Windar Photonics — Update 23 March 2016

Windar Photonics was founded to develop and commercialise a low-cost light detection and ranging (LIDAR) system. This is mounted on top of an individual wind turbine where it measures forward-looking wind direction. The information enables dynamic control of the direction and pitch of the turbine, resulting in increased power output and reduced damage from strong winds. The competitive advantage of the system is its low cost, some 70% below existing systems, enabling payback times that are sufficiently attractive to drive commercial uptake of the system.

The issues with the distributor targeted with developing the key Chinese market significantly held back product uptake during FY15, in effect delaying roll-out by about a year. Nevertheless, progress was made selling systems for trials in all three key markets, strengthening engagement with both OEMs (new-build sales) and windpark owners and operators (retrofit sales). Windar also enhanced the product portfolio and won its first volume order. Management is confident that this intensifying engagement will lead to volume sales from Q216, having already received the first volume order, which is to retrofit a wind park in the US. Our estimates assume market penetration will ramp up during and beyond the forecast period, so that during FY18 4% of all new turbines installed globally during the year (c 950 units) will be shipped with Windar’s LIDAR systems and 0.6% of turbines already installed globally (c 3,200 units) will be retrofitted with Windar’s systems.

Since Windar has only recently received its first order for volume deployment of its systems, we have considered a range of possible scenarios on which to base a DCF fair value, using a discount rate of 40% and terminal growth of 2% (see page 8 for more details):

The key catalyst for an uplift in the share price would be further announcements of volume orders.

Sensitivities: Related to commercial success

To achieve substantial scale and value Windar needs to manage a number of sensitivities:

Windar Photonics was created from technology developed by founder Jørgen Korsgaard Jensen and the DTU (Danish Technical University) to develop and commercialise a low-cost LIDAR system for measuring wind speed. Unlike competitive products, Windar’s LIDAR is designed for a price-point at which it is economically viable to mount a LIDAR system on an individual wind-turbine to measure the strength and direction of incoming wind directly. This information is used to adjust the orientation of the turbine in real time so as to optimise electrical power output and reduce damage to the turbine. The monetary value of the increased power output gives a payback for the LIDAR of one to three years, depending on the turbine size and local electricity tariffs. Exhibit 1 below shows the timeline of the company’s development:

Windar was admitted to AIM in March 2015, at a share price of 100p. Since the IPO, significant progress has been made selling systems for trials in the three key markets of North America, Europe and Asia, strengthening engagement with both OEMs for new-build sales and with utilities for retrofit sales. The first volume order has been received and is scheduled for delivery in FY16. Management expects other volume orders to be received from Q216 onwards. As part of this broader customer engagement activity, the product offer has been expanded to include blade pitch alignment, which reduces the load on turbine blades, thus extending turbine lifetime, and integration with a wider range of wind turbines.

The LIDAR technique has been around since the 1970s. It is based on firing a low-power laser beam into wind, measuring the reflections of the light from moving air particles and using this information to calculate the speed and direction of the wind using the Doppler principle. Windar’s WindEye has been designed for use as a turbine mounted system, using a solid-state laser as the high intensity light source, rather than relatively expensive fibre amplified lasers. This results in a system price point that is up to 70% cheaper than competitive products which have been developed from ground-based, expensive high-fidelity technology. At this lower price-point it is economically viable to mount LIDAR systems on individual turbines rather than having a single LIDAR for use across an entire wind-farm. In addition, WindEye has no mechanical moving parts, is light, compact and robust (see Exhibit 2), is easy to install and requires limited maintenance, all of which is ideal for long-term deployment on top of a turbine. WindEye emits two laser beams at 60 degrees to each other, extending 80 metres in front of the turbine. These measure the movement of particles in the air, giving precise information about the speed and direction of incoming wind (Exhibit 3). Independent tests at the DTU comparing results from WindEye and a metrological mast, which is the standard for measuring wind speed, have confirmed that WindEye measures both the speed and direction of incoming wind with precision.

The data output by the WindEye system is fed into the turbine control system. For retrofit deployment an intermediary sub-system is required. Windar’s WindTIMIZER (Exhibit 4) takes output from WindEye and converts it into the appropriate protocol for the turbine controller. It also adds a fail-safe function so that if the WindEye output is temporarily missing, as happens when the turbine blades cut the laser beams, the turbine control system defaults to the basic anemometers fitted to the back of the turbine for measuring wind after it has reached the turbine. An intermediary system is not required for OEM deployment, as in this situation the turbine manufacturer works with Windar to ensure that the turbine control system is able to accept WindEye output directly.

WindEye supplies forward-looking wind direction and speed data in real time to the turbine control system. This re-orientates the turbine so that it is always head on to the incoming wind, extracting the maximum amount of energy from it. This contrasts with conventional wind measurement methodology where sensors take readings of air flow at the back of the turbine. The wind flow is distorted as it passes round the turbine, so the measurements taken of flow in this area are not the same as measurements of the incoming wind taken directly. The sensors have to be calibrated so that the true speed and direction of incoming wind can be estimated from the measurements they take in the turbine’s wake. In practice this calibration is not perfect because it is very difficult to calculate the impact of turbulence at the back of the turbine and to compensate for it. In addition, the wind sensors may be slightly misaligned: a 5 or 6 millimetre sensor misalignment can result in a 15 degree yaw misalignment, causing a 5-6% energy loss, and the terrain and neighbouring turbines may cause other distortions to the wind flow. As a result of these factors the information the turbine controller receives about incoming wind direction from conventional sensors is often incorrect, resulting in a turbine orientation that is several degrees away from facing the wind. For example, data collected from a 3.6MW wind turbine over a two-month measurement period, in which wind data from traditional sensors was compared against the more accurate WindEye measurements showed a mean misalignment during the period of 6 degrees. Numerous customer trials have subsequently confirmed that WindEye results in improved yaw alignment and yield.

Payback for operators based on energy efficiency gains

In the 3.6MW turbine example, using WindEye data rather than output from conventional sensors would have significantly reduced turbine misalignment, resulting in an energy gain of 35MWhrs, equivalent to a 2.4% improvement in efficiency. The estimated return of investment by deploying WindEye on this turbine would have been 1.5 years. Windar’s system has been tested on a wide range of wind turbine types and power ratings to identify the potential efficiency improvements that could be achieved by deploying WindEye. This includes wind turbines across the power spectrum from <1mW to the largest 6mW turbines designed for offshore use. The payback period for an operator of a turbine will depend on a wide range of parameters including power rating, average yaw misalignment, price of electricity and any subsidy regimes. Exhibit 5 analyses potential payback time under a typical European feed-in tariff (FIT) regime, showing how this varies with turbine size and the increase in efficiency achieved.

As can be seen, the larger the turbine, the quicker the payback period, although the payback period is attractive for most scenarios involving turbines of 2.0MW power or greater. 1.5MW and 2.0MW turbines account for the greatest proportion of the current globally installed turbine fleet, providing a substantial retrofit opportunity. Improved yaw alignment also causes additional stress loading on the turbine components, resulting in premature wear and tear and accelerating the maintenance cycle. The financial benefits of reducing loading provided by Windar’s LIDAR are excluded from this analysis. The incremental cost of a Windar LIDAR (<€25k) is not significant compared with the cost of a turbine (c €1m/MW).

Improved pitch alignment and reduced wear

Accurate real-time information about incoming wind warns the turbine about sudden excessively strong gusts of winds, enabling it to twist the turbine blades so that the flat of the blade does not receive the force of the wind full on. This reduces the associated wear, increasing the potential life of the turbine components and lowering maintenance costs. Third-party testing has shown that forward-looking LIDAR sensors can reduce stress on the blades, gearbox and associated components by at least 10-14%. This benefit is not included in the payback scenarios above.

In response to those turbine OEMs who are keen to offer improved pitch alignment, Windar is currently developing a four beam LIDAR, which provides anticipatory pitch control and gust prevention as well as yaw alignment. This new product, WindVISION, which is intended as an alternative to WindEye rather than a replacement, is scheduled for launch later in 2016.

Windar’s products are used in the wind turbine market. This market is forecast to continue to grow as energy policies across the globe demand increased contributions from renewables and wind power is an established and proven technology. According to the Global Wind Energy Council (GWEC), 63GW of wind turbine capacity were installed globally during 2015, a 22% year-on-year increase, bringing the cumulative installed capacity to 432GW.

China is the largest market with respect to both annual installations and installed capacity as its government is implementing policies intended to reduce dependency on coal for energy generation and the associated smog affecting its major cities. The legislative environment in the US continues be supportive, following a bi-partisan vote by Congress in late 2015 for a multiyear extension of the Production Tax Credit and the alternative Investment Tax Credit through to 2019. GWEC predicts annual capacity installed globally to grow with a 5% CAGR between 2014 and 2019, though we note that its 2015 forecast of 53.5GW was substantially lower than the actual amount.

Assuming that the current mean turbine rating is 2.5MW, the GWEC statistics represent around 175,000 turbines installed globally, with approximately 25,000 new turbines delivered each year. Windar is addressing the installed base through contact with the owners and operators of wind farms. It is addressing the new-build market though relationships with OEMs, with the goal of integrating LIDAR with turbine control systems during manufacture. The sales cycle is lengthy, with potential customers purchasing individual units for use on in situ trials before committing to a volume purchase. A major milestone was reached in FY15 with the first volume order, which is from a US utility to retrofit a wind park. The contract value is c US$0.9m, for delivery in 2016.

Windar has a significant number of trial installations with utility companies in Asia, Europe and North America. These are providing results that confirm the attractive business case for the adoption of WindEye and WindVision. Windar has supplied six of the top 10 wind park operators globally by market share. Following the order received in FY15 for the US windpark retrofit, management expects other volume orders to be received from Q216 onwards.

Four out of the top 10 turbine manufacturers have already successfully tested Windar’s system and have entered the development stage of direct turbine integration. As a result of this activity, the product offer has been expanded to include blade pitch alignment and integration with a wider range of wind turbines.

Some of the funds raised at the time of listing have been used to strengthen the sales team in Denmark and to establish local sales representation in China, Spain, Germany, Brazil and the US. Windar had intended to access the Chinese market via an exclusive distribution agreement with Swiss-based TRES Wind who have a good relationship with the Chinese wind turbine manufacturer Shanghai Taisheng Wind Power Equipment Co. The distribution agreement was dependent on certain sales levels being achieved in 2015. There were installation issues on the initial deployments in China, so these levels were not reached. Consequently Windar has decided to terminate the agreement and access the Chinese market direct through its offices in Beijing and Shanghai. We understand that the initial installation issues have been resolved and that the revised arrangement is working well. This is important given that China is the largest market with regards to both cumulative installed capacity and annual deliveries.

Windar’s LIDAR has been designed using a solid state laser, resulting in a substantial price point discount to peers (Exhibit 7). Since the use of a semiconductor laser is a fundamental differentiator, Windar has patents for the use of a semiconductor laser in a LIDAR wind sensor in Russia, the US and Europe with applications filed and pending in India, China and Japan.

As the price differential is so great, the other systems are used in a different way from Windar’s system and are therefore not true competitors. WindEye systems are mounted on individual turbines for the lifetime of the turbine, monitoring incoming wind in real time. Rival systems are used to monitor the difference between actual incoming wind speed and the results generated by the turbine wind sensors over an extended period, and this information is used to recalibrate the wind sensors. In this methodology, one system is used for many turbines, but yaw adjustment is not optimal and power yield is compromised. In practice, many wind farm operators do not use LIDAR technology at all, and rely solely on measurements from traditional, simple wind direction and speed devices mounted behind the turbine.

The management board consists of founder and COO Jørgen Korsgaard Jensen, CEO Martin Rambusch and NED Johan Blach Petersen. The board was augmented at the IPO by the appointment of chairman John Weston, the former CEO of BAE Systems (1998-2002), who has subsequently held the position of chairman at a series of early-stage development and commercialisation technology businesses. Simon Barrell was also appointed as senior NED. He is a chartered accountant who brings substantial financial experience, previously as FD of Napier Brown Foods, as well as a NED and chairman of a number of public companies.

Windar needs to manage a number of sensitivities to achieve its plans to fully commercialise the technology and achieve substantial scale and value:

Given the early-stage nature of Windar, we believe that relative peer rating valuation techniques are unsuitable and we have therefore derived a DCF valuation out to 2025 based on a range of possible scenarios. We consider three scenarios dependent on the rate of market penetration:

Exhibit 8 shows our assumed win rates in each scenario using GWEC market forecast data. Running our financial model assuming an average selling price of <€25k for each of these scenarios, a tax rate of 22% and a discount rate of 40% to reflect the relatively early-stage nature of this technology and a terminal growth rate of 2% gives an indicative value of between £35m and £107m as shown in Exhibit 9, with our forecast base case suggesting an indicative value of £57m under these assumptions. These calculations exclude the impact of any financing activity in FY16, which we model as funded through long-term debt totalling €2.5m (£1.9m).

The share price has fallen by over 20% since the Admission to AIM at 100p/share and a market cap of £38m, reflecting the delays in market penetration caused by the issues with the former distributor in China. The current market cap (£31m) is substantially below the lower bound of our indicative valuation range. Receipt of further volume orders should act as a catalyst towards our mid-case indicative value of c £57m, which is based on the roll-out modelled in our estimates.

Noting the problems Windar experienced during FY15 with its distributor in China, our reinstated estimates show significantly lower FY15 revenues than modelled in our March 2015 note. We understand that the decision to sell directly in China is resulting in meaningful engagements with potential customers so the problems appear to be temporary, in effect delaying roll-out by about a year.

H115 revenues totalled €0.1m. This was lower than management expectations because of the issues in China and lower than H114 (€0.4m), which benefitted from some sales to customers in China. Administrative expenses (excluding IPO costs which we treat as an exceptional item), increased by 70% year-on-year (€0.7m) as management used funds raised in H214 to invest in personnel and increased sales and marketing activities and to lease a new, larger facility in Copenhagen. Pre-exceptional operating losses widened by € 0.7m to €1.6m.

The January 2016 trading update noted that FY15 revenue will be within the revised revenue guidance of €950k (€1,038k FY14), indicating a modest half-year on half-year ramp-up in unit deliveries as engagement strengthened with both OEMs (new-build sales) and utilities (retrofit sales). The half-year on half-year improvement is the result of a significant increase in activity in both the European and North American markets following a decision to refocus sales and marketing activities there rather than China. Full year (FY15) sales were broadly evenly distributed between the three regions. Since FY15 revenues are expected to be similar to those for FY14, yet there has been a substantial increase in personnel and sales and marketing costs following the FY14 fundraising activities, we model the pre-exceptional operating loss widening from €1.8m in FY14 to €3.2m in FY15.

Windar received its first volume order during FY15. This order, worth c$0.9m, is from a US utility to retrofit a wind park and is scheduled for delivery in FY16. Management is confident that some of the ongoing trials being carried out by utility customers and wind turbine manufactures will also convert to volume orders, resulting in a substantial increase in revenues from Q216 onwards. Management expects growth in each of the three key markets, as the decision to terminate the agreement with the distributor in China and to start selling directly in the region appears to be working well. Noting the length of time it takes to complete product trials, we take a prudent view with regards to the conversion rate during FY16, giving revenues totalling €6.4m and a small (€0.3m) operating loss. A single additional sale the size of the US order received during FY15 would turn this into a small operating profit. Management expects FY16 revenues to be between €6-9m, so our estimates are very much towards the lower end of this range. Our estimates assume market penetration will ramp up during and beyond the forecast period, so that during FY18 4% of all new turbines installed globally during the year (c 950 units) will be shipped with Windar’s LIDAR systems and 0.6% of turbines already installed globally (c 3,200 units) will be retrofitted with Windar’s LIDAR systems.

Windar is using the £6m raised at 100p/share from a pre-IPO private and institutional funding round to invest in business development, manufacturing capacity and working capital. Cash reduced by €2.8m to €2.8m during H115 (excluding €0.1m deposits and €0.8m Growth Fund borrowing), reflecting operating losses, a €0.6m rise in inventory and €0.7m reduction in payables. Our model assumes a modest increase in working capital during H215 resulting in an estimated €0.6m cash at end FY15. Our estimates show Windar operating at slightly above EBITDA break-even during FY16. However, the continued investment in R&D (€0.5m capitalised during FY16) and in working capital to support sales growth, is expected to result in a funding gap during the year. Our estimates model this to be €1.3m, financed through long-term debt, though management could opt to factor sales in order to finance working capital requirements if necessary. From FY17, we estimate that the cash generated from operations is more than sufficient to cover the working capital required to support future growth. Longer-term, management intends to distribute 50% of earnings as dividends.

Given the potential funding shortfall, management has decided not to commence paying down the Growth Fund loan, as it has the option not to start repaying this until the loan reaches maturity in June 2020. The loan bears interest at 12%. Management may at any point until the maturity of the loan either repay the loan in part or in full, or initiate an annuity repayment scheme over a four-year period. If an annuity repayment scheme is initiated, the interest rate will be reduced to 8% over the repayment period.