Lime Energy: Delivering Energy Efficiency

The high upfront cost of efficient buildings (and efficiency in

general) is more than offset by the significant long term rewards,

as you can see from the McKinsey chart below.

Despite the long term benefits, the upfront cost is often a

barrier, especially to government entities in today's tight

budgetary environment.

Performance contracting offers them a way to square the circle

between the long term budget benefits of efficient buildings and

the often significant capital cost. This works by funding the

capital improvement with debt secured by future energy savings. An

Energy Service Company (ESCO) guarantees a certain level of energy

savings and performance (hence the term Performance Contracting.)

Yet performance contracting comes at a cost. No ESCO puts

its balance sheet behind a promise of energy savings solely out of

a desire to green the economy. That ESCO has a cost of funds

just like everyone else, and in the case of a performance

contract, this cost of funds is built into the contract

price. Entities which understand what needs to be done and

can borrow at reasonable interest rates or have cash can wring

greater savings out of energy efficiency services by avoiding

performance contracts.

ESCO Business

That's where Lime Energy Co

(NASD:LIME)

comes in. Lime (a name derived from "Less Is More

Efficient") has been providing energy efficiency services for 20

years, both directly to clients and also as a subcontractor to

ESCOs. Lime does not have the balance sheet to guarantee

performance contracts itself, but it does have significant

expertise in delivering the energy efficiency services that make

performance contracts work.

In a recent interview, Lime CEO John O'Rourke told me that his

current ESCO clients include Johnson Controls (NYSE:JCI),

Honeywell

(NYSE:HON),
Constellation

Energy(NYSE:CEG), Clark Energy, and PEPCO

(NYSE:POM). According to O'Rourke, Ameresco (NYSE: AMRC),
the

publicly traded pure-play ESCO firm that was profiled in the most
recent

part

of this series, "would probably never

use us," because of overlap in certain in-house capabilities and

(I suspect) a bit of inter-company rivalry.

In its 20 years of business, Lime has worked with many ESCOs and

directly with public sector or institutional customers which do

not need performance contracts. One such example is the

United States Postal Service (USPS), which issued competitive

solicitations for multiple regions where the USPS financed the

work directly instead of a traditional performance contract. Lime

was awarded several of these IDIQ contracts with achieved savings

in excess of 30 million kWh per year.

While the ESCO business is becoming more competitive, the

business of actually delivering energy efficiency has become

somewhat less competitive. In Lime's core Northeastern market,

several energy efficiency contractors have recently gone out of

business or shrunk their operations significantly. These

businesses were unable to weather the trough that the ESPC

industry experienced over the last three years. Lime survived by

re-directing their focus to other areas, and found growth

opportunities in the private sector.

Utility Business

Lime has carved out a niche for itself managing Demand Side

Management (DSM) programs for utilities. This is the fastest

growing part of Lime's business, which O'Rourke expects to reach

about 40% of revenues in 2011. Part of the reason for the

rapid growth is likely Lime's track record, in which the company

has "blown savings goals out of the water" over the last three

years.

Utility DSM targets tend to be conservative, since the utility

itself usually plays a very large role in setting the regulatory

process, and utilities have a vested interest in setting targets

low to keep them easily achievable, so Lime's track record may not

be as impressive as O'Rourke makes it sound. On the other hand,

targets for delivered savings have increased dramatically over the

last few years, and utilities face penalties for failure to meet

these goals.

The urgency and market opportunity vary widely between utilities

and state regulators, but according to O'Rourke, utility spending

on DSM programs is increasing consistently by over 20% per year,

and he's not exaggerating. I checked O'Rourke's numbers with

Howard Geller, the Executive Director of the Southwest

Energy Efficiency Project, and he told me

that “Based on data collected by the Consortium for Energy

Efficiency, utility spending on programs that help their customers

save electricity and natural gas has been increasing by more than

25% per year in recent years.”

In addition to this rapid growth, the utility business brings two

main benefits to Lime. First, it is a source of earnings

stability, since contracts tend to be multi-year and not seasonal

like much of Lime's energy efficiency business. (The energy

efficiency business is back-loaded towards the end of the year

when many commercial and industrial (C&I) clients decide if

they should go forward with energy efficiency projects depending

on budget constraints.) The second benefit of the utility business

is as a way to reach new C&I clients. Lime may initially

contact a C&I client as part of a DSM program, but then go on

to provide energy efficiency measures for the client beyond those

in the utility program.

Current utility clients include the Long Island Power Authority

and National Grid (NYSE:NGG), but O'Rourke hopes to win additional

contracts this year.

LEAD

Finally, Lime has recently introduced a new division (called Lime

Energy Asset Development, or LEAD) to develop its own energy

projects in-house. These projects involve the development, design

and construction of larger alternative energy projects where the

clients purchase the energy produced, rather than the asset

itself. These larger projects will be limited by Lime's ability to

finance them, but doing project development in-house should allow

Lime to maintain strong margins on the projects, and Lime need

only undertake them when it will not put undue pressure on Lime's

balance sheet.

Financial Metrics

Lime is not yet profitable, but O'Rourke says the company has

enough capital to grow 30% for the next two years and achieve

profitability in 2012 without raising additional capital “anytime

soon.” Analyst consensus earnings are for a loss of 8 cents a

share this year, and a profit of 21 cents next. The company has $6

million in net cash on the books, no net debt, and a free cash

flow of negative $9 million over the last 12 months. Since the

third and fourth quarters tend to be the most profitable, cash

should increase over the next two quarters, and so O'Rourke is

probably right that current assets and credit lines should be

sufficient to bring Lime to consistent profitability.

With the stock currently trading at $3, and expected earnings of

$0.21 next year, Lime seems quite reasonably valued for a company

growing at 30% a year. However, given the current climate of

uncertainty, the back-loaded C&I business may turn out to be a

little disappointing this year, and possible earnings misses

caused by C&I clients deferring energy efficiency projects in

order to conserve cash may lead to a somewhat lower stock price in

the next few months. The C&I business has been falling as a

percentage of revenue, so any such earnings misses are unlikely to

be dramatic, but investors are taking any excuse to sell

alternative energy stocks in the current climate.

Conclusion

I like Lime's business, and think the company is fundamentally

strong, and the valuation is quite conservative. However, I expect

the current stock market rally to be short-lived. A renewed market

decline, along with a possible earnings miss caused by C&I

clients hoarding cash in the climate of uncertainty could easily

lead to a lower stock price in the coming months. I'll be watching

the stock closely and buying cautiously if either of these comes

to pass.

DISCLOSURE: Long AMRC. No position in LIME, but I may initiate

one at any time.

DISCLAIMER: Past performance is not a guarantee or a reliable

indicator of future results. This article contains the

current opinions of the author and such opinions are subject to

change without notice. This article has been distributed

for informational purposes only. Forecasts, estimates, and

certain information contained herein should not be considered as

investment advice or a recommendation of any particular

security, strategy or investment product. Information

contained herein has been obtained from sources believed to be

reliable, but not guaranteed.