Smart DOE Battery Manufacturing Grants and Dilution for Dummies 21 comments
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Last month I wrote about a very smart plan the DOE developed for $4.5 billion in smart grid grants authorized by the American Recovery and Reinvestment Act of 2009 ("ARRA"). I was particularly impressed that the DOE's plan created a functional public-private partnership where grants would be available to companies that could raise matching funds from private sources, but would be denied to companies that could not attract substantial private sector funding.
While I hoped a similar plan would be adopted for $2 billion in ARRA battery manufacturing grants, my research was hindered by a broken link at www.grants.gov that wouldn't let me download the Funding Opportunity Announcement ("FOA"). Late last week, a reader sent me a copy of the FOA and I was delighted to learn that the same guiding principles will apply to ARRA battery manufacturing grants.
In the FOA for its "Electric Drive Vehicle Battery and Component Manufacturing Initiative" the DOE established goals for five classes of ARRA grant funding as follows:
| Industry subsector | Total Funding | Awards | Award Size |
| Cell and Battery Pack Manufacturing Facilities | $1,200 million | 7 to 8 | $100 to $150 million |
| Advanced Battery Supplier Manufacturing Facilities | $275 million | 14 | $20 million |
| Advanced Lithium ion Battery Recycling Facilities | $25 million | 2 | $12.5 million |
| Electric Drive Component Manufacturing Facilities | $350 million | 3 to 5 | $80 million |
| Electric Drive Subcomponent Manufacturing Facilities | $150 million | 6 to 8 | $20 million |
The FOA also provided that grant recipients will generally be expected to provide 50% of the required funds from private sources. While the DOE has the power to approve grant requests with lower cost sharing ratios (subject to a floor of 25%) any reduction in the cost sharing ratio will count as a negative factor. Teaming among suppliers, manufacturers and end users is encouraged but not required. If the plan works like it's supposed to, $2 billion in DOE grants will be matched with $2 billion in private capital and used to build $4 billion in new manufacturing plants. It's a far more aggressive start than I could have hoped for when I first argued that America needs to rebuild its domestic battery manufacturing infrastructure.
To put the magnitude of the ARRA battery manufacturing grants in rough perspective, nine of the pure play energy storage companies I track account for about a third of the U.S. battery market and have a combined book value of $1.5 billion. If their ratios are typical, then the book value of the entire domestic battery industry is approximately $5 billion. By the time you add $4 billion in new factories and then add a like amount for associated inventories and accounts receivable, it's easy to forecast outstanding growth in the energy storage sector for several years. It's impossible to identify the likely winners of the grant selection process, but it's a pretty safe bet that every company that can apply will. I also believe that my nine pure play energy storage companies, as a group, are likely to receive a significant share of the awards.
Applications for the first round of ARRA battery manufacturing grants must be filed by May 19, 2009. The DOE plans to select the first round of grant recipients by the beginning of July and finalize the first round of grant awards by the end of September. While there will undoubtedly be a tremendous amount of posturing, positioning and PR over the next several weeks, I don't foresee any clearly investable events before the end of June.
None of the pure play energy storage companies I track has huge cash reserves that can be spent on new factories. This leads me to believe that every company selected for an ARRA battery manufacturing grant will have to go out into the market and find new financing for all or part of its matching funds. Once the new plants are built, a second round of financing will be required for associated inventories and accounts receivable. For most, the required financing will exceed their current capital by a wide margin. Since many of the likely recipients are smaller companies that cannot be classified as high quality credit risks, I expect them to rely heavily on the equity markets. One thing is certain; it will be a target rich environment for investors that are willing to make a long-term commitment to the energy storage sector.
Since it's impossible to talk about large stock offerings without having somebody worry about dilution, this is probably a good time to tackle that issue. I want to apologize in advance for the complexity of the following discussion, but these are critically important issues. So take your time, read it slowly and feel free to ask me about anything that's unclear.
Everybody above the age of five understands the concept of dilution. If you're sitting in a restaurant with a half-empty coffee cup and the server tops it off –
- With water, your beverage is diluted;
- With coffee, your beverage is unchanged; and
- With espresso, your beverage is fortified.
The same basic rules apply in corporate finance and substantially all sales of newly issued shares fortify the issuer's balance sheet. Nevertheless perception problems and other complexities frequently arise because every stock sale impacts three distinct groups who think dilution is important and approach the issue from different perspectives.
- New investors typically view dilution from a book value perspective and think they're being diluted if the purchase price they're being asked to pay exceeds book value per share;
- Insiders typically view dilution from a paid-in capital perspective and think they're being diluted if the purchase price of new shares is less than the average price paid for outstanding shares; and
- Public shareholders typically view dilution from a market price perspective and think they're being diluted if the purchase price of new shares is less than the prevailing market price.
All three perspectives are fundamentally valid, fundamentally flawed and irreconcilable. In most cases, the best a company can hope for is a modest discount from market.
Since the differences between book value, paid-in capital and market price per share can be immense, it's important for investors to understand the range of possible outcomes. The following table provides comparative book value, paid-in capital and market price data for each of the pure play energy storage companies that I would classify as likely applicants for ARRA grants. The data has been taken from the most recent SEC reports filed by the companies and gives pro-forma effect to the conversion of any non-redeemable preferred stock.
| Net Book | Total | Book | Paid-In | Market | ||
| Value | Shares | Value | Capital | Price | ||
| Symbol | (000s) | (000s) | Per Share | Per Share | Per Share | |
| Cool Emerging Group | ||||||
| Ener1 | HEV | $106,413 | 113,474 | $0.94 | $3.39 | $6.48 |
| Valence Technology | VLNC | ($63,081) | 122,754 | ($0.51) | $4.06 | $2.30 |
| Altair Nanotechnologies | ALTI | $37,752 | 93,153 | $0.41 | $1.99 | $1.09 |
| Cool Sustainable Group | ||||||
| Maxwell Technologies | MXWL | $61,233 | 23,129 | $2.65 | $8.56 | $9.21 |
| Ultralife Corp | ULBI | $83,065 | 16,959 | $4.90 | $10.02 | $7.74 |
| Cheap Emerging Group | ||||||
| Axion Power International | AXPW.OB | $7,924 | 35,333 | $0.22 | $1.62 | $1.55 |
| Cheap Sustainable Group | ||||||
| Enersys | ENS | $661,751 | 47,975 | $13.79 | $7.59 | $18.99 |
| Exide Technologies | XIDE | $486,382 | 75,478 | $6.44 | $14.71 | $6.56 |
| C&D Technologies | CHP | $49,116 | 26,296 | $1.87 | $1.22 | $1.89 |
I regularly participate in pricing negotiations between investment bankers and emerging public companies that need to raise equity. In each case the first thing the bankers do is paraphrase Benjamin Graham and tell my clients that while the stock market is a voting machine, investment banking is a weighing machine. Next they explain that after completing their due diligence they plan to ignore the market price and base their negotiations on fundamental business, technological and product issues like the ones I've been discussing for the last nine months.
While it is generally easy to move the bankers up from a lowball initial offer by showing how historical expenses created enduring non-financial value for an emerging client, the banker's resolve typically stiffens to the consistency of granite as the negotiation approaches 80% of market price. The final negotiating rounds are always bare-knuckle affairs but when the table pounding and cursing is over, my clients invariably acknowledge the supremacy of the golden rule of capitalism (he who has the gold makes the rules) and accept the best price they can negotiate.
I have no experience with transactions like the ones that will be negotiated over the next few months. Potential investors will rightly argue that the ARRA grants effectively double the benefit of their investment for a grant recipient and its shareholders. The grant recipients will rightly argue that the ARRA grants effectively cut the new investors' dilution risk in half. While my right-brain tells me that the ARRA grants will simplify negotiations between companies and investors, my left-brain knows better. On The Mickey Mouse Club of my youth, Wednesday was "anything can happen day." For the next four months, energy storage investors need to remember that every day is Wednesday.
Disclosure: Author holds a large long position in Axion Power International (AXPW.OB) and small long positions in Exide (XIDE) and Enersys (ENS).
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This article has 21 comments:
To really oversimplify your message, are you proposing that investors 'buy the dips'?
While the awarding of grants are likely to be cheered with increased stock prices, the additional stock offerings these grants will necessitate are likely to drive prices down due to fears of dilution. So the price action on these companies could be a little bit wild.
However, you argue, fears of dilution are just fears and the net combined effect of the grants and stock offerings is likely to be positive.
Therefore, 'buy the dips' and hang onto your hat?
As a summary of your message, John, is this close?
Your warning about valuation is well taken. However, when it comes to government grants, "cool" and "emerging" might very well turn out to be selling points—depending on the attitude of the granting agency. If I could buy the whole sector with an ETF to cast a broad net for the subsidy benefits, I would do so.
Frflyr, I can't offer any insights on the drive component sector, but agree that it's probably worth watching.
Don Harmon
You don't hear that one much anymore these days.
More like, "he who has the gold, ducks for cover."
In the future it may be "he who has the gold, runs for reelection".
I have read your articles with great interest over the past 2 months. Is there any way you can lay out a few senarios as to what could happen to AXPW in terms of Revenues and profits over the next few years? To hold a "large long" position, you must have some idea/hope for the future? For an outsider, it is difficult to even guess. thank you, stuartg
Frflyr, Axion's been around for about five years but because of some of the problems it faced in the early years and has since resolved, it kept an extremely low profile. This time last year, the 200-day average volume was roughly 5,200 and today it's more like 16,400. As long as trading volumes remain low, the spreads will typically be fairly large. As volume increases the spreads should decrease. It's just the way these things work.
Stuartg, trying to predict ramp-up rates is always difficult when you're looking at an entirely new class of product like the PcB battery. Starting in Q-3 Axion should be able to put something on the order of PbC batteries a day out for testing in different applications, which should throw off a couple million in quarterly revenue. The next ramp comes when another piece of automated production equipment comes on line and hopefully increases capacity by 5x to 10x. At that point, the entire electrode fabrication process will be automated and it should permit rapid expansion of testing, move quarterly revenue into a more respectable range and perhaps bring the company to break-even. The big leaps will come as the testing and sales cycle is completed and optimal uses for the device become clear. At that point I would foresee a series of joint ventures where Axion sells electrode assemblies to other manufacturers that make products for a particular application.
I'm hoping that the Q-1 earnings call that should be coming shortly will help clarify both my murky view of the future and yours.
seekingalpha.com/artic...
I can't imagine a company that would have a better chance of having the politicians ears than GE and it would be a shame if they somehow managed to capture a disproportionate share of the pie.
I've already written an article and sent it off for publication. It will show up on altenergystocks.com first and then Seeking Alpha will pick it up. Should be out either today or tomorrow at the latest.
Chloride as a major provider of UPS batteries which is an interesting market niche and BYD which makes commodity lithium batteries and is hell-bent on the low-cost producer strategy.
About Exide: Does anyone know if XIDE has been able to keep any good employees/ or does any significant R&D since its scandals and massive environmental liabilities?
Finally, what about Polypore? It makes components. Are its products anything special?