John Petersen

Last week I spent a couple days with ePower Engine Systems working my way through a variety of business and technical due diligence issues. As always happens with new clients, it was a full immersion course in how ePower’s technology works, what the documented performance of the current tractor is, and how that performance is expected to change as ePower:

• transitions from a four cylinder engine designed for stationary use to an EPA compliant six cylinder engine designed for the trucking industry;
• automates a new charge control system that will opportunistically charge the batteries in a more fuel efficient manner;
• evaluates the potential economic and performance advantages of using a rare earth permanent magnet generator instead of a conventional AC generator; and
• evaluates the potential economic and performance advantages of using a rare earth permanent magnet drive motor instead of a conventional AC induction motor.

ePower’s original development work was done using a 197 hp John Deere diesel engine and a Marathon generator with a rated capacity of 115 kW that can be over-rated to 128 kW for brief intervals. In all but the most extreme conditions, the ePower tractor is designed to minimize generator over-rating by using an array of 56 PbC batteries from Axion Power International (AXPW.OB) for acceleration and hill climbing boost.

Since the current John Deere engine was designed for stationary use with a generator, it is not EPA compliant and its horsepower rating does not account for parasitic engine loads like power steering, air conditioning, airbrake compressor and other accessory and hotel loads. As a result, the maximum sustained generator output of the current tractor is about 93 kW.

ePower recently bought an EPA compliant 240 hp on-road Cummins diesel engine that was salvaged from a wrecked truck. Unlike the John Deere engine, the Cummins engine is rated on net useful horsepower at the flywheel after parasitic loads. It’s 32 pounds lighter than the John Deere engine and has an advertised fuel consumption of 6.8 gallons per hour at 1,800 RPM. With the Cummins engine, ePower believes they’ll be able to run their existing generator at full capacity without difficulty.

Over the last several months ePower has been conducting fuel economy testing of their current tractor in the Cincinnati region. The topography is best characterized as gently rolling hills with grades of 1% to 3% and typical altitude changes of up to 300 feet. The fuel economy tests were conducted according to SAE J1321 protocols using multiple trips over several 40 to 46.5 mile routes with city, suburban and highway profiles. Data was recorded at average speeds of 55 and 59 mph and any results that deviated from the average by more than 5% were excluded.

The blue bars in following graph show the documented fuel economy of the ePower tractor with a variety of loads ranging from empty to fully loaded. The red blocks at the end of the current fuel economy bars represent ePower’s estimates of the incremental fuel savings that should be realizable with (1) the six cylinder Cummins engine upgrade, (2) automation of the charge control circuitry, and (3) integration of a rare earth permanent magnet generator.

For purposes of comparison, the graph also includes a single line for the national industry average across all weight classes and the goals of the DOE’s Supertruck program.

Since ePower’s ongoing work is by nature a research and development project, there can be no assurances that the planned tractor upgrades can be completed over the next several months or that the third generation tractor will meet current performance expectations.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock. Author has recently accepted an engagement to serve as legal counsel for ePower Engine Systems in connection with certain business planning and corporate finance activities.

The post What I Learned During Last Week’s Visit With ePower appeared first on Alternative Energy Stocks.

John Petersen

In late October I gave a keynote presentation at Batteries 2012, one of the largest lithium-ion battery conferences in the world. During the conference, I was buttonholed for a couple hours by the chairman’s global strategy team for one of the top three lithium-ion battery manufacturers in the world. They started by explaining that their Global 100 company is abandoning the plug-in vehicle market to focus on sensible applications where it can earn a reasonable margin. Then they started drilling down with a series of detailed and probing questions about whether any of the principal lead-acid battery markets might be an attractive opportunity for a company with their size, scale and stature.

While it may strike some of my readers as heresy, I told them that the lead-acid battery sector’s biggest vulnerability was in the rapidly evolving micro-hybrid market where industry leaders Johnson Controls (JCI) and Exide Technologies (XIDE) were focusing on the battery products they wanted to sell instead of the battery solutions their customers needed. After all, if legacy industry leaders won’t respond to changing customer needs, then it’s high time for new leaders that will respond.

The micro-hybrid revolution

Micro-hybrids are the most sensible automotive fuel efficiency technology imaginable. The primary goal of all micro-hybrids is simple: turn the engine off when it’s not powering the wheels. Last February, in a report titled “Every Last Drop: Micro‐ And Mild Hybrids Drive a Huge Market for Fuel‐Efficient Vehicles,” Lux Research segregated micro-hybrids into three broad classes:

• Light Micro-Hybrids, which reduce fuel consumption by about 5%, are typically compact and sub-compact cars that offer limited stop-start functionality and don’t have regenerative braking.
• Medium Micro-Hybrids, which reduce fuel consumption by about 10%, are sub-compact through full-size cars that offer greater stop-start functionality and may offer limited regenerative braking.
• Heavy Micro-Hybrids, which reduce fuel consumption by up to 15%, are usually mid- and full-size cars that offer the highest level of stop-start functionality, take full advantage of regenerative braking and offer a variety of advanced fuel economy innovations like high speed coasting.

While micro-hybrids are a new idea to most Americans, over half of new cars sold in Europe already use the technology and the U.S. is certain to follow suit over the next few years as automakers scramble to meet these short-term corporate average fuel economy standards.

This graph from Lux shows how the global micro-hybrid market is expected to evolve over the next five years and grow from about five million units in 2011 to almost forty million units a year by 2017.

On a regional basis, Lux forecasts that:

• The European micro-hybrid market will grow from over 4 million units in 2011 to 12.6 million units by 2017.
• The North American micro-hybrid market will grow from a standstill in 2011 to over 8 million units by 2017.
• The Japanese micro-hybrid market will grow from about 400,000 units in 2011 to over 6 million units by 2017.
• The Chinese micro-hybrid market will grow from under 300,000 units in 2011 to 8.9 million units by 2017.

It will be the fastest technology revolution in automotive history. The reason for the speedy ramp is simple. Micro-hybrid technology won’t be a consumer option. Instead it will be standard fuel economy equipment.

The mechanical changes required to implement micro-hybrid technology are simple and cheap. One big challenge is that a micro-hybrid turns its engine off at every stop and turns it back on when the driver takes his foot off the brake. A second and even bigger challenge is that automakers want micro-hybrid systems to be transparent to their customers. The accessories have to keep working when the engine is off and they can’t stutter or fade when the engine restarts. It’s an immense challenge for the conventional lead-acid batteries we’ve all come to know and hate.

This graph from BMW shows the typical load on a micro-hybrid battery during an engine off event and the subsequent charge recovery cycle.

The block on the left (in red) represents the engine off period. The accessories draw 575 watts of power for a minute (34,500 watt-seconds) and the starter draws an additional 3,600 watts for one second. The car doesn’t start re-charging the battery (in green) until it’s done accelerating. Once the battery has recovered, the car draws 80 watts of power for another minute (4,800 watt seconds) before the next engine off event. In total, the duty cycle requires the battery to deliver and recover 42,300 watt seconds of power per cycle. With an average of one engine off event per mile, a micro-hybrid will demand 654,000 watt-seconds from its battery during a 16 mile commute where a conventional car would only need 6,000 watt-seconds.

The bottom line is that micro-hybrids require their batteries to do 100 times the work and if the batteries can’t stand the strain, the mechanical systems can’t deliver the fuel savings. Micro-hybrid systems that fail quickly because of feeble batteries are nothing more than green-wash. The automakers understand that problem and over the medium- to long-term they can’t settle for less. There’s always a bit of regulatory rubber when new technologies are being introduced and refined, but once a new technology becomes widespread the regulators get far more demanding.

Legacy manufacturers’ initial response

Last week I wrote an exclusive article for Seeking Alpha that explained the differences between the two principal classes of lead acid batteries. It described flooded lead acid batteries as “Lead-acid 1.0” and AGM batteries as “Lead-acid 2.0.” It further explained that the various types of enhanced flooded batteries are the equivalent of
Lead-acid 1.x while various types of enhanced AGM batteries are the equivalent of Lead-acid 2.x. Since the analogy resonated deeply with many readers who were previously confused about the issue, I’ve decided to continue using that classification system.

This graph from a presentation at the recent European Lead Battery Conference shows what happens to the dynamic charge acceptance of three different types of AGM batteries over one year of simulated service using the BMW micro-hybrid duty cycle. The basic AGM battery, Lead-acid 2.0, is the blue line on the bottom. An enhanced AGM battery with graphite paste additives, Lead-acid 2.x, is the red line in the middle. A second type of enhanced AGM battery with expanded graphite and activated carbon paste additives, Lead-acid 2.x.y, is the green line.

A brand new AGM battery that can accept a 50 amp charging current will take 72 seconds to recover the energy consumed during an engine off cycle. A one-year-old AGM battery that can only accept a 10 amp charging current will take 430 seconds to recover that energy. A micro-hybrid that can turn the engine off once a minute will always save more fuel than a micro-hybrid that can only turn the engine off once every seven minutes.

This graph is the main reason I told the lithium-ion battery manufacturer that the lead-acid battery industry was vulnerable in the micro-hybrid market. Instead of recognizing and accepting the reality that Lead-acid 1.x and 2.x will never be suitable for micro-hybrids, the industry leaders were stubbornly promoting improved versions of legacy products that can’t provide the performance the automakers must have. Since my meeting in October the dynamic has gotten significantly better and if it continues, my concerns over vulnerability will rapidly pass.

Legacy manufacturers’ evolving responses

The last two months have been a fascinating time as the two biggest legacy manufacturers started to back away from their earlier insistence that Lead-acid 1.x and 2.x would be ideal solutions for micro-hybrids.

The first legacy manufacturer to soften it’s position was Exide Technologies, which announced a strategic alliance with Maxwell Technologies (MXWL) in mid-November. The two companies plan to jointly develop and market integrated battery-ultracapacitor solutions for a wide array of transportation and industrial applications. While the details remain sketchy, it appears that the Maxwell-Exide alliance will offer a micro-hybrid solution that’s similar to a system launched by Maxwell and Continental AG in the fall of 2010. That system pairs an AGM battery from Continental with a 2,400 Farad ultracapacitor module from Maxwell. The combination is reportedly very good at avoiding voltage sags and accessory fade when the engine restarts, but it can’t address the biggest energy drain in a micro-hybrid; the 60-seconds of accessory use during an engine off interval. Since the Maxwell-Continental system only addresses the engine restart loads, the problems with rapidly declining dynamic charge acceptance in the AGM battery remain and so do the performance deterioration issues.

The second legacy manufacturer to significantly change its position was Johnson Controls which surprised many during last week’s “Strategic Review and 2013 Outlook Analyst Presentation.” In that presentation the president of JCI’s Power Solutions unit came right out and said that Lead-acid 1.x and 2.x were not adequate solutions for heavy micro-hybrids. He then went on to explain that JCI was planning to launch an integrated lead-acid and lithium-ion battery solution that would use a 12-volt lead-acid battery for the engine start load and a 42-volt lithium-ion battery for the accessory loads. Curiously, JCI continues to claim that Lead-acid 1.x and 2.x will be ideal solutions for light and medium micro-hybrids even though those vehicles just have a milder case of the battery problems that plague heavy micro-hybrids. I expect that position to evolve into something more reasonable over the next couple years.

The emergence of Lead-acid 3.0

Over the last decade immense progress has been made in the development of an entirely new class of lead-acid battery that integrates components from conventional lead-acid batteries and supercapacitors into an entirely new class of device. These asymmetric lead-carbon capacitors, Lead-acid 3.0, use normal pasted lead-grids for their positive electrodes and sophisticated carbon electrode assemblies for their negative electrodes. One of these devices, the PbC battery from Axion Power International (AXPW.OB) has proven to be a very promising solution for the power demands of micro-hybrids. This graph from Axion’s recent presentation at the European Lead Battery Conference shows why.

While a top-quality AGM battery starts out with the ability to accept a 50 amp charging current but rapidly fades over the first year of service, the PbC is able to accept a 100 amp charging current for almost five years without degradation and its charge acceptance doesn’t fall into the 50 amp range for almost nine years. The PbC recently completed a three-year performance-testing regime at BMW, which has reportedly sent its results to a third-party for an independent peer review. The next logical step in the process will be fleet testing prior to a production decision. When BMW conducted fleet testing of AGM batteries for micro-hybrids in 2007, the work took six months. While testing of the PbC may take more time, it shouldn’t take much longer because there’s very little an OEM can learn in a car that it hasn’t already learned in the laboratory.

Three years ago the PbC was a promising dark horse contender in the battle for position in the micro-hybrid battery space, but it hadn’t proven its mettle in performance and validation testing by automakers. Today the principal validation and testing work has been completed and while there’s a chance that fleet testing will reveal issues that weren’t discovered in the testing laboratories, that possibility is remote. My inner optimist wants to believe fleet testing can be completed in time for a 2014 model year design win next September. My inner pragmatist thinks a design win for the 2015 model year is more likely.

The next likely steps

The recent actions of Exide and JCI evidence a dawning realization that the micro-hybrid revolution will require more robust and more costly energy storage systems than automakers are used to buying. In JCI’s strategic review Mr. Molinaroli spent a good deal of time discussing the economic constraints on battery manufacturers. He said that while consumers were willing to accept a three-year payback on fuel economy systems, they weren’t willing to pay more. That suggests that automakers will strive to reach the following price targets for the battery systems in the three classes of micro-hybrids assuming fuel savings of 5%, 10% and 15%, and gasoline prices of $3.50 and $4.00 a gallon.

These are challenging price points, particularly when you get into systems that integrate two different types of energy storage devices and have to design sophisticated control electronics to accommodate the differences.

In all probability, Lead-acid 1.x and 2.x will be the only viable solutions for light-micro hybrids because the price targets are so low. The most likely solution will be dual battery system that uses a flooded battery for the engine start loads and an AGM battery for the accessory loads. The probability that a single battery system will survive over the long term is remote.

The medium micro-hybrid space presents a significant challenge for both the automakers and the battery industry. The dual battery systems that are likely to dominate the light micro-hybrid space won’t be adequate for the heavier demands of medium micro-hybrids. In particular, the rapidly declining charge acceptance of Lead-acid 1.x and 2.x will preclude extensive use of regenerative braking which depends on the battery’s ability to rapidly accept a regenerative charge during a short braking interval. While the capabilities of integrated battery-ultracapacitor systems are better than dual battery systems alone, the medium micro-hybrid niche is a natural target for the PbC once it finishes the performance and validation testing process.

The heavy micro-hybrid space is shaping up as a battleground between the dual chemistry systems proposed by JCI and Axion’s PbC. Lithium-ion batteries have the high charge acceptance needed for large accessory loads and they can handle aggressive regenerative braking loads but they’re expensive and very complex, particularly when you get into higher voltage batteries that require extensive changes to existing automotive control and accessory systems. In the heavy micro-hybrid market, I believe the PbC will enjoy a significant cost advantage.

Who benefits and when?

I love talking about the intricacies of battery technologies but understand full well that the primary question in the minds of investors is “who benefits and when?” The short sweet answer is every company in the sector.

Automakers are building micro-hybrids today and they want to build more aggressive micro-hybrids next year and the year after that. The only battery manufacturers who have the near-term ability to satisfy the automakers needs for better energy storage systems are the legacy leaders JCI and Exide. Both of these companies can expect significant increases in their per vehicle revenues and margins over the next few years. The rapid revenue and margin gains already baked into the business cake but they’re not yet reflected in the stock prices. No matter how the micro-hybrid battery market develops, these legacy leaders will remain leaders for years to come.

Another near-term beneficiary is Maxwell which should see its ultracapacitor sales ramp rapidly as automakers strive to minimize voltage sags and accessory fade during engine restart cycles. The integrated AGM battery and ultracapacitor combination is not an ideal long-term solution to the dynamic charge acceptance problems that plague Lead-acid 1.x and 2.x, but it is a very good solution for automakers that want their micro-hybrid systems to remain transparent to drivers.

In the medium- to long-term, I believe Axion’s PbC presents the greatest upside potential and the greatest risk. OEM testing has proven that the PbC offers extraordinary performance in the micro-hybrid duty cycle. While the test results have been great, the critical steps of fleet testing and contract negotiation haven’t started yet, so the PbC is still a year or two away from a formal design win. First generation PbC batteries are relatively expensive, but the materials used in a PbC battery are no  more costly than the materials used in a conventional AGM battery. As Axion increases production from start-up volumes to credible commercial quantities, its opportunities for economies of scale and experience curve effects are tremendous. Over the longer term Axion wants to become a component supplier to the legacy leaders, rather than a competitor. While it will have to overcome a good deal of “not invented here” thinking, if the automakers demand the PbC’s performance, their battery suppliers will have no choice.

While pharmaceutical and biotech investors understand that stock values change rapidly when R&D stage companies advance from Phase II clinical testing to Phase III efficacy trials, unique new battery technologies are rare enough that the market hasn’t quite come to grips with the striking differences between where the PbC technology was in 2009 and where it is today. The last three years have been a veritable PR drought because there isn’t much to talk about while OEM testing is being conducted. That dynamic will change significantly over the next year as first tier OEMs and battery users in automotive, railroad, heavy trucking and stationary applications launch a series of large scale demonstration projects as a prelude to rapid commercialization.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

The post How The Micro-hybrid Revolution Will Radically Change The Battery Market appeared first on Alternative Energy Stocks.

John Petersen

Over the last couple weeks there’s been a lot of message board chatter about ePower Engine Systems, a transportation technology company that has selected the PbC® battery from Axion Power International (AXPW) for its series hybrid electric drivetrain for over-the-road freight haulers who drive heavy Class 8 tractors. Since I introduced ePower to Axion and have tracked their progress for a couple years, I called ePower’s CEO Andy Claypole to ask his permission to share what I’ve learned about ePower’s hybrid electric drivetrain.

After a series of phone calls and e-mails, Andy graciously sent me a technical presentation on ePower’s series hybrid drive and gave me permission to share the presentation with readers and discuss ePower and its technology in greater detail. Click here to download a copy of ePower’s presentation.

ePower Engine Systems LLC is a closely-held advanced transportation technology developer that’s using inexpensive off-the-shelf components to bring series electric drive, the mainstay of the nation’s rail transportation system, to highway transportation. Their goal is to narrow the fuel efficiency gap between 480 ton miles per gallon for railroads and 110 ton miles per gallon for heavy trucks.

In a truck with series electric drive, there is no mechanical connection between the engine and the wheels. Instead, the engine powers a generator and electricity from the generator powers an electric drive motor. This configuration maximizes fuel efficiency by running the engine at its optimal RPM and eliminates the need for complex heavy truck transmissions while delivering the instantaneous peak torque of an electric motor.

In furtherance of their goal to maximize fuel efficiency, ePower takes series electric drive a step further by sizing the generator for steady vehicle state operations at highway speed and using an array of 52 PbC batteries to provide additional power for acceleration and hill climbing, and increased energy savings from regenerative braking. The ePower drivetrain is a true series hybrid electric drive and a first for the trucking industry. The design is suboptimal for mountainous routes with substantial elevation changes, but it’s extremely efficient in flatter terrain.

While a typical Class 8 tractor operating in the US with an 80,000 pound gross vehicle weight achieves fuel economy in the 5.2 mpg range, the same truck with an ePower system will deliver fuel economy of 10 to 14 mpg, values that crush the DOE’s 2018 SuperTruck target of 6.8 mpg for conventional heavy trucks. It works out to an annual fuel savings of roughly 11,500 gallons per vehicle.

During the startup phase, ePower has focused on the retrofit market because around 37% of the 2.7 million trucks in the US-fleet are more than five but less than twelve years old. These trucks have outlived their original drivetrain warranties and are often less efficient than newer trucks, but they have substantial remaining useful life in their chassis, bodies and other components.

The cost of converting a tractor with a conventional diesel drivetrain to a series hybrid electric drivetrain is approximately $70,000 (batteries included) and ePower believes its retrofits will pay for themselves through fuel savings alone in 18 to 24 months.

Currently, ePower is doing all required retrofit work in its own facility. Once its system is fully developed and proven, ePower intends to provide the necessary conversion components in kit form for sale to certified installers including fleet operators and other service entities. It also hopes to license its technologies and systems upstream into the OEM market.

ePower’s original design used absorbed glass mat, or AGM, batteries to provide acceleration and hill climbing boost. Unfortunately, the AGM batteries were poorly suited to long-string use and ePower was not satisfied with the frequency of battery failures. The AGM batteries also tended to degrade rapidly, which impaired acceleration and hill climbing boost while diminishing the efficiency of regenerative braking systems. ePower believes the long-string behavior and high dynamic charge acceptance of Axion’s PbC battery will overcome both of these challenges.

The PbC batteries were delivered to ePower in mid-November and installed in swappable battery boxes that will give ePower the ability to switch back and forth between the old AGM batteries and the new PbC batteries in a couple of hours. During the first week in December, ePower plans to conduct a series of benchmarking tests to compare the on-road performance of the two battery systems in the same vehicle. It will then devote the rest of December to a road show for potential customers. In early January, the first PbC powered truck will be delivered to ePower’s customer and a second AGM powered truck will be brought back into the shop for a PbC upgrade.

I believe the ePower system is intriguing for several reasons. Firstly, it’s a frontal assault on fuel costs, the biggest expense burden in the trucking industry. Secondly, ePower’s initial marketing efforts are directed at medium to large fleet operators who are more inclined to assume the risk of testing an idea in real world conditions instead of devoting years to laboratory work. Thirdly, the ePower system is an extremely efficient use of batteries. Finally, it doesn’t take much market penetration in a million-unit fleet to represent a substantial revenue base for ePower and Axion.

If results from ePower’s prototype demonstrations are favorable, there is a significant likelihood that several large freight operators will purchase multiple retrofits for similar testing programs to determine where series hybrid electric drivetrain would fit into their operations. ePower’s series hybrid electric drive system is not a silver bullet solution for all truckers and all routes, but the economics can be very compelling for firms with established routes and schedules where a series hybrid electric drivetrain can do the required work at a lower cost.

Disclosure: Author is a former director of Axion Power International (AXPW) and holds a substantial long position in its common stock.

The post ePower’s Series Hybrid Electric Drive – Unmatched Fuel Economy for Heavy Trucks appeared first on Alternative Energy Stocks.

John Petersen

Last week Debra Fiakas of Crystal Equity Research published an article titled “No Battery Producer Left Behind” that was based on old information about the relationship between Exide Technologies (XIDE) and Axion Power International (AXPW) and reached several erroneous conclusions. Since I’m a former Axion director, the stock is my biggest holding and I follow the company like a hawk, Tom Konrad asked me to clarify the record and present a high level overview of Axion’s business history, stock market dynamics and technical accomplishments over the last four years.

Since Tom’s request is a tall order, the article will run longer than usual, but it will tie together several themes I’ve discussed in the past.

Axion’s price chart since September 2009 has been a vision from investor hell. However, I believe the market performance is 180 degrees out of synch with technical and business realities. I’ve been an Axion stockholder for nine years and my average cost per share is in the $1.25 range, but I’ve never felt better about my risk-reward profile than I do today.

Business History

Axion was organized in September 2003 for the purpose of conducting basic research and development on a new lead-carbon battery technology. Axion’s PbC® battery is a third generation lead-acid battery that eliminates the primary cause of lead-acid battery failure, the rapid accumulation of lead sulfate crystals on the negative electrodes. It does this by replacing the lead-based negative electrodes with carbon electrode assemblies. The PbC battery is basically a hybrid device that’s half lead-acid battery and half supercapacitor. It has a number of unique performance characteristics, including:

• Lower energy density (±25% to 40%) because carbon stores fewer ions than lead;
• Five to ten times the cycle life because carbon electrodes eliminate sulfation;
• Ten to twenty times the charge acceptance because carbon electrodes act like supercapacitors; and
• Self-equalization in long battery strings that reduces the need for complex battery management systems.

Unlike most R&D companies, Axion went public at a very early stage because there were several groups that claimed partial interests in the technology and the only way to consolidate ownership was in a publicly held entity. Like most R&D projects, expectations were high at the outset but faded over time as the challenges of developing a completely new battery technology and proving its value to cautious and skeptical users became clear. The process took far longer than we thought it would, but the market potential turned out to be far greater we originally anticipated.

From 2003 through the spring of 2009, Axion’s R&D efforts focused on optimizing the performance of its materials and components, designing an electrode assembly that could be used as a plug-and-play replacement for the conventional lead based electrodes used in battery plants around the world, developing automated manufacturing methods for the electrode assemblies and characterizing the performance of manufactured pre-commercial prototypes.

The first clear sign of R&D success arrived in April 2009 when Axion entered into a multi-year global supply relationship with Exide. The second and more convincing sign of R&D success arrived in August 2009 when the Department of Energy awarded a $34.3 million ARRA battery manufacturing grant to “Exide Technologies with Axion Power International” for the purpose of producing “advanced lead-acid batteries, using lead-carbon electrodes for micro and mild hybrid applications.”

The market reacted well to both events and in August 2009, Axion’s stock price peaked at $2.75 per share while its market capitalization peaked at $97 million. It’s been a long downhill slide ever since.

Axion’s relationship with Exide was always complicated because of size disparities. As an R&D company Axion ran a tight ship and in April 2009 it had $8.4 million in assets, $6.1 million in equity and  $1.8 million in annual revenue. Exide, in comparison, had $1.9 billion in assets, $326 million in equity and $3.3 billion in annual revenue. The ARRA grant made a complicated relationship more difficult because Exide didn’t want to share the grant proceeds without extracting a pound of flesh and Axion believed its technology was the fundamental justification for the DOE’s decision. By the summer of 2010 it was clear that Axion and Exide had different visions and would be following different paths. Current relations between the two companies are competitively cooperative, but far from close.

Stock Market Dynamics

While Axion’s technical prospects were bright in the fall of 2009, its financial condition was grim. In its Form 10-Q for the period ended September 30, 2009, Axion reported $283,000 in working capital and $3.6 million in adjusted net assets. With the equity markets still reeling from the impact of the 2008 crash, there was substantial doubt about Axion’s ability to survive another quarter. Those uncertainties persisted until late December when Axion announced a $26.1 million private placement of common stock that saved it from imminent collapse and gave it a sound financial footing for the first time in its corporate history. Axion’s 10-day moving average price was $1.65 before the offering and the deal was priced at $0.57, a painful 65% discount. The deal terms were hard, but they weren’t unfair for a private placement transaction of that magnitude.

I was thrilled when the 2009 private placement came together because 70% of the stock was bought by four big investors who each acquired blocks that were roughly equal to Axion’s total reported trading volume for 2009. When one big investor takes 70% of a deal, you need to worry about the stock flowing back into the market. When four big investors split 70% of a deal and they each buy blocks that represent a full year’s trading volume, it’s generally safe to assume that they’re swinging for the fences and the shares won’t flow back into the market for years. Unfortunately, things didn’t quite work out according to plan.

The market reacted reasonably to the 2009 private placement and during the month immediately following the offering, the price drifted down into the $1.15 range. Based on my prior experience with substantial private placements by public companies, it looked like the market was reacting normally and the retail price for liquid thousand-share blocks would stabilize at roughly twice the placement price for illiquid million-share blocks.

Axion’s market dynamic started to get ugly in late-April and early-May when liquidation trustees for two legacy stockholders that held a combined total of 3.5 million shares started to aggressively compete for buyers by dropping the offering price in a market that traded about 45,000 shares a day. By mid-July, the stock price had fallen by 50% while the average daily volume doubled. That price decline spooked other stockholders and increased the selling pressure, which drove the stock price to new lows. The extraordinary selling pressure continued in 2011 and 2012 as one large stockholder after another began to liquidate their positions for reasons ranging from secondary repercussions of the 2008 crash, to fund management changes and even an accidental death. As a result, the annual trading volume progression over the last four years was:

Axion may have been a very illiquid stock that traded by appointment in 2009, but it has developed a solid liquidity base over the last three years. More importantly, information from SEC reports filed by certain large holders combined with daily short sales data published by FINRA has left me highly confident that substantially all of the Axion shares that were previously held by large stockholders who wanted to sell have been absorbed by retail investors who did their homework, climbed their personal walls of worry and accumulated shares despite Axion’s dismal market performance. While market activity over the last three years has been dominated by a few large holders that were willing to sell at any price, I believe the future market will be dominated by a large number of retail investors who were greedy when others were fearful and bought Axion’s stock based on the fundamental economic potential of the PbC technology.

Technical Accomplishments

Axion’s basic research and development work on the PbC technology was substantially complete by the end of 2009. It had advanced the PbC technology from a glorified science fair project to a manufactured pre-commercial prototype that was suitable for delivery to potential customers who wanted to conduct their own testing and determine whether the PbC battery suited their needs. Axion used a portion of the proceeds from the 2009 offering to build a fully automated second generation production line for its carbon electrode assemblies and upgrade its principal manufacturing facility, but most of the proceeds were used to support customer testing activities and pay for a variety of demonstration projects in the new evolving markets summarized below.

Automotive Idle Elimination Systems In response to new emissions control and fuel economy regulations, the auto industry is in the midst of a fuel economy renaissance. The world’s automakers are all implementing proven fuel economy technologies at a torrid pace on a fleet-wide basis. One of the most cost-effective fuel economy systems available to automakers is also one of the most sensible – turn the engine off while a car is stopped in traffic and restart it automatically when the driver takes his foot off the brake. Depending on the manufacturer, these stop-start or micro-hybrid systems improve fuel economy by 5% to 15% for a few hundred dollars in incremental cost.

The biggest challenge of idle elimination is that powering accessories during engine off periods and restarting the engine when the light changes puts tremendous strain on the battery and today’s best starter batteries simply aren’t up to the task. The batteries begin to degrade as soon as they’re placed in service and within a few months a car that turned the engine off at every light when it was new can only turn the engine off once or twice during a commute. Idle elimination systems that don’t function properly because of weak batteries can’t save fuel.

In the summer of 2009 Axion began quietly working with BMW, which wanted to test the PbC battery for possible use in its mainline vehicles with the EfficientDynamics fuel economy package. The first 15 months of testing were conducted in deep secrecy. Axion’s stockholders didn’t learn about the existence of the BMW relationship until September 2010 when Axion and BMW jointly presented the preliminary results of their testing at the European Lead Battery Conference in Istanbul.

The following graph is an updated and annotated version of the graphs Axion and BMW used in 2010 to show the superiority of the PbC battery in a stop-start duty cycle. They grey lines relate to the left-hand axis and show changes in the dynamic charge acceptance of the batteries as they age. The black lines relate to the right hand axis and show the amount of time the batteries needed to recover from one engine off event in preparation for the next engine off opportunity. As you look at the graphs, it’s important to remember that:

• The “Charge Time” scale for the AGM graph is 10x the scale for the PbC, and
• The “Equivalent Drive Time” scale for the AGM is stated in months while the PbC scale is stated in years.

BMW completed its laboratory and vehicle testing of the PbC this summer and was pleased enough with the results that it hired an independent testing organization to confirm them. If the confirmation testing is successful, Axion believes the next logical step will be fleet testing to demonstrate the PbC’s performance in a variety of climate and traffic conditions. Based on the stellar results BMW obtained during its three-year testing and validation program, several other automakers have skipped the preliminaries and gone directly to advanced testing of the PbC for their idle elimination systems.

While US automakers are just beginning to implement idle elimination systems, industry consensus holds that the technology will be used in 34 million vehicles a year by 2015 and substantially all internal combustion engines by 2020.

Battery-Powered Locomotives Freight and passenger railroads in the US use roughly 3.7 billion gallons of diesel fuel per year, which gives them a huge incentive to reduce their operating costs by using fuel more efficiently. Moreover, like other transportation sectors, the railroads are subject to increasingly stringent emissions regulations, particularly for rail yards in urban areas. In 2007 Norfolk Southern (NSC) launched an ambitious program to develop a battery-powered locomotive that could be used as a switcher in urban rail yards, or combined with conventional locomotives to create a hybrid train that would use battery power to augment the conventional locomotives during acceleration and hill climbing and recover a portion of the energy that’s currently wasted in braking and downhill grades. Since NS used 476.6 million gallons of diesel fuel in 2011, it believes the potential economic and environmental benefits of battery-powered locomotives are extremely attractive.

In September 2009, NS introduced its first battery-powered switching locomotive, the NS 999. While the early demonstrations showed that the NS 999 could do the required work, the AGM batteries they selected for the locomotive were not able to withstand the tremendous regenerative braking loads of a switching locomotive. When the original batteries quickly failed, NS began its search for a better energy storage alternative. After discretely testing hydrogen fuel cells and nickel metal hydride, lithium iron phosphate, sodium beta and a variety of lead-acid batteries, NS decided that Axion’s PbC battery was best suited to its particular needs. Axion announced the initiation of a development relationship with NS in June 2010.

Over a period of two years, NS conducted a grueling sequence of performance tests using its in-house development staff, Penn State University and Axion to obtain double redundant results. In addition to showing that the PbC could handle the regenerative braking loads from a battery-powered locomotive, the testing program also explained why the first generation prototype failed.

Whenever conventional batteries are connected in series, the resulting battery string is only as strong as its weakest link and as the string ages the differences between batteries get harder to control. Unlike all othe
r batteries, strings of PbC batteries tend to self-equalize over time because of their unique charging behavior. The following graph highlights the differences between the long-string performance of conventional AGM batteries and Axion’s PbC batteries.

In April of this year, NS ordered $475,000 of PbC batteries for their planned rebuild of the NS 999. Their goal is to have the locomotive working this winter. Upon completion of the NS 999 rebuild, NS plans to build a larger six-axle locomotive for testing in long haul hybrid train applications. If the two planned prototypes perform as expected, the next logical step will be statistically valid fleet testing throughout the NS system. Norfolk Southern’s locomotive fleet includes 240 switching and auxiliary units and 3,900 multipurpose units. Collectively, the nation’s Class I railroads operate a total of 23,500 locomotives.

Stationary Storage Products In November 2011 Axion commissioned its PowerCube stationary energy storage system. While stockholders knew that the product was being developed, they didn’t know that Axion, in cooperation with Viridity Energy, had taken all necessary actions to qualify the PowerCube as a behind the meter frequency regulation resource in the PJM Interconnection, the regional transmission organization for Pennsylvania and twelve other States. In September 2012, Axion unveiled a small version of the PowerCube for residential and small commercial customers.

Over the last couple years grid-based energy storage has become a hot topic and most battery manufacturers are launching products for utilities, renewable power producers and commercial and residential power users. It’s an intensely competitive market where the principal differentiators are likely to be reliability, total cost of ownership and customer service. Axion’s stationary storage systems perform well and respond in milliseconds, but they don’t necessarily perform better than products from Axion’s competitors. The self-equalizing behavior of PbC batteries in long string applications should be as attractive in stationary systems as it is in rail applications.

As near as I can tell the key features that will differentiate Axion’s products are low maintenance and user-centric design. Axion developed the PowerCube in cooperation with Viridity with the primary goal of maximizing the economic benefit to commercial users who want to reduce their power costs while avoiding costly interruptions. Similarly, Axion developed its residential PowerHUB in cooperation with Rosewater Energy with the primary goal of optimizing performance and minimizing maintenance for small-commercial and high-end residential customers who need reliable, stable and clean power for their sophisticated security, entertainment, climate control and other electronic systems.

Trucking Industry Products In October of this year, Axion made a presentation at the SAE’s Commercial Vehicle Congress in Chicago that outlined its plans to introduce specialty products for the trucking industry. The first planned product will be battery systems for the auxiliary power units that are quickly becoming industry standards as most states adopt laws and regulations to restrict idling while trucks are parked for driver rest periods. To date, industry experience has shown that AGM batteries fail quickly in APUs and a better solution is needed. Axion’s SAE presentation used this graph to highlight the performance differences between AGM batteries and PbC batteries over a six-month period in a simulated APU duty cycle.

The primary target-market for APU battery systems is the 650,000 heavy-duty trucks that haul the nation’s freight. In 2006, the average long-haul truck idled for 6 hours per day and total national fuel consumption in idling trucks was estimated at 665 million gallons, or a little over 1,000 gallons per truck. Fuel costs alone make four-battery APUs a compelling economic proposition.

In its SAE presentation Axion said that it planned to begin field testing of PbC-based APU systems by 2013, which suggests that a formal announcement of the testing program and its development partner will be made in the next few weeks. Since the SAE presentation used Freightliner’s ParkSmart System as an example of the target market, I think there’s a pretty good chance that Freightliner will be the development partner.

A second trucking initiative Axion briefly discussed in their last conference call was the shipment of 52 PbC batteries for a prototype Class 8 tractor that combines a small diesel engine with a series hybrid drive to deliver fuel economy in the 12 to 14 mpg range, as opposed to the 5 to 6 mpg performance that’s currently prevalent in the industry. Preliminary test data from this project is expected this year.

Risks and Uncertainties

Production Capacity Axion’s electrode fabrication line was designed to produce enough electrodes for about 150 batteries per shift. While Axion has not disclosed its cost of building and installing the production line, news stories and financial statement disclosures lead me to believe an estimated cost of $3 million per line is reasonable. By the time you account for efficiency differences in a multi-shift operation, I’d estimate the maximum capacity of the single electrode fabrication line at 350 batteries per day, which is adequate to support testing and evaluation activities, but inadequate for commercial sales. When demand for PbC batteries increases, Axion will need up to $50 million in additional capital to expand its electrode fabrication capacity from 350 to 3,500 PbC batteries per day.

Production Costs Axion’s electrode fabrication capacity is very limited, which means that it has no significant negotiating power with suppliers and the fixed costs of its electrode fabrication facility are spread over a small number of units. In combination, these factors make current versions of the PbC objectively expensive. I’ve done some back of the napkin calculations on the bill of materials for a PbC battery and compared those numbers with the bill of materials for an AGM battery. The bottom line is basically a wash when you substitute ounces of expensive carbon for pounds of cheaper lead. Once demand for PbC batteries ramps, Axion should enjoy a stronger bargaining position with suppliers and derive substantial savings from the more efficient utilization of its physical plant. Additionally, the current electrode fabrication line is a second-generation version. As Axion works its way down the normal learning curve for manufacturing enterprises, additional cost savings are almost certain to arise. While management has scrupulously avoided making promises about future cost reductions, the opportunities for real and substantial economies of scale cannot be overlooked.

Anticipated Financing At September 30th, Axion had $4.2 million in cash, $6.8 million in working capital and $13.3 million in stockholders equity. It will require additional operating capital by the end of Q1-2013. Axion’s Form 10-Q disclosed that management is currently seeking additional capital from sources that are in alignment with its business objectives and long term strategy. During the recent conference call, the CEO explained that the next financing transaction would probably be a 2013 event and disclosed that the investors who provided $8.6 million of additional capital in February of this year are willing to participate in another round if an appropriate strategic partner is not identified. Since the terms of a future offering will not be negotiated until immediately prior to closing, they’re a significant uncertainty.

Investment Conclusions

In a no
rmal case I would have expected Axion’s stock price to stabilize in the $1.15 range after the 2009 offering. I would also have expected the price to slowly appreciate from that base level in response to the following significant technical accomplishments:

• The June 2010 announcement of a relationship with Norfolk Southern;
• The September 2010 announcement of a relationship with BMW;
• The November 2011 commissioning of the PowerCube as the first behind the meter frequency regulation resource in the PJM Interconnect;
• The decision to use the PbC in Norfolk Southern’s battery powered locomotive prototypes;
• The successful completion of BMW’s testing activities; and
• The September 2012 launch of the residential PowerHUB;

While each of these events would have been big news in a typical micro-cap company, they didn’t register on Axion’s price chart because of the extremely unusual market dynamics that prevailed when the announcements were made. While Axion’s stock has been “broken” for the last three years, I believe the market dynamic that caused the problem has been resolved and the only thing that’s holding the stock at present levels is fear that higher prices will only give rise to another round of heavy selling. After three years of unrelenting selling pressure despite an increasing body of proof that the PbC is an extraordinary new battery technology, I understand the fear. I also know that Axion has arrived at a key transition point and is poised to shed the R&D company market dynamic that prevailed for the last nine years as the PbC earns a place in several billion-dollar niche markets where competitive battery technologies simply can’t do the work.

Most R&D companies that enter the valley of death never emerge. For the fortunate few that do, the hard times last longer than anyone expected. The one trait all entrepreneurs share is unbridled optimism. The three traits all survivors share are determination, focus and fiscal restraint.

After nine years of hard work, adversity and limited financial resources, I believe Axion has finally arrived at the “Innovation Trigger” for the next stage in its development.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

The post Axion Power – A Battery Manufacturer Charging Forward appeared first on Alternative Energy Stocks.

John Petersen

In late June I wrote a forward looking article that identified several companies in my energy storage and vehicle electrification group that I expected to perform well or perform poorly during the third quarter. Since short-term market changes are notoriously hard to predict, it’s worthwhile to look back and see where I got things right and where I got them wrong. So I’ll start today with a quick summary table and assess the relative accuracy of my Q3 calls, and then turn my attention to Q4, which is shaping up as a time of bright opportunity for some companies and continuing risk for others.

My list of expected Q3 winners included Exide Technologies (XIDE), Active Power (ACPW) and Axion Power International (AXPW.OB). I was wrong on all three counts because Active Power lost 1.2%, Exide Technologies lost 7.7% and Axion Power lost 20.6%

My list of expected Q3 losers included Valence Technologies (VLNCQ.PK), which lost 98.4% when it filed a voluntary petition under Chapter 11 of the Bankruptcy Code, and Tesla Motors (TSLA), which lost 6.4%. While I was right on both counts, Tesla didn’t perform as poorly as I expected and just last week it completed a $195 million secondary offering that should keep it out of the ditch for a couple more quarters. While I rarely have glowing praise for Tesla’s business model or product line, its management team deserves double kudos for pulling off a critical eleventh hour financing transaction on better terms than I would have thought possible.

Q-4 Winners

Exide Technologies was on my list of likely Q3 winners and it remains on my list of likely Q4 winners. Over the last five years, Exide has reported total earnings of roughly $35 million after restructuring and impairment charges of almost $210 million. Since its earnings were so bad for so long, Exide trades at a 10% discount to book value and 8% of sales while its peers trade at an average of 1.6 times book and 44% to 70% of sales.

I maintain long-term price tracking charts on all the companies I follow and believe Exide’s chart is signaling a turn to the upside in the fourth quarter. If you look at the chart you’ll see that the 10-, 20- 50- and 200-day weighted moving average prices are clustered in a $0.13 range and during the third quarter the 10-, 20- and 50-day averages all moved up through the 200-day average, signaling the beginning of a new trend. Similar chart patterns existed in the summer of 2009 and the fall of 2010. While I’d be reluctant to estimate the next peak, Exide’s past performance is enough to convince me that a double is likely and a good deal more is possible.

Active Power was on my list of likely Q3 winners and it remains on my list of likely Q4 winners. Since the end of June the 10-, 20-, 50- and 200-day averages have all drifted down a couple cents and are currently clustered in a two-cent range. Active Power’s historical stock price behavior is enough to convince me that a double is likely, if not a triple.

Axion Power International was on my list of likely Q3 winners and it remains on my list of likely Q4 winners. The last couple years have been very difficult for Axion as one legacy holder after another decided to liquidate for reasons that had little or nothing to do with Axion’s business and technical progress. As near as I can tell the legacy holders, as a group, are down to something less than a million shares. Since much of the buying over the last couple years has come from readers of my blog, I expect the market dynamic to quickly reverse from a supply driven downtrend to a demand driven uptrend. In addition to price data like I provided for Exide and Active Power, my Axion chart includes a fifth line that tracks 50-day average trading volume to highlight periods of intense selling pressure since January 2010.

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Last week I had the pleasure of delivering a keynote presentation for the 13th European Lead Battery Conference in Paris. For readers who are interested, an online version of my ELBC presentation with voiceover is available here.

While other lead battery manufacturers who presented at the ELBC talked about improving their charge acceptance rates from 0.05 to 0.1 amps per amp-hour of rated capacity, Axion was presenting charge acceptance rates of 2.0 to 3.0 amps per hour of rated capacity with four to five times the cycle life. These are not modest incremental gains like one typically sees in the battery world. Instead, they’re disruptive step changes that have several first tier OEMs and battery users making substantial direct investments in the kind of redundant validation testing that always precedes the adoption of a new technology for use in mass market products. While Axion’s PbC is not a silver bullet for all battery applications and the company still faces a variety of manufacturing, commercialization and financing risks, the principal technical risks of developing an entirely new class of energy storage device have, in my view, been successfully overcome.

In addition to my three primary picks, I’m seeing interesting chart patterns develop for Altair Nanotechnologies (ALTI), Johnson Controls (JCI), Maxwell Technologies (MXWL) and UQM Technologies (UQM). The stock prices for all four of these companies have been beaten down this year and could well be poised for a turnaround.

Q-4 Losers

The scariest company in my tracking list is A123 Systems (AONE) which peaked shortly after its IPO and has been on a downhill slide ever since. In May and June of this year, A123 announced a pair of toxic financing deals that had variable conversion rates and seemed likely to be highly dilutive. In August A123 announced that China’s Wanxaing Group had agreed to provide up to $450 million of additional financing in exchange for an 80% ownership stake. The combination of these three transactions has had A123 printing stock faster than the Fed prints money ever since.

On June 30th A123 had a total of 147 million shares outstanding. By August 6th the total had climbed to 170 million and by August 23rd the total had climbed to 202 million. The reason for the explosive ramp in the number of shares outstanding was a decision to leave the toxic securities in place, instead of redeeming them, and to alter the terms of the Wanxaing financing to provide for a variable conversion rate that’s tied to a percentage of ownership rather than a fixed stock price.

During the period from June 30th through August 23rd, total reported trading volume in A123’s stock was 305 million shares, or roughly 5.5 times the number of newly issued shares. Since August 23rd, another 491 million s
hares have traded. Since it’s impossible to tell whether the proportionality between new share issuances and total trading volume has held steady over the last three months, it’s also impossible to estimate the total number of shares currently outstanding. At a minimum I’d expect A123 to report 300 million shares outstanding on September 30th, but the actual number could be far higher. Based on the terms disclosed for the Wanxaing transaction, that would imply a fully diluted share count in the 1.5 billion range.

In light of the production problems it’s experienced to date and a recent brush with insolvency that will be clearly visible on the face of its September 30th financial statements, I continue to believe that Tesla Motors will soon pass its peak of inflated expectations and begin a descent into the Valley of Death that resembles the A123 experience. I don’t want to denigrate Tesla’s accomplishments as the first fledgling automaker to bring a new car to market since DeLorean, but it seems like all of the possible good news is already priced into Tesla’s stock while the bulk of the execution risks and disappointment opportunities have become frighteningly imminent.

I get hundreds of comments every time I mention Tesla’s name. The enthusiastic readers I hear from expect rave reviews, expect high reservation conversion rates, expect demand to skyrocket, expect the Model S to perform flawlessly in heavy daily use and expect Tesla to avoid the delays, defects and missteps that plague even seasoned manufacturers who launch a completely new product. I may be cynical when it comes to the applicability of Moore’s Law in the battery and auto industries, but I’m a firm believer in Murphy’s Law, fondly known as the fourth law of thermodynamics, which states: “If anything can go wrong, it will.”

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

The post Energy Storage: Q4 2012 Winners and Losers appeared first on Alternative Energy Stocks.

John Petersen

On Wednesday A123 Systems (AONE) announced the execution of a Non-binding Memorandum of Understanding with the Wanxiang Group that will, if successfully implemented, restore A123 to a sound financial footing. Since the basic deal terms are a good deal more complex than the reports one reads in the mainstream media, I think a drill down into the detail may be helpful for investors who want to understand what a restructured A123 will look like. The critical document for this analysis is the MOU included as Exhibit 99.2 to A123’s recent report on Form 8-K.

The basic business deal has three distinct structural elements:

• A $75 million senior secured bridge loan facility with associated warrants;
• A $200 million senior secured convertible note financing; and
• A block of warrants that will, if exercised, generate up to $175 million of additional equity.

The bridge loan facility will be secured by substantially all of A123’s assets and has been separated into two tranches. The first $25 million, which includes $15 million in cash and a $10 million letter of credit, will be immediately available to A123 upon execution of definitive agreements. The $50 million balance will be funded when certain first tier conditions are satisfied, including:

• receipt of a favorable determination from the Committee on Foreign Investment in the United States;
• receipt of Chinese government approvals;
• retention of the R&D and engineering teams; and
• other usual and customary conditions.

Barring a mass exodus of the R&D and engineering teams, I think there’s a high probability that the entire $75 million bridge loan facility will become available to A123 over the next couple months; Wanxiang will obtain a reasonable level of de facto control; and A123 will get enough breathing room to finish a more comprehensive restructuring.

The senior secured convertible note financing will be more complicated and time consuming. Wanxiang’s commitment to buy $200 million in notes is subject to several second tier conditions, including:

• reasonable assurances that A123’s government grants and tax credits will remain available;
• stockholder approval of the restructuring transaction;
• conversion or repurchase of at least 90% of $143.8 million in convertible notes that were issued in April 2011;
• conversion or redemption of the $50 million in convertible notes that were issued in May 2012;
• an increase of the number of directors from seven to nine and the election of four directors designated by Wanxiang;
• compliance with Hart-Scott-Rodino and other antitrust laws; and
• continued listing of the Common Stock on Nasdaq.

It’s clear from the MOU that the retention of A123’s government grants and tax credits is a critical valuation issue. If the grants and credits remain in place, the exercise price of the bridge financing warrants will be $0.425, but the exercise price will be reduced to $0.17 if the grants and tax credits are lost. Similarly, the conversion price of the senior secured notes and the exercise price of the related warrants will be $0.60 per share if the grants and tax credits remain in place, but they’ll both be reduced to $0.24 if the grants and tax credits are lost.

Under the circumstances, I think A123 will probably get the necessary government assurances and approvals. It should also be able to negotiate the redemption or repurchase of its outstanding debt on reasonable terms. While investors may grumble, particularly if the proxy statement for the required stockholder approvals includes a reverse split to solidify A123’s Nasdaq listing, there really isn’t an alternative so they’ll eventually go along.

While the series of transactions have been described as a $450 million rescue in media reports, the only funds Wanxiang will be required to invest are $75 million for the bridge loan facility and $200 million for the senior secured convertible notes. If one assumes that no additional shares will be issued in connection with A123’s outstanding convertible debt, the bridge loan warrants will give Wanxiang the power to obtain 51% voting control by tendering that debt in payment of the exercise price. While conversion of the notes would increase Wanxiang’s voting control to 75% if it chose to exercise its rights, a reasonable risk manager could conclude that voting control coupled with $200 million in secured debt was a more advantageous position for Wanxiang given the uncertainties of A123’s business.

I’ve always believed that prudent investing begins with a worst case analysis. In the A123 – Wanxiang transaction I believe the worst case is a $75 million equity infusion that will increase A123’s book value to $188.8 million, or $0.544 per share, and give Wanxiang voting control. While the $200 million senior secured convertible note financing will increase A123’s liquidity, a substantial portion of the cash will be used to redeem or repurchase A123’s other debt securities.

I believe it’s safe to assume that the holders of the $143.8 million in convertible unsecured subordinated notes that A123 issued in April 2011 will be willing to accept a haircut in connection with an early redemption. I don’t, however, have any basis to predict what the haircut might be. While holders of the $50 million in convertible unsecured senior notes that A123 issued in May 2012 might also be willing to accept a haircut in connection with an early repayment of the $39.6 million balance, I’d expect their negotiating position to be more aggressive. In a worst case scenario, the bulk of the $200 million in proceeds from Wanxiang’s senior secured convertible note financing will be used to retire junior debt.

On balance I believe the Wanxiang transaction is a positive development for A123’s stockholders because it will stop the issuance of additional common shares under the 2012 notes and help alleviate the intense selling pressure that’s resulted from the issuance of 23.4 million new shares since June 26th. It will also restore A123’s stockholders equity to a more reasonable level and give the company time to restructure its affairs. The transaction is not, however, a permanent solution to A123’s problems and any number of uncertainties are yet to be resolved.

While I don’t see anything in the deal structure that would justify a rush to the exits. I believe investors who decide to hold or buy A123’s stock must pay careful attention to future releases that quantify the current uncertainties. This is not a good time for irrational exuberance.

Disclosure: None.

The post The Wanxiang Transaction Is Not Necessarily A Permanent Solution For A123’s Problems appeared first on Alternative Energy Stocks.

John Petersen

July has been a ghastly month for stockholders of A123 Systems (AONE) who’ve watched in horror as the stock price collapsed from $1.30 on July 5th to $0.49 at Friday’s close. While there was unfavorable news of a director resignation yesterday, all the other news over the last month has been positive, at least at first blush. In my view the market activity was both predictable and directly attributable to recent toxic financing transactions that will have A123 printing stock faster than Ben Bernanke is printing dollars for the foreseeable future. I’d love to be able to tell A123 stockholders their pain is over, but it’s not.

Toxic note and warrant financing

On May 11th, A123 announced that it had closed a $50 million offering of convertible notes and warrants. The principal was payable in 26 semi-monthly installments commencing on July 1, 2012 and could, at the company’s option, be settled with cash or with shares of A123’s common stock valued at the lesser of $1.18 per share, or 82% of the volume weighted average price, or “VWAP,” of the common stock for the five trading days immediately preceding a settlement date, but in no event greater than the VWAP of the common stock on the last trading day before the settlement date.

Since the number of shares issuable upon conversion of the notes and exercise of the warrants exceeded the limits of A123’s Certificate of Incorporation and the transaction required formal shareholder approval under Nasdaq listing rules, $30 million of the offering proceeds were deposited in a segregated bank account pending:

• Stockholder approval of the note and warrant transaction;
• Stockholder approval of an increase in the company’s authorized shares; and
• Effectiveness of a resale registration for the common shares underlying the notes warrants.

The necessary stockholder approvals were received on June 29, 2012 and the resale registration statement was declared effective as of 4:00 p.m. on July 5th. By the time the registration statement was declared effective, the payment terms had been modified slightly to increase the number of installments to 29 and increase the amount payable in each of the first three installments to 1-2/3 the base amount, but the other terms remained unchanged. The segregated funds were promptly released to the company.

The notes are a classic example of “death spiral financing” where payments are made with discounted shares of common stock and the number of shares required for a payment increases as the stock price declines. At an assumed stock price of $1.30 a share, A123 would be able to make a $2 million installment payment by issuing 1,876,173 new shares of common stock. At an assumed stock price of $0.65 a share, it would take 3,752,345 new shares of common stock to make the same $2 million payment. In both cases, the market value of the stock used to make the payment would be about $2.4 million, but only if the noteholder who received stock instead of cash sold quickly enough to capture the current market price.

Toxic equity financing

On July 6th A123 announced that it had signed agreements to sell 7,692,308 shares of its common stock, together with warrants to purchase additional shares of common stock, for gross proceeds of $10.0 million. While the press release had the look and feel of an ordinary financing transaction, I was troubled by a sentence that said, “The number of shares of Common Stock issuable upon exercise of the warrants (which have a nominal exercise price) is based on a fixed 18% discount to the volume-weighted average price, or VWAP, of our common stock on specified trading days during two measurement periods over the next three weeks.” Since I was surprised that the offering went off without an obvious discount to the previous day’s closing price, I decided to dig a little deeper in an effort to better understand what the “real deal” was.

I found my answers in the SEC registration statement for the equity offering, which included copies of the Prospectus and the associated warrant agreement.

When I read the Prospectus I learned that the “nominal exercise price” of the warrants was $.001 and the structure included an automatic cashless exercise for the warrants. So the investors were effectively buying 7.7 million shares on day one and expecting to receive two additional tranches of “free shares” on the 12th and the 30th of July.

Using the formulas in the Prospectus and warrant agreement, I calculated that 843,628 additional shares would be issued in each tranche if the market price remained stable at $1.30 per share through the exercise dates. By the time I accounted for the warrants, it was clear the original deal would result in the issuance of 9,379,564 shares for gross proceeds of $10 million, or an effective price of $1.07 per share.

In light of A123’s recent troubles, I didn’t find a discount of 18% from the market price particularly troubling. I was, however, concerned that the terms might create an incentive for aggressive investor behavior, so I made a mental note to re-run the numbers at the end of the month to see how it all worked out.

The outcome was a textbook example of what can happen when the number of shares to be issued in the future is contingent on the future market price of the underlying stock.

During the period between the closing date and the first warrant exercise date, A123’s price fell to $0.88. So the VWAP used to calculate the number of free shares issuable to warrantholders was approximately $0.9167 instead of $1.30. When I ran that VWAP value through the calculations specified in the Prospectus and warrant agreement, I got to a net cashless issuance of 2.8 million shares, compared to the 843,628 shares that would have been issued if the price had stayed stable.

By the second warrant exercise date, A123’s price had fallen to $0.49. So the VWAP used to calculate the number of free shares issuable to warrantholders was approximately $0.5367 instead of $1.30. When I ran that VWAP value through the calculations specified in the Prospectus and Warrant Agreement, I got to a net cashless issuance of 7.5 million shares, compared to the 843,628 shares that would have been issued if the price had stayed stable.

Between the original issuance and the two warrant tranches, A123 ultimately sold 18 million shares of common stock for gross proceeds of $10 million, or an effective price of $0.56 per share. The market did not respond well to the rapid increase in the number of shares in the hands of willing sellers.

An Excel spreadsheet with the key Prospectus disclosures and important warrant agreement terms, along with market price data and detailed exercise price calculations can be downloaded from my Dropbox.

What it means for stockholders

My first, last and only experience with a price linked conversion formula was in the late 80s when one of my clients sold a preferred stock that was convertible into common stock for 75% of the market price on the conversion date. The investor that provided the financing proved to be far less friendly than management expected. A few months after the offering the investor grew disenchanted with the way things were going. Instead of selling its preferred stock, it began to aggressively sell common stock into the market, which drove the price down to a very distressed level. It then converted the preferred stock into common stock for 75% of a bargain basement price. By the time the sm
oke cleared, the investor was my client’s biggest stockholder and management was seeking new employment.

I’ve seen dozens of comparable proposals since then and my clients have wisely rejected them all.

The big problem with price linked conversion ratios is that aggressive selling behavior has no negative consequences for the investor. If aggressive selling drives the price down, the investor simply gets more shares at an even lower price. The outcomes aren’t always catastrophic for existing stockholders, but they’re invariably painful.

Over the last couple months, A123’s financing activities have created two scenarios that are likely to result in a year of market problems. While the worst may be over from the equity offering, it’s impossible to tell whether the warrantholders have already sold the 7.5 million shares that will be credited to their accounts on Monday. While the equity offering was a problem because it created two discrete opportunities for aggressive selling, the debt offering created 26 opportunities that will come along every other week for the next year.

I’m usually bullish on stocks that have been beaten down to unreasonably low levels by misfortune and unforeseen events. In A123’s case, however, the financing structures the company put in place to help it overcome its business problems have created a toxic supply overhang that virtually guarantees significant future price erosion.

Under the circumstances, I believe A123 is not a suitable investment for anybody but professionals.

Disclosure: None

The post A123 Systems, An Object Lesson In Toxic Financing appeared first on Alternative Energy Stocks.

John Petersen

Today is the fourth anniversary of my blog on investing in the energy storage and electric vehicle sectors. Over the last four years I’ve penned 275 Articles and 45 Instablogs on topics ranging from technical minutiae to broad macroeconomic trends. Since most of my work focuses on challenges and risks instead of lofty and optimistic goals, I’m often derided as a curmudgeon who doesn’t understand the dream. Truth is I’ve been a guide in the Valley of Death for over thirty years and while I love panoramic scenery, I can’t overlook the dangers of old mine shafts, cactus patches and the poisonous critters that live in the valley. So I while occasionally gaze in awe at the majesty of the landscape, my big concern is always the next step.

The scary part is knowing that companies I praise rarely live up to my lofty expectations but companies I criticize always perform worse than I think they will.

Most companies that enter the Valley of Death don’t emerge. For the fortunate few that do, the difficult times usually last longer than anyone expected. The single character trait all entrepreneurs share is unbridled optimism. The three character traits all survivors share are determination, focus and fiscal restraint. The following graph from Osawa and Miyazaki is a stylized view of the cumulative losses companies suffer as they transit the Valley of Death.

The next graph from the Gartner Group is a stylized view of the Hype Cycle, a well-known but frequently misunderstood market phenomenon that gives rise to extreme overvaluation during a company’s early stages that’s frequently followed by a period of extreme undervaluation in later stages when the major development and commercialization risks have been overcome, cash flows are about to turn positive and stockholders have grown so weary of waiting for good news that they’re willing to sell at distressed prices despite improving business fundamentals.

The graphs are not perfect overlays on a horizontal time scale, but they’re close, and that’s where the dangers lurk. The reason for the differences between the two graphs is a curious split personality of investment markets that was first described by Benjamin Graham who observed, “in the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine.” Stock prices always peak in early stages of a product launch because the dream is so beautiful. At the Peak of Inflated Expectations, the voting machine personality is firmly in control. When the day-to-day difficulties of building a successful and sustainable business become obvious prices begin an inexorable slide into the Trough of Disillusionment. As they reach the bottom of the trough, the weighing machine personality assumes control.

In combination, these graphs are the reason for Warren Buffet’s oft quoted wisdom that “Investors should remember that excitement and expenses are their enemies, and if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful.”

That’s why truly successful investors who understand the Valley of Death usually follow one of two strategies:

• Venture capitalists buy during the Innovation Trigger and plan on selling during the Peak of Inflated Expectations.
• Vulture capitalists buy during the Trough of Disillusionment and plan on holding for the long term.

Everybody else is betting on the greater fool theory of investing which holds that no matter the price paid by a fool, there will always be greater fool who’s willing to pay an even higher price. The lucky ones can make a few bucks but those who press their luck frequently learn the identity of the greatest fool of all.

As I confessed above my record at predicting short-term success is spotty at best and many companies that I’ve praised over the last four years have been mired in muddle through survival mode for longer than I would have thought possible. With the sole exception of C&D Technologies, however, they’ve all survived and they continue to make solid business progress. Companies in the survivor group include Active Power (ACPW), Exide Technologies (XIDE), Maxwell Technologies (MXWL), ZBB Energy (ZBB) and my old teammates at Axion Power International (AXPW.OB). These companies have all had their ups and downs, but they’ve avoided catastrophic errors and grown their businesses through determination, focus and fiscal restraint. I continue to believe that all five will emerge from the Valley of Death as formidable competitors in their respective sub-sectors and provide market-beating returns for patient investors.

Turning to the other side of the ledger, my track record has been flawless when it comes to identifying companies that were riding the Hype Cycle but unlikely to survive the Valley of Death. Beacon Power, Ener1 and most recently Valence Technologies (VLNCQ.PK) were complete and utter failures that ended up in Chapter 11. Altair Nanotechnologies (ALTI) avoided a total loss by selling control to a Chinese company after its stockholders lost 90% of their value. A123 Systems (AONE) is on the deathwatch and seems unlikely to survive the year after watching its market capitalization shrivel from $2.3 billion in December 2009 to $123 million at yesterday’s close. The one trait they all shared was an errant belief that the glory days would last forever and that bullish press releases could obviate the need for determination, focus and fiscal restraint.

Over the last several months I’ve become increasingly vocal about the risks Tesla Motors (TSLA) faces as it launches its first credible consumer product and begins a long and arduous trek through the Valley of Death. Adherents and advocates are certain that I don’t understand the dream. Truth is I understand the dream perfectly but I know that no company can overfly the Valley of Death on the wings of a dragon. The only way through the valley is on foot in sweltering heat.

At March 31st Tesla had $123 million in working capital and $154 million in stockholders equity. Unless it slashed spending during the second quarter, its June 30 financial statements should show working capital and stockholders equity of roughly $65 and $85 million, respectively. At yesterday’s close, Tesla’s market capitalization was an eye-watering 45 times its estimated net worth, or about ten times higher than it should be at this stage in the company’s development.

Tesla is entering the most cash intensive period in its business history where it will have to make cars instead of talking about them. Unless management acts quickly, Tesla will run out of cash this quarter
. I was surprised that Tesla didn’t close a substantial capital raise during the second quarter because its financial statements were looking so weak at the end of March. Now that we’re two weeks into July with nary a peep about additional fund raising, I have to believe Tesla is facing difficult market conditions and significant investor skepticism over immediate execution risks that can’t be overcome with happy talk. The potential investors have the upper hand in this particular waiting game because they know that Tesla is trapped between the rock of a down-round financing and the hard place of a going concern qualification on the Form 10-Q it has to file by August 9th.

The clock is ticking.

As a long-term guide in the Valley of Death I’ve been in that position before and know how the game is played. This is not an opportune time for retail stockholders who aren’t paying attention to the carrion birds circling overhead.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

The post EVs, Batteries and Tales From The Valley of Death appeared first on Alternative Energy Stocks.

John Petersen

In June an anonymous blogger at Clean Technica dubbed me the “EV Black Knight,” the mortal enemy of electric cars.  While I was flattered by the tribute, I was deeply offended by the suggestion that I might be foolish enough to impale a lithium-ion battery pack with the burnished broadsword of economics.

Seriously, anybody who’s spent any time studying battery safety knows that shockingly bad things can happen when you puncture a lithium-ion battery pack with a conductor and even a full metal jacket wouldn’t be enough to protect a knight errant from the kind of explosive thermal runaway that did about $5 million of damage to a GM battery testing laboratory that was designed to safely manage catastrophic battery failures.

Truth is I’d rather have an e-bike than a horse, I find pens mightier than swords and I think green eyeshades enhance vision while face visors lead to the kind of tunnel vision I find so appalling in ideologues and Tesla (TSLA) stockholders who apparently think we can waste massive quantities of metal for the dubious luxury of powering a car with coal instead of gasoline.

I think the basic problem is that we’re painfully aware of energy costs but blissfully ignorant of the cost of making the machines that either produce or consume energy.

In the case of the family car, we know it burns 400 gallons of gas a year and hate the fact that each gallon costs $3 to $4. Heck, over a 15-year useful life we’ll spend $18,000 to $24,000 on fuel alone. Spending as much for fuel as you spend to buy the car seems outrageous until you consider that the cost of fuel includes the cost of:

• Manufacturing the machines that drill for and produce crude oil;
• Manufacturing the machines that that transport crude oil for refining;
• Manufacturing the machines that convert crude oil into fuel; and
• Manufacturing the machines that transport fuel to market.

I’ve never seen a detailed analysis, but I’d give long odds that if you start with the purchase price of the family car and add a proportional share of the cost of the upstream machinery, equipment and processing facilities that keep it running, you’ll find that machinery represents at least three-quarters of total ownership costs.

While I can’t pin down a precise number, most reports that discuss the economics of wind power claim an all-in power production cost of $.05 per kWh. In the typical analysis 25% of total power production cost is attributable to operations. The remaining 75% is attributable to capital cost recovery – the cost of manufacturing the turbines that turn free energy into useful energy.

With the exception of simple devices that burn fuel directly for heating and cooking, the cost of every useful form of energy pales in comparison to the cost of the machines that use the energy and the cost of the upstream machinery, equipment and processing facilities that deliver energy to our machines in a useful form.

If you spend enough time thinking about the supply chain, the issues become obvious.

We don’t have an energy cost and supply problem.

We have a machinery cost and supply problem.

Energy from wind, sun and water may be free, but machines to make that energy useful are anything but free. The same is true for coal, oil, natural gas and uranium. The in-place energy resources cost nothing, but the machines that extract, transport, refine and use those resources are expensive indeed.

Last year we produced 1,996 kg of energy resources for every man, woman and child on the planet. We also produced 214 kg of iron and steel per capita and 19 kg of nonferrous metals.

While energy resources are single use commodities, ferrous and nonferrous metals are essential for the manufacturing of:

• EP – machines that produce energy and convert it to useful form;
• EU – machines that use energy to perform useful work; and
• NM – non-mechanical essentials of modern life including buildings, power distribution grids and an infinite variety of durable and disposable consumer and industrial goods.

The essential conundrum of modern life is that EP + EU + NM can never exceed total metal production. If we increase metal consumption in one category we have to reduce it somewhere else unless one believes in natural resource fairies.

According to a recent McKinsey study, “Resource Revolution: Meeting the world’s energy, materials, food, and water needs,”  the planet supports 1.8 billion middle class consumers. Over the next 20 years that number will increase to 4.8 billion, a gain of almost 270%. Every one of them will demand energy produced by machines, energy using machines and the non-mechanical essentials of modern life. The problem, of course, is there simply won’t be enough raw materials to go around.

Something’s got to give!

Simply stated, the great challenge of our species will be overcoming persistent global shortages of water, food, energy, building materials and every commodity you can imagine.

The McKinsey report argues that available resource productivity improvements could:

• Offset 100% of the expected increase in land demand;
• Address more than 80 percent of expected growth in energy demand;
• Offset 60 percent of anticipated growth in water demand; and
• Address 25 percent of expected growth in steel demand.

Unfortunately the report is completely silent on more troublesome resources like nonferrous metals that are absolutely essential for:

• EP;
• EU; and
• NM.

Whether we like it or not, supply chain shortfalls will have to be overcome by wasting nothing, recycling everything and making the most efficient possible use of every natural resource.

That doesn’t leave much room for idealists that want to use non-recyclable 1,000-pound battery packs so they can choose coal instead of gasoline to power their car.

In the battery industry the strain on metal supply chains will be immense. The problems won’t be overwhelming for metals like lithium and lead that are abundant in nature but require major new investments in mines and infrastructure, but they’ll be crippling for metals like copper, nickel, cobalt, vanadium and rare earths, which are already in short supply and likely to encounter even more daunting supply chain disruptions over the next two decades.

I’m not a Black Knight wantonly attacking peaceful, frugal and righteous peasants. I’m humble scrivener with enough mining and oil and gas experience to know when the specious assumptions of aspiring eco-princelings can’t work.

I’d certainly never waste hundreds of pounds of steel to protect myself from starry-eyed fools in motley who didn’t endure the cruel tutelage of Sister Mary Angelica in their formative years.

This article was first published in the Summer 2012 issue of Batteries International Magazine and I
‘d like to thank editor Mike Halls and cartoonist Jan Darasz for their contributions.

Disclosure: I have no direct or indirect interest in Tesla and I have nothing to gain or lose from its stock price movements. While I am a former director and current stockholder of Axion Power International (AXPW.OB), a nano-cap company that has developed a robust and affordable lead-carbon battery for use in micro-hybrid, railroad and stationary applications, I can’t see how the success or failure of a fairy tale product like the Tesla Model S could impact the value of my investment in a company that’s focused on relevant mainstream markets.

The post Musings From The EV Black Knight appeared first on Alternative Energy Stocks.

John Petersen

While I jumped the gun last week and published my third quarter outlook for the energy storage and vehicle electrification sectors early, it’s worthwhile to take a look back and see how my tracking list of companies performed over the last quarter and examine the past to see what the tea leaves in the bottom of the cup portend for the coming quarter. So without further delay I’ll present my price performance table for the second quarter that ended on Friday.

Q-2 was a dreadful quarter for Maxwell Technologies (MXWL) and ZBB Energy (ZBB) as their prices fell by 64% and 41% respectively. While the declines were precipitous, they were also one-off events and I believe both companies are trading at very attractive prices for investors who want to position their portfolios for the mean reversion upswing that usually follows fast on the heels of a painful downturn. My long-term tracking charts for both companies show distinct bottoms forming and I believe they’re both likely to trend up for the rest of the year.

It was also an ugly quarter for UQM Technologies (UQM), Valence Technology (VLNC) and Tesla Motors (TSLA). While I believe UQM is attractively priced, I’m convinced that Valence and Tesla are only seeing the beginning of storms that are likely to get more severe through the summer and fall months.

The following table tracks several key financial metrics for the companies I follow. Today I’ll try to explain why I track this data and show how I use peer group comparisons to identify stocks that are either overvalued or undervalued. If you want to understand the balance of this article, you should pay close attention to the table instead of simply blowing past the data and focusing on the words.

The first metric I consider when analyzing any company is working capital adequacy. I see development stage companies that don’t have at least twelve months of working capital as problem children because as sure as the sun will rise tomorrow, they’ll be going back to the market for more money within a few months. The two companies with the worst working capital positions are A123 Systems (AONE) and Tesla. Both had less than six months of working capital at March 31st, even after adjusting A123’s numbers for a recent $50 million toxic debt offering, and both will look truly dismal when their June financial statements are released in early August. Wunderlich Securities recently cut its price target on A123 to $0.50 and I think they’re being generous. Absent a major turnaround, I expect A123 to follow the path blazed by Solyndra, Beacon Power and Ener1. While Tesla has a couple more financing rounds left in its bag of tricks, I don’t expect the terms to be particularly generous to existing stockholders because the execution risks are so massive and so immediate.

The second financial statement metric I key on when trying to distinguish overvalued from undervalued is the difference between a company’s market capitalization and its book value. That number is a good proxy for the value the market puts on a company’s technology, customer base and other intangibles that don’t show up on the balance sheet. When the market premium is a low or negative number, it indicates either opportunity or risk. When market premium is an objectively high number, it’s a sign of extreme price risk – much like a robotic voice screaming “Danger Will Robinson, Danger!”

Turning to the table, A123 is trading at a modest discount to book value that doesn’t fully reflect the risks it will face over the next six months as it tries to recover from a simple calibration error that gave rise to roughly $70 million in warranty costs and inventory write-offs. A123’s cash needs will be huge and the best they could do in their last financing round is a death spiral note that’s payable bi-monthly and convertible at 85% of market. Possible future product offerings in the micro-hybrid and aviation markets aren’t even interesting because neither is soon enough or large enough to materially improve A123’s operating results over the short-term.

Next on the list is Valance technology, which has had a deficit in its stockholders’ equity for years. A bad capital structure has finally caught up with Valence and it will probably lose its Nasdaq listing sometime in July. Valence’s LiFePO4 battery technology is proprietary, but it’s not all that different from A123’s proprietary LiFePO4 battery technology. With both companies needing major equity infusions, I see more risk in Valence than I do in A123 because the market values its technology, customer base and other intangible assets at a $167 million premium to A123. Frankly I just don’t see a good reason for the discrepancy.

The only company in the table with an obviously low market premium is Exide Technologies (XIDE) which trades at a 35% discount to book value because the market has grown weary of exaggerated losses flowing from a multi-year business restructuring that’s finally coming to an end. Once the bleeding stops, I expect Exide to perform very well.

On the extreme bleeding edge of the market premium spectrum we have Tesla which trades at a silly level of 21.4 times book value while every other company I follow trades at three times book or less. That valuation excess is solely attributable to the Hype Cycle, which seems to be running its course. Over the last two years Tesla has been driven higher and higher as the delivery date for its first Model S cars drew nigh. The long anticipated event finally happened a week ago Friday and the Model S drew spectacular reviews from the automotive press. Despite the good news, the price fell by 7% last week.

The reason is simple. The market expected the deliveries to go off without a hitch and it expected rave reviews. So there was no “good” left in that news. Now, however, the business dynamic has changed. Instead of sounding like a politician and focusing on how good it’s going to be, Tesla will have to begin dealing with day-to-day business realities like actual reservation conversion rates, actual production problems and actual manufacturing cost overrruns. While I suppose Tesla could be different from every new manufacturer in the history of business, I see very little in the way of unexpected good news that could lift its stock price while Tesla’s business of making electric cars is entering a target rich environment for sequential disappointments that could crush its stock price. This is not a favorable risk reward dynamic for investors who care about their portfolio value.

The thing I like best about the market premium metric is that it lets an investor assemble a hierarchy of opportunity to compare the different companies in a sector. The following table is a simple example that excludes several outliers and shows market premium as an absolute number, and as a relative number compared to book value, my “BS to Book ratio.”

I’m not a fan of electric cars because the entire sector has been mercilessly over-hyped while the real economic costs and illusory environ
mental and national security benefits are just now coming to light. If I did want to make an EV investment that had a good chance of significant appreciation instead of an outsized risk of loss, I’d pick UQM and Kandi Technologies (KNDI) over Tesla. Kandi is profitably selling low cost transportation for the masses in China, a country that’s striving to raise living standards for all of its people. Kandi has a healthy working capital balance and a low BS to Book ratio. UQM is still reporting modest losses, but its balance sheet is strong and its BS to Book ratio is one of the lowest in my tracking group. The risk-reward dynamic for both companies is quite favorable because the potential for additional price deterioration is modest while the potential for future price appreciation is substantial. In other words, they’re both polar opposites of Tesla.

The same kind of analysis holds in the middle range where Axion Power (AXPW.OB), ZBB, Active Power (ACPW) and Maxwell carry market premiums that range from $14.3 million to $72 million and have BS to Book ratios of 2.0 or less. A blog like this one is not a good place to  slice and dice the respective technical strengths of four companies that are focused on different products that have different applications that don’t really compete with each other. But all four of them are one or two solid announcements away from market premiums in the $200 to $400 million range which A123 and Maxwell both carried at some point in the last twelve months.

When you’re betting on trees to grow, you don’t pick the tallest one in the forest because it’s the one most likely to get struck by lightning. You don’t pick the diseased trees because of their high mortality risks. Instead you pick healthy young trees that have modest mortality risks but are poised to enter a period of sustained growth. For my money all four of these mid-range companies have that kind of significant growth potential for this year, and through 2015 and beyond.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

The post Energy Storage: Q-2 2012 Review and Analysis appeared first on Alternative Energy Stocks.