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Ocean Power IPO Heads for Choppy Waters

Kevin Kelleher

In 1886, an entrepreneur had the bright idea of building a machine that could harness the massive power of ocean waves.

He anchored it off the San Francisco coast, and within months a ship carrying 40 tons of dynamite veered close to the rocky coast. The crew abandoned it, and when it detonated, it carried the wave-power technology with it.

That should have been a sign, but other businessmen continued to place wave-power machines off the California coast. The potential was just too enticing: Using natural resources, without having to find or exploit them, to generate electricity.

But none succeeded, and many were abandoned to become curious landmarks for passersby.

But with energy alternatives to oil in bigger demand, wave power is back in vogue. Early Wednesday, New Jersey-based Ocean Power Technologies(OPTT Quote) went public in an initial offering that priced 5 million shares at $20 each -- at the low end of its expected $20-to-$22 range.

The stock was recently off 79 cents in its first day of trading to $19.21.

While Ocean Power's works are unlikely to explode in the ocean or be abandoned, the long history of wave-power technology is worth bearing in mind because of the risk involved. In Ocean Power's case, the risks revolve around its large losses to date and the intense competition in rapidly developing energy niche.

Since October 2003, Ocean Power's shares have traded on the London Stock Exchange's AIM market, where many smaller U.S. companies with little history of profit -- or with a distaste for regulatory costs in the Sarbanes-Oxley era -- have sought refuge.

Its LSE stock has had the kind of volatility that could make conservative investors seasick. Its chart looks like waves out of The Perfect Storm -- rising from 63 in July 2005 to 110 the following October, sinking down to 52 last November only to surge to 119 last month.

If someone could harness the volatility of that stock, they'd light up London.

That said, there's a lot going for Ocean Power. Founded in 1984, it's hardly a newcomer. Its buoys are designed to convert wave energy into mechanical energy, which is in turn converted into electricity. A group of 40 buoys can power up to 4,000 homes, either by adding power to a grid, or directly connecting to homes that are too remote to plug into one.

Buoys offer advantages over wind-power farms that can be deployed offshore. They stand 30 or 40 feet above the ocean's surface, compared with wind turbines that can reach as tall as 300 feet. The waves they rely on are a more consistent source of energy than wind. And, by using satellite and meteorological data, the supply of energy can be predicted in advance.

The problem with the Ocean Power IPO lies less in the technology than in the expanding competitive field. Even since the oil crisis of the 1970s, engineers have taken wave power seriously again. Ocean Power's PowerBuoys look just like that -- buoys with elongated bottom halves -- while others look like giant snakes and still others have long stingray-like wings.

Wikipedia lists 33 companies with wave-power aspirations, but there are surely more. All the competing approaches are good for innovation, but only a handful of these are likely to emerge from an inevitable shakeout.

The other risk is that Ocean Power is hitting the U.S. markets at a far earlier stage of development than the IPO market is used to seeing. However, investors are taking a devil-may-care attitude about money-losing start-ups if they have a strong whiff of promise, so Ocean Power will probably get a pass.

That doesn't reduce the longer-term risk. Through 2004, the vast bulk of its revenue came from the U.S. Navy. That hurt the company in its fiscal year ended April 2006 when a Navy contract was delayed, pushing its revenue down 67%.

The good news is that Ocean Power has been relying on companies for revenue in recent years, including defense contractor Lockheed Martin , Spanish utility Iberdrola and French oil giant Total . In the nine months through January 2007, the Navy accounted for 57% of revenue, a number that is likely to decline if Iberdrola and others buy more PowerBuoys.

That much seems a reasonable bet. So far this year, the Scottish government gave Ocean Power a conditional grant to built a 150-kilowatt system off Orkney, Scotland; and the Pacific Northwest Generating Cooperative signed an agreement to develop a system off the Oregon coast.

But even if those plans pan out, they could take years to erase the company's high R&D and administrative costs. In the nine months through last January, product development costs rose 56% to $4.1 million -- equal to 271% of revenue. SG&A costs rose 42% to $3.1 million, or 204% of revenue.

Given the growing demand for alternative energies, it's easy to wish companies like Ocean Power well. But there is a difference between good wishes and wishful thinking. Until near-term profit is in sight, Ocean Power's stock might find itself navigating rocky waters for a while.