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 (NASDAQ: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.
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:
|Calendar 2009||7.2 million shares|
|Calendar 2010||22.0 million shares|
|Calendar 2011||77.7 million shares|
|2012 to Date||76.6 million shares|
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.
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.
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 (NYSE: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 other 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
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.
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.
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.
In a normal 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 was a former director of Axion Power International (AXPW) until 2007 and holds a substantial long position in its common stock.