In late July, I published an article titled Understanding the Mechanics and Incentives in Axion Power's PIPE that provided a counterpoint to two articles that my friend and colleague Tom Konrad published in Forbes. In both of his Forbes articles, Tom was bullish about Axion Power International's (NASDAQ:AXPW) PbC battery technology and business prospects, but bearish about the risks to existing stockholders arising from a $10 million financing transaction in early May that was structured as a variable conversion rate "private investment in public equity," or PIPE.
Tom's core thesis was that the PIPE investors would try to drive Axion's stock price down into the $0.06 range in the September-October timeframe to maximize the number of shares issuable to them and then ease up to maximize the value of their investment. Overall, Tom expected Axion to issue 131 million new shares in connection with the PIPE transaction. My counterpoint thesis was that the PIPE investors would try to drive the stock price down until they had locked in a couple months of beneficial pricing and then ease up to maximize their profit. Overall, I expected Axion to issue about 70 million new shares in connection with the PIPE transaction.
We were both wrong. Things have not gone as badly as Tom expected and they've not gone as well as I expected. Like most things in life, reality staked out the middle ground between the pessimist and the optimist. Axion's stock price for the last four months has been range bound between $0.10 and $0.16 with a volume weighted average price of $0.13 for the period.
In late July, Tom and I were both trying to forecast the future by gazing into foggy crystal balls and guessing at the likely future behavior of the PIPE investors. Now that we have six months of experience, I think predicting the course of future events is easier because there's more data. Over the last six months, Axion issued 53.5 million shares and repaid $5.2 million of the PIPE debt, together with accumulated interest. While the specific dates of the stock issuances are impossible to nail down, the following table shows the approximate number of shares issued during each of the last six months, the reported trading volume in each of those months, and the ratio of cumulative stock issuances to cumulative trading volume.
My first conclusion is obvious. The PIPE transaction pushed trading volume through the roof and Axion is on track to trade over 170 million shares in 2013, or roughly twice 86.5 million shares that traded in 2012. My other conclusions are more nuanced and rooted in a phenomenon known as the OTC double-count.
In the OTC markets, a share of stock that moves from the hands of a selling stockholder to the hands of a buying investor is typically reported as two trades, rather than one. The first trade is printed when the selling stockholder sells shares to a market maker. The second is printed when the market maker resells those shares to a buying investor. While there are occasional in-house crosses and other direct trades that don't flow through a market maker and are only printed once, the assumption that every stock movement is printed twice is generally pretty accurate.
Once you understand the double-count, a striking picture emerges. It becomes clear that the overwhelming bulk of sell-side activity over the last six months has been PIPE investors pushing shares into the market while a bottom-feeding stockholder base lies in the shallows absorbing whatever the PIPE investors want to sell. Based on the trading patterns to date, I don't think the PIPE investors are accumulating a position. Instead I think they're buying at an average price of about $0.10 per share and selling for a couple pennies of spread. If the PIPE investors were shopping for groceries, they wouldn't buy green bananas.
According to Axion's most recent Form 10-Q, there were 166.8 million shares outstanding on November 7th. If the stock price stays range bound until the PIPE investors are repaid, Axion will issue another 38 million shares to the PIPE investors and about 10 million shares to current and former Axion insiders who bought $1 million in subordinated debt concurrently with the PIPE. Overall these issuance transactions will take the post-transaction share count to a maximum of 215 million shares by March of 2014. At the current share price, that works out to a fully diluted market capitalization of $24.4 million for a company that's spent 10 years and almost $100 million developing the first truly unique battery technology in over two decades. While Axion will need to seek additional financing before the end of 2014, it believes its available resources will be adequate to carry it into the fourth quarter, so the stock will have at least a couple months to recover before the next financing.
In my view, Axion's stock presents a tremendous opportunity for value investors who buy with an 18 to 36 month investment horizon and understand the nature of the Hype Cycle, a market phenomenon that universally applies to new technologies and small public companies.
Axion is an unusual company because it went public at the beginning of the R&D phase instead of completing its R&D work first. The process of refining the PbC technology, developing cost-effective manufacturing methods and proving the performance of the PbC battery to potential customers has taken far longer and cost far more money than I expected when I structured a reverse merger between Axion and a public shell I controlled in late 2003. The result of a long drawn out development process and a seemingly interminable testing and validation process is 10-year research and development project that sports a market capitalization equal to 25% of the cumulative cash investment.
When you look at the Hype Cycle graph, you'll see that transition stage companies like Axion that have just exited the R&D stage are situated at the lower left hand corner. If Axion's R&D work was successful, it should mark the beginning of a new hype cycle, an entry point that's usually denied to everybody but VCs and institutional investors.
Since July of this year, I've spent most of my time focusing on the corporate finance and business development needs of ePower Engine Systems, an R&D company that's developing an engine dominant series hybrid drivetrain for long-haul heavy trucks. In September, I decided that ePower was the most attractive opportunity I'd seen since the early 90s. To pursue that opportunity, I withdrew from the practice of law and accepted a job as ePower's executive vice president. The biggest unexpected benefit of my new job is that it's given me a unique opportunity to evaluate the PbC battery from the customer's perspective instead of the developer's perspective.
Speaking as a customer, the PbC is a hell of a battery and we wouldn't have a product without it.
By mid-December, we expect to be testing the fuel economy of a Class 8 sleeper cab with our third-generation prototype drivetrain. Based on the results we got from our second-generation prototype and the published specifications for the 2014 EPA emissions compliant Cummins diesel engine we're using in the new prototype, we're expecting fuel economy in the 9 to 10 mpg range with an 80,000 pound GVW and fuel economy of better than 10 mpg for weight classes under 70,000 pounds that represent over 80% of the truckloads on the road. When I compare our expected fuel economy with the current national average of 6 mpg for Class 8 trucks, I'm more than a little jazzed. Our current plan is to build 10 commercial prototypes over the next six months and put those tractors in the hands of fleet owners for fuel economy verification and durability testing. If things progress according to plan, which never happens in real life, we could be building 10 trucks a month by the end of 2014.
While I hope ePower will become an important customer for Axion over the next couple years, I don't think we'll be the primary driver of Axion's success. Instead I believe the drivers of Axion's success will be first-tier companies like BMW, Norfolk Southern and others who have been testing the PbC for the last four years and have presumably gotten the same spectacular battery results I've seen at ePower.
Axion is still a high-risk nano-cap company that will face any number of challenges as it cements customer relationships and responds to the customers' needs, but those are good problems to have. Today the market is still waiting for a customer to emerge that will give Axion a clear path to sustainable revenue growth. Unless I'm way off the mark that customer will emerge before the next financing and the most likely outcome for new investors will be a range-bound stock for several months followed by a rapid ramp from a fraction of cumulative investment to a multiple of cumulative investment. Axion is not a stock for widows and orphans, but it's a solid medium-term speculation with limited downside risk and extraordinary upside potential.
Additional disclosure: 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 am a former director of Axion Power International (OTC:AXPW) and hold a substantial long position in its common stock. I currently serve as executive vice president of ePower Engine Systems, a privately held company that's developing an engine-dominant series hybrid drivetrain for heavy trucking.