction business model.

Trading volumes in XWES shares is shallow, giving larger investors a challenge in building long positions. After accounting for insider holdings, the public float is approximately 6.7 million shares. However, most shares appear to be in the hands of devoted institutional and accredited investors, who are loath to let go of shares are current price levels. We estimate that the constructive float is closer to 3.0 million shares.

The alternative is to wait for a modest recovery in the stock price and take a chance that management will opt for a follow-on offering of common stock to fill the corporate coffers. World Energy went public through a reverse merger. On some financial platforms the name of the old operation is still displayed for the XWES stock symbol. An issuance of shares could solve the vexing problem of shallow trading activity and confusion over corporate identity.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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