Siemens Energy: Winds of Change

Sector

Industrials

Background

Mark Hiley is CEO of The Analyst. We cover the history of Siemens Energy before and after its spin-off, why grid technologies are the growth engine of the business, and the turnaround challenge facing its wind power division.

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Date

August 7, 2024

Episode Number

177

Business Breakdown: Siemens Energy

Siemens Energy, spun off from Siemens AG in 2020, is a global leader in energy technology, operating across the energy value chain with a focus on conventional and renewable power. With approximately EUR 35-40 billion in revenue and a market cap of around EUR 20 billion, the company is positioned to capitalize on the energy transition, balancing traditional energy sources with renewables. However, its wind division, Siemens Gamesa, presents significant challenges, offsetting the profitability of its gas and power segments. Below is a detailed breakdown of Siemens Energy’s business model, financials, market dynamics, and competitive positioning, with a focus on the unique aspects of its operations and a Hamilton’s 7 Powers analysis.

Background and Overview

Siemens Energy was formed to streamline Siemens AG’s sprawling conglomerate structure, which had grown complex over its 150-year history. The spin-off aimed to enhance focus on energy-specific megatrends, including renewables, grid modernization, and energy independence, while improving capital allocation and shareholder value. Siemens AG retained a 30-40% stake initially, which has since been partially sold or transferred to its pension fund.

The company operates in two primary segments:

1. Gas and Power (~EUR 25 billion revenue): Encompassing gas services, grid technologies, and transformation of industry (including sustainable energy systems, electrification, automation, digitalization, and compression).
2. Wind (Siemens Gamesa) (~EUR 10 billion revenue): Focused on onshore and offshore wind turbines, with a significant service component.

Siemens Energy employs approximately 90,000 people and serves major customers like national grid operators (e.g., National Grid, TenneT). Its order backlog exceeds EUR 110 billion, reflecting strong demand driven by electrification, grid resiliency, and the energy transition.

Ownership and Valuation

• Ownership: Siemens AG’s initial 30-40% stake has been reduced through sales and transfers to its pension fund. Siemens Energy is now a standalone public company listed in Germany.
• Market Cap: Approximately EUR 20 billion.
• Valuation Context: Comparable to GE Vernova, Siemens Energy trades at a valuation reflecting its growth potential in gas and power, tempered by losses in its wind division. The market perceives the gas and power segment as a stable, cash-generative asset, while wind introduces volatility. No specific EV multiples were provided, but the EUR 20 billion market cap suggests a moderate multiple given the company’s breakeven-to-slightly-positive net income outlook.

Key Products, Services, and Value Proposition

Siemens Energy’s portfolio spans the energy value chain, providing equipment and services for power generation, transmission, and renewable energy. Its value proposition lies in its ability to deliver integrated solutions for both conventional and renewable energy systems, leveraging engineering excellence and long-term service contracts.

• Gas Services: Supplies large gas turbines for power generation, with a high attach rate for sticky, high-margin (20%+) service contracts lasting decades. This segment benefits from a consolidated market and capital-light operations.
• Grid Technologies: Provides critical components for grid resiliency and interconnection, capitalizing on booming demand for grid modernization. It’s the fastest-growing segment, with a low CapEx-to-sales ratio.
• Transformation of Industry: A catch-all segment with smaller, profitable niches (e.g., industrial steam turbines) and a speculative hydrogen business, which faces scalability challenges without subsidies.
• Wind: Produces wind turbines, with offshore as the core focus. The segment is loss-making due to supply chain issues, project delays, and technical problems, but its EUR 40 billion backlog signals future potential.

Segments and Revenue Model

Siemens Energy’s revenue model is a mix of equipment sales and high-margin, long-term service contracts, with distinct dynamics across segments.

1. Gas and Power:
• Revenue Model: Approximately 35-40% of gas services revenue comes from new turbine sales, with 60-65% from service contracts. Grid technologies and transformation of industry rely on equipment sales (e.g., HVDC converters, substations) with smaller service components.
• Customers: National and state grid operators, utilities, and industrial clients.
• Contract Structure: Long-term (decades-long) service contracts for gas services; multi-year equipment supply agreements for grid technologies, often extending into the 2030s.
2. Wind (Siemens Gamesa):
• Revenue Model: Primarily equipment sales (onshore and offshore turbines), with ~EUR 2.5 billion from service contracts. Offshore projects dominate, with long-cycle contracts (2-5 years from order to completion).
• Customers: Renewable energy developers, utilities, and governments.
• Contract Structure: Long-term, fixed-price contracts with prepayments (10% down payments). These contracts have been loss-making due to inflation and supply chain disruptions.

Splits and Mix

• Segment Mix (Revenue):
• Gas and Power: 70% (EUR 25 billion)
• Wind: 30% (EUR 10 billion)
• Segment Mix (Profitability):
• Gas and Power: Generates ~EUR 2 billion in net income, with double-digit margins in gas services and grid technologies.
• Wind: Losses of ~EUR 2 billion, offsetting group profitability.
• Geographic Mix: Predominantly Europe-focused, with significant exposure to North America and emerging markets. Grid technologies benefit from European grid integration and U.S. interconnection projects.
• Customer Mix: Large, stable clients (e.g., National Grid, E.ON) dominate, reducing customer concentration risk.
• Historical Mix Shifts: Gas and power have shifted from loss-making (2019-2020) to profitable, driven by demand for grid resiliency and gas baseload. Wind’s losses have intensified due to supply chain issues and technical failures (e.g., 3x, 4x turbine platforms).

KPIs

• Order Backlog: EUR 110 billion (gas and power: ~EUR 70 billion; wind: ~EUR 40 billion), signaling strong future revenue visibility.
• Revenue Growth:
• Gas Services: Low-to-mid single-digit growth, with potential acceleration from data center demand.
• Grid Technologies: >30% growth in 2024, with 20% CAGR expected through the decade.
• Wind: Flat-to-declining near-term due to loss-making backlog, with potential doubling if offshore orders materialize.
• Margin Trends:
• Gas Services: Double-digit, with service margins >20%.
• Grid Technologies: 8-10%, with upside to double-digit.
• Wind: Negative, targeting breakeven by 2026-2027.
• Acceleration Indicators: Grid technologies’ order intake doubled (EUR 10 billion to EUR 20 billion) and backlog tripled (EUR 10 billion to EUR 30 billion) in two years, reflecting a structural demand surge.

Headline Financials

• Revenue Trajectory: Revenue has stabilized at EUR 35-40 billion, with gas and power driving growth (grid technologies at >30% in 2024). Wind revenue is flat, constrained by loss-making projects.
• EBITDA and Margins: Gas and power deliver double-digit margins, with gas services at ~20% on services. Wind’s EUR 2 billion loss drags group EBITDA to breakeven. Margin expansion hinges on wind recovery.
• FCF: Gas and power are highly cash-generative due to low CapEx and high-margin services. Wind’s losses and higher CapEx (R&D, turbine manufacturing) suppress group FCF. Disposals (e.g., Siemens India, Trench) have bolstered liquidity.
• Capital Intensity: Gas and power are capital-light (CapEx-to-sales <2%), while wind is capital-intensive due to R&D and manufacturing. Group CapEx is modest relative to revenue, supporting high returns on capital in profitable segments.

Value Chain Position

Siemens Energy operates across the energy value chain, from power generation (gas turbines, wind turbines) to transmission (grid technologies) and industrial applications (electrification, compression). Its primary activities include:

• Manufacturing: Gas turbines, grid components, and wind turbines.
• Service: Long-term, high-margin maintenance contracts.
• R&D: Developing next-generation turbines and grid technologies, though wind R&D has been value-destructive.

Position: Midstream to downstream, focusing on equipment supply and aftermarket services. Siemens Energy is not vertically integrated into raw materials or project development, which reduces exposure to upstream volatility but limits control over supply chain costs.

GTM Strategy: Direct sales to large grid operators and utilities, leveraging long-term relationships and engineering reputation. Service contracts ensure recurring revenue and customer lock-in.

Competitive Advantage: Siemens Energy’s value-add lies in its engineering excellence, consolidated market position, and sticky service contracts. Its ability to provide integrated solutions (e.g., wind turbines paired with grid components) differentiates it from pure-play competitors.

Customers and Suppliers

• Customers: National grid operators (e.g., National Grid, TenneT), utilities, and renewable energy developers. Customers prioritize reliability, long-term partnerships, and engineering quality, given the mission-critical nature of energy infrastructure.
• Suppliers: Siemens Energy relies on a consolidated supply chain for components (e.g., steel, bearings, cables). Supply chain disruptions and inflation have impacted wind, highlighting supplier power in a constrained market.

Pricing

• Gas Services: Pricing power has increased due to capacity constraints and consolidated markets. Service contracts command premium pricing (>20% margins) due to high switching costs.
• Grid Technologies: Strong pricing power driven by supply-demand imbalances and long-term contracts extending into the 2030s.
• Wind: Historically weak pricing due to fixed-price contracts signed pre-inflation. Future pricing discipline is critical to profitability, with management urged to pass risks (e.g., steel price increases) to project owners.
• Drivers: Pricing is influenced by industry fundamentals (supply constraints), branding/reputation (Siemens’ engineering excellence), and mission-criticality. Wind pricing is sensitive to regulatory approvals and supply chain costs.

Bottoms-Up Drivers

Revenue Model and Drivers

• Gas Services:
• Model: Equipment sales (35-40%) and service contracts (60-65%). Service contracts are sticky, with decades-long duration and >20% margins.
• Volume: 100-110 large gas turbines built annually, with demand rising (30-40 additional units from data centers). Growth is driven by grid resiliency needs and coal phase-outs.
• Price: Increasing due to capacity constraints and cherry-picking high-margin contracts.
• Grid Technologies:
• Model: Equipment sales (e.g., HVDC converters, substations) with smaller service components. Long-term contracts extend into the 2030s.
• Volume: Order intake doubled (EUR 10 billion to EUR 20 billion), backlog tripled (EUR 10 billion to EUR 30 billion). Revenue growth >30% in 2024, with 20% CAGR expected.
• Price: Strong pricing power due to supply constraints and critical grid investments.
• Wind:
• Model: Equipment sales (onshore/offshore turbines) and services (~EUR 2.5 billion). Offshore dominates, with long-cycle contracts and 10% prepayments.
• Volume: Flat near-term due to loss-making backlog. Offshore auctions (10-20 gigawatts annually) could drive EUR 15 billion in annual orders.
• Price: Weak historically due to fixed-price contracts. Future discipline is key to profitability.
• Mix:
• Product Mix: Gas services and grid technologies are high-margin, core segments. Wind is high-risk, high-potential.
• Geo Mix: Europe-centric, with growth in North America and emerging markets.
• Customer Mix: Stable, large clients reduce risk.
• Organic Growth: Driven by grid technologies and gas services. Wind growth is contingent on execution.

Cost Structure and Drivers

• Variable Costs:
• Gas and Power: Materials (e.g., steel, components) and labor for equipment manufacturing. Economies of scale and modular product lines reduce costs.
• Wind: High variable costs due to supply chain inflation (steel, transport) and project delays. Unhedgeable costs (e.g., steel prices) exacerbate losses.
• Fixed Costs:
• Gas and Power: Low fixed costs (CapEx ~EUR 0.5-0.6 billion for EUR 25 billion revenue). Operating leverage drives profitability as revenue grows.
• Wind: High fixed costs from R&D and manufacturing footprint. Factory underutilization contributes to losses.
• Cost Analysis:
• % of Revenue: Gas and power have low COGS (high gross margins), with services driving profitability. Wind’s COGS are high, eroding margins.
• % of Total Costs: Fixed costs dominate in wind (R&D, factories), while gas and power benefit from variable cost flexibility.
• EBITDA Margin: Gas and power: double-digit (8-20%); Wind: negative. Group margin expansion requires wind recovery and continued gas/grid growth.

FCF Drivers

• Net Income: Breakeven to EUR 1 billion, constrained by wind losses.
• CapEx: Low for gas and power (<2% of sales), higher for wind (R&D, manufacturing). Group CapEx supports high returns in profitable segments.
• NWC: Net negative working capital (EUR 3 billion) due to prepayments, offset by contract liabilities (EUR 13 billion). Cash conversion cycle is favorable in gas and power but strained in wind.
• Disposals: Sales of Siemens India and Trench bolstered liquidity, supporting a net cash position.

Capital Deployment

• M&A: Limited near-term M&A due to wind losses and balance sheet focus. Long-term, M&A could target grid or service adjacencies.
• Organic Growth: Prioritized in grid technologies (capacity expansion) and gas services (service contract expansion).
• Dividends/Buybacks: Unlikely until wind stabilizes and net cash exceeds working capital liabilities (2027-2028).

Market, Competitive Landscape, and Strategy

Market Size and Growth

• Total Addressable Market: The global energy equipment market is growing, driven by grid modernization, electrification, and renewables. Grid technologies alone could see 20% CAGR through the decade, with a multi-trillion-euro market by 2030.
• Volume Growth: Gas turbines (100-110 units annually, +30-40 from data centers); grid components (doubling order intake); wind (10-20 gigawatts of offshore auctions annually).
• Price Growth: Rising in gas and grid due to supply constraints; wind pricing needs discipline to recover margins.
• Industry Growth Stack: Driven by electrification (data centers, EVs), grid resiliency, coal phase-outs, and energy independence post-Ukraine war.

Market Structure

• Gas Services: Highly consolidated (Siemens, GE Vernova, Mitsubishi, Baker Hughes). Low MES allows few players to dominate.
• Grid Technologies: Consolidated (Siemens, Hitachi, Mitsubishi). High MES and long-term contracts create barriers.
• Wind: Offshore is a duopoly (Siemens, Vestas in Europe); onshore is fragmented (Siemens, Vestas, GE, Nordex). High capital and R&D requirements limit new entrants.
• Cycle: Grid technologies and gas services are in a structural upcycle, potentially a “super cycle” driven by decades of underinvestment. Wind is in a recovery phase post-bust.

Competitive Positioning

• Gas Services: Market leader with sticky service contracts and modular products. Competes on engineering quality and long-term reliability.
• Grid Technologies: Dominant in Europe, leveraging reputation and capacity constraints. Competes on scale and delivery reliability.
• Wind: #1 in offshore, #3 in onshore, but lags Vestas in profitability and execution. Technical issues (3x, 4x platforms) and supply chain woes weaken positioning.
• Risks: Wind losses threaten balance sheet stability; grid capacity constraints could limit growth if not addressed.

Hamilton’s 7 Powers Analysis

1. Economies of Scale: Strong in gas and grid due to low CapEx-to-sales and high order volumes. Wind lacks scale benefits due to underutilized factories.
2. Network Effects: Limited, as energy equipment is not platform-based. However, long-term service contracts create customer lock-in.
3. Branding: Siemens’ engineering reputation commands premium pricing in gas and grid. Wind’s technical issues tarnish brand perception.
4. Counter-Positioning: Integrated solutions (wind + grid + gas) differentiate Siemens from pure-play competitors, though execution lags.
5. Cornered Resource: Proprietary turbine and grid technologies provide an edge, but wind’s technical failures reduce this advantage.
6. Process Power: Modular product lines in gas services enhance efficiency. Wind’s complex supply chain and R&D missteps hinder process power.
7. Switching Costs: High in gas services (decades-long service contracts) and grid technologies (long-term partnerships). Lower in wind due to competitive alternatives.

Strategic Logic

• CapEx Bets: Grid technologies require capacity expansion to meet demand, a critical capital allocation decision. Wind needs disciplined R&D to monetize existing platforms.
• Vertical Integration: Limited, as Siemens focuses on equipment and services rather than upstream (e.g., raw materials) or downstream (e.g., project development).
• Horizontal Expansion: Potential in grid adjacencies (e.g., cables) or service contract growth. Wind recovery is the priority.
• MES: Gas and grid have achieved MES, creating defensible positions. Wind’s high MES and losses make it vulnerable to Vestas.

Unique Dynamics and Key Takeaways

1. Integrated Energy Transition Play: Siemens Energy’s ability to bridge conventional (gas) and renewable (wind) energy with grid solutions is unique. The industrial logic of combining wind turbines, gas baseload, and grid components aligns with the future grid, but execution in wind has been poor.
2. Gas Services’ Sticky Service Model: The 60-65% service revenue with >20% margins and decades-long contracts creates a capital-light, high-ROIC business. This annuity-like cash flow contrasts with wind’s volatility.
3. Grid Technologies’ Super Cycle: The tripling of backlog and >30% growth reflect a structural demand surge from grid underinvestment, electrification, and energy independence. Capacity constraints give Siemens pricing power, a rare dynamic in industrial markets.
4. Wind’s Boom-Bust Cycle: Wind’s losses (EUR 2 billion projected) stem from fixed-price contracts, supply chain inflation, and technical issues. The duopoly in offshore wind offers recovery potential, but discipline in pricing and R&D is critical.
5. Capital Allocation Pivot: The spin-off from Siemens AG sharpened focus on shareholder value, evident in disposals (Siemens India, Trench) and a net cash balance sheet. Future allocation will balance grid expansion with wind stabilization.
6. Supply Chain Constraints: Across segments, supply chain consolidation (e.g., cables, bearings) creates bottlenecks, enhancing pricing power but exposing wind to cost inflation.
7. Engineering Excellence vs. Financial Discipline: Siemens’ reputation for engineering is a double-edged sword. While it secures long-term contracts, over-engineering in wind (e.g., diameter wars) has destroyed value, echoing Rolls-Royce’s challenges.

Conclusion

Siemens Energy is a complex but compelling business at the heart of the energy transition. Its gas and power segment, particularly grid technologies, is a high-growth, capital-light engine capitalizing on a generational grid modernization cycle. Gas services’ sticky, high-margin contracts provide stability, while grid technologies’ surging backlog signals sustained growth. However, the wind division’s losses and operational challenges pose significant risks, offsetting group profitability and straining cash flow. The company’s EUR 110 billion backlog and net cash position provide a foundation for recovery, but wind’s turnaround hinges on pricing discipline, supply chain stabilization, and R&D rationalization.

From a 7 Powers perspective, Siemens Energy’s economies of scale, switching costs, and branding in gas and grid create defensible positions, while wind’s weaknesses highlight the need for process power and counter-positioning. The business model’s unique strength lies in its integrated approach to the energy value chain, but realizing this vision requires overcoming wind’s drag. For investors, Siemens Energy offers exposure to megatrends (electrification, decarbonization) with a volatile but potentially transformative upside if wind can achieve breakeven by 2026-2027.

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