Ambient: The Biggest Winner Of The Duke/Progress Energy Merger

| About: Ambient Corp (AMBT)

This Tuesday July 3rd was a big day as Duke Energy Corp. (DUK) and Progress Energy Inc. said they had completed their merger now valued at about $32 billion to form the nation's largest electric company.

Duke won federal approval for the merger in January 2011 and it took a little less than 17 months to close the deal.

The combined company will serve more than 7 million customers in North Carolina, Kentucky, Ohio, Indiana, Florida and South Carolina. Duke Energy's more than $100 billion in assets include power plants in Central America and South America and a growing portfolio of wind and solar renewable energy projects in the U.S.

The market was surprised that Progress CEO Bill Johnson, who was tapped to lead the combined company as president and chief executive decided to leave by "mutual agreement,". He is going to receive as much as $10.3 million so don't feel too bad for him. Duke CEO Jim Rogers, who was expected to be executive chairman, has instead been named CEO of the new company.

Interestingly, the effect of Jim Rogers becoming CEO sent shares of Ambient Corporation (AMBT) up 10.77% to $6.07 per share for a gain of 59 cents on the day. So what's the relationship here?

We first had Ambient on our radar screen when we looked for companies with the highest percentage of revenue growth over the past few years listed on the Nasdaq.

View: Annual Data | All numbers in thousands
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Period Ending Dec 31, 2011 Dec 31, 2010 Dec 31, 2009
Total Revenue 62,306 20,358 2,193
Cost of Revenue 35,490 12,023 1,836
Gross Profit 26,816 8,335 357
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At first we thought this was a misprint because revenue grew from $2.193 million in 2009 to $62.306 million in 2011 for a gain of 2741%.

We decided to read every page of the company's 2011 annual report. This stuff is actually kind of complicated so we are going to copy and paste the points we found to be important and informative.

The Electric Power Distribution Grid

The grid was largely designed and built decades ago, and is increasingly becoming strained. According to the U.S. Department of Energy, or DOE, in the United States 70% of transmission lines are 25 years old or older; 70% of power transformers are 25 years old or older; and 60% of circuit breakers are 30 years old or older. The current grid infrastructure, both in the United States and abroad, simply is not designed to accommodate the dynamic electricity distribution requirements of today or the future. As a result, the aging grid is prone to reliability, security, availability and power quality issues, costing utilities and consumers billions of dollars each year.

It is amazing to think that the power grid has been around for so long without any real modernization. Unfortunately, we are seeing the after affects now with over 1 million people are still without power due to the recent storms in the US.

However, the market is starting to be created and the U.S. government is spearheading the development of the "smart grid":

Anticipated Smart Grid Investment

Pike Research forecasts that smart grid investment will total $52 billion in North America by 2015, $80 billion in Europe by 2020 and $171 billion in Asia by 2017. The U.S. government is a substantial proponent of smart grid technologies, primarily through the American Recovery and Reinvestment Act of 2009, or ARRA, which awarded more than $3.4 billion in stimulus funding for smart grid technology development and demonstration, plus $615 million for smart grid storage, across 99 smart grid initiatives to be spent by 2013.

Our Solution

The Ambient Smart Grid® Communications Platform

The Ambient Smart Grid® communications platform, which includes hardware, software and firmware, enables utilities to both effectively manage smart grid applications and directly integrate certain applications into our products themselves. Our communications platform provides a utility with a secure, two-way, flexible and open IP architecture that efficiently networks smart grid applications and different technologies within each application and supports multiple communications technologies currently used by utilities, such as Wi-Fi, radio frequency, cellular technologies, power line communications, serial and Ethernet. Our communications platform enables the integration of smart grid applications, such as smart metering, demand response, distribution automation and monitoring, and direct load control. It also provides an open and flexible platform allowing for the addition of multiple applications, as well as enhancements and future applications.

Our Ambient Smart Grid® communications nodes are attached on or near a utility's transformer, and they support applications and connectivity to devices that comprise the smart grid. These communications nodes are physical boxes we designed for use in the harsh, outdoor environments in which utilities operate. Our network management system, known as AmbientNMS® is the software that manages the large numbers of devices on a smart grid network. By enabling such system interoperability, our communications platform both reduces implementation and ongoing communications costs, and improves overall power management efficiencies. Furthermore, our communications platform also accommodate smart grid applications installed directly into our communications nodes, which include our own developed technology and third-party technology, thereby substantially increasing their functionality.

Basically, what this means is that Ambient makes the Nodes that allows for the power grids to communicate with each other and with the central system software which is also run by Ambient. In other words Ambient is making the power grid intelligent kind of like the Cisco (CSCO) of the power grid.

Make no mistake about it, Ambient is a one trick pony because Duke Energy (DUK) is the only customer. Without Duke, Ambient is dead on arrival but it is unlikely that this 7 year relationship ends anytime soon.

Duke Energy Relationship

Since 2005, we have maintained a strategic relationship with Duke Energy and we believe that we are the leading supplier of its smart grid communications technology in connection with its smart grid implementation. ... Duke Energy announced plans to invest $1 billion over the next five years in smart grid equipment for its service territories including Ohio, Indiana, Kentucky and the Carolinas. The following table summarizes the evolution of our relationship with Duke Energy:

2005

Security and safety testing of our communications nodes

2006

Delivery of approximately 700 communications nodes for pilot deployment

2008

Commercial agreement for 9,000 communications nodes

2009

Award to Duke Energy of $204 million in ARRA digital grid stimulus funds and Duke Energy announcement of plans to invest a total of $1 billion in smart grid deployment initiatives over five years

Long-term supply agreement with Duke Energy to supply our communications nodes and services through 2015

2010

Full-scale smart grid deployment by Duke Energy in Ohio, which includes smart meters, automated power distribution equipment and a communications network encompassing more than 130,000 of our communications nodes, 700,000 electric meters and 450,000 gas meters

Deployment by Duke Energy of approximately 20,000 of our communications nodes

2011

Deployed a cumulative total of approximately 75,000 Ambient communications nodes, including approximately 3,000 of our communications nodes in the Carolinas

Total backlog of approximately $35 million as of December 31, 2011

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Duke Energy is actively deploying thousands of our communications nodes each month and is licensing the AmbientNMS® system, specifically for its deployment in Ohio. We believe that we are the predominant provider of communications nodes and network management system software for Duke Energy's Ohio deployment.

We believe that we have demonstrated that our technology is secure, two-way, flexible, open, scalable, reliable and cost-effective through the total deployment of approximately 75,000 communications nodes in the field with Duke Energy. We believe that Duke Energy will continue to predominantly use our communications platform for the remainder of its Ohio smart grid deployment through 2013. Furthermore, Duke Energy's pilot deployment of approximately 3,000 communications nodes in the Carolinas predominantly uses our communications platform as well. Throughout the past five years, we have worked with Duke Energy to develop our communications platform, which has enabled Duke Energy's ability to deploy its smart grid initiatives.

We believe that we have a substantial opportunity to grow our business with Duke Energy. In addition to the 130,000 communications nodes scheduled for deployment in Ohio, we estimate that Duke Energy would potentially require hundreds of thousands of communications nodes if it implements a full deployment of smart grid communications nodes in Indiana, Kentucky and the Carolinas. According to Duke Energy, it is currently working through the planning process to finalize full-scale deployment plans in Kentucky and the Carolinas and has filed with the North Carolina Public Utilities Commission for the required approvals. Duke Energy is using information from its North Carolina pilot programs and its Ohio deployment to enhance its customer experience in its other service territories. We believe that substantially all smart grid communications nodes deployed by Duke Energy to date are our communications nodes.

For 7 years Ambient has been working with Duke and now that Jim Rogers, the CEO of Duke is leading the combined Duke/Progress Energy the chances are good that Ambient will be able to sell into Indiana, Kentucky, Florida and the Carolinas.

Looking at the financials, Ambient has produced $75 million in revenue over the past 5 quarters. All of this is related to the Node deliveries to Ohio. Based on the company's most recent quarterly filing the backlog as of March 31, 2012 stands at $29 million.

I am assuming that the entire Ohio project represents approximately $104 million USD. Gross margin for 2011 increased slightly to approximately 43% compared to approximately 41% for 2010. That means the total Ohio project yielded around $44 million in gross profit.

Let's do some future estimates here...according to the U.S. Census the state of Ohio has 5,127,508 households. The total number of households in the Duke/Progress Energy foot print is 21,790,635 according to the US Census.

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Now of these 6 states Duke has 7.1 million customers or about 1/3 of the total number of households. Assuming the ratio of 1/3 holds true for each state Ambient generated its Ohio revenue from 1.7 million households. Thus the revenue per household would be $61 each.

Take that number times the remaining Duke customers of 5.4 million and you have $330 million USD. With a 43% margin the five extra states would yield $141.9 million in gross profit. Keep in mind this is having only 1/3 of the market.

Clearly Duke is in the business of gaining customers. At some point it would probably make sense for Duke to just buyout Ambient and not pour hundreds of millions into the company via revenue. It will probably happen if and when the other states approve the smart grid upgrades. There is also maintenance revenue and as well all know once you go tech there is a never ending upgrade cycle every few years.

AMBT has a strange structure with 16.61 million shares outstanding and just a tiny 2.89 million shares in the float. We rarely see such small floats on the Nasdaq.

We've been tempted to buy shares of Ambient but its relatively illiquid and fear of the Duke merger made us nervous. If the CEO of Progress took over as scheduled he may not retain the Ambient relationship.

Now that this hurdle is gone we will look for a dip in the shares to gain an entry point.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.