The Lithium-ion Battery Bust
2012 has been a year of unprecedented carnage in the lithium-ion battery industry as one manufacturer after another went bankrupt, dissolved joint ventures, wrote-off assets or restructured operations in a desperate attempt to survive. The year's headline stories include:
January 26, 2012
Ener1 (NASDAQ:HEV) filed for protection under Chapter 11 of the Bankruptcy Code and left its stockholders holding worthless paper.
March 31, 2012
Panasonic (PC) booked $3.7 billion of asset and goodwill impairments in the lithium-ion battery and solar cell businesses it acquired from Sanyo.
July 12, 2012
Valence Technology (OTCPK:VLNCQ) filed for protection under Chapter 11 of the Bankruptcy Code and left its stockholders holding worthless paper.
September 12, 2012
Bosch and Samsung (OTC:SSNLF) dissolved their SB LiMotive joint venture and Samsung launched a global effort to reposition its lithium-ion battery business in non-automotive sectors.
September 30, 2012
Panasonic booked another $3 billion of asset and goodwill impairments and announced plans to close three of its six battery plants.
October 16, 2012
A123 Systems (OTC:AONEQ) filed for protection under Chapter 11 of the Bankruptcy Code and left its stockholders holding worthless paper.
October 24, 2012
Dow Chemical (NYSE:DOW) announced plans to record a substantial fourth quarter impairment charge to write down the value of its lithium-ion manufacturing assets.
November 1, 2012
Sony (NYSE:SNE) reportedly opened discussions to sell its lithium-ion battery unit to Chinese buyers for roughly 0.35 times sales.
December 7, 2012
In conjunction with plans to move its operations to China, Altair Nanotechnologies (NASDAQ:ALTI) announced a 1 for 6 reverse split after implementing a 1 for 4 reverse split in October 2011.
December 11, 2012
Substantially all of A123's assets, which had a book value of $495 million at June 30, 2012, were sold to China's Wanxiang America Corp. for $256.6 million.
While Dow, Ener1, Valence, A123 and Altair were relative newcomers to the lithium-ion battery space, Samsung, Sony and Panasonic/Sanyo have been industry leaders for decades and collectively account for about 60% of global production. Each of these manufacturers faced and succumbed to different business challenges, but the underlying themes were remarkably similar:
- Manufacturers overbuilt capacity in anticipation of demand that didn't develop;
- Consumers balked at the high cost and limited utility of electric cars, so demand ramped more slowly than advocates, pundits, governments and product managers expected;
- Expected improvements in energy density and battery performance proved elusive as unicorns;
- Expected economies of scale couldn't be achieved in a mature industry with highly refined manufacturing methods, equipment and supply chains; and
- Profit margins were savaged as manufacturers tried to meet unreasonable price expectations of automakers and match unreasonably optimistic price quotes from competitors.
The last few years have been a textbook example of the hype cycle as human imagination latched onto lithium-ion batteries as a panacea solution that would give rise to a thriving electric car industry and painlessly free us from the tyranny of big oil. The frenzy peaked in the summer of 2009 when the government doled out $1.2 billion in battery manufacturing grants. Within a year, the euphoria started to fade and by December of 2010, Energy Secretary Chu was cautioning that competitive electric cars will require batteries that can endure 15 years of deep discharges, offer five to seven times the energy storage capacity of current lithium-ion batteries and cost two-thirds less.
These would have been lofty goals in information technology where electrons don't take up space, have weight or dictate the choice of materials. They were impossible goals in the battery industry where ions do take up space, do have weight and do dictate the choice of materials. There's a reason that today's best batteries are only four or five times better than the batteries Thomas Edison manufactured a century ago. The laws of chemistry are nowhere near as flexible or forgiving as the laws of physics that dominated the information technology revolution.
Now, for the first time in a decade, the DOE is devoting substantial resources to financing R&D on new technology instead of trying to force unsuitable and uneconomic legacy technology into a reluctant and price sensitive market. Absurd public relations positions like promising five times the energy and one-fifth the cost in five years are still common, but they're no longer credible.
Meanwhile, a growing consensus among industry analysts cautions that while the dream of cost-effective lithium ion batteries endures, the possible performance gains and production economies that will be required for mass market adoption are not likely before 2020, and may take far longer to migrate from laboratories to factory floors.
The Advanced Lead-Acid Battery Boom
On Monday of this week, Pike Research published a new report on Advanced Lead-Acid Batteries that backtracked on years of irrational exuberance over the potential of lithium-ion batteries and reached a startling conclusion:
"Advanced lead-acid batteries represent a technology that bridges the gap between legacy forms of battery storage and the future market. *** As a result, advanced lead-acid batteries are well positioned to capture early market share in motive, transportation, and stationary applications ...
Despite the future challenges that loom on the horizon, the advanced lead-acid industry is filling important demand for energy storage devices now. Pike Research forecasts the market to expand at a compound annual growth rate [CAGR] of 19.8% over the next 8 years. Of the $18 billion market in 2020, 58% of those sales will be from the transportation sector, historically one of the most of important industries for lead-acid batteries.
Enhanced flooded batteries [EFBs] and absorbed glass mat [AGM] batteries represent the bulk of existing advanced lead-acid market share, while fast charging lead-acid batteries represent the future of the market."
The easiest way to conceptualize lead-acid batteries is to think in terms of product generations.
Lead-acid 1.0: Historically, lead-acid batteries were flooded devices where lead electrodes were immersed in an electrolyte bath. Flooded lead-acid battery technology became the backbone of the lead-acid battery industry and still accounts for the substantial bulk of global manufacturing capacity and sales.
Lead-acid 2.0: A second class of permanently sealed, maintenance free lead-acid batteries was invented in the '70s. Instead of immersing the electrodes in an electrolyte bath, AGM batteries use an absorbent fiberglass mat to carry the electrolyte. The main benefits of AGM technology are better charge acceptance, longer cycle-life and no maintenance. Until recently, production capacity was limited to a couple million units a year and AGM batteries were only used in high value applications where reduced maintenance, increased safety or better performance justified the price premium. Over the last five years, global demand for AGM batteries has exploded and manufacturing capacity has ramped from a few million to tens of millions of batteries per year. This rapid shift in demand has been a boon for battery manufacturers because AGM batteries cost twice as much and generate three times the per unit margin.
Enhanced lead-acid 1.x and 2.x: Over the last few years, leading manufacturers of flooded and AGM batteries have launched a plethora of new products that are generically classified as "enhanced" batteries. The goal of all enhanced batteries is to extend cycle-life and increase charge acceptance rates. Common enhancements include using thinner and purer electrode grids, changing electrode paste composition by adding small amounts of carbon and other additives to reduce sulfation and making other changes to reduce acid stratification. While all these enhancements have value and can boost battery performance by 50% to 100%, they're incremental changes rather than generational advances.
Lead-acid 3.0: The third class of advanced lead-acid battery that has developed over the last ten years represents a fundamental change in the way lead-acid batteries work. Where flooded and AGM batteries use pasted lead grids for their positive and negative electrodes, third generation batteries use pasted lead grids for the positive electrodes and carbon compounds for the negative electrodes. The end result is a hybrid device that's part lead-acid battery and part supercapacitor.
Lead-carbon batteries have lower specific energy than flooded and AGM batteries because a given volume of carbon can't store as many electrons as the same volume of lead. However, lead-carbon batteries more than compensate for a modest loss of energy storage capacity with cycle lives that are five to ten times longer and charge acceptance rates that are ten to twenty times better than conventional and enhanced flooded and AGM batteries.
These are the "fast charging lead-acid batteries" that Pike described as "the future of the market."
The following schematic highlights the architectural differences between conventional lead-acid batteries and the newer lead-carbon devices. The lead-lead electrode pair on the upper left is used in all flooded and AGM batteries. The lead-carbon alternatives on the upper right and bottom center only exist in third generation devices.
One of the most intriguing aspects of lead-carbon devices is that they change the way lead-acid batteries work, but they don't change the way lead-acid batteries are manufactured. Asymmetric lead-carbon devices can be built on any AGM battery line. While split-electrode devices require modest equipment modifications, they can be made in both flooded and AGM architectures. As a result, both third-generation technologies can be quickly and seamlessly integrated into existing infrastructure.
Since third generation batteries evolved during the last ten years, they're not widely available yet because testing in the battery industry is only slightly less rigorous than new drug testing in the pharmaceutical industry. After all, automakers can't afford to recall a $30,000 vehicle because they short cut or scrimped on testing a $300 component.
During the last three years, both types of lead-carbon batteries have been subjected to exhaustive validation tests by automakers, railroads, industrial equipment manufacturers and end-users of large-scale stationary storage systems. They've both completed the industrial equivalent of Phase I and Phase II new drug trials with flying colors and are going into the industrial equivalent of Phase III new drug trials in several industries. Depending on the industry where the batteries will be used, the final testing and validation will take from several months to a few years before final implementation decisions are made. When all required testing and validation is completed, the new face of the lead-acid battery industry will offer lithium-class performance at an affordable price. Third generation lead acid batteries won't ever be used for portable electronics, electric cars and other toys, but for applications where size and weight are not mission critical constraints, they'll be the only rational choice.
Understanding the Investment Opportunities
There are three public companies that manufacture first and second generation lead-acid batteries.
The largest is Johnson Controls (NYSE:JCI), which has a global manufacturing and distribution footprint and a dominant position in the automotive OEM market. JCI reported $5.9 billion in revenue and $854 million in segment income from its Power Solutions unit for its fiscal year ended September 30th. While battery sales only represented 14% of JCI's revenue, they generated 32% of its segment income. At yesterday's close, JCI's market cap was $19.6 billion, or 1.7 times book value, 0.47 times TTM sales and 16 times TTM earnings.
The second largest is Exide Technologies (XIDE), which has a global manufacturing and distribution footprint and generates roughly two-thirds of its revenue from automotive batteries and one-third of its revenue from commercial and industrial products. Exide reported $3.1 billion in revenue and $56.7 million in net income for its fiscal year ended March 31st. For the six-months ended September 30th, Exide reported $1.4 billion in revenue and a net loss of $120 million. At yesterday's close, Exide's market cap was $233 million, or 0.9 times book value and 0.08 times TTM sales.
The third largest is Enersys (NYSE:ENS), which has a global manufacturing and distribution footprint and generates the substantial bulk of its revenue from commercial and industrial products. Enersys reported $2.3 billion in revenue and $144 million in net income for its fiscal year ended March 31st. For the six-months ended September 30th, Enersys reported $1.1 billion in revenue and $89.6 million in net income. At yesterday's close, Enersys' market cap was $1.7 billion, or 1.5 times book value, 0.74 times TTM sales and 10 times TTM earnings.
There are two innovation leaders in third generation lead-acid battery technology, but Axion Power International (NASDAQ:AXPW) is the only public company that's active in the space. Axion has been developing its patented PbC® battery since 2003 and an impressive lineup of first tier players have been testing pre-commercial prototypes since mid-2009. Since Axion is still engaged in the final stages of a long-term research and development program, it reported $8.1 million in revenue and a net loss of $8.3 million for 2011, and $6.7 million in revenue and a net loss of $6.4 million for the nine months ended September 30th. At yesterday's close, Axion's market cap was $34 million, or 2.6 times book value and 3.6 times TTM sales.
Among the first tier battery manufacturers, I believe Exide has the greatest short-term upside potential because it's had more than its share of operational problems over the last few years. The combined impact of restructuring costs and commodity price swings have savaged earnings for several years and eclipsed the company-wide economies resulting from an affirmative decision to punish short-term performance to optimize long-term performance. Over the last 24 months, Exide's stock price has fallen from a peak in the $12 range to the current price of $2.90. Since its restructuring activities are almost complete and the market is rapidly shifting to higher margin products, I continue to believe that Exide is a multi-bagger in the making.
My second favorite in the first tier battery manufacturer is Enersys. The stock has been a stellar performer since the doldrums of 2009 and its execution has been solid on all fronts. Last month, Enersys signaled its intent to move into the large-scale energy storage market in a big way with its OptiGrid Stored Energy Solutions, a new turnkey megawatt hour scale energy management system for utilities and large industrial applications. Coinciding with the launch, Enersys is completing construction of an OptiGrid Stored Energy Solutions customer showcase in southern Vermont that will help its customers understand the product platform and see the system in operation. Since Enersys trades at a relatively low P/E multiple of 10 times earnings, I believe it also has substantial short- to medium-term upside potential.
When it comes to the "fast charging lead-acid batteries" that Pike described as "the future of the market," Axion Power is the only game in town. While Axion's stock market performance has been dismal since it closed a deeply discounted equity offering in December 2009, its business performance has been nothing short of spectacular as an impressive array of first tier OEMs and major battery users have subjected PbC prototypes to grueling test regimes. Over the last three years, the PbC has demonstrated extraordinary performance during the first two stages of OEM and end-user testing. Axion expects to begin the third stage of OEM and end-user testing for automotive, railroad, trucking and stationary applications over the next six months.
While R&D companies in the pharmaceutical industry usually gain market value as their new products navigate the testing and validation process, Axion's price has drifted steadily lower and instead of carrying an increasingly large intangible asset value for its highly successful long-term research and development program, Axion's current market capitalization, net of tangible assets, values the PbC technology at roughly 63% of cumulative R&D spending.
While it's difficult to predict the timing of future implementation decisions with any degree of certainty, the possibility of a technical failure is extremely remote given the amount of testing and validation work that's already been completed. When the market finally understands and appreciates the economic potential of Axion's third-generation PbC technology, the stock should perform very well. Axion will need to complete another modest financing round to carry it through the third phase of OEM and end user testing. If the financing closes before the third stage testing programs are formalized, the offering may go off at a modest discount to current price. If the third stage testing programs are formalized before the financing closes, the offering will probably go off at a significant premium to the current price.
Disclosure: I am long AXPW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I was a director of Axion Power International from January 2004 through January 2007.