A 4x in 4 Years Surfing the Data Center Tsunami? ($TGEN)

Tecogen is reminiscent of other data center buildout winners $TSSI and $PSIX. Its products are patented and differentiated, and have only a 2-year payback period.

I titled this post with a nod to my $TSSI writeup. Since the time of that post, TSS Inc. has scaled rapidly to meet Dell’s data center demands. The stock has enjoyed both earnings growth and multiple expansion, leading to an exceptional run:

Microcaps providing needed products for data centers have seen outsized returns and will likely continue to do so. Consider, for example, $PSIX, which has performed exceptionally well providing natural gas turbines to bring electricity and energy stability to data centers:

Both companies seized the opportunity, executed well, and eventually uplisted, which has further resulted in rerating based on seasoning and increased liquidity. Another story, though larger cap, is Modine. A thermal management company, the stock is up 1400% over the last 3 years.

In many ways, if TSS reminded me of a mini-SMCI, and PSIX of a mini-Weichai, TGEN reminds me of a mini-Modine. While there’s no guarantee around Tecogen being able to replicate these performances, the ingredients are there, and it “feels” highly similar. When small companies are riding a megatrend, find product-market fit, and execute, the results can be explosive. There is a reasonable path where the company reaches full factory utilization and rerates, leading to a $200m+ market cap within the next several years.

Tecogen

There’s no need to rehash the ongoing mega-trends of both data center buildout and AI-driven power demand. Both are poised to continue for 5+ years, with Microsoft committing to spend $80B on data center buildouts in ‘25, and overseas investment of $20B announced just last week. This is an unprecedented level of investment.

Therefore, it’s interesting to look into the biggest cost factors for data centers. Power, power distribution, and cooling typically comprise ~30% of variable costs.

Tecogen operates three main segments, all of which are implicated in power/cooling spending: products (chillers and cogenerators), services, and energy provision.

Chillers

Currently, data centers rely largely on purely electricity-driven chillers. Chillers are responsible for removing heat from the data center environment and maintaining a stable temperature. This is key to maintain an optimal environment for operations and avoid overheating/fires. Electrical chillers essentially run 24/7 in data centers.

In contrast, Tecogen’s chillers can run both off electricity or natural gas. Under different power regimes, this dynamism can be extremely useful (and eco-friendly):

Typically, natural gas is much cheaper, and does not detract power from the data center’s compute operations. This can offer significant cost savings—as much as 50%, and typically 30-40% per management (!!). It should also be noted that investment costs in Tecogen’s chillers are further defrayed by an FITC, which the company highlights. This yields a mere 2-year payback period, per management:

The company has recently been through a factory transition, so many of these divisions have rather strange YoY growth numbers, but under normal operating conditions (which have resumed), chillers contribute around 45% of the company’s product revenues.

Fascinatingly for such a small company, these products seem fairly unique and differentiated among American manufacturers. The company has been aggressive in patenting its products and software (see here, here, and here, etc.). They are leaders in the hybrid-chiller space, having developed the first standardized natural gas engine-driven chillers in 1987. Manufacturers focused in a meaningful way on these products are few and far between. Further supporting their market leadership are their continually published white-papers. Seeing real white-papers is very rare for a microcap (and again reminds me of $TSSI).

Cogenerators

Tecogen also sells cogenerators, which—again under normal conditions—contribute another 45% of the company’s product revenues. Cogenerators supply electricity and hot water for commercial and industrial applications. I believe the market may be discounting this segment from a data-center perspective. Through a process called trigeneration, cogenerators are often used in concert with chillers. The heat they produce is used to create a thermal difference with a refrigerant, which increases cooling. Trigeneration demand has born out before for Tecogen:

However it should be noted that most of Tecogen’s cogeneration/trigeneration revenue stems from “traditional” customer purchases.

Energy Production

The company also supplies electrical and thermal energy produced by its products. This segment is fairly small, representing around 8% of revenues.

Services

The company signs long-term service agreements with its customers, providing operations and maintenance services. Obviously this segment scales with the product segment, but it is far less “lumpy”. In fact, YoY, the services segment has been flat, indicating that an equal number of customers aged out and were added. This ties with a fairly flat YoY growth in products (the result of production being shutdown due to moving factories). Obviously, if the data center optionality plays out, services will growth accordingly. These revenues are far less lumpy than product revenues, providing stability to financials and projections. Obviously, these contracts have high margins, contributing to the company’s historical EBIT margin which hovers ~50%.

Financials

The company’s TTM financials are fairly confounding at first glance, but as mentioned this is due to production interruptions as they switched factories to lock in more favorable lease terms. Production resumed in Q3’24. The CEO has indicated that he expects 6M in Q4’24 revenues, and 7M in Q1’25. Let’s assume they do 28m in revenues in 2024, ex-data center.

Considering normalized historical financials, the company will be near net income positive with these revenue numbers. Comparable small cap industrials trade at an EV/Revenue multiple of 2-3x, so that would give an implied market cap of $56-84m, or ~$2-3.6 / share. The company today trades at the low end of this range. In case this seems overly optimistic, consider that it traded within this range pre-Covid:

In the post-Covid period, all of the company’s business lines slowed, and some of their customers went bankrupt. This hurt the stock and the multiple never rerated. At a historical multiple (and take that, of course, with a grain of salt), the company is traded w/out regard for much data center upside. However the $28m of revenue may actually be conservative; the company is at a record $12m of backlog, with the recent demand for its cogeneration products. These recent announcements, which have occurred after the last earnings call, should represent >$7m of revenue:

Another way to look at the current price is to consider that the company traded at 1x revenue before the data center opportunity was emphasized by management. Backing out the current EV, the data center opportunity is implied at a mere ~$30m for the company. Are these prices and implications fair? What could this opportuntiy be worth?

If data center EBITDA is valued at a much higher multiple than commercial/industrial electrical and heating—say 10x—it candidly wouldn’t surprise me to see the company’s market cap near double on the announce of its first contract. Keep in mind that that a precedent data center project they secured in 2019 was for $8.4m. If they secure a similar project in today’s environment, they will not just enjoy 50% margins on the revenue… they will also enjoy a second order effect wherein the opportunity is validated. In this scenario, we would see a rapid rerate.

Management has been confident and has continually stated that it is in talks with data centers and expects the first data center customer to be secured in Q1’25. Once proven, data center demand is constrained not by demand, but by the company’s ability to utilize its factories. The value proposition is extremely strong.

A 2-year payback period means that, if this tech is widely adopted, the runway would be essentially unlimited. Data centers are intended to have useful lives between 25-30 years, so this means that Tecogen’s products can save them 30% on energy costs for over 20 years. If borne out, it would be CapEx malpractice not to adopt hybrid chillers.

The company has around 26,000 square feet of manufacturing space. Looking at product dimensions, I’d estimate they can produce around 250 400-ton chillers / year. At current rates of $400/ton, this would be around $40m in revenues at peak without scaling. This ties with their historical high revenue of $35m (which likely didn’t represent full utilization).

Historical EBITDA margins have been ~50%. Within a few years, if they gain recognition and demand continues, it would not be absurd for the company to trade at a 10x EV/EBITDA multiple. This would yield $200m market cap, without expanding their capacity. Operating leverage is here quite significant. Caveat: the numbers contained are extremely hand-wavy. There is obvious execution risk. And finally, their chillers are intended more for modular and small-medium data centers; competitors like Vertiv are focused more on hyperscalers.

Management believes in the thesis and insiders have been buying continually:

This is despite the already extreme levels of alignment and insider ownership:

Fascinatingly, it should also be noted that the Hatsopoulos brothers founded $TMO, a $200B+ company. Given that John was recently buying on the open market, he still has involvement and interest (although he is quite elderly). George has sadly passed.

Risks

Without convincing data center customers of the value proposition, the story is fairly uninteresting, and the company is fully valued. It’s worth monitoring the first quarter of 2025 to see if they meet the guidance of securing a customer. This is an obvious risk and I’d expect near 30% downside from these levels if they fail to do so in Q1.

It’s also always difficult to estimate their actual capacity, which they will hopefully disclose on the next earnings call. It’d be worthwhile to have a theoretical revenue number, assuming demand outpaced utilization.

Additionally—although insider ownership is a positive—there are concerns when there is this level of insider ownership. “Family businesses” often trade at a discount due to the potential difficulty of convincing influencing management, and management’s potential lack of concern for the market. Insiders do not have a controlling stake, but they nearly do. If insiders choose to sell, this will also create a massive overhang on the stock.

Finally, there are many of the warts of a microcap company. Liquidity is tough with ADV around 40,000 shares, though this has been rapidly increasing. Revenues are lumpy and dependent on idiosyncratic. The management team seems solid, but bizarrely, the CEO also serves as the CFO. This isn’t great from a corporate control perspective. Caveat emptor.

Conclusion

Regardless of almost everything, there should be no doubt data center spend will continue for the foreseeable future. Tecogen has a unique, differentiated product, and a compelling value proposition. The company is fully valued with regard to its traditional business, but its business has significant operating leverage and massive optionality if the data center thesis plays out.

Frankly, I think it will. I think the company will, as promised, secure its first data center customers, begin producing nearer and nearer to full capacity, and rerate. Once this begins, news may arrive fast, and incremental news will almost certainly be positive. Downside to historical fair value (although the decline would probably be larger in practice) is not huge from these prices—maybe 30-40%, given the record backlog in their traditional business line. Upside is 300%+ without a lager factory. If this product is proven out, customers will come.

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