Silver Spring Networks: A Potential Multi-Bagger In The High Growth Smart Grid Market

Company and Financial Overview

Silver Spring Networks (SSNI) is a leading networking platform and solutions provider that enables utilities to transform the power grid infrastructure into smart grid. SSNI was founded in 2002 to address this challenge, pioneering a fundamentally new approach to connect utilities with millions of devices on the power grid. Since inception, SSNI has been awarded contracts to network more than 22 mn Silver Spring-enabled devices, of which 15.8 mn have been delivered to utility customers.

What are the Key Investment Highlights?

According to IDC Energy Insights, SSNI is the market leader in the US for Electric Advanced Metering (EMA) infrastructure communications with 31% market share. The company revenues have grown 60x over the past 3 years to touch $196 mn in 2012. Its gross margins have turned positive for the first time in 2011, while EBITDA is still negative. However things are expected to turn around from 2013, and EPS is projected to turn positive.

USD million	2008	2009	2010	2011	2012	2013e	2014e	2015e
Revenue	0.1	3.3	70.2	237.1	196.7	360	440	560
Growth (%)		5584%	2030%	238%	-17%	83%	22%	27%
Gross Profit	-12.2	-36.8	-50.0	23.0	31.7	124	174	225
Growth (%)	n/a	n/a	n/a	-46%	138%	391%	141%	129%
Margin	-21043%	-1115%	-71%	10%	16%	34%	40%	40%
EBITDA			-140.6	-88.3	-81.4	8.9	50.3	96.8
Growth (%)	n/a	n/a	n/a	-37%	-8%	-111%	465%	92%
Margin			-200%	-37%	-41%	2%	11%	17%
EPS	-14.60	-18.30	-14.60	-7.62	-1.56	-0.06	0.70	1.38
Growth (%)	n/a	n/a	n/a	n/a	n/a	n/a	n/a	97%

Its balance sheet also looks strong with $142 mn of cash (and negligible capital lease obligation), accounting for ~15% of its market cap. The stock is expected to generate a significant amount of free cash flow in the coming years given its minimum capital expenditure and outsourcing of its production. The company's gross margins have increased over the years due to sales mix shift towards SaaS, scale economics and continued product optimization. SSNI has reached an inflection point where higher sales would lead to operating leverage and more earnings power in the future.

Compelling Business Model with Recurring Revenue Base: SSN has built a strong business model serving the needs of the high growth smart grid market with the ability to cross sell additional services to its installed base. The AMI end point units act as a base to leverage more solutions like Demand Side Management (DSM) and Dis! tribution! Automation (DA).

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Life time value per customer at a 2.6x initial sale value: Though the initial product cost is $50 per endpoint, SSNI has the option to sell extra gas attachment for $20 and cross sell other related SaaS, DA and DSM solutions.

	Initial AMI Sale	10-Year Value with other opportunities	Comments
AMI endpoint	50	50	Initial Product cost
Gas Attachment		20
Recurring Services/ SaaS		40	$4 annually for 10 years
Cross Selling (DA & DSM)		20	High margin potential
Total	50	130	2.6x initial sale value

A Vibrant Partner Ecosystem: Over the years, Silver Spring has signed partnership deals with more than 75 members that provide parts of hardware and software. As a result SSNI is able to focus on the high value parts of the smart grid component system. SSNI incorporates the communication hardware inside the meters and does not manufacture any AMI. Hitachi and EMC are 2 partners who have invested around $50mn in SSNI. It should be noted that Hitachi has a strong market presence in Japan, while EMC is a key player in the data analytics.

Segment	Partners
Advanced Metering Partners	Clevest Solutions, Ecologic Analytics, EDMI, Elster, eMeter, Freestyle Technology, GE, Itron, Janz, Landis+Gyr, Nansen, Oracle OPN, OSIsoft
Demand-side Management Partners	Aztech Associates, Belkin! , Carrier! Corporation, CEIVA Energy, ClipperCreek, Computime, Comverge, Control4, Cooper Power Systems, Digi International, ecobee, ECOtality, Emerson Climate, Energate, Energy Aware, Enphase, Entek, GE Energy, Jetlun, LG Electronics, Onzo, Radio Thermostat of America, Rainforest Automation, Simple Energy, Tendril, ThinkEco, Whirlpool
Distribution Automation Partners	ABB, Advanced Power Technologies, Beckwith Electric, Cooper Power Systems, DC Systems, Dominion, Dynamic Ratings, Eaton Corporation, G&W Electric, GridSense, HD Electric Company, Horstmann, Horstmann, iUS Technologies, NovaTech, Power Systems Integrity, RCCS, Richards, S&C Electric Company, Schneider Electric, SEL, Sentient, Siemens, Tollgrade, Utilidata
Software Partners	Clevest Solutions, DC Systems, Dominion, Ecologic Analytics, eMeter, Itron, Oracle OPN, OSIsoft
Industry Partners	International Council on Large Electrical Systems - Australia, Demand Response and Smart Grid Coalition, Edison Electric Institute, GridWise Alliance, Institute of Electrical and Electronics Engineers, IP for Smart Objects Alliance, SmartGrid Consumer Collaborative, SunSpec Alliance, Utilities Telecom Council, ZigBee Alliance

$130 Bn Market Opportunity by 2019: According to Mckinsey, the development path for the smart grid has reached an inflection point in the United States. More than 50 mn smart meters are slated to be installed by 2015 and deployment of new grid and customer applications is accelerating, driven in part by an infusion of federal government stimulus funds. The stakes will be enormous, with the total potential value generated in the United States from a fully deployed smart grid reaching as high as $130 billion annually by 2019. Smart grid applications can be grouped into three broad categories: advanced metering, grid applications, and customer applications.

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What About Competition?

Many new companies have entered the market given the strong growth potential. The competitors can be broadly spread into 3 major types: i) cellular carriers, ii) metering solution providers and iii) enterprise networking firms.

	Metering	Enterprise Networking	Cellular Carriers	Silver Spring Networks
Focus	Meters	Enterprise & Carrier Solutions	Consumer Services	Smart Grid Solutions
Network Technology	Proprietary Moving to Open	Entering Market - 1st Generation	Repurpose Existing Network	4th Generation IPv6 Network
Value Proposition	Vertical Integration	High Capacity Network	Existing Infrastructure	Proven Platform
Key Players	Landis + Gyr, Itron, Elster	Cisco	AT&T, Verizon, T-Mobile

SSNI has solutions that are purpose built for the smart grid, while the architecture of other segments are not. Itron (ITRI) would be SSNI's closest listed competitor, which could give it a tough fight considering its Cisco (CSCO) partnership and the SmartSynch acquisition. Further it has signed long term key relationship contracts with major utility companies and has a broad base of endpoint installed. Silver Spring supported by its strong R&D investment is the dominant market leader with 32% market Share in the AMI segment.

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Source: SSNI

What Is The Market Miss! ing?

Revenue Growth + Operating Leverage Should Drive Stock price movement

The company recently listed on the NASDAQ after raising $81 mn in an IPO. However the stock price has been hovering around the $20-22 range. I personally feel that the market it missing the revenue growth potential of SSNI over the next 3 years. SSNI has reached an inflection point where higher sales would lead to operating leverage and more earnings power in the future. The future multiple expansion for SSNI depends on the new contract wins and rising market share.

	EV/Sales, 2014	P/E, 2014	Sales CAGR, 2012-14
Silver Spring Networks	1.9x	21.5x	45%
Aruba Networks (ARUN)	3.5x	20.6x	19%
Cisco Systems	1.6x	9.7x	6%
F5 Networks (FFIV)	3.4x	13.1x	12%
Juniper Networks (JNPR)	1.6x	13.3x	6%
Radware (RDWR)	2.9x	13.4x	9%
Riverbed Technology (RVBD)	2.2x	10.7x	24%
Sonus Networks (SONS)	1.6x	50.4x	6%
Ubiquiti Networks (UBNT)	3.3x	12.0x	13%

Now I will discuss the reasons and potential for SSNI's revenues to grow more than 11x, 2012 revenues: i) High revenue visibility from order backlog, potential for pilot conversions and ii) the demand rising from the municipal and cooperative utilities.

Strong Growth and Revenue Visibility: In my view, Silver Spring enjoys high revenue visibility owing to the following reasons.

Revenue Visibility of 11.3x, 2012 sales over the next 3 years
Order Backlog	825	Comments ($ mn)
As of 31 Dec2012	745	6.2mn endpoints and DA & DSM solutions
Singapore Power & Light or CPS Energy	80	0.75m network endpoints
Pilot Potential	1,400	15 customers with 25m endpoints
Total	2,225
2012 Revenues	197
Revenue growth	11.3x	2012 Revenues

$750mn + Order Backlog: SSNI had total order backlog of $745mn as of 31st March 2013. This includes delivery of 6.2 mn network endpoints and DA & DSM solutions. However these numbers do not include the recent award wins from Singapore Power & Light or CPS Energy. The value of these additional wins could be in the $80mn+ range amounting to 0.75 mn end points.

$1.4bn revenue potential from Pilots: Currently SSNI has ~15 customers who are in the pilot phase using its AMI products with a market potential for 24mn endpoints. This 24mn end points is 4x the currently contracted order backlog of 6.2mn units. The management had stated that it has a success rate of 70% historically in terms of contract wins.

Recurring revenue streams from the installed end point base: SSNI can leverage its existing customer base of 16.2mn units by providing network management services and hosted applications as a service. Currently ~70% of the customers are using the service under long term contract agreement (3-5 years). This revenue base (11% of total sales) has a $2 per end point potential today.

Expanding Sales Volume to existing customers: This includes i) those that are not part of the deployment or backlog and involves expa! nding the! current deployment rate and ii) cross selling of other services like DA & DSM. Singapore Power & Light recently awarded <1000,000 end points, which is a small part of its ~1.5mn fully deployment potential. The management believes that penetration for DA and DSM are very less (~15%) and has about 20 pilots in this.

Pipeline: SSNI has large customer base that are considering smart grid solution and could skip the pilot phase using other deployment as references.

Pilots Potential If converted
	Country	Potential
AEP	US	5.0
AES Eletropaulo	Brazil	5.8
WEL Networks Limited	New Zealand	0.1
Western Power Corporation	Australia	1.0
Dominion	US	2.4
Others		11
Total		25.3
Source: Press release (mn units)

Under penetrated Municipal Utilities Market Should Drive Next Leg of Growth: Globally, the US was the first country to have regulatory mandates to adopt smart grid technologies. California & Texas were the first states to have such mandates. There are numerous white papers and research on the market size and growth potential on smart grid available publicly. But what the market is missing is the potential of Municipal Utilities, which would drive the next leg of growth.

According to EIA there are ~150 mn electric customers in the US. Of these 60 mn (40%) of them have installed AMI end points. This includes 19 mn (2/3rd of market share by volume) end points of SSNI as well. The remaining 60% of the market (91 mn) end points are still not penetra! ted.

Customer mn)

Market share

Comments

Total Customer base

151

100%

Contracted

60

40%

Not Contracted

91

60%

SSNI Share

20

33%

of contracted

Municipal and cooperative utilities

40

44%

of Not Contracted

SSNI of new endpoint order base

13

33%

Based on current market share

Revenue potential per end point

$130

Total Revnue potential over life

$1,733

2012 Revenues

197

Revenue growth

8.8x

2012 Revenues

Municipal and cooperative utilities together account for a ~40 mn customer base, of which only a small fraction (7%) has adopted smart grid technology. The initial focus of the smart grid companies has been on the large investor owned utility firms. With the technology becoming more standardized, it becomes a reference example for these Municipal and cooperative utilities.

Standardized solutions are available based on the experience and learning curve of the large firmsIncreased standardization reduces cost of installation as well as time.Constrained municipal budgets have financial incentive to reduce cost and improve efficiency. For example, street lighting cost ~35% of the energy expenditure and implementation of smart grid could reduce it to 25% levels.Loan guarantees programs for rural municipal utilities and cooperatives by! USDA for! grid modernization (~$ 300mn disbursed till date).The currently installed legacy one-way/mobile meter reading systems are obsolete (25+ years) and need replacements.

A survey of municipal utilities for the past two years, anticipates the next wave of smart grid expenditures will be led by municipal utilities. Of those surveyed, 72 percent said smart meters are a prerequisite to the utility's vision of a smarter grid and 41% expect to fit one in the next 3 years.

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Source: GTM Research

GTM Research estimates that municipal utilities will spend $4.5 billion to $9 billion from now until 2017 on smart grid technologies, with AMI and DA deployments leading the list of projects, followed by demand response and consumer-facing services. Though not all would adopt smart grid immediately, the 60 mn customers would serve as reference points for the other utilities. Most of the underpenetrated markets are with the municipal and cooperative utilities. SSNI looks well set to tap this demand in the next 2 years. SSNI has already signed deals with the following municipal and cooperative utilities: i) CPS Energy for ~1,100 end points and Sacramento Municipal for 600 endpoints.

To date, investor-owned utilities were the major players behind smart grid deployments (>75% already pursuing grid modernization). These investor-owned utilities adopted a learn by doing approach that resulted in disparate networks and a fragmented vendor supply chain. Unlike their big investor-owned utilities, the small Municipal Utilities are cash constrained. As a result, integrating these moving parts, such as legacy hardware and networks, will be the crux for vendors hoping to capture business from municipal utilities that plan to upgrade. SSNI looks well set to benefit from this muddle and garner more market share, given it superior technology.

Key Risk Fa! ctors: i)! Lumpy revenues, ii) regulatory hurdles and intellectual property challenges & iii) rising competition from Asia

Conclusion: In my view, Silver Spring has a very attractive business model with multiple growth drivers. The market is yet to reward the new award wins and the high revenue growth potential of the stock. SSNI looks well positioned to drive revenue and earnings growth, given the strong demand from municipal utilities. It is also trading at attractive valuations and could be a potential multi bagger.

Source: Silver Spring Networks: A Potential Multi-Bagger In The High Growth Smart Grid Market

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)