Writing an investment blog on hype-riddled sectors like vehicle electrification and energy storage is tough because the topic is emotionally charged and expectations are often based on political promises, issue advocacy, press releases and mainstream media stories that never tell the complete truth. As a result I spend a huge amount of time debunking popular mythology that's 180 degrees out of sync with business realities and responding to commenters who refuse to believe cars with plugs will be:
- Five to six times less efficient than HEVs when it comes to reducing national gasoline consumption;
- Nine to twelve times less efficient than HEVs when it comes to reducing national CO2 emissions;
- Subject to short-term supply constraints because of their reliance on scarce raw materials;
- Experimental concepts that require years of testing before they're ready for prime time;
- Beyond the price range of all but the most affluent consumers; and
- Wholly unacceptable to consumers that expect a three to five year payback on the cost premium.
The risk and the opportunity for investors is that distorted perceptions of commercialization timelines have led to unreasonably high expectations for lithium-ion battery developers that may experience huge revenue growth in the second half of the decade and unreasonably low expectations for lead-acid battery manufacturers that are certain to experience huge revenue growth over the next five years. As the revenue impact of current automotive production decisions becomes more clear and the wide gulf between expectations and reality narrows, I believe that the equities of objectively cheap lead-acid battery manufacturers will surge while the equities of objectively expensive lithium-ion battery developers underperform.
For better or worse, the markets are emotional creatures that can't help but react to press releases and news stories designed to fire the imagination and inspire "wouldn't it be great if ...?" thinking. Some of the more inspirational examples of the unrelenting electric vehicle hype we've seen over the last few months include:
- Tesla Motors' production of its thousandth electric Roadster in time for the 2010 Detroit Auto Show;
- Fisker Automotive's planned production of the Karma plug-in hybrid on the strength of a 1,300 unit order book;
- Th!nk Global's rescue from bankruptcy on the strength of a 2,300 unit order book;
- Toyota Motors' (TM) planned demonstration fleet of 500 plug-in hybrids based on their Prius HEV platform;
- General Motors' planned production of the Volt plug-in hybrid at a rate of 8,000 to 10,000 vehicles annually;
- Mitsubishi Motors' (OTC:MMTOF) planned production of the MiEV electric car at a rate of 8,500 vehicles annually;
- Nissan Motors (OTC:NSANY) planned production of the Leaf electric car at a rate of up to 20,000 vehicles annually; and
- President Obama's audacious goal of a million plug-ins on the road by 2015.
If one just reads the press releases and news stories, it seems like the whole world is going electric and the days of sunshine, lollipops and roses along Electric Avenue are just around the corner. Perhaps it's my skeptical nature, but plans alone don't impress me because I've seen so many ill-conceived plans fail. I also remember that:
- DeLorean Motor Company produced and sold 9,000 cars in 1981 and 1982 before its CEO decided that he needed to boost revenue by importing agricultural products from South America;
- Ferrari sells approximately 7,000 vehicles per year;
- The Bentley division of Volkswagen sells 8,000 to 10,000 vehicles per year; and
- Toyota Motors sold its millionth Prius in 2008 and is gearing up to produce 1,000,000 HEVs annually by 2011.
In isolation, the press releases and news stories seem impressive. In the context of an industry that sold 10.5 million vehicles in 2009 during the worst recession since the 1930s, the planned introduction of cars with plugs is inconsequential. These are PR stunts, not credible products. While cars with plugs may become credible by 2020 if they can earn consumer confidence at rates that are comparable to HEVs, I believe their growth potential over the next five years is modest at best.
The following graph comes from www.hybridcars.com and shows annual domestic HEV sales over the last decade. In light of high cost, limited flexibility and unresolved consumer acceptance, performance and safety issues, I have to believe the ramp rate for cars with plugs will be far slower than the ramp rate for HEVs, which took nine years to hit the million vehicle mark.
The eco-religious will strenuously disagree with my admittedly conservative view that a goal of "one million plug-ins by 2015" is sheer presidential fantasy, but differences of opinion are what make horse races and investments interesting.
Once you back away from the wishful thinking and start looking at automakers' real-time production decisions, a different picture emerges. Instead of trying to leap tall buildings with a single bound, the automakers know that a journey of a thousand miles begins with a single step and they've started on the journey because their customers demand it. The technologies that are going into production, however, are rational incremental steps to improve efficiency without reinventing the industry. The step that is most important for energy storage investors is the rapid implementation of idle elimination technologies, which are typically referred to as either micro-hybrids or stop-start systems.
There are few ideas that are more sensible than idle elimination. Instead of burning gasoline and spewing emissions while you're stuck at a stoplight, turn the engine off until the light turns green. Stop-start systems have little value for a drive in the country, but they can reduce fuel consumption in congested city driving by 6% to 10% for an outlay of a few hundred dollars. After several years of testing, automated stop-start systems have proven themselves to the point where the entire industry is adopting them as standard equipment. A few examples of major stop-start production decisions include:
- Mercedes Benz, which will introduce stop-start systems throughout its entire passenger car line;
- BMW, which has already implemented stop-start systems on all Series 1 and 3 vehicles with manual transmissions;
- Volkswagen (VLKAY.PK), a stop-start pioneer that is implementing the technology throughout its passenger car line;
- Toyota, which has already impemented stop-start systems in its Auris and Yaris lines; and
- Ford (F), which plans to introduce stop-start systems throughout its entire passenger car line.
In short, the widespread implementation of stop-start technology is not something that might happen on some fine day in the vaguely defined future. It is happening today in factories around the world and while the future of cars with plugs is unclear, it is virtually certain that stop-start technology will be standard equipment within a few years because it's a cheap and proven way to improve fuel economy and reduce emissions. The following graph comes from a 2008 Frost & Sullivan presentation and summarizes their forecast of global hybrid vehicle sales over the next five years, broken down by technology type. The blue sections of each column represent stop-start systems.
Micro hybrids with stop-start technology are already saving about a hundred million gallons of gasoline per year. By 2015 they'll be saving well over a billion gallons of gasoline per year, which compares favorably to the 400 million gallons that could be saved if the presidential goal of a million plug-ins by 2015 was remotely possible. Once again, sensible action by private enterprise has trumped central planning by delivering vastly superior results for far less money.
The major challenge with stop-start technology is that it's very hard on starter batteries because instead of starting the car once per trip, a stop-start system will stop and restart the engine at every stoplight. The current approach is to use premium lead-acid batteries instead of the lower quality batteries the auto-industry historically used as original equipment. The long-term solutions that are currently in final stages of development include:
- Using a combination of batteries and supercapacitors to satisfy the intense demands of stop-start systems, an approach that's being developed by Maxwell Technologies (MXWL) and Continental AG (CON.DE).
- Using lead-carbon batteries that combine battery and supercapacitor characteristics in a single device, an approach that's being developed by Exide Technologies (XIDE), Axion Power International (OTC:AXPW) and East Penn Manufacturing.
While the numbers were eclipsed by the headline awards to lithium-ion battery developers and largely ignored by investors,
- $34.3 million to Exide Technologies with Axion Power for the production of advanced lead-acid batteries using lead-carbon electrodes for micro and mild hybrid applications; and
- $32.5 million to East Penn Manufacturing for production of the Ultrabattery (lead-acid battery with a carbon supercapacitor combination) for micro and mild hybrid applications.
In other words, these are real technologies that are being built into real production model vehicles and being sold to real customers today. There's no wishful thinking involved. The wave of change has hit the shore and will wash through the entire industry over the next few years.
The Hype Cycle
Professional investors understand that all emerging technologies are subject to a phenomenon the Gartner Group calls "the hype-cycle" and they time their investments accordingly. Venture capital types typically buy before the technology trigger point and sell at the peak of inflated expectations. Value investors frequently wait for the trough of disillusionment before they buy for the long term. The only professional investors that are active during the peak of inflated expectations are traders. TIAX LLC offered the following overview of emerging vehicle technologies and the hype cycle at the Plug-in 2008 Conference.
The big problem with graphs like this one is that they don't provide specific guidance to investors on where individual companies stand. Since I've never been one to avoid controversy and experience has proven that my opinions don't impact the markets I've decided to bite the bullet and offer one man's views of where the pure-play energy storage companies are located on the hype cycle curve.
A123 Systems (AONE) had a tremendously successful IPO in September and is currently trading at 132% of the offering price. It finished 2009 in solid financial condition and has done a great job of managing short-term expectations. All things considered, I'd peg A123 somewhere along the upward slope between the technology trigger and the peak of inflated expectations. While I expect A123's focus on cars with plugs to eventually result in significant disillusionment, the day of reckoning is probably 18 to 24 months off.
Ener1 (HEV) has been a centerfold darling of the cars with plugs set for several years and may well be past its peak of inflated expectations. Ener1 finished 2009 in dreadful financial condition and will require massive capital infusions to stay afloat and provide matching funds for the ARRA battery manufacturing grant it received last August. Ener1 recently filed a Form 8-K to disclose the presentation materials it's currently using in discussions with private investors. Given current market conditions and the huge hits that other companies have taken in recent down-round financings, my sense is that Ener1 is headed into the trough of disillusionment unless management can pull off a major miracle.
Maxwell Technologies (MXWL) has done a very effective job of publicizing its work on stop-start solutions and explaining the potential to investors. As a result, its stock has gone from a low of $4.50 to a closing price of $17.23 on Friday. I've toured Maxwell's supercapacitor plant in Rossens, Switzerland and believe their Boostcap technology has an important role to play as the micro-hybrid market develops. My sense is that Maxwell has already passed through its trough of disillusionment and is now working its way up the slope of enlightenment.
Exide Technologies (XIDE) has done a terrible job of publicizing its work on stop-start solutions because it already sells a couple billion dollars of batteries into the automotive market every year. So unlike the new kids on the block, Exide doesn't need to attract new customers. It just needs to visit existing customers and show how the new lead-carbon product will better serve the customer's needs. The same dynamic exists at East Penn Manufacturing, which couldn't care less about PR because it's privately held and already has a massive customer base. I believe that Exide is out on the plateau of productivity and rapidly approaching a new technology trigger point with the lead-carbon solutions for the micro-hybrid market. With a stock price that only equates to 24% of trailing sales, I think Exide has tremendous potential as customer testing of its new products matures into substantial purchase orders over the next year.
Axion Power International (OTC:AXPW) is my old home team and I'm far from unbiased because I've watched the PbC technology mature from laboratory experiment through commercial prototype and am proud of the time I served as board chairman. Axion has always been a public relations oddity because it partnered with East Penn in 2004 and Exide in 2008, which means it's always had to behave like a mature manufacturer instead of taking some of the liberties one would normally expect from a technology start-up.
As a result of its existing partnerships with two of the three largest automotive battery manufacturers in the world, Axion doesn't need to attract its own customers because its partners already have them. Axion's stock price took a bit of a beating in December when it completed a $26 million down-round financing with some very high quality institutional investors, but when its partners start signing high-volume supply contracts with their existing customers, I expect a technology trigger response that bodes well for Axion's future stock price.
Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its stock. He also holds a small long position in Exide Technologies (XIDE).