Gambling on green: sustainable technologies

Why is General Electric paying a huge premium for sustainable technologies?

It's a stormy day in Vancouver, but Elyse Allan exudes calm. Here for Globe 2006, a conference examining ways businesses can profit from cleaning up the planet, the General Electric Canada president and CEO is answering questions about her company's March 14 bid to purchase Zenon Environmental Inc. When asked if the bid — $760 million, or $24 a share — was a trifle overvalued considering the stock has traded around $15 since the beginning of the year, Allan demurs: “It's good value for an excellent technology.”

She's right, at least on the technology. Zenon (TSX: ZEN), based in Oakville, Ont., manufactures and distributes membranes that purify water by means of osmotic filtration, and is the field's acknowledged world leader. Allan says the acquisition is part of GE's Ecomagination strategy, announced by über-CEO Jeff Immelt last May, in which the company develops or acquires sustainable technologies for distribution in emerging markets such as China. Still, valuing acquisitions at a 60% premium raises a few questions.

David Calhoun, GE vice-chairman and president, projects revenues from GE's water platform to grow to nearly US$2.5 billion next year. And GE analyst Mary Anne Sudol says the acquisition plugs a hole in GE's water infrastructure. But longtime Zenon analyst Sara Elford, of Vancouver-based Canaccord Capital, expresses surprise. “In the absence of a competitive bidding process, GE paid a lot,” Elford says. “Based on my modelling, the price is 30 times forecasted 2007 EBITDA.” Owners of Zenon stock won big. Founder and CEO Andrew Benedek enthusiastically endorsed GE's proposal; on May 3, shareholders are expected to rubber-stamp it.

Allan says Zenon is part of a series of recent acquisitions by GE in “clean” technologies. Those include Massachusetts-based water purification company Ionics Inc., which GE bought in November 2004 for US$1.1 billion, or US$44 a share — a 50% premium over market price. Allan acknowledges the strategy is expensive: “Over the past few years, we have spent considerable billions. We want to make sure we are leveraging them.” The aim is to offer a “full menu” of sustainable technology solutions, a strategy of vertical integration designed to meet Immelt's Ecomagination pledge of doubling revenue from green technologies to US$20 billion in 2010 from US$10 billion in 2004. Spending on related research is also doubling, to US$1.5 billion a year.

Immelt has at least one success story in hand. GE snapped up Enron's wind turbine business in 2002 for US$358 million, and revenues grew from US$500 million to nearly US$2 billion by 2005. According to New York-based analyst Deane Dray of Goldman Sachs, Immelt's on to something. Dray told The Economist in December he expects 60% of GE's overall revenue growth to come from selling sustainable technologies to emerging economies. The numbers look promising: China, for example, has earmarked US$85 billion for pollution controls prior to the 2008 Beijing Olympics. GE management wants a piece of that pie.

But such a strategy carries significant risk. For example, it's unclear clients in developing countries will pay First World prices for “clean tech” products. The marketplaces GE is targeting aren't known for their respect for intellectual property; potential competitors may simply rip off the technology and manufacture it cheaply.

So is GE's green strategy sound? Hard to say, judging by the share price, which has been in the low US$30 range for years. On April 13, however, the company announced record first-quarter earnings of US$4 billion, up 14% from Q1 last year. All 23 analysts covering the stock give it a green light: they rate it a Buy, Outperform or Hold. Not one would sell.