Owner-Oriented Investment Research and Commentary - Have a private comment or question? Email us at commonstocksense@gmail.com

Friday, October 16, 2009

Wall St. Speculation Alive and Well in Clean Tech -- Risky Business

A 10/6/09 BBC article entitled Downturn is 'climate opportunity' relayed the message from the International Energy Agency (IEA) that "the global recession provides a window of opportunity to curb climate change and build a low-carbon future". A few key points from the article:
  • [the IEA's] prescription would lead to greenhouse gas concentrations being stabilised at the equivalent of 450 parts per million (ppm) of carbon dioxide - a level that, according to some analyses, offers a good chance that the rise in the global average temperature since pre-industrial times could be kept within 2C.
  • Without these policies, the agency calculates that concentrations will soar to 1,000ppm by mid-century - levels that, in many scientists' views, would lead to catastrophic and irreversible consequences.
  • But political and financial capital needs to be invested soon if the world is to follow the 450ppm path, it says, with emissions needing to peak around 2020.
The article included the following graph showing potential Co2 emissions and reductions, revealing that approximately one half of reductions from the reference scenario result through "End-use efficiency":

This brings us to our primary topic: companies that manufacture electric batteries for cars and other applications (i.e. end-use efficiency). We previously commented on this sector in our post,
Berkshire Hathaway's BYD Purchase - Great "Trade" yet Long-Term Economics are Critical Question in July. In that analysis, we noted the following regarding BYD based on the company's 2008 annual report:
  • Gigantic revenue growth
  • But, margin compression
  • And, low return metrics
  • With huge capital consumption to fund growth
  • Quick conclusion: the facts tell us that BYD operates in a low margin, low return, competitive business that consumes significant capital.
In August, we continued our "clean tech" analysis with Competition for BYD and Divergent Views on "Green" Cars - EVs versus Hybrids. In addition to competition from the auto makers mentioned in that post, we are aware of other companies aggressively seeking market share in the battery segment: Ener1 (HEV, $7.04) and A123 Systems (AONE, $23.06). Both companies are growing top-line rapidly while losing money and consuming massive amounts of capital to fund expansion.
If large operating losses and capital consumption weren't enough to make us cautious with regard to these companies, valuation presents another red flag. On an enterprise value basis, Ener1 is valued at 38 times trailing twelve month revenue and 8 times 2010E revenue. The Market is enthusiastic about recent program wins and DOE grants.

A123, which only went public a few weeks ago at $13.50 and is up 71%, is valued at 24 times TTM revenue. If we apply the same blistering +69% Y/Y revenue growth reported for the company's most recent quarter to TTM revenue of $90 million, the company is valued at 14 times estimated forward revenue of $152 million.

In both cases, we understand that the Market is embracing the growth potential of the businesses, yet the valuations appear very rich. As we recently pointed out for Blue Nile (NILE, $61.26), ENER and AONE appear to be trading on/in thin air.

Briefly, let's take a closer look at A123 Systems. The company has big backers, including GE (GE, $16.79), Qualcomm (QCOM, $42.45), and Motorola (MOT, $8.13), all of which retained a large ownership position post IPO:
The company announced on 9/30/09 that it closed its initial public offering of 32,407,576 shares of common stock at a public offering price of $13.50 per share, with the underwriters purchasing all 4,227,075 shares available through the over-allotment option. The IPO prospectus shows the underwriters involved in the deal: MORGAN STANLEY, GOLDMAN, SACHS & CO., BOFA MERRILL LYNCH, DEUTSCHE BANK SECURITIES, LAZARD CAPITAL MARKETS, and PACIFIC CREST SECURITIES. Based on our prior experience, we believe "sell-side" firms typically initiate equity research coverage 45 days following an IPO. More on this later.

The prospectus also includes a financial summary:

And -- of course -- key risk factors, including:
  • We have had a history of losses, and we may be unable to achieve or sustain profitability. We have never been profitable. We experienced net losses of $15.8 million for 2006, $31.0 million for 2007, $80.5 million for 2008, and $40.7 million for the six months ended June 30, 2009. We expect we will continue to incur net losses in 2009. We expect to incur significant future expenses as we develop and expand our business and our manufacturing capacity. In addition, as a public company, we will incur additional significant legal, accounting and other expenses that we did not incur as a private company. These increased expenditures will make it harder for us to achieve and maintain future profitability. We may incur significant losses in the future for a number of reasons, including the other risks described in this prospectus, and we may encounter unforeseen expenses, difficulties, complications, delays and other unknown events. Accordingly, we may not be able to achieve or maintain profitability.
  • We have yet to achieve positive cash flow, and our ability to generate positive cash flow is uncertain. To rapidly develop and expand our business, we have made significant up-front investments in our manufacturing capacity and incurred research and development, sales and marketing and general and administrative expenses. In addition, our growth has required a significant investment in working capital over the last several years. We have had negative cash flow before financing activities of $29.1 million for 2006, $56.1 million for 2007, $76.0 million for 2008, and $62.2 million for the six months ended June 30, 2009. We anticipate that we will continue to have negative cash flow for the foreseeable future as we continue to make significant future capital expenditures to expand our manufacturing capacity and incur increased research and development, sales and marketing, and general and administrative expenses. Our business will also require significant amounts of working capital to support our growth. Therefore, we may need to raise additional capital from investors to achieve our expected growth, and we may not achieve sufficient revenue growth to generate positive future cash flow. An inability to generate positive cash flow for the foreseeable future or raise additional capital on reasonable terms may decrease our long-term viability.
  • Our limited operating history makes it difficult to evaluate our current business and future prospects. We have been in existence since 2001, but much of our growth has occurred in recent periods. Our limited operating history may make it difficult to evaluate our current business and our future prospects. We have encountered and will continue to encounter risks and difficulties frequently experienced by growing companies in rapidly changing industries, including increasing expenses as we continue to grow our business. If we do not manage these risks successfully, our business will be harmed.
Bottom-line: although we've not completed deep fundamental analysis (e.g. management meetings, channel checks, SWOT analysis, modeling) and could be missing something, we are hard-pressed to build a positive case for purchasing shares at current levels given a perusal of A123's history of losses, risk factors, and valuation. In fact, the evidence points to taking trading profits (a "Sell") and/or betting against further upside (a "Short").

It will be interesting to see where the underwriters come out on the name. We were always objective, unbiased in our "sell-side" days and believe most analysts simply want to make good, fundamental stock calls to keep their stock-picking reputation intact. However, we're not oblivious to potential conflicts at some firms. In this case, we're aware of certain hedge fund traders wagering that at least a few analysts will be bullish on AONE and play into the upward momentum of fast money hands. We're all for innovation and curbing CO2 emissions, but we'll see what happens from the sidelines.

Happy investing,

Jeffrey Walkenhorst

Disclosure: no positions.

© 2009 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.