Juicing up the market

In a way, A123 Systems Inc., which filed for an initial public offering in August, represents much of what venture capital stands for: a huge market opportunity, the potential to be a billion-dollar company and, with the worries plaguing the economy, maybe even a bit of hope.

In a year that's seen but a handful of venture-backed initial public offerings, the prospective float for A123, which makes next-generation lithium-ion batteries for hybrid electric vehicles and other applications, could be the first to break through the glut and is poised to offer validation for other well-funded battery technology startups, which are watching the upcoming offering with keen interest.

"It will be a proof point of the model that basically you can apply innovation toward a large industry that's virtually had very little innovation over the last 10-plus years," says Scott Bonham, a GGV Capital co-founder and managing partner and an investor in Boston-Power Inc., a startup that makes lithium-ion batteries for laptops and other devices. "I'm really excited and hope that they do well because it will lead the way."

Naturally, A123's planned IPO could go either way, or not at all. Only 43 IPOs have priced so far this year, compared with 174 in the same period last year, according to Renaissance Capital's IPOhome.com, and the average return to date is -11%, compared with an average of 13% in 2007.

With all eyes on A123, a lukewarm reception could persuade companies to stay private longer, says Lux Research Inc. senior analyst Ying Wu. "There's going to be a combination of what the company does financially on its own and also what the overall U.S. climate looks like," she adds.

However, Wu argues that despite the conditions in the IPO market, A123's fundamental financial picture makes it a good candidate for a successful public debut. A123 isn't profitable yet but generates more than $40 million in revenue from its power-tool applications, and its IPO valuation will include projections for its future hybrid electric vehicle and grid applications. Black & Decker Corp. is the company's only customer at this point, according to the prospectus, though it has development agreements with General Motors Corp. and others. A123 investors were unavailable for comment, given the quiet period.

For energy storage overall, the market opportunity is significant. Lux Research estimates the global market was worth $41.2 billion in 2007, with a compound annual growth rate of 7.5% since 2004. And, as Bonham notes, there are many fronts for innovation, like greener, safer or faster-charging batteries, which is one reason why A123's peers, many of which have been around for a while and are at various stages of commercialization, continue to draw double-digit rounds.

PowerGenix Inc., for one, just unveiled a $30 million round from Bessemer Venture Partners and others for its rechargeable batteries. Next-generation lead-acid battery developer Firefly Energy Inc. recently closed a $15 million Series C led by Khosla Ventures and others, and Boston-Power kicked off 2008 with a $45 million round led by Oak Investment Partners.

"As with any sector, a visible IPO and how a company performs afterward has some effect -- but battery companies will ultimately be judged by the public markets," notes Boston-Power founder and chief executive Christina Lampe-Onnerud. For now, Bonham expects the judgment will happen in the private markets.

When the market might return and when any of A123's peers are ready for an exit is a tough call, but not necessarily more than a few years off, watchers say. Lux Research found in a study earlier this year exits in alternative power and energy storage have been modest so far, averaging 4.5 times cash-on-cash returns. "However, 69% of VC-backed companies [founded since 1997] continue to operate and many are getting overdue for exits, suggesting the next few years will be critical for VC returns in the field," the study said.

The burgeoning interest in electric cars is driving demand for new battery technologies, Bonham says. "It's going to dramatically grow the market for batteries -- just that alone," he says. And with electronic devices continually emerging, he says he's not worried about demand.

But the recent turmoil that's rocked the financial system and slashed the number of investment banks can't be ignored. All that VCs and startups can do now, Bonham says, is "build real businesses and then, when the markets come, they come."

A successful A123 IPO might just bring that a little closer to reality.