MarsYu/iStock via Getty Images

MarsYu/iStock via Getty Images

Stem (NYSE:STEM ) is an exciting energy storage stock focused on high-margin software solutions. It expands into solar software with the acquisition of AlsoEnergy. The company is set for decades of growth with a best-in-class AI-driven solution.

Energy storage is the next step in the transition towards renewable energy. Renewable energy is already economically attractive, and storage makes it available 24/7 at a reasonable cost. More about energy storage is available in my energy storage overview article.

Stem's software optimizes energy storage for front of the meter and behind the meter customers. Forecasting supply and demand accurately pinpoint the perfect time to charge and discharge batteries. It sounds simple but has to take in a lot of variables. Wrong timing of charging/discharging reduces the savings/earnings of energy storage. Athena software saves 30% more than the competition.

It's a technology-agnostic platform. Lithium-Ion is the prime technology today, but upcoming technologies have advantages over Li-Ion.

Consider this an update of my previous work about Stem.

The acquisition of AlsoEnergy is more transformative than it may look on the surface. It immediately expands its software revenues with a direct positive impact on Stem's gross margins and EBITDA. Stem grows its customer base significantly with cross-selling opportunities for energy storage and solar software. Stem announced the acquisition on December 16 and expects to close in Q1 2022.

Stem already has the necessary software for energy storage optimization. It now adds monitoring and optimizing of solar power plants. Like Stem, it improves efficiency, increases performance, and reduces costs for its customers. This value-adding approach leads to a high 99% retention rate. It's a perfect match with Stem that can add its AI capabilities to AlsoEnergy.

AlsoEnergy has 32.5 GW solar assets under management. There is a 30% overlap in customer relationships. The other 70% is an opportunity for both solutions. AlsoEnergy services 200,000 sites as opposed to Stem's ~950 systems.

Stem's software revenues would more than triple from $21M to $78M based on the last twelve months. It's crucial for gross margins. Hardware only achieves a ~10-30% gross margin. The software will reach an 80% gross margin. Stem's software revenues will increase exponentially over the next five years. With AlsoEnergy, it jumps a couple of years forward.

Such an acquisition comes at a price. Twelve times sales for a company with 23% CAGR historical growth is rather expensive. It's still attractive because of the immediate improvement of Stem's profile. Stem achieves positive cash flows faster, and cross-selling opportunities improve software sales projections. The deal is financed with cash from the convertible bond issued in November.

Battery storage capacity will expand exponentially over the next decade.

These macroeconomics support Stem. According to the IEA, battery storage capacity should increase ninefold by 2025 and grow 34 times by 2030 to reach a net-zero carbon scenario in 2050.

Based on the 27 GWh installed capacity in 2020 and Stem's 1 GWh AUM at year-end, Stem had a global market share of ~3.7% in 2020. It's an emerging leader who should follow the market at least if not gain market share.

Stem published Q3 results in line with its forecast. Revenues increased 334% year on year. Bookings were up 183%, and the contracted backlog stood at a record of $312M. The AUM (assets under management) increased by 40%. AUM is the most important metric as it defines how much GWh energy storage uses Athena.

It expects ~$74M revenue in Q4 and $147M for 2021. The seasonality could also lead to a significant increase in AUM at the end of Q4. It doesn't include AlsoEnergy.

Stem follows the initial financial forecast in January before the SPAC merger. It's a bit ahead on the software side and signaled it could fall a bit behind on hardware. It won't be good for revenue but is acceptable for the company. It leads to higher margins, predictable revenues, and cash flows.

Stem's primary asset is the AI-powered Athena software. It doesn't need hardware deliveries but uses them to sell its software contracts. Hardware has a 100% software attach rate. These contracts have a 10-20 year duration. The company won software-only agreements in the past, seeing more software-only opportunities.

It talked about such a contract at an EV charging facility during the latest earnings call. EV fast-charger stations are demanding on the grid. Using these EV stations at peak capacity leads to slower charging. Energy storage mitigates these demand peaks. Athena predicts demand and utilizes energy storage accordingly.

Stem issued $460M green convertible notes. The notes have reasonable conditions with only 0.5% interest and a conversion rate of $29.24 per share. After the acquisition, Stem's cash position of ~$436M is more or less equal to its convertible debt. It will use more cash to secure supply over the next few quarters. If the company wants to make more large acquisitions, it will need more debt or more capital.

Stem is in a good position today. The balance sheet offers flexibility for its expansion plans. The convertible note raise was surprising initially. It makes sense after the acquisition.

Stem is richly valued. After the acquisition, the valuation improves quickly. The original business plan already counted on fast growth, and AlsoEnergy revved up 2022 expectations.

Here are my estimates for 2022 and the converging valuation metrics to value Stem. I used Stem's initial growth plan and AlsoEnergy growth rate of 23%. I kept the EBITDA margin equal for AlsoEnergy as it still needs to be integrated into Stem. I assumed a full-year contribution of AlsoEnergy, although this is unlikely. It's easier for valuation purposes. For the ratios, I used a market cap of $2.7B that accounts for the acquisition shares, but not for possible dilution by convertible debt.

2022 shows how attractive the deal for Stem is. With its own strong growth, Stem is reasonably valued in 2022 already. The acquisition's positive effects should snowball in the next couple of years. Stem's margins increase faster with increasing revenue.

There is a lot of competition in energy storage software. Every upcoming company develops its software with AI. Stem believes it will close more software-only deals like it did in the past. Major competitors are Tesla (TSLA), Fluence (FLNC) (a joint venture between Siemens (OTCPK:SIEGY, OTCPK:SMAWF) and AES (AES)), NEC Energy Storage, and Wärtsilä (OTCPK:WRTBF, OTCPK:WRTBY). The addition of solar helps Stem to compete and win more software-only contracts.

The supply chain is a risk for almost any company today. Stem managed this very well with no delays in the business plan as opposed to Fluence. Stem executes picture-perfect.

AlsoEnergy expands Stem's capabilities. There is more room to build out the software platform. It could add wind, hydro, and even traditional generation monitoring and optimizing features to its portfolio. Another significant acquisition would probably mean more dilution, though.

Stem increases its software revenues and margins immediately with AlsoEnergy. This acquisition improves the business profile of Stem. It shows on the 2022 metrics and valuation.

Everything aligns for an excellent 2022 for Stem. A couple more quarters of spectacular growth in line with its initial expectations should assure the market of the management's skills. The company is reasonably valued and operates in a high-growth sector. It's on the right path to becoming a market leader.

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This article was written by

In short: GARP, value, thorough analysis, and a lot of common sense. I look for stocks trading below their true value. Buying at the right time and holding them for a long time leads to attractive profits. I follow the basic principles of value investing and do my research through publicly accessible knowledge. I mostly use the Annual and Quarterly Reports of the company. For ratios, I use Seeking Alpha and similar websites to get ratios from sectors and individual stocks. All expressions are my own. I do not represent a company. I cover stocks worldwide, mainly in North America and Europe. All my experience from stock picking comes from reading a lot of books and articles. Any investments you would take after an article or discussions with me are your own responsibility. You should do your own due diligence before an investment.

Disclosure: I/we have a beneficial long position in the shares of STEM either through stock ownership, options, or other derivatives. 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.

Additional disclosure: Any investments you would take after a piece or discussions with me are your responsibility. Please do your own due diligence before an investment.