One of the more interesting companies to launch an IPO in
the last few years is Windlab, a windfarm development company that was founded
in 2003 to commercialise software developed at the CSIRO. Windlab’s proprietary
software Windscape overlays atmospheric modelling on geographical features to
identify and evaluate potential windfarm sites. In their prospectus they
claimed this software gives them a significant advantage over other windfarm
development companies, as it enables them to identify sites with high wind
resources without conducting costly and lengthy on-site testing. As evidence of
this claim, the two windfarms that delivered the highest percentage of
their maximum output throughout 2018 are on sites found and developed using windscape, Coonooer Bridge and Kiata both in Victoria.
The company listed in August 2017 on the ASX at $2 a share,
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equalling a fully diluted market cap of $146.3 million. While initially results
were promising, with the company making a profit of $9.5 million in 2017, 2018
has seen a complete reversal of that progress, with revenue dropping from $23.1
million to $3.5 million, and the company making a loss of $3.8 million. As a
result, the share price has declined steeply, and is now trading at around $1.04,
or a market cap of $77 million.
While for the average company a decline in performance of
this magnitude would suggest that something is seriously wrong, I don’t think
this is the case for Windlab. Like any company that gains most of its revenue
from developments, significant swings in profit from one year to the next are
inevitable. The company went from reaching financial close on two windfarm
sites in 2017 to one in 2018, and while the failure to reach financial close on
a single project was disappointing, it is not surprising given the long
timeframes required for most wind farm developments. It is my belief that the market has
overreacted to Windlab’s 2018 results due to a misunderstanding or mistrust of
the companies operating model, and that at the current share price the company
is significantly undervalued.
The Case for Windlab
Windlab is ideally placed to take advantage of this, as the
development of windfarm sites is perhaps the most profitable part of the wind
farm industry. From 2014 to 2017 the company managed an average Return On Equity
of 42%, in a time that included significant growth and the cost of listing on
the ASX.
| . | 2017 | 2016 | 2015 |
| Revenue | $ 24,515,379 | $ 18,101,100 | $ 10,012,006 |
| Expenses | -$ 10,098,372 | -$ 13,023,113 | -$ 8,524,804 |
| Profit before income tax | $ 14,417,007 | $ 5,077,987 | $ 1,487,202 |
| Income tax | -$ 4,912,534 | -$ 1,779,491 | $ 14,687 |
| Profit | $ 9,504,473 | $ 3,298,496 | $ 1,501,889 |
| Equity at the start of the year | $ 13,404,230 | $ 9,207,680 | $ 7,699,065 |
| ROE | 71% | 36% | 20% |
| Average | 42% | ||
The company is able to achieve this sort of ROE as windfarm developments are sold once all approvals and agreements signed but before construction begins, meaning developing multi-million dollar projects does not require significant capital. For example, take the site of the Coonooer bridge wind farm, a 19.8 megawatt wind farm in North Western Victoria with a total development cost of $48.6 million. After identifying the site with Windscape, Windlab spent only $300,000 in acquiring the land, then spent $2.2 million or research and planning applications for a total investment of only $2.5 million. Windlab then sold 96.5% of the equity in the Coonoer Bridge to Eurus Energy for just over $4.7 million who then funded the construction of the site with help from grants from the state government. In total, Windlab walked away from this transaction with over $4.7 million in cash and a remaining 3.5% stake in the project, a return of over 111% on the initial investment.
Valuation
While historically Windlab has sourced most of its revenue
from wind farm development, the company also has a growing asset management arm
of the business, where they provide asset management services to Wind and
Electricity farms, in addition to significant equity in operating and soon to
be operating Windfarms. Although historically insignificant when compared to the companies development fees, these sections of the business are quickly growing, and seems to be the
managements way of ensuring cashflows are a little more predictable in the
future.
In order to accurately value Windlab, I have therefore broken
down the company into three separate areas.
Inventory (wind farm development projects)
The book value Windlab gives to its inventory as per the
2019 financials is $9.69M, though this is overly conservative as projects are
valued at the lower of their cost or net realisable value. In order to get a more accurate picture of the
actual value of Windlab’s inventory, I have tried to assign individual value to some of
Windlab’s larger projects.
Lakeland Wind Farm
Lakeland is a 106 megawatt project located in Northern
Queensland. While Windlab does not give a breakdown of inventory values, due to
its size and stage in the development cycle the Lakeland Wind Farm is probably
the single project with the largest value in the companies inventory. Lakeland is also one of the main causes for
the decline in share price over the last six months, as the project was scheduled
to reach financial close in 2018 until the primary investor pulled out at the
last minute. This delay has meant the project is now subject to new requirements
to connect to the electricity grid, which will mean significant additional
costs to increase the stability of the connection (this is a change to the
nation-wide connection criteria for renewable energy plants designed to address
unstable supply).
While these setbacks are undeniably concerning, Windlab
claims that the delay has also allowed them to re-tender for more efficient
turbines and they have not yet impaired the inventory value of the project,
something they have done in the past when projects are compromised. As per
their latest announcements Windlab are still confident of reaching financial
close on this project in 2019.
If successful, Lakeland will be the largest project brought
to financial close by Windlab to date, at 106 Megawatts. For Kennedy, a 56 megawatt
project, Windlab received a financial close payment of 5.4 million, while
keeping 50% equity in the project. If Windlab is to acheive a similar margin and
equity structure for Lakeland, this would result in a payment to Windlab of
$10.2 million, with the remaining 50% equity in the project worth at least
$10.2 million as well, for a total value of $20.4 million. Given the
uncertainty around the project though, a 50% discount would seem appropriate,
which gives the project a total value of $10.2 million for our calculations.
Miombo Hewani
Another late stage windfarm project for Windlab is the
Miombo Hewani windfarm in Tanzania. This 300-megawatt, $750 million project is
Windlab’s first foray into East Africa, and is undoubtedly the companies most
ambitious yet. The project received approval from the Tanzanian government in
July 2018 and will receive partial funding from the Government of Finland. Windlab
have not committed to achieving financial close in 2019 for Miombo Hewani which
is understandable given the uncertainty of operations in Africa, but as development approval is already in place as well as some funding arrangements, financial
close can’t be too far off. Demonstrating the significant potential value of
Miombo Hewani and Windlabs other East African investments, Eurus Energy, a
Japanese sustainable energy company that has partnered with Windlab in the past
recently bought a 25% stake in Windlab’s east African projects for $10 million USD,
valuing Windlab’s remaining stake in their East African portfolio of development projects alone at $30
million USD, or $42.2 million AUD. While this may seem excessive, Windlab
stated in their prospectus that their target development margin for Windfarm
developments is $250,000 per megawatt of capacity, and from 2015 to 2017 the company
had overachieved this, with margins of $260,000 to $490,000 per megawatt. If
Windlab was to successfully reach financial close on Miombo Hewani at their
target development margin, this would result in a payment of $75 million alone. As a result, adopting the value assigned by Eurus Energy of
$42.3 million for the companies East African projects seems reasonable.
Greenwich
The last late-stage development project worth noting in this
section is the Greenwich Windfarm in the USA. Windlab officially sold the
project in 2018, but will only receive the bulk of their payment of $4 million
USD (5.6M AUD) when construction begins. While Windlab have stated
they expect to receive this payment in 2019, a group of neighbours have mounted
a challenge to the project to the Ohio Supreme Court seeking to dispute the approval given by the Ohio Power Board. .
Given the uncertainty of the case, it is probably prudent to discount this
payment by 50%, which would mean a value of $2.8 million for Greenwich.
While the projects listed above are the most likely to result
in some form of payment in the next 12 to 18 months, Windlab has numerous other projects earlier in the development cycle. These include:
- 640 megawatts of approved potential capacity across multiple projects in South Africa. (While South African Renewable Energy projects have been on hiatus, it does seem the projects are about to get up and running again after a recent change of government
- 250 megawatt project in Northern Queensland that Windlab is intending to submit a development application for in 2019
- 230 megawatt project in Vedigre USA that Windlab no longer has control over, but is eligible for up to $4.6 million in success payments if the project reaches financial close.
While an exact value for all of these projects is difficult, I have assigned a value of $15 million for the remainder of Windlab's projects.
Excluding Windlab’s asset management business, which I will
cover separately, Windlab spends around $6.4 million a year on project
expenses, administration and employees. The projects I have listed above are
predominantly expected to reach some form of financial close in the next three
years, so it seems logical to assign a cost of $19.2 million, or three years of
costs to the above calculations. Once a tax rate of 30% is factored in, you are
left with a total inventory value of $35.177 as per the below table.
| Project | Value |
| Lakeland | $ 10,200,000.00 |
| East African projects | $ 42,300,000.00 |
| Greenwich | $ 2,800,000.00 |
| Other projects | $ 15,000,000.00 |
| Total | $ 70,300,000.00 |
| Book value | $ 9,690,000.00 |
| three years of annual costs | $ 19,200,000.00 |
| tax on projected profit | $ 12,423,000.00 |
| Value after tax | $ 38,677,000.00 |
Operating Wind Farms
Currently Windlab has significant equity in two large
operating or soon to be operating Wind Farms, Kiata, in Melbourne’s North West
which has now been operating for just over a year, and Kennedy Energy Park in
Northern Queensland that has completed construction and will be connected to the
grid in the coming months. Both projects were originally found and developed
using Windlab’s proprietary technology Windscape, with Windlab then
subsequently selling down equity in the project to help fund development.
Windlab owns 25% of the Kiata wind farm and 50% of Kennedy, and combined these
two projects have a book value of $43.6 million on the Windlab balance sheet.
Kiata is a 30 megawatt 9 turbine windfarm in Northern
Victoria that had its first full year of operation in 2018, with a total profit
of $4.57 million for the year. Wind farms are thought to have a useful life of
roughly 20 years, after which significant refurbishment costs are needed in order to continue operation. If we discount these future cash flows at a rate of 7%,
(which seems reasonable given the relative low risk of an established wind
farm) we get a total value for Kiata of just under $43.9 million. This values
Windlab’s stake at $10.97 million.
To value Kennedy is a little more complex, as it has not yet
begun operation. However, we know that the project is a 56-megawatt project,
combining 41 megawatts of wind with 15 megawatts of solar. The plant also has 2
megawatts of battery storage to help modulate supply and allow storage of excess
energy in non-peak times. If we extrapolate the annual profit per megawatt of
capacity of Kiata in 2018 of $152,353 and assign the same discount rate, we
are left with a value for Kennedy of $83.6 million, or $41.8 million for
Windlab’s 50% ownership.
Combined, this gives a value of $52.86M for these two
projects.
Asset management
Windlab’s asset management arm is perhaps the easiest to
understand and value. Windlab leverages its expertise by providing ongoing
management services to existing wind and solar farms, both that the company has
an equity stake in, and to third party independent energy farms or resources. This
side of the business is quickly growing, with revenue increasing by 27% in 2018
to $2.97 million, with profit before tax of $610,000, or $427,000 after tax
assuming a 30% tax rate. The company signed a significant asset management
contract in early 2019 for a solar farm, indicating that they are continuing to
grow this business. Given both the significant growth of this area and the
broader growth potential of the industry, a P/E ratio of 20 seems coservative, which would value Windlab’s asset management division at 8.5
million.
Software
Lastly, As Windlab has demonstrated ability to use Windscape to
develop high-performing Windfarms, it seems only fair to give a value to the Windscape
software itself. Windlab is continuing to use this software to identify
projects into the future, and the company has proven that this software can
provide the company with a significant edge on development projects. While this is a difficult thing to do, $10,000,000
seems like a conservative valuation, considering both Windlab’s historical performance and
the likely growth of the energy sector in the future.
Putting it all together
| Area | Value |
| Development Projects | $ 38,677,000.00 |
| Operating wind farms | $ 52,770,000.00 |
| Asset Management business | $ 8,500,000.00 |
| Windscape software | $ 10,000,000.00 |
| Cash | $ 14,622,414.00 |
| Liabilities | -$ 10,755,130.00 |
| Total | $ 113,814,284.00 |
| Shares outstanding (diluted) | 73848070 |
| Price | $ 1.54 |
If we add together the values as per the above calculations,
we are left with a total value of $113.8 million for the company, or $1.54. As the
company is currently trading around the $1.02 mark, this suggests the company
is significantly undervalued at its current price.
