IPO Analysis: The Ultimate Story Stock, A123 Systems

Short of Google (GOOG), IPOs don’t get any sexier than A123 Systems (AONE). No one disputes the potential of battery powered cars, massive storage of green energy from solar and wind, and having virtually every appliance from lawnmowers and vacuum cleaners to computers and entertainment cordless. But in the words of the internet, A123 is more eyeballs than monetization.

To be sure they have actual revenue, but they are running a negative gross margin on product sales. In essence the more they sell, the more they lose. And they predict the revenue from their largest customer Black and Decker (BDK) is expected to shrink considerably. No more revenue is expected from Mercedes-Benz (DAI) HighPerformanceEngines (Vodafone McLaren Mercedes Team). That leaves only BAE Systems (BAESY.PK) for growth.

The truth is in the prospectus. The only real-life applications besides power packs for hand tools have been: BAE Systems’ Hybridrive propulsion system for busses and a few Hybrid Ancillary Power Units for the AES Energy Storage unit of AES Corporation.

Here’s where it gets interesting. A123 is designing and developing batteries and battery systems for BMW, Chrysler, GM, Shanghai Automotive (SAIC), Delphi and Better Place. While A123 invests in custom automotive research and development, they expect most of their revenue for the “foreseeable future” from very few customers. And none of the potential automotive customers have committed to long-term contracts or minimum production volumes. So far A123 is much more hype than substance.

I cannot judge whether A123’s technology is superior to its competition. But it has some fierce competitors: Bosch, Dow Chemical (DOW), NEC, Panasonic, Sanyo and Samsung. Nissan (NSANY), Toyota (TM) and Volkswagen have entered into joint ventures to produce batteries that don’t include A123.

A123’s major manufacturing facilities are located in China and Korea. Their key strategy is to reduce cost by starting to manufacture in Michigan. Makes sense to me; lower costs by moving production from low cost countries to a high cost state in a high cost country. It only makes sense when the government gets involved in this Ponzi scheme.

The US DOE Battery Initiative granted A123 $249.1M to build manufacturing facilities in Michigan. The company also believes that it will be able to borrow up to $235M from the Advanced Technology Vehicles Manufacturing Loan Program. The company expects to be required to invest 25¢ for each DOE Battery Initiative dollar. In addition, the Michigan Economic Growth Authority (MEGA) granted $10M and offered up to $4M in loans. MEGA is topping their deal with a 15 year tax credit. Even the government can’t resist something this sexy.

Product revenues were $53.5M in 2008 and $36.6M in the first 6 months of 2009. But cost of product sold was $70.4M and 39.2M respectively. Throw on operating expenses of $79.6M and $40.3M, and you get losses of $80.5M for 2008 and $40.7M for H1 2009. With no definitive volume automotive contract in the near future, it looks like A123 is a pipe dream.

It might be helpful to view a speculation on A123 like a small biotech. Though, I take A123 more seriously than the ethanol debacle. No doubt green energy needs smoothing and electric cars will be a reality. But will A123 survive long enough to benefit? While automotive is the highest profile application, it is too much like what General Electric (GE) calls “long cycle businesses.” A123 will need to concentrate on less sexy applications to keep the company going until the brass ring comes in.

I might speculate on A123 when they break even on a gross margin basis and the hype in the stock is deflated. The trick is to enter when the fundamentals start to look like a viable business, but before the first major automotive and power grid deal is announced.

Disclosures: Author is long GE; GE has made an investment in AONE.

Comments

[Windsun33:]

I have felt that AONE was over valued out of the chute, and still do. Because it was an IPO it took off like crazy, but a stock with the same fundamentals would be selling for $3.

Oct 08 10:21 AM

[Zenfar:]

"The trick is to enter when the fundamentals start to look like a viable business, but before the first major automotive and power grid deal is announced."

What if the first major automotive and/or power grid deal comes before the fundamentals. That would seem reasonable has the major deal would obviously change the fundamentals of the company.

Long AONE and QTWW

Oct 08 01:30 PM

[Mayascribe:]

So A123 is supposed to replace gas hogs? By being a cash hog?

No major guaranteed contracts; only studies, and sales in dribs and drabs of prototypes. Most of what they sell, they lose money by selling it. They have never made a profit in any year that they have existed. Never.

What kind of red herring premise is this? Ah...it's Ener1's. They're burning through taxpayers cash, too. No way would I invest in either of these boondoggles.

Oct 08 03:47 PM

[ScroogeMcduck:]

Hey maya, golds had a good run up recently I feel like a correction is comming gonna sell my position in (AUY) I'm up 45% what do u think?

Oct 08 03:54 PM

[Mayascribe:]

Scrooge: I can only say that I was adding to my gold positions today.

Who the heck knows what's going to happen, but gold is breaking out, and the next resistant level to the upside is $1080. I think we'll get there soon. Booking profits is always a good thing. If you have the selling itch, maybe sell half now, and half later. Remember, though, yesterday Barclays had a 1500/ounce call.

I'm bullish on gold, and have a significant % of my e-gamer account in the yellow metal, especially overweighted in my absolute favorite, Jaguar Mining (JAG). Bought more in my brokerage account yesterday. Have you looked at their e-presentation yet? Best I've ever seen from any miner. Go here to get it: jaguarmining.com Well worth the 20 minutes, maybe after closing. JAG is one bumpy ride of a stock to own, though.

By the way, I did a some DD on your pick Silvercorp Metals, and am up over 4% since you gave me the tip. Thanks!

Another angle on mining is Rare Earth Elements--REEs. If you haven't put Jack Lifton on your following list, it's suggested you do, and then read everything he's written here on SA. Jack's over in China right now, giving three speeches. When he gets back, try to read what he has to say, as China controls 97% of the world's REEs, in which pretty much every gadget you use, every flat screen TV you look at, every car and every battery in the car, have REEs.

Hope tis helps, buddy!

Oct 08 04:18 PM

[Douglas Kor...:]

Lithium has NOT proven itself as more than a niche market in Battery EVs. The proven battery chemistry is LEAD and NIMH, that's why GM and Chevron went out of their way to kill those and don't seem to even care about killing Lithium. Lithium is much more expensive, and doesn't last as long as NiMH. So what's to like?? An unproven technology that the one foe who SHOULD hate it, Chevron, has not bothered to stop. Since Chevron hasn't bothered to kill Lithium, you can bet that they aren't worried about it! So the battery EV market is problematic, at best, for Lithium.

The energy storage idea is just plain bullshit. It's not practical to use batteries to store solar energy or for peak shaving!! Utilities pump water up to places like Lake Castaic to "store" off-peak energy; the loss is at most 20%, there isn't any big replacement costs, as there would be for Lithium, and it's proven and reliable. So yes, I doubt this; it's as much hogwash as the idea of a large market for solar backup batteries. I have 8-year-old lead-acid backup batteries that cost less than $100/kWh; why would I go to Lithium for my solar electric backup system?? At a cost of $1200/kWh??? And how many people have solar electric systems, much less battery backup systems?

The power tool market is fine, but look at the numbers: it's just not enough money to support this kind of hype, IMO.

The big question is, if it's a bubble, when will the peak of the bubble be reached?

Oct 08 05:31 PM

[Random Capital:]

A123 Systems is using old technologies and the company is not able to generate Cash Flow. We value the stock at $5.00. The Future is: quantumbattery.ch/drup.../ and Antro Group is already using it. solo-duo.hu

Oct 09 12:37 AM

[ScroogeMcduck:]

Maya, Thank you for your time always nice to hear other opinions from someone with similar strategies. I'll definitely check out JAG's presentation sometime today. Glad to hear you up in (SVM) keep up the good research.


On Oct 08 04:18 PM Mayascribe wrote:

> Scrooge: I can only say that I was adding to my gold positions today.
>
>
> Who the heck knows what's going to happen, but gold is breaking out,
> and the next resistant level to the upside is $1080. I think we'll
> get there soon. Booking profits is always a good thing. If you have
> the selling itch, maybe sell half now, and half later. Remember,
> though, yesterday Barclays had a 1500/ounce call.
>
> I'm bullish on gold, and have a significant % of my e-gamer account
> in the yellow metal, especially overweighted in my absolute favorite,
> Jaguar Mining (seekingalpha.com/symbo...). Bought more in
> my brokerage account yesterday. Have you looked at their e-presentation
> yet? Best I've ever seen from any miner. Go here to get it: jaguarmining.com
> Well worth the 20 minutes, maybe after closing. JAG is one bumpy
> ride of a stock to own, though.
>
> By the way, I did a some DD on your pick Silvercorp Metals, and am
> up over 4% since you gave me the tip. Thanks!
>
> Another angle on mining is Rare Earth Elements--REEs. If you haven't
> put Jack Lifton on your following list, it's suggested you do, and
> then read everything he's written here on SA. Jack's over in China
> right now, giving three speeches. When he gets back, try to read
> what he has to say, as China controls 97% of the world's REEs, in
> which pretty much every gadget you use, every flat screen TV you
> look at, every car and every battery in the car, have REEs.
>
> Hope tis helps, buddy!

Oct 09 08:16 AM

[Duude:]

There are two great times to offer up an IPO, but with different goals & beneficiaries. The more celebrated time is when the demand for a company's product or service is an ever-growing phenomenon and can only be effectively addressed through a major expansion of corporate assets which will require vast quantities of new capital to reach that goal. The other time is when a company's founders have invested a lot of time and sweat, but now realize their time has grown short to cash in before the train has left the station. I haven't studied this company enough to register an opinion. Caveat Emptor!

Oct 09 03:56 PM

[KillaCycle:]

Your key quote says it all "I cannot judge whether A123’s technology is superior to its competition." That is exactly why the typical finacial advisor doesn't understand why A123Systems is selling at such a high price.

Your comparision to a biotech firm is not bad, but still a bit off the mark. Think about the inventions Velcro, Teflon and the LASER. When these were first invented, they were "interesting" but it was difficult to imagine the widespread applications they each would have. They were not an incremental improvment on an existing product, but were a major breakthrough in technology.

A123Systems has improved power and cycle life by about a factor of 4 or 5 with their "NanoPhosphate" technology. This is not just hype. Their standard 26650 M1 cells have many times more power and many times better cycle life than the competition. (All the electric drag racers are well-aware of the superiority of A123Systems cells.)

Like Velcro, Teflon, and the LASER, it will take awhile for product designers to discover that such powerful long-lived cells exist, and to begin to manufacture products that make full use of the remarkable capabilities.

Your raincoat has Teflon in it to make it waterproof, Velcro fasteners, and the fabric was cut with a LASER. When these were first invented, was your raincoat listed in the prospectus?

Oct 10 10:23 AM