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When temperatures soared late last summer, something happened in Manhattan and Chicago that hasn't in decades: severe power outages due to increased demand. Hospitals lost power for operating-room equipment, clinical labs lost tissue cultures when freezers stopped working, and banks of computer servers in several corporate headquarters ground to a halt.
The reason was simple: Electric utilities have slowed spending on the electrical-grid infrastructure over the past 10 years because deregulation has made the profit picture unclear. Until those uncertainties are resolved, repeats of last summer's disaster are likely. In the meantime, businesses are looking beyond utilities for their power needs. One company that has a good chance of building its business by meeting that demand is FuelCell Energy (FCL), which makes small power generators for commercial enterprises.
FuelCell Energy is the only significant player in fuel-cell technology that uses molten carbonate to produce electricity. It's one of the simplest forms of fuel cells, and advocates of the technology argue that molten carbonate has an enormous potential advantage in the commercial market: It operates at a constant temperature of 1,200F, which is more than sufficient for heating a business and meeting electricity needs.
VAST MARKET.
Not surprisingly, FuelCell is targeting the commercial market, especially businesses that want to have in-house power-generating facilities for critical systems. "Traditionally, the market consisted only of hospitals and other public-safety institutions," says Merrill Lynch analyst Sam Brothwell, who rates the stock a buy. "But now it's any company that relies on a bank of computer servers, which today is just about every company out there."
Brothwell says he has talked to Internet service providers that have been stockpiling lead acid batteries as a backup power source in case of power failure. "Lead acid is not exactly a technology of tomorrow. This is a need that's here and now, and FuelCell has a product that's available and works."
FuelCell's primary product is a 250-kilowatt production plant that can fit into a conference room and produce energy at around 10 cents per kilowatt hour. That's nearly twice the cost of power-grid electricity, but the company says it expects to reduce costs to around 6 cents per kilowatt hour by 2003, once its Connecticut factory has completely ramped up production and brought economies of scale into play. If such an efficiency can be reached, the market for their product is difficult to estimate.
"The need for pure, clean energy that's free of disruptions and spikes is growing drastically," says CIBC World Markets analyst Hugh Holman, who also rates the stock a buy. The potential market could be worth $100 billion in just a few years, says FAC/Equities analyst William Fogel, who rates the stock a strong buy. A more conservative estimate comes from an Allied Business Intelligence report, which calls for global demand by 2010 to be more than 15 times what it is today. To supply one year's worth of demand at that level would be enough to keep FuelCell's current factory operating at full capacity for 13 years.
NEW GENERATION.
To be sure, the power-generation revolution isn't happening yet. Ironically, the threat of a deteriorating power-grid infrastructure might be eliminated by another aspect of deregulation: distributed power generation. Previously, utility monopolies resisted allowing power to be generated directly by businesses and homeowners as part of the power grid. They argued that it was dangerous and that generation problems they didn't control could pose a danger to the whole grid. But deregulation and recent advances in technology, such as what FuelCell is developing, are changing that.
In several states that have passed advanced deregulatory legislation, it will soon will be possible for a homeowner or business to create electricity while still being hooked up to a power grid for access to more electricity at times of peak demand. In some instances, a business with a generator can even feed some of its electricity back into the grid and get paid for it.
If such a future does come to pass, probably the best technology to use for such mini-power plants is the fuel cell. A fuel cell converts hydrogen into electricity through a chemical reaction whose only byproduct is water. A number of experimental fuel cells designed for home or business convert natural gas into hydrogen, thus exploiting a readily available power supply.
Because of the enormous promise of fuel cells, a handful of fuel-cell stocks have enjoyed enormous gains recently. There's Ballard Power Systems (BLDP), which makes automotive fuel cells and has enjoyed a 64% rise in its stock price in the past year. Plug Power (PLUG), which has a contract to supply General Electric (GE) with household fuel cells, has risen 237% since its initial public offering last October.
Still, there's a potentially steep downside to the prospects for these companies. For example, FuelCell Energy makes no significant revenue outside of its grants from the Energy Dept. Chief Financial Officer Joseph Mahler expects the company to reach profitability by 2004, provided that demand reaches projections.
NEST EGG.
There are safeguards in the company's financial structure that make it look more attractive than most zero-revenue companies. For one thing, it has $64 million in the bank thanks to an April secondary share offering. Mahler says that nest egg will keep the company afloat long enough to reach commercial production levels over the next two years. The company also already has a functioning factory on which it needs to spend only $16 million to expand production to meet demand for the next couple of years. "After that, if demand is much greater, we will have to return to the capital markets for money," says Mahler. "But if demand is that great, finding new investors won't be a problem."
FuelCell also maintains that potential competitors face enormous barriers once the market for its product develops. It's the only company currently developing carbonate fuel-cell technology, and it has been working on it for 10 years. Also, it has numerous patents that could impede any potential rivals, and it employs most of the world's experts in this field. "It's not the kind of technology that you can just re-create overnight," says Brothwell. "It's almost impossible to reengineer."
Yet FuelCell's stock is risky to own -- despite the promise of the company's technology. The stock is extremely volatile. It's trading at $40.25 as of market close on Friday, May 19, and that's less than half its high of $95.50 just two months ago. You can expect to see plenty more ups and downs before it matures into a more traditional growth stock (which is certainly not guaranteed).
If the company doesn't make profits until 2004, it will be extremely difficult to analyze the company's prospects until then, and investors should note how quickly the market turned away from profitless dot-com stocks last quarter once things started going downhill in that sector. But if you believe in the technology, FuelCell could be one of those stocks that, 10 years from now, you wish you had bought cheap in 2000.
Jaffe writes about the markets for Business Week Online What's your take on fuel cells? Let us know at our Ask Sam Jaffe Forum EDITED BY BETH BELTON
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