Battery Investing for Beginners, Part II

John Petersen

Last Friday I published “Battery Investing for Beginners” as an introductory piece for investors who don’t know much about the energy storage sector but are interested in learning more because of the hugely successful initial public offering by A123 Systems (AONE). Since the article was well received and there seems to be a good deal of reader interest, I’ve decided to continue the theme with a series of articles where I’ll try to build a contextual framework for the industry and show where various types of energy storage devices and their manufacturers fit into that framework. Since I don’t want to spend too much time replowing old ground, I’ll rely on hyperlinks to my earlier blogs and third party source documents.

I’m a lawyer, not a journalist. My undergraduate degree was in accounting with a solid base of hard science. I’ve spent the last 30 years working in securities law where most of my work involved small natural resource or technology development companies. I’m not an engineer or scientist, but my chosen field of practice requires me to understand the science well enough to explain it. My foundation in the energy storage sector dates to 2003 when I took on a client named Axion Power International (AXPW.OB) that was organized to develop a novel energy storage device that’s half lead-acid battery and half supercapacitor. I spent the next five years working as Axion’s general counsel and served as a member of its board for four of those years. I stepped down from my position as Axion’s board chairman in January 2007 and brought in successor legal counsel in early 2008. I still own a substantial long position in its stock. In short, I know the energy storage sector well and understand what the principal players are trying to accomplish, but I come from the lead-acid side of the business and because of my long history with high-tech innovation I’m not as excited by gee-whiz technology as many commenters. I like to think of myself as a cautious optimist who sees the opportunities but never overlooks the challenges.

Everybody understands the basic problem. We passed an inflection point for peak cheap oil in the late ’90s and fuels that are expensive today can only become more costly in the future. We’ve also passed the inflection point for peak cheap electricity. When you factor in concerns over CO2 emissions as a possible cause of climate change, we have a real mess on our hands. The good news is that fundamental economics are finally kicking in and forcing us to attack the issue of energy waste while we search for new ways to generate electricity from non-traditional sources. Merrill Lynch strategist Steven Millunovich believes we are at the dawn a new industrial revolution, the age of cleantech. I believe he’s right.

When I started writing this blog, I decided to limit its scope to “pure-play” energy storage device manufacturers that file regular reports with the SEC. The decision resulted in three noteworthy exclusions: Johnson Controls (JCI), which is the largest battery manufacturer in the world but only gets 15% of its revenue from battery sales; SAFT Groupe (SGPEF.PK), a profitable French battery manufacturer that does not file reports with the SEC; and BYD (BYDDY.PK), a Chinese manufacturer of cell phones and automobiles that gets 23% of its revenue from battery sales and does not file reports with the SEC. The decision also left me with a small but reasonably comparable short list of companies that only differ in the nature of their products and the development stage of their businesses. For investors who would rather track an index that includes JCI and BYD, I recommend the Energy Storage and Battery Technology Stocks Index (*BTTRY) published by Tickerspy.

There are two basic classes of energy storage devices: cool devices like lithium-ion batteries, supercapacitors and high-speed flywheels that promise extraordinary performance and are relatively expensive in terms of cost per unit of storage capacity; and cheap devices like lead-acid batteries, flow batteries and low-speed flywheels that offer lower levels of performance but are relatively inexpensive. My favorite source of cost data on energy storage technologies is a July 2008 Sandia National Laboratories report on its Solar Energy Grid Integration Systems – Energy Storage (SEGIS-ES) program. The following table separates the raw Sandia data into short duration power technologies, short duration energy technologies and long duration energy technologies; orders the technological contenders based on the average of current and 10-year projected cost data reported by Sandia; and identifies the American companies I follow that are focused on each storage technology.

There are also two basic classes of pure-play energy storage companies: emerging entrepreneurial companies that are developing new technologies; and established manufacturing companies that have solid customer bases and sustainable business models. A fifth and final class is a rapidly expanding group of Chinese battery manufacturers that have listed their shares in the U.S. but are not expected to be major players in the growth of America’s domestic battery industry. To allow for fundamental differences among their technologies and business models, I’ve segregated my universe of pure play energy storage companies into five classes that I’ll briefly describe below and summarize in a series of tables that identify the individual companies and provide summary data on their share prices, market capitalizations and key financial ratios.

Cool Emerging – My cool emerging class consists of thinly-capitalized developers of relatively expensive energy storage technologies. Their annual operating losses are typically large in relation to their total assets and they’ll be dependent on additional financing for an indeterminate period of time. Cool emerging companies are typically valued on the basis of the perceived potential of their technology and their expected time to market.

Cool Sustainable – My cool sustainable class consists of well-capitalized developers of relatively expensive energy storage technologies that have a substantial customer base. Their annual operating losses are typically smaller in relation to their total assets and their need for additional financing is generally less pressing. Cool sustainable companies are typically valued on the basis of their earnings potential and business development plans.

Cheap Emerging – My cheap emerging class consists of thinly-capitalized developers of relatively cheap energy storage technologies. Their annual operating losses are typically large in relation to their total assets and they’ll be dependent on additional financing for an indeterminate period of time. Like their cool counterparts, cheap emerging companies are typically valued on the basis of the perceived potential of their technology and their expected time to market.

Cheap Sustainable – My cheap sustainable class consists of well-capitalized manufacturers of relatively cheap energy storage technologies that have a substantial customer base. Like their cool counterparts, cheap sustainable companies are typically valued on the basis of their earnings potential and business development plans.

Chinese Companies – My last class consists of Chinese companies that have listed their shares in the U.S., but operate solely in Asia. They’re generally profitable and may export products to the U.S., but they’re not expected to be key players in America’s drive to develop a thriving domestic battery manufacturing industry.

My fundamental premise is that current conditions in the energy storage sector are a lot like they were in high-school.

There are four publicly held lithium-ion battery developers vying for supremacy in the high profile contest to become the technology superstar for PHEVs and EVs. They’re competing against each other, a number of foreign companies and a host of privately held companies for a market that will be a long time coming. While they all trade at prices that would give value investors a nosebleed, the odds that a particular company will make it to the NFL draft are remote at best.

At the other end of the spectrum there are a small number of emerging and sustainable companies that are manufacturing and developing technologies for the more mundane energy storage needs of the average consumer who would be hard-pressed to buy a $22,000 Prius class hybrid, much less a $40,000 Volt class PHEV.

As the newly born excitement over the energy storage sector wanes and fundamental investment analysis gains supremacy, I expect the relative valuations of the cool technology companies to either remain flat or fall while the relative valuations of the cheap technology companies rise to more reasonable levels. On Thursday I’ll put together an analysis of how that investment thesis has held up since last November and establish a new set of foundation metrics for future tracking comparisons. I continue to believe cheap will outperform cool for the foreseeable future. Only time will tell whether I’m right or wrong.

DISCLOSURE: Author has a large long position in Axion Power (AXPW.OB) and small long positions in Enersys (ENS), Exide (XIDE), ZBB Energy (ZBB) and Active Power (ACPW).