This post by Barry Pasikov is excerpted from a letter of Hazelton Capital Partners.

Hazelton Capital Partners was researching the renewable energy sector when we discovered Enernoc, a provider of energy intelligent software and demand response solutions. From 2005 to 2014, Enernoc increased its revenues from $10 million a year to over $470 million, by participating in a niche segment of the electricity industry – Demand Response. Demand Response is a tool employed to reduce electricity usage during times of peak demand. For eight months out of the year, an electrical grid will operate around 60% of its peak capacity. However, from June through September that number will often spike up to and above 100% during periods of sharp demand (heat waves), making the grid unstable. In preparation for higher electricity demand, grid operators will conduct a yearly forward capacity auction. The auction brings together suppliers of electricity and companies like Enernoc, who are willing to provide a reduction in demand. Suppliers indicate how many megawatts of electricity they will add to the grid and at what price, while Enernoc will offer to reduce megawatt capacity at a specific price. When the grid operator achieves the number of megawatts needed (both from supply and demand reduction), a clearing price is set.

Knowing the exact amount of megawatts it will need to reduce when called upon, ENOC reaches out to its 6500 commercial and industrial (C&I) clients to see who is willing to reduce their electrical consumption, by how much, and for what price. During a Demand Response event, Enernoc will be contacted and told the start time, the number of megawatts of reduction and an approximate end time. The company will communicate with its clients and execute preestablished protocols (example: turn down lighting, shutting down elevator banks, reducing air conditioning usage to 70%). In total, demand response events take place between 5-6 times a year and last, on average, for less than three hours. ENOC gets paid both for agreeing to provide capacity reduction and for the actual reduction. The revenue earned is then split with Enernoc’s C&I clients. Since capacity auctions happen 2 years in advance, Enernoc and the market have clear optics into its future revenue streams. Having grown quickly over the past 10 years, Demand Response has become a mature market of approximately $1.4 billion and is expected to continue to grow by 6% a year. With its 35% market share representing 80% of its yearly revenue, ENOC began to diversify by expanding both internationally and into energy software.

In 2014, Enernoc, through acquisitions and organic growth, expanded its software solution programs into a newly launched Energy Intelligent Software (EIS) suite. This reconstituted EIS platform was designed as a SaaS (software as a service) subscription model focusing on how a company procures its electricity, how much it procures, and when it uses the electricity. Energy software is approximately a $5 billion market in the US and $20 billion globally. Recognizing a similar growth trajectory to that of the early days of Demand Response, Enernoc decided to ramp up its offering and establish a strong foothold. Hazelton Capital Partners’ investing thesis was centered around the belief that Demand Response would continue to drive Enernoc’s revenues in the short-run, but within 4-5 years, EIS contribution would help double revenues by representing 50% of its revenues.

Unfortunately, Hazelton Capital Partners’ investing thesis was ill-fated, mistimed, and wrong. The expected EIS growth never materialized as software revenues declined in 2016. What was not fully appreciated in our investing thesis was the significant negative impact a sharp decline in energy prices would have on the EIS business model. Throughout 2015 and into the first quarter of 2016, both oil and natural gas prices declined to levels not seen since 2002. The reversal in energy prices made Demand Response less appealing and the need for EIS a much harder sell. Many of the companies that were already piloting Enernoc’s software in a limited number of locations decided to delay any further deployment. The steady decline in energy costs caused businesses to focus on improving sales and margins which have a more significant impact on their bottom line than upgrading energy procurement or monitoring usage. Prior to launching its EIS platform, ENOC ramped up its sales and marketing team in anticipation of the flurry of demand. By the end of 2016, facing the anemic growth of its software suite, Enernoc reduced its sales and marketing staff by 40%. Some of that decline was from overlapping roles from previous acquisitions, but the majority was right sizing the company’s current staffing needs.

Over the two years that Hazelton Capital Partners held shares of ENOC, the fund opportunistically bought and sold shares reflecting our lowered intrinsic valuation while improving our overall cost basis. However, given that our investment thesis was no longer valid, the Fund began looking for an exit strategy and found it on June 22nd, when Enernoc announced that it had agreed to be acquired by the Enel Group for $7.67/share. In total, Hazelton Capital Partners lost approximately 15% on its investment.