Li-ion Battery Manufacturers: The Bleeding Edge of Energy Storage Technology

As a lawyer, I’ve had the privilege of working with some of the finest scientific minds in the world. They all started with brilliant concepts and impressive laboratory results, but a substantial majority failed to create a viable business.

After countless clients that started well and ended up mired in a swamp, I’ve come to understand that technology is a two-edged sword. On the leading edge, developers of low cost technologies can build fortunes. On the bleeding edge, developers that can’t control their costs and manufacture competitive products often morph into the financial equivalent of a black hole. Sadly, I believe most current developers of advanced Li-ion batteries are on the bleeding edge of energy storage technology and are doomed to spend years, if not decades, hemorrhaging cash.

I frequently feel like Cassandra, the Greek princess who was given the gift of prophecy and then cursed so that no one would believe her. When I read reports about how an MIT researcher has developed a new material that will allow Li-ion batteries to recharge in seconds or how Japan’s national alternative energy development agency has targeted a 50% reduction in Li-ion battery costs over the next year, I don’t get excited over the mirage of progress.

Instead, I start asking buzz kill questions like “How much will these new materials add to the cost of a battery?” and “How can anybody reasonably target a 50% price reduction over the next year when the average has been 5% for the last 20 years?” The answers, of course, are “plenty” and “they can’t.” The stories are cheerleading and hype, not rigorous analysis; and we all know what happens when optimistic forecasts collide with immutable economic laws.

The fact is that everyone, including me, wants an easy, quick and painless solution to our growing energy dilemma. However wishes, hopes, dreams and desires can’t change the fact that until somebody overcomes the cost, performance, abuse tolerance and cycle-life issues that the DOE has analyzed in depth and I’ve discussed in earlier blogs, there will be no Li-ion solution for the average consumer’s energy storage needs. Progress is being made, but it’s an uphill battle where the goal is measured in miles and the progress is measured in feet.

Every time I mention the elephant in the living room, I’m inundated with comments suggesting that the data I’ve cited is old or unreliable. The contrary authority invariably says something like “Lyons said that most estimates put the near-future cost for battery manufacturing at $250-300 per kWh once economies of scale are ramped up” or points me to a Chinese website. The only response I can offer is balderdash! With annual revenues of several billion dollars, the Li-ion battery sector already has plenty of scale. What it lacks are meaningful potential economies.

Economies of scale are modest savings that can reduce per unit cost as a profitable business grows. They arise from factors like discounts on raw materials purchases, greater worker specialization, lower financing costs and reduced spending on ancillary items like research and development. For a more detailed discussion of the topic, see “What Are Economies of Scale?

An estimated 75% of the cost of a battery goes for raw materials. So unless you insist on believing in a commodity fairy that will slash raw materials costs despite rapidly escalating global demand, you can’t honestly believe that vaguely defined economies of scale will make insanely expensive products affordable. Even the happy talk articles like the most recent one from Japan merely serve to prove the point:

“NEDO also analyzed battery cost (not a cell but a battery pack) as of March 2009. It estimates that the cost is about ¥200,000/kWh (approx US$2,016/kWh) for both types of batteries.”

In January I published a comparative breakeven analysis for an EV-40 and an EV 100 using the $1,333 per kWh value for Li-ion batteries that I took from a July 2008 Sandia Laboratories report on its Solar Energy Grid Integration Systems – Energy Storage Program. That analysis showed that an EV-40 could not break even at gas prices of less than $3.70 and an EV-100 could not break even at gas prices of less than $9.20. Even if I use the latest happy-talk target out of Japan and give effect to the vainly anticipated battery price collapse, the breakeven points work out to $3.02 for an EV-40 and $7.54 for an EV-100. At those prices, there are only two classes of buyers, the emotionally committed and the mathematically challenged. This is not encouraging news in a recession.

When evaluating any company, the first thing I want to know is whether it can sell a product and earn a reasonable gross margin on the sale because without gross income net income is impossible. In general, high gross margins are wonderful things and low gross margins are very bad things.

The universe of publicly traded Li-ion battery manufacturers is small so there are not a large number of reliable data points. Nevertheless, I was able to do some digging through SEC filings and cobble together the following table that compares historical product sales, gross profit and gross margin data for five active Li-ion battery manufacturers (Click on the table for a PDF version).

From both a revenue growth and gross margin perspective, Advanced Battery (ABAT) has been an impressive performer and seems to be on the leading edge of Li-ion technologies. At the other end of the spectrum, Valence Technology (VLNC) and A123 Systems seem to be stuck on the bleeding edge. While Ener1 (HEV) and China BAK Battery (CBAK) have modest gross margins, their performance falls far short of leading edge; in fact, they’d be poor performers among the conventional battery manufacturers that I’ve identified in the following table.

Over the course of my career I’ve had substantial experience with both leading edge and bleeding edge companies. As a lawyer, I try to discourage potential clients from starting down a road that has a low chance of commercial success because life is short and dealing with disappointed investors is never pleasant. Once a project begins I carefully watch for signs that a client is tending away from the leading edge and toward the bleeding edge because an early failure is invariably easier to cope with than a client that lives on the bleeding edge for years. Factors I view as warning flags that a company is approaching the bleeding edge include:

Countertrend revenues	When companies like Ener1’s Korean subsidiary report revenue declines while their peers are reporting substantial revenue increases, I see yellow and orange flags.
Gross margins	High gross margins are usually a reliable indicator of a superior product and small gross margins can be tolerable in high volume industries, but negative margins are a red flag.
Debt financing	In the absence of a long and well-established earnings history, substantial debt is toxic and leading edge companies don’t have substantial liabilities to anyone.
Related party debt	A heavy reliance on insider financing is normal during the formative years, but when the insiders of public companies like Valence and Ener1 purchase secured debt instead of straight equity the risk to common stockholders skyrockets.
Idle factories	In the absence of a cogent explanation, idle factories are a red flag that the owner cannot manufacture and sell a commercially viable product. There are always opportunities for viable products and a manufacturer like Ener1 that can’t harvest the low hanging fruit will rarely succeed with more sophisticated customers.
Operating expenses	Leading edge companies like Advanced Battery aggressively control operating expenses at all levels, which permits them to take over 70% of their gross margin to the bottom line. Profligate spenders like Ener1, Valence and A123 are far closer to the bleeding edge.
Nosebleed valuations	When a market leader like Advanced Battery trades at 6.8 times earnings and has a market capitalization of $110 million, no reasonable investor can justify market capitalizations of $193 million or $483 million, respectively, for companies like Valence and Ener1 that have never even come close to reporting a profit.
PR perspective	Leading edge companies talk about events while bleeding edge companies publicize goals. What will happen if the DOE reviews A123’s $1.8 billion loan request or Ener1’s $480 million loan request and decides the requests don’t meet regulatory requirements?
Veiled hubris	New entrants in a technological field are almost never better at manufacturing and marketing than their entrenched competitors who offer comparable products. Li-titanate batteries from Ener1 may compete with Toshiba’s SCiB line, but they are unlikely to be demonstrably better or cheaper. Likewise Li-phosphate batteries from Valence and A123 may compete with products from BYD, but assuming competitive superiority without demonstrable proof is the pinnacle of veiled hubris.

On August 15, 2008, when the Dow [^DJI] was at 11,660 and the Ardour Global Index [^AGIGL] was at 3,370; I offered a short-list of pure play energy storage companies that were likely to benefit from an unprecedented surge in demand for manufactured energy storage devices that will be driven by cleantech, the sixth industrial revolution.

The intervening eight months have been a tough time as the Dow has collapsed to 7,401, a shocking 36.5% decline; and the Ardour Index has plummeted to 1,285, a breathtaking 62% plunge. As a group, my short list of pure play energy storage companies has tracked the Ardour Index and fallen an average of 60%. The following chart compares closing prices of those companies on August 15, 2008 with their closing prices on March 19, 2009.

Combined, the short list companies have a current market capitalization of $2.1 billion. As I previously reported, Federal grants for advanced battery manufacturing will inject $2 billion in new capital into the battery industry over the next two years and grants for electricity delivery and reliability projects are likely to bump that total by another $1 to $1.5 billion. Moreover, effectively unlimited debt financing will be available through an alphabet soup of DOE guaranteed loan programs. In combination, the likely impact on the energy storage sector is mind-boggling.

If one assumes that the DOE does not understand the difference between the leading edge and the bleeding edge and it decides to treat all applicants equally, there is a remote chance that the bleeding edge battery manufacturing companies will have sufficient resources to justify their current market capitalizations when the dust settles, but those market capitalizations are not likely to increase significantly from current nosebleed levels. Instead, the market performance is likely to come from companies that focus on their accomplishments rather than their goals.

At heart I’m an incurable optimist and I firmly believe that “In America we get up in the morning, we go to work and we solve our problems.” (From The Lost Constitution by William Martin). But our problems are not going to be solved by airbrushed centerfolds that thrive on the bleeding edge and promise simple and economically implausible solutions to incredibly complex problems.

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

Comments

[jimp]

Do you have any thoughts on buying mining company's that mine for Rare earth elements, Lynas corp for example?
If a large part of the cost of the battery comes from "raw" material, do you think SQM, lynas corp would be good investments? Thank you.

2009 Mar 22 06:40 AM

[John Petersen]

jimp, I try to stay away from discussing mining stocks, but the people who sold the blue jeans, shovels and food to the miners in the California gold rush had much more consistent results than the miners did. No matter where the battery industry goes, the raw materials suppliers will likely thrive as long as their reserves hold out. So I'd have a hard time criticizing companies like SQM.

2009 Mar 22 06:46 AM

[jscilla]

Damn, you are one tedious person. You call yourself an optimist, but
bash the future of LI ion, while supporting the old technology of
Pb acid. You caution people about investing in 'bleeding edge'
companies, yet you have a large holding in Axion, a money
losing company.

As an investor in ABAT I am tired of seeing articles about ABAT listed on Yahoo from Seeking Alpha, because I know that it is just another article by you.

Spare the world of your weekly rants. They don't help me or
anybody.

2009 Mar 22 08:13 AM

[John Cordes]

Once again nice analysis and cudos for also being literate, a bonus for your articles.

Now that ABAT has the electic bicycle business, do you think this synergy is a meaningful plus for their bottom line, and wouldn't it benefit practical R & D field testing of battery performance?

2009 Mar 22 08:36 AM

[Alphameister]

With a substantial position in ABAT, I approached your article with some trepidation.....only to be pleasantly surprised by your citation of ABAT as the leading edge in Li-ion technology. I wonder if jscilla read your post before commenting on it!

2009 Mar 22 09:20 AM

[Alphameister]

Just checked out your related holdings and will likely take a small stake in ACPW. Thanks for your insights.

2009 Mar 22 09:29 AM

[Matt_the_Batt]

with regard to the ongoing weakness of the US-Dollar, you should consider to take the European SAFT Batterie Group into account.

2009 Mar 22 09:33 AM

[John Petersen]

jscilla, going to the comment section of an article without reading it first is never a good idea. Today I had nothing but praise for ABAT and identified it as the only Li-ion company worth owning. But you were so interested in posting a rant that you didn't bother to read prior to condemnation.

John Cordes, I've always been impressed by ABAT's plans for electric bikes and scooters like the Veken. My issues come when people want to use exotic battery chemistries to power 3,000 pounds of steel at freeway speeds.

Matt, SAFT is a great company, but fundamental economics in Europe where gas prices are 2x to 3x your prices in the States make for a different business dynamic. I avoid talking about them because information is a bit more complicated to obtain and the currency translations can also be problematic. But any company that can partner with JCI for Mercedes Benz and ABB for utility applications is doing a lot of things right.

2009 Mar 22 09:55 AM

[Mad Hedge Fund Trader]

So where's it going to come from? Politicians, industrialists, and environmentalists who see battery powered vehicles as the wave of the future are overlooking the fact that 50% of the world supply of lithium comes from impoverished, landlocked Bolivia. This is a country that until now was best known for killing off famous foreigners (Che Guevara, Butch Cassidy and the Sundance Kid), and being the source of a new form a venereal disease. Lithium ion batteries are four times more efficient than the current generation of nickel cadmium batteries, and are essential for electric cars to finally become economically viable. But now that the country finally has something the world wants, nationalism is rearing its ugly head. Local politicians see their country as the Saudi Arabia of the highly corrosive, toxic, reactive metal, and are already discussing ways to restrict access. The only other supplies are to be found in Chile, Argentina, Australia, China, and Nevada. Should the US invade to insure supplies? Iraq worked didn’t it? The best way for opportunistic investors to play this is to buy Sociedad Quimica Y Minera (SQM), Peru’s largest producer of lithium.

2009 Mar 22 10:19 AM

[MuMu Moorthi]

ABAT is a service company, resells batteries from number manufacturers. Not a battery manufacturer and you can not put them into this category. There are numuber of companies like this who are doing well. It is not fair to other companies to include ABAT in this category. Also ABAT is moslty reselling lead acid batteries, no much involved with lithium batteries. Similarly Enersys, C&D, Exide etc., are all lead acid battery companies.

2009 Mar 22 10:26 AM

[John Petersen]

MuMu, I think you might want to read ABAT's Form 10-K which tells an entirely different story about ABAT's business activities. Gross profit margins never lie and resellers don't get to keep almost half of the cash that flows through the door unless they're dealing with incredibly unsophisticated manufacturers.

2009 Mar 22 10:47 AM

[Jack Lifton]

This is the best and most comprehensive discussion of the economics of high-tech startups that I have ever seen. It should be required reading in all B-Schools instead of just those in Southeast Asia where it will be immediately added to the syllabi. It cannot be overemphasized that the market is driven by emotion not logic. You can make money in the short term by graphing the "frenzy," but in the long term, where everyone future resides, only the cold logic of economics prevails.

2009 Mar 22 11:10 AM

[Paul Killinger]

Indeed, our new Administration is beginning to learn about "immutable economics laws" on a wide range of fronts according to the CBO's budget report published this past week. That likely won't intimidate their DOE from squandering the bulk of the funds already dedicated to this once-in-a-lifetime opportunity, however.

2009 Mar 22 11:17 AM

[Paul Killinger]

John,

How about the idea of developing a basket of alternative energy stocks and possibly their materials providers in the form of a sector specific ETF or mutual fund? Or is something like that too expensive to get started?

2009 Mar 22 11:28 AM

[John Petersen]

Many thanks Jack. I always expect some heat when I write an article like this one so it's nice to hear kind words for the effort.

Paul, I think Secretary Chu may be more familiar with the problems of bleeding edge technology than some give him credit for. Over the years at Lawrence Berkely I'm sure he's seen a lot more tech driven startups than I have. He also has a habit of using phrases like "cost effective" and "viable business plan" when he speaks to the press. While we will only be able to assess the wisdom of his decisions in 20/20 hindsight, I remain hopeful that we'll see the eggs go into a wide variety of baskets so that a couple high-risk disasters don't gut the effort.

Tom Konrad, a fellow writer at altenergystocks.com does a lot of writing on alternative energy ETFs and mutual funds.

2009 Mar 22 11:38 AM

[searcher]

"..resellers don't get to keep almost half of the cash that flows through the door unless they're dealing with incredibly unsophisticated manufacturers." John, very droll. A pleasure to read such literate, reasoned and forbearing commentary.

2009 Mar 22 01:13 PM

[battman]

John,

Another good article. One thing I find interesting and some readers don't want to see is that you're not bashing Li-ion, you're just saying at this point it won't be as prevalent as many want to believe (due to costs, limited raw materials, etc), but that it is and will continue to be part of our lives. Even your disclosure states you own a couple of Li-ion co's.
Lead carbon batteries should very well become the standard for quite some time but they won't be alone, and I don't think you've ever said anything different.
Keep up the good work, I appreciate your candid look. Reminds me of the Ballard hey day when there was no way we weren't all going to be driving fuel cell powered cars by the early 2000's.

2009 Mar 22 01:18 PM

[John Lounsbury]

John - - -

Thanks for keeping me tuned in to the energy storage sector. I have a significant postion in ABAT, much of it established 1-2 years ago, based on analysis of the financials. In spite of my analysis efforts I am down more than 40% on the position. However, the financials still look good to me and I have recently added to the position. More recently I also added a smaller position in CBAK. My positions in these companies have nothing to do with any potential for automobile applications, but are based on the smaller battery potential growth.

If it were not for your articles I would be totally ignorant of the trade-offs in energy storage for cars, grids and other applications. Thanks for continued effort.

2009 Mar 22 01:35 PM

[John Petersen]

Searcher, people who take the time to read and understand deserve all my respect. I occasionally get my Irish up but prefer to keep things as level as possible because harshness merely stands in the way of the message.

Battman, I love Li-ion in appropriate applications, which is why I've always liked ABAT. However, on an emotional issue like storage the pendulum frequently swings too far and too fast as people expect more from a technology than it can deliver. I'm convinced we need every solution that exists and a lot that haven't been invented yet. I believe that all energy storage companies that stay right sized in their ambitions offer solid opportunities for investors. I also believe that some of the disrespected lead-acid companies have far more upside potential than people will realize until its too late.

John, any time a public company can survive on less than $5 or $6 million in SG&A my hat is off to management, because they clearly understand that costs matter across the board. ABAT is amazing in that respect and has fabulous margins. If they can keep it up, the payoffs will be well worth the temporary price decline. Remember the words of Sam Walton who said "I still own it all so I haven't lost anything" after the '87 crash?

2009 Mar 22 02:01 PM

[1980XLS]

SQM is from Chile, not peru.

Mercedes' battery for the new "S Calass" Hybrid are sourced through Contnental.

Gm's "VOLT" appears to be utilizing "LG Chem" technology at this point. But GM wants to control the manufacturing themselves at this point.

Nevada's Lithium Deposits are owned by the Geman Company
Chemtall, a division of Rockwood Holings (ROC)

Lithium Battery disposal is not Toxic.

Bolivia has the most low cost lithium available to harvest.

They will be working with miners to exploit those reserves.

Insider buying suggests Valence may be waiting to get aquired by perhaps one of the larger "non Lithium" battery companies.

Cobasys or ENS perhaps?

These are all points to consider when investing in this field.

It is my belief that intellectual property will be the big winner.

Question is who has it, A123, HEV? GE is a major investor in Think and A123.
Why would Think use HEV? Then again, A123 has ties to MIT., who just claims a breakthrough in chargability.

As far as manufacturing:

Government interference and politics will once again try to manipulate the free market. Their R&D/ Bailout funds will have strings attached such as "Green Jobs", AKA payback to the UAW.

That means the money will go to the firms committed to producing in the USA.

I believe that frontrunner would be HEV at this time.

Do not underestimate the politics of this industry.
Al gore is involved in Think USA. Yet to go into full swing.

2009 Mar 22 02:42 PM