How to Determine Value of Alternative Energy Stocks

Valuation Metrics for Alternative Energy Storage Stocks

Over the last six months I’ve written thirty-two Seeking Alpha articles on energy storage, an industrial sector that is developing basic enabling technologies for cleantech, the sixth industrial revolution. My initial plan was to evaluate the relative long-term investment potential of a short list of pure-play energy storage companies by focusing on the performance, costs and benefits of their technologies. While I expected to run out of ideas within a couple of months, readers kept asking incisive and probing questions that deserved detailed answers, so I continued the series and delved deeper into the relative values of the energy storage companies on my list. My core philosophy comes from the work of value investor Benjamin Graham who said, “In the short run, the market acts like a voting machine, but in the long run it acts like a weighing machine.”

Recently, several readers have asked me for a more detailed explanation of the analytical framework and valuation metrics I use to compare companies. Since I’ve previously written at length about the strengths and weaknesses of the principal storage technologies, I won’t revisit those topics today. Instead, I’ll try to focus on how the market’s voting machine is likely to respond to the real world’s economic weighing machine of over time. The following is no more than one man’s considered opinion based on personal experience; but I hope my comments and observations will help readers make better investment decisions.

As many readers know, I’m a lawyer who’s spent the last 30 years guiding entrepreneurial companies through the corporate finance process. Over the years I’ve had countless opportunities to help current and former clients develop their plans and pursue their businesses. In the process I’ve learned that all growing companies face similar problems, challenges and difficulties at similar stages of development. I’ve also developed a pretty good sense of what works and what doesn’t work when the predictable business development issues arise.

Analytically, I divide companies into two classes, speculative investments and everything else. Due to the nature of my practice, the bulk of my experience comes from working with early stage companies and the visionaries who manage them. My experience beyond the speculative investment stage is limited to the occasional special project because as clients grow they invariably require more comprehensive services than my firm can offer. While most financial analysts use far more stringent standards, I classify a company as a speculative investment if:

• The company’s net loss in the most recent year equals or exceeds its total revenue for the year, or
• The company’s net loss in the most recent year equals or exceeds its net worth at year-end.

As soon as a company falls into either of these categories, I eliminate all goodwill and intangible assets from its balance sheet to calculate a “net tangible book value,” which I then deduct from market capitalization to arrive at an “intangible premium” that represents the proportion of the market capitalization attributable to non-financial assets, business expectations and voting machine factors. As a final step, I try to identify the specific business, technical and economic factors that either justify the intangible premium or lead me to believe that the intangible premium is excessive. Since it’s a highly subjective process, I strongly encourage each reader to make his own judgments.

The following table identifies six pure play energy storage companies that I would classify as speculative. For each company, I’ve taken the raw financial data from third quarter SEC reports, folded in reported fourth quarter changes for acquisition and financing transactions and then annualized their nine-month revenue and earnings in an effort to estimate their financial condition at December 31st. I did not try to estimate fourth quarter changes arising from sales or other operating factors. My numbers will undoubtedly be off, but they shouldn’t be off by much.

click to enlarge

If you focus on the intangible premiums, you’ll see a huge variation among the six companies. At the low end of the spectrum ZBB Energy’s (ZBB) market capitalization is only $3.9 million greater than its tangible net worth. In my experience that’s a low intangible premium for a speculative stock. At the other end of the spectrum, Valence Technologies (VLNC) and Ener1 (HEV) have intangible premiums of $264 million and $464 million, respectively. In my experience, both of those intangible premium are unsustainably high. The three remaining companies are clustered in the $15 to $45 million range, which is low compared to historical norms, but probably not unreasonable under current economic conditions.

Over the years, I have developed a set of touchstone principles that I adhere to when advising speculative clients. Most of them are little more than sound business practice, but in the heady atmosphere of a speculative company, sound business practice is often the last thing people consider because the dreams are more fun. I think they can also be useful for investors who want to evaluate speculative companies:

• Like children in developing countries, small companies rarely starve but frequently die of dysentery.
• Debt is always toxic because nobody wants to invest money that will be used to pay for past mistakes.
• Whenever equity financing is available, take it because you will need it.
• Unless you plan to sell equity at a discount to net tangible book value, any talk of dilution is meaningless.
• If you’re lucky, it will take twice as long and cost twice as much to accomplish any goal.
• Talk about milestones when you pass them, not when you establish them.
• Be cautious with forward-looking statements because broken promises are disastrous.
• Successful manufacturing is far more difficult and expensive than successful science.
• Product testing and marketing cycles are directly proportional to product life cycles.
• Since you don’t want all your eggs in one basket, a product that has several uses is far less risky than a specialty product for a niche market, even if it’s a huge niche.
• Grow your revenues gradually, but make sure the growth is sustained and consistent.
• You need to go with the flow instead of fighting momentum.
• In a competitive market, the cheapest product that can do the work will always take the lions’ share.

Based on the financial data in the summary table, I believe all six of the speculative companies will need additional capital in 2009. Since they follow sound business principles, their capital needs are modest and their intangible value premiums are relatively low, I think ZBB and Axion Power (AXPW.OB) should be able to attract the capital they need at attractive prices. I am less confident when it comes to Beacon Power (BCON) because it will be years before Beacon’s planned frequency regulation projects make a substantial contribution to overhead. I’m a cynic when it comes to Altair Nanotechnologies (ALTI) , Valence and Ener1 because they routinely violate sound business principles; their cash needs are far greater than their peers and their intangible value premiums range from moderate in the case of Altair to outrageous in the case of Valence and Ener1. Since new investors always bring a scale and conduct detailed peer group comparisons when they conduct due diligence, I think all three of these companies are in for a very tough time.

While it may be a bit simplistic, I’ve found that my methodology can be useful for comparisons between established companies that are not operating close to the edge. The following table identifies eight pure play energy storage companies that I would classify as established. Once again, I’ve taken the raw financial data from third quarter SEC reports, folded in reported fourth quarter changes for acquisition and financing transactions and then annualized their nine-month revenue and earnings in an effort to estimate their financial condition at December 31st. I did not try to estimate fourth quarter changes arising from sales or other operating factors. My numbers will undoubtedly be off, but they shouldn’t be off by much.

The biggest problems I have with using a table like this to compare established companies arises from immense differences in relative size and the fact that the first four companies on the list are based in China and operate in a business, regulatory and cultural environment that I don’t fully understand. Those problems are compounded by the fact that well-established companies frequently have property, plant and equipment accounts that do not fairly reflect the true value of their underlying assets. Despite the difficulties, I have no problem concluding that China BAK (CBAK), the largest of the Chinese battery companies, should not be valued at a 30% discount to Advanced Battery, the smallest of the Chinese battery companies. Likewise I have no problem concluding that Enersys (ENS) and Exide (XIDE) are undervalued when you compare their market capitalizations with everybody else in the industry.

I used the financial data in the tables, my touchstone principles for speculative companies and a little bit of common sense in connection with the preparation of my recent review and outlook article on energy storage stocks. Since nothing much has changed over the last four weeks, I won’t bore readers by restating my conclusions here. I would, however, encourage new readers who want to better understand the energy storage sector to read as many of my past articles as they can stomach.

Currently, the markets are operating in voting machine mode and because of the economic turmoil nobody really seems to understand what their votes mean. As stability returns over the next year and the nation comes to grips with the massive energy storage issues that confront it, I expect a weighing machine mentality to become more prevalent. When that happens, I expect the market capitalizations of the high premium companies to plummet while the market capitalizations of the low premium companies surge.

Disclosure: Author holds a large long position in Axion Power International, a leading U.S. developer of lead-carbon batteries. He also holds small long positions in Exide and Enersys and plans to buy a small long position in ZBB Energy.

Comments

[henarl:]

Paul: I hope you were just trying to make a point with your 4 share a week example. Obviously commissions would kill you, and you wouldn't get that full $300 yearly dividend since you would not have the whole 200 shares at each ex dividend date. Also, you cannot realistically just assume a double in three years on a big cap stock like GE.
All of that said, I agree with your position that buying solid dividend paying stocks will almost always have better long term results than speculating in penny stocks. I would add that selling out of the money covered calls could greatly increase the total return on a stock like GE. And, if you intend to hold the stock long term, I would use a dividend reinvestment program.

Jan 26 06:44 PM

[edFl:]

I have started taking a hard look at ZBB, and notice a fairly common corporate structure for micro cap new tech companies. There are no REAL sales people, just techno sales people. All one needs to do to understand this is view the power point presentation from the last road show - very informative but no sizzle!
Companies with new tech, operated by engineers, are the backbone of inovation. My message is - get out there and hire smart closers, They move faster, cover more territory and know when tech support is needed to get the deal done.

Jan 26 06:50 PM

[longtermstocks:]

I agree the articles name is a little off base- SA should have kept what you had!

Jan 26 09:35 PM

[frflyer:]

Loren
I also like what BCON is doing, but John is probably right that if nothing else, it's probably a little early for this company's stock. I know from my own mistakes about buying promising stocks too early.
I bought a small stake in Metabolix at more than twice what it is now, because I was so impressed with their bioplastics technology.
I was way too early. Same thing with Genomics stocks that I thought would become the Microsofts and Intels of the biotech world. Celera, Millenium, Human Genome Science, Affymetrix, etc.
For a good part of 1999, they acted like they just might, but crashed with the Nasdaq in Feb 2000 and never recovered.

I spent six months or more learning about the science on the internet.
After reading an article about Affymetrix's GeneChip technology, in 1995, I was hooked, even the editors of Wired magazine, who published an article about AFFX were amazed.
I began following biotech companies.
Then Celera sequenced the fruit fly genome in 5 months, and started on the human genome, which they eventually completed in 9 months or so, and Genomics was on fire.
As a result, I was so convinced, that I failed to get out while I was ahead. I had more or less discarded my trading sense for a long term buy and hold strategy. The logic was, that if you bought a Microsoft or a Cisco Systems when it was young and held on for years, you would have a huge payoff. A virtual fortune from a small investment. Those who sold because they doubled their money missed the big move and maybe even lost money on the stock they bought with the proceeds from the double.

The market will always make a fool of you when you think you have it figured out.

But stuffing a small stake away as speculative for the long term is understandable. I like the idea of buying baskets of stocks in up and coming industries. That's why I have 7 solar stocks. One or two homerun stocks can more than make up for several that fail. There are numerous alternative energy stocks that I follow that are in the early stage. I keep them on my radar and wait for further developments.


Good job John

Jan 26 10:43 PM

[hall999999:]

John, while this article is much longer than your explanation on valuing companies in your previous installment and uses tables to clearly illustrate how you do it, it still says the same thing - a company with a larger premium between market cap and tangible value (stockholder equity) is overvalued compared to a company with a small (or no) premium. I don't think it is a helpful way to compare individual companies.
If you said, "In general, companies with a high premium tend to be overvalued compared to companies with a small premium." or, "look for companies with a lower premium (relative to market cap/revenue/growth rate/etc." then I would find some merit in it. But as presented all you're showing is that one stock is cheaper than the other. It is a little like this:

Cost to Build Asking Price Premium
(tangible value) (market cap)
----------------------...
home A $200,000 $600,000 $400,000
home B $400,000 $500,000 $100,000

Is home B a better deal? Which home has a better chance of increasing in value in the next several years? Without more information I have no idea.

Also, the two companies you cite with the smallest premiums (negative premium in fact) - CBAK and XIDE - are also the two companies that show earnings losses for the year. I'm not making a judgment about their future prospects but merely pointing out that maybe the market is valuing them based on facts rather than being irrational. There are two parts to the equation for an inexpensive stock. Maybe, as you say, the market cap will increase to correct the imbalance. But it could also be that the tangible value will decrease.

One other thing. There is no "voting machine mode" or "weighing machine mentality". The market is always a voting machine in the short run and always a weighing machine in the long run. I think what you were trying to say is just that eventually the better businesses will sport the better stock prices or that the stock market will get back to more rationally valuing companies.

P.S. - to those who believe Mr. Petersen is biased because he owns stock in the companies he seems to favor - While he may be biased has it occurred to you that maybe he owns the stocks BECAUSE he believes them to be a better value?

Jan 27 12:19 AM

[hall999999:]

Darn blog formatting. That table was easier to read when I typed it. If it's unclear:

The first figure is "Cost to Build" (i.e. tangible value)
The second figure is "Asking Price" (i.e. market cap)
The third figure is "Premium"

Jan 27 12:24 AM

[Paul Killinger:]

henarl,

I didn't want the concept to sound too confusing.

And there are all kinds of solid high yielding stocks around today, not to mention terrific bond yields from going concerns. Really the opportunity of a lifetime. (Which we can use, considering the drubbing we've been through.)

Some investors believe the market is a casino, though. Say BCON triples from .70 to 2.10 (as unlikely as that may sound). Whoopee, they took all kinds of risk for a gain of 1.40 a share.

GE, on the other hand, will come back to the mid-20's or 30 in the not too distant future. (If it doesn't, we've got alot worse problems than we think ahead.) And we get paid 10% to wait. It just makes sense.

Jan 27 12:38 AM

[John Petersen:]

John Adam, the Firefly battery is based on a different theory than the CSIRO battery the article talks about. The US equivalent is made by Axion which is what I've been trying to explain for months now. Please check out my article from last week for more detail.

seekingalpha.com/artic...

Henarl, actually buying small caps leads to provide better yields over time, but you need to be careful, selective and diversified. While they don't do it as frequently, blue chips fail too. All of today's blue chips were once small caps and somebody made many thousands of percentage points in the transitions.

www.2000wave.com/artic...

Hall999999, in the middle ranges your logic is absolutely accurate. When you get to the extremities, however, everything falls apart. My favorite proof is a comparison of Ener1 ($464 M Mkt Cap) and Exide ($282 M Mkt Cap). If not for a fourth quarter acquisition of a plant in Korea, Ener 1 would have had annualized sales of under $1 million compared with Exide's sales of almost $4 billion. Ener1's September 30 assets were $62 million compared with Exide's $2.25 billion. In fact the only metric where Ener1 is not a rounding error on Exide's balance sheet is outstanding shares, where Ener1 has 100 million and Exide 75. The voting machine is clearly out there and working overtime.

Jan 27 12:58 AM

[hall999999:]

You're right. Ener1 shouldn't be valued higher than Exide. But what do you consider to be middle ranges? Certainly not all of the comparisons you've made are extremities.

BTW, I started looking into Exide to see if I could get a better idea of why the stock is so low and I found this article from November:

www.cnbc.com/id/276647...

Apparently a hedge fund that owned almost 1/3 of the stock (23.7M) is being liquidated. According to the article the fund manager will spend a year and a half liquidating the funds' positions. Do you think this is adding a lot of selling pressure to the stock? Could it keep the stock price down for a year or more?

Jan 27 05:14 AM

[John Petersen:]

hall999999, if you take the Chinese stocks out of the equation, I own the ones that I think are severely undervalued.

Exide and Enersys have come under tremendous selling pressure from hedge fund liquidations. To make matters worse, Exide is just a couple years out from a reorganization and it's still being hit with some clean-up and reorganization associated tax costs. If you look at their core income statement, without restructuring and bizzare tax costs, Exide is making about $60 million a year. The only real problem either company has is an old-tech image that the pretenders to the throne are doing their best to perpetuate.

I've written at length in my early articles on the relative strengths and weaknesses of the various battery technologies. Currently, the voting machine hype over Li-ion is deafening, but nobody has been able to give me a rational weighing machine reason why a $1,300 per kWh technology is preferable to $250 to $500 per kWh technologies, particularly when a user will need to buy 50s, 100s, 1,000s and 1,000,000s of kWh to solve the coming storage requirements.

If Graham is right, the weighing machine will crush the current market darlings and elevate the red-headed stepchildren. If he's wrong, I'm going to lose a lot of money.

Jan 27 07:30 AM

[John Adam:]

John P.,

I am not trying to sell the CSIRO battery or the Firefly battery technology which correspond to existing batteries not theory. My point should have been obvious, combine the Firefly battery with the supercapacitor like in the CSIRO UltraBattery which does not use advanced lead acid technology.

<<The so-called UltraBattery combines 150-year-old lead-acid technology with supercapacitors>>...

Then with the same weight you would get 3 or 4 times the energy storage capacity and the Honda Insight tested would become a PHEV for much less than the GM Volt. Also, use the new 4 door Honda Insight and ditch the transmission. You then have a Honda Volt for much less than the GM Volt.

The automobile market is huge and I do not care who does this. Combining technologies makes sense when you share a percentage in MILLIONS of sales. These technologies are not incompatible. Honda or GM should connect the dots and work with CISIRO and any advanced lead acid technology like Firefly's. Make them an offer that they can not refuse!

Jan 27 01:10 PM

[John Petersen:]

John, I would be very interested in seeing what Firefly's foam electrode would do for a lead-carbon device. In battery industry parlance, the Firefly battery and the CSIRO and Axion hybrids are all classified as advanced lead acid technologies. Firefly uses a foam core to reduce unnecessary lead weight and improve electrolyte access to the active material. CSIRO replaces one half of the negative electrode with a carbon electrode that gives the cell supercapacitive characteristics. Axion replaces the entire negative electrode with a carbon electrode that gives the cell supercapacitive characteristics. The electrochemical reactions are exactly the same in all three cells.

Jan 27 01:55 PM

[John Adam:]

John P.,

Do you think that GM might make its pathetic stock more attractive by starting to think "outside the box". If they bought an interest in Firefly, foam electrodes, and Axion, cell super capacitive technology, and started a CSIRO type project to test an UltraBattery 2.0 would you take a more serious look at GM and their stock and Volt technology?

Jan 27 04:55 PM

[John Petersen:]

John, I'm not a fan of GM or any other large company because I've found that projects get completed in garages and small companies before they even get on the budget committee agenda in big ones. I view energy storage as a horse race and all of the current solutions as inadequate. But the only way things will improve is if the government supports innovation while staying out of commercialization decisions. The oft-derided French term Laissez Faire means let them make. America is home to the most creative people on earth. The only way to stifle that creativity is to put government functionaries into a position where they pick a winner instead of holding a horse race.

Jan 28 01:21 AM

[John Adam:]

John P.,

The Volt exists and GM has made a commitment to produce them in large quantities in 2010. I do not care for the way GM is managed either. What I suggested would show a significant change in attitude on their part. The US automobile companies will continue to lose market share until they actively pursue the transition to electric vehicles to replace inefficient ICE vehicles. By some estimates the USA could produce 20% of its power from wind. In my opinion the USA has the potential to produce much more electric power from its solar, geothermal and water power resources.

Battery technology is necessary to store all the electric power that we generate. Today we waste enough electric power to run our vehicles using batteries charged with power that is currently being wasted. We have the technology to create a VERY smartGRID that could charge millions of large PHEV batteries 24/7 and stop wasting much of the electric power that we now generate using dirty fossil fuels and could eventually generate using clean renewable intermittent sources from wind, solar, etc.

However, none of this will happen if we do not radically change our Energy Policy that causes our Foreign Policy Problems. Improving ICE MPG 50% means nothing when we are over 60% dependent on Terrorist Oil. Electric motors are 3 to 4 times more efficient than ICE engines. The great majority of our daily commutes are less than 40 miles each way. What our goal should be is a NO BRAINER. Doing the math tells me that our position can rapidly change if we take this new path. Running faster down the old circular path will get us nowhere.

Is this an investment opportunity? Obviously it is! We could well lose EVERYTHING if we do not. American Capitalism supports INVESTMENT! Socialism does not.

Jan 28 12:47 PM

[John Petersen:]

John, I'm with you on almost all points. If I were running Axion or any other battery company the last thing I would want to do is cut some sort of a deal with GM because they would demand an arm, a leg and my firstborn male child as an entry fee, and then I'd have to deal with their insufferable bureaucracy to get anything done. If change is going to happen, it will move from the ground up, not the top down.

The simple fact is you're right. We need to get started today using the tools we have readily available today and be ready to replace them with better tools when they come along.

Jan 28 12:58 PM

[John Adam:]

John P.,

Even the Idiots that run GM know that when you are on life support you do not haggle with your oxygen vendor. GM stock is worthless now, but with an UltraBattery 2.0 it would be worth a lot! GM could make an offer that would cost them very little and be worth a tremendous amount if the people with battery technology believe in their technology and are willing to work to produce the batteries. GM has the infrastructure to produce millions of cars NOW and could ramp up production rapidly.

If the companies with these compatible battery technologies are willing to work together to produce an UltraBattery 2.0 then THEY could ask Honda if they would be willing to work with THEM. Willingness to cooperate would be a big bargaining chip here since 2+2+2+2 could = 80 not 8!!

Jan 28 01:40 PM

[John Petersen:]

John, you'll need somebody a lot smarter than me to figure all that out, but dealing with a Honda would be no easier than dealing with a GM because they would still want an arm, a leg, a first-born male child and all the Asian manufacturing rights. I've been doing small companies for 30 years and the best performers are the ones who can walk into GM, stand there flatfooted and say "this is our price - pay it or we're going down the street."

Selling to the auto companies on their terms are a lot like selling to WalMart. You get monster volume and paper thin margins. It's far more sensible to go after the lower hanging fruit and bulk up before standing toe to toe with a giant.

Jan 28 04:52 PM

[Joe Eckstein:]

Hi John,

I'll list the reasons for Beacon's "good investment" status:
- new customers across the country keep knocking on their door
- even with them entering regulated industry, the necessity of instant grid boosting has regulators bending over backwards to let them in
- each site that they set up will generate revenue ad nauseam if they maintain the flywheels
- over time their flywheel process will become less expensive, essentially they're all prototypes now is what I would guess.
- carbon fiber prices will drop over the long haul if any of this technology is to make it
- you may be right that the long term "payback" of each installation will be slow, however a point will be reached - long term where there is a breakeven, and what is an affordable stock now may be considered extremely stable and valuable due to the working capital that may earn nice dividends

I like your company too, but I had to point this out! I'm more of an Ultralife fan though, being nearby it in Rochester, NY.


On Jan 26 09:02 AM John Petersen wrote:

> Loren, it seems like our problem stems from the fact that I don't
> think Beacon is an incredible investment. They have a 20 MW facility
> under construction that will throw off up to $10 million a year in
> gross revenue. After paying interest and principal on the $50 million
> in construction debt, the free cash that will be available to offset
> $20 million in annual losses won't go very far. Currently, it looks
> like Beacon will probably need something on the order of 80 to 100
> MW of capacity to reach break-even. That's years of construction
> and years of equity funded losses. I love the concept underlying
> Beacon's technology, but the numbers are dismal and until somebody
> can show me how that is going to change, I'll remain unimpressed.

Feb 04 01:22 AM

[John Petersen:]

Joe, I like Beacon and I like what they're doing as long as investors focus on the long-term potential and understand that the Company is a long way from break-even. Beacon was an easy target when it was trading at $2+. It is far harder to criticize at $0.50.

Feb 04 02:39 AM