2021 was the year of the special purpose acquisition company (SPAC), but amid the craze of young companies coming public through SPAC mergers, there were many that were money losers for investors. There were even SPACs that brought companies without any revenue to the public markets, and those proceeded to hurt shareholders too.
While the majority of SPAC mergers were not good investments, there were a few potential diamonds in the rough. Stem (STEM 3.28%) is one young company that came public in 2021, and its shares quickly flew up to $50 before falling back around the SPAC price of $10. Does this mean Stem is another forgettable SPAC, or does it have some growth potential over the next decade for patient investors? Let's find out.
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What Stem does
The cost of renewable energy sources like solar and wind has been coming down dramatically, but managing energy in these areas can be difficult. After all, the sun doesn't always shine and the wind doesn't always blow. Storing energy for later use is critical in making renewable energy mainstream, and Stem is helping achieve this with a market-leading energy storage system that helps companies manage their renewable energy usage.
Stem's use of artificial intelligence (AI) is what excites me most. The company pulls data on weather, energy usage, real-time energy prices, and even the time of day to optimize use. It then brings all this data together and compares it with prices to make its customers' energy consumption the most cost-effective by automating the expenditure of energy.. In other words, the company is making renewable energy more practical by tearing down the barriers and past problems of green energy.
Stem had just $74.5 million in revenue in the first nine months of 2021, but it has gained bountiful experience since its founding in 2009. It's a dominant player in the energy storage space, with big-name companies like Amazon and Walmart as customers. It has over 950 storage systems across the U.S. and $312 million in contracted backlog. That's more than Tesla, a competitor on the storage side but a partner with Stem on the AI side. With such a dominant position -- Stem controls 75% of the storage market in California and it's the largest company in the space in the U.S. -- it could be easier for Stem to integrate its AI into its systems than a start-up without this leading edge.
What could propel it forward
Green energy is expected to be massive over the coming decades. The global energy storage market is expected to grow 35 times larger by 2030 at a 35% compound annual rate. Additionally, Stem estimates that its addressable market will become 25 times larger by 2050, worth $1.2 trillion by then.
The company does have a few flaws that could cause it to miss out on this massive opportunity. Financially, Stem is not very strong. Revenue has been growing at a rapid pace -- in the third quarter of 2021, its revenue grew 334% year over year to $40 million -- but its gross margin and profitability are very poor. The company reported just 8% gross margin in Q3, and while that did improve from negative 15% in the year-ago quarter, that is concerning considering its software has 80% gross margin. In the first nine months of 2021, the company also lost $74 million in free cash flow. Stem has $576 million in cash and short-term investments to fuel its cash burn, but this can't go on forever.
Stem has some optimistic views on its growth opportunity. The company projects full-year 2021 revenue of $147 million, implying $72.5 million in revenue in Q4, which is almost as much as the company made in the first nine months of the year. If it hits this estimate, that would mean shares are trading at 11 times sales, which is not a terrible valuation. However, the concern lies in the company's ability to actually hit that figure.
Is Stem a buy?
With Stem's lack of financial stability and optimistic outlook, it's not for the faint of heart or investors looking for a reliable and steady investment. This is a "swing for the fences" stock, but one that -- if successful -- could be incredibly lucrative. With so much growth expected in the green energy space in the coming decades, Stem certainly has the potential to be an amazing investment, but investors have yet to see its consistent execution as a public company.
Its ability to optimize efficiency could make both the world and your portfolio much better in a decade, which is why I like the stock today. However, this company is for investors with a long-term time horizon, a diversified portfolio, and a large risk appetite. If it can capitalize on its leadership position with strong AI as the energy space expands, Stem could reward patient and risk-tolerant shareholders immensely in 10 years.
