Axion Power: An Extraordinary Nano-Cap Opportunity

Oct.15.13 | About: Axion Power (AXPW)

(Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.)

Last week I accepted a full-time job as executive vice president and chief financial officer of a small privately held company, a life-changing transition that I've vigorously resisted for over 20 years. It just goes to show that I need to be careful about using the word never.

My new employer, ePower Engine Systems, Inc., is developing an engine-dominant diesel-electric series hybrid drivetrain for Class 8 tractors, the workhorses of the global freight hauling industry that consume over 100 billion gallons of diesel fuel per year and emit over a gigaton of CO2. The inspiration for ePower's drivetrain comes from diesel-electric locomotives, the most energy efficient overland freight haulers on the planet.

In ePower's series hybrid drivetrain, there is no mechanical linkage between the engine and the wheels. Instead, a 50% smaller diesel engine operating at optimal speed powers a generator that sends electricity to a drive motor that turns the wheels. The result is immense torque for acceleration and hill climbing, significantly better fuel economy and reduced wear and tear on drivetrain components. Since the system is engine dominant, the batteries are only used for acceleration boost, regenerative braking and climbing gentle grades that require more horsepower than the genset can provide. For big climbs, the five-speed automatic transmission simply downshifts to a lower gear like all other heavy-duty tractors.

I began nurturing ePower as a potential client in 2010 after its CEO found my blog and contacted me about battery problems they were experiencing with a first-generation prototype that got over 10-mpg at 45 mph with a 5 ton payload. Since ePower's battery needs were a perfect fit for the emerging performance characteristics of Axion Power International's (NASDAQ:AXPW) PbC battery, I introduced the two companies. While it took almost three years for the companies to nail down an agreement, ePower incorporated an array of 56 PbC batteries in its prototype drivetrain earlier this year and followed up with fuel economy testing using the SAE's J1321 protocol.

The fuel economy testing involved multiple trips over 40 to 46.5 mile routes with city, suburban and highway profiles in rolling hills with grades of 1% to 3% and elevation changes of up to 300 feet. Data was recorded at average speeds of 55 and 59 mph and any results that deviated from the average by more than 5% were excluded. The blue bars in the following graph show the fuel economy of ePower's second-generation prototype at several gross vehicle weights. The red blocks show the incremental fuel economy ePower expects to realize from its third-generation prototypes that should be on the road by the end of November. The green bars show the average fuel consumption for the Class 8 fleet and the EPA's 2017 targets for Class 8A and 8B tractor-semitrailer combinations.

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The most intriguing aspect of my evolving relationship with ePower was the opportunity to see Axion's PbC battery through the customer's eyes. Over the last four years ePower suffered from an endless series of problems that were all attributable to the inability of flooded and absorbed glass mat batteries to handle near-constant shallow cycling and accept regenerative braking charges that regularly spike to 180 kW or more. The tractor would perform well for four hours and then the batteries would need to spend 8 to 12 hours on a charger. To make matters worse, the near-constant shallow cycling promoted rapid negative electrode sulfation and made it impossible to get more than 3,000 miles from a battery string. These weren't critical issues during the technology development phase, but they would have been showstoppers in commercial trucking. The PbC batteries solved ePower's battery problems instantly and they've had no difficulty driving the tractor for six to ten hours while keeping the entire system in balance.

The third generation prototypes ePower is currently building on a day cab and a sleeper cab chassis will each use a 240 hp six-cylinder 2014 EPA compliant Cummins (NYSE:CMI) diesel engine; a generator, an inverter duty drive motor and an AC vector drive controller from the Marathon and Unico divisions of Regal-Beloit (NYSE:RBC); a PbC battery pack from Axion; and a suite of proprietary system control electronics ePower fabricates in house. We expect the third-generation prototypes to get at least 8-mpg with a 20 ton payload and believe that fuel economy of up to 10-mpg may be possible when the system is optimized. Our goal of saving 3,000 to 10,000 gallons of diesel fuel per tractor-year for about the price of a Model S from Tesla Motors (NASDAQ:TSLA) may be ambitious, but we believe it's achievable. Based on conversations with fleet-operators, we're convinced that an engine-dominant diesel-electric series hybrid drivetrain that reliably meets the industry's performance requirements could rapidly become the gold standard for the global trucking industry, just as it did in the global rail industry.

Last week Axion published a small news release advising stockholders that it would be doing a joint presentation with Norfolk Southern (NYSE:NSC) this afternoon at the 7th Annual ASME Rail Transportation Division Fall Technical Conference to update work on the NS 999 Electric Switcher - a hybrid locomotive powered by strings of Axion's PbC batteries. Axion subsequently posted a copy of the presentation materials to the Investor Relations page of its website. I think this is an extraordinary event because it's the fourth time that a multi-billion dollar development partner has wrapped its arms around Axion's PbC technology. Other examples include BMW, General Motors and a first-tier automotive systems developer that won't be identified until an inquisitive Axion stockholder wrests a copy of a relatively recent grant application from the DOE under the Freedom of Information Act.

This graphic from Norfolk Southern's portion of the joint presentation speaks volumes about the importance of Axion's PbC battery to Norfolk Southern's battery-powered locomotive development effort.

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While many investors don't understand the nuances, there is a caste system in manufacturing where major players do business with each other while upstarts like Axion are viewed first as nuisances, second as competitive risks, third as acquisition targets and finally as serious partners that should be treated like peers. The process of moving from the bottom rung on the manufacturing food chain to meaningful partner status is painful, time consuming and expensive. It frequently involves years of apparent inactivity as the majors engage in endless testing, validation, process assessments and scalability evaluations. During the doldrums markets tend to assume that none of the hard work will bear fruit and all the effort will have been in vain. When the first implementation decision is made, the presumption shifts overnight as the market concludes, "if it's good enough for Customer A it will most certainly be good enough for Customers B through F."

At this year's annual meeting, Axion's CEO Tom Granville explained that the company is involved in two projects with multi-national battery manufacturers that are evaluating the portability of Axion's technology with an eye to developing collaborative production relationships. He also reaffirmed an earlier promise that Axion would make a substantial sales announcement before the next quarterly earnings call in mid-November.

Axion's recent PIPE financing has a variable conversion price, which makes it hard to get a firm grip on the number of common shares that will be outstanding when the smoke clears. My best current estimate is that the final share count will be a little shy of 200 million, which gives Axion an implied fully-diluted market capitalization of about $25 million; a figure that's roughly 2.5 times current book value but only one-quarter of the cumulative investment over the last decade. While all of Axion's business relationships are suggesting that an implementation decision is imminent, the market is currently pricing the stock for failure.

I've seen this dynamic before with transition stage companies and the outcome is always the same. If commercial implementation is delayed the stock price continues to wallow. Once an implementation decision is made, market capitalizations quickly surge from a fraction of cumulative investment to a multiple of cumulative investment.

Almost three years ago I wrote an article titled "Energy Storage, The Valley of Death and The Elephant Hunters" that explained how stocks behave as companies like Axion make the transition from R&D to commercial sales. While Axion's transition has taken far longer than I expected, all the signs and portents indicate that the PbC will be solidly competitive in several billion-dollar market niches. Axion's stock remains a very high-risk investment but the worst-case outcome is continuation of the long slow price decline that's developed over the last three years while the best-case outcome is an epic multi-bagger.

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Now that I've had a chance to see the PbC through the customer's eyes, I'm convinced that the likely outcome is a multi-bagger. I've owned over a million shares of Axion stock for years and have an average acquisition cost that's roughly 10 times the current market price. I've never felt better about my risk-reward profile.

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'm a former director of Axion Power International and have a substantial long position in its common stock.