Here is the second half of our two-piece report on Plug Power (PLUG). The first half of our report drew a lot of interest and hopefully helped to educate recent investors about PLUG. Judging by the comments section, there are a lot of new investors that don't fully understand what they've gotten themselves into. With "story stocks" such as PLUG, it is important to separate fact from fiction.
In this report, we will discuss eight of the widespread misperceptions about PLUG.
Fiction #1: PLUG products provide a tangible benefit over existing battery technology
"Plug Power sells productivity savings, first and foremost."
-Andy Marsh, President & CEO 12/4/2013
We think this data point is the most important because it invalidates the entire PLUG investment thesis. A lot of online "experts" commenting on PLUG have swallowed the company's marketing message without any independent verification. PLUG claims its products are superior to existing battery technologies and that they provide a superior run time of 6-8 hours and quicker refueling time. These benefits, in turn, result in lower down time for employees.
Our primary research refutes these claims. We interviewed several of the warehouse managers for PLUG's largest customers (yes, the Fortune 500 customers). These customers are featured prominently on PLUG's website, press releases, and investor presentations. We believe these people are a superior source of information (better than online articles, message boards, or PLUG's sales department) because they are the ones who use the PLUG product on a daily basis.
According to the warehouse managers, PLUG fuel cells do not perform as advertised. The company promises run times of 6-8 hours but in reality these folks are barely getting 4 hours from PLUG fuel cells. For context, the average electric battery provides 6 hours of runtime.
This shortfall in run time (4 hours vs. 6-8 hours advertised) is very important because it invalidates the entire value proposition of PLUG's products. According to one large (and disappointed) PLUG customer, a PLUG fuel cell requires approximately 6 minutes to refuel. The actual refueling only takes 3 minutes but it takes on average 3 minutes to hook up the unit, unhook it, and travel time.
Advancements in battery changing technology have decreased the amount of time it takes to change a battery from 10 minutes down to the current time of only 6 minutes. As you can see, battery advancements have eliminated PLUG's value proposition.
Direct quotes from the PLUG customers we interviewed:
"Honestly, we wouldn't do it again. What they promised us on run time never happened. They promised 6-8 hours and we barely get 4."
"The ROI wasn't there with the run time we actually got. It won't pay for itself."
"I know we've stopped putting in any more hydrogen systems. We did (city #1)*, (city #2)*, and us but we're not doing anymore."
"A new electric battery will outperform the hydrogen fuel cells."
"Some of our operators can outwork the fuel cell. These are guys that really know how to work a lift. The fuel cell can't keep up with the workload and you end up having to stop. This is more down time."
"I don't want anyone to spend money they shouldn't."
*city name omitted to protect the customer's privacy
To summarize our findings, PLUG products perform worse and cost more. They also cost more to operate. The PLUG customers we spoke with expressed concern about rising hydrogen prices which are increasing the cost of operating the fuel cells. The energy costs for an electric battery are significantly cheaper than hydrogen.
Additional customer concerns cited ranged from the fuel cells exploding, which has happened several times in the past few years, to having to remove water from the units. The refueling pump is supposed to pull the water out of the unit but it often doesn't work fast enough. Units needing to de-water are taken out of service which leads to downtime.
Finally, we think there is a common misperception amongst new investors that PLUG supplies the hydrogen to customers in a recurring razor/razorblades model. This is unequivocally not true. Large chemical companies such as Praxair (PX) and Airgas (ARG) supply the hydrogen. PLUG only has five Sales & Service employees; it does not have a fleet of delivery vehicles nor the scale or logistical capabilities.
Fiction #2: PLUG will be profitable in 2014
This is another huge misperception that was encouraged by PLUG's CEO, Andy Marsh, during the December business update. During the presentation, Mr. Marsh repeatedly predicted imminent profitability yet he barely touched on the financial model that he was citing to back up his claim. While "PLUG is finally profitable" makes for a nice headline story, the devil is always in the details.
We went back through the presentation to recreate Mr. Marsh's financial model below:
For starters, the "profitability" Mr. Marsh was touting is based on a heavily-adjusted number that violates several concepts of standard US GAAP accounting and real world economics. The adjusted "profitability" PLUG uses is EBITDAS (earnings before income taxes, depreciation, amortization, and stock based compensation). This figure conveniently omits ~$6.3m in real, recurring expenses for PLUG.
The other aggressive assumption used in the model is the revenue input. During the 12/4 Business Update presentation, Mr. Marsh said he expected the order backlog to be $30-40m at the end of 2013. He then went on to say that his revenue model for 2014 was based on 70% of the order backlog. A month later, PLUG announced an order backlog of $32m at the end of 2013. The backlog came in at the low-end of the range and therefore makes the revenue target of $58.6m harder to attain in our opinion.
Investors should be aware that Mr. Marsh has a terrible history when it comes to forecasting revenue and shipments.
In the Q4 2011 earnings release, PLUG claimed:
"Plug Power enters 2012 with a backlog of more than 1,900 GenDrive units representing approximately $36.0 million in revenue."
Actual 2012 revenue: $26.1m (-18% shortfall)
Actual 2012 product shipments: 1,391 (-27% shortfall)
An even more dramatic example of Mr. Marsh's inability to accurately forecast demand for his company was shown in PLUG's 2010 guidance:
"Confident in its material handling and prime power markets, Plug Power issued the following milestones for 2010:
Dramatically increase our shipments, shipping between 2,100 and 2,300 systems, consisting of 1,100 GenDrive and 1,000 GenSys fuel cell units;
Generate between mid-$40 and low-$50 million in revenue;
Achieve a gross margin percentage in the mid-teens"
Actual 2010 revenue: $19.5m (-57% shortfall from the mid-point of the range)
Actual 2010 product shipments: 650 (-70% shortfall)
Actual 2010 gross margin: -51%
In addition to PLUG's forecasting credibility issues, we have reservations about the sustainability of orders. As we discussed in the first part of our report, PLUG was on the verge of insolvency for most of 2013 and therefore many customers halted orders. This is evident by the paltry $1m of orders placed from January 2013 to May 2013. We think the current pace of orders in Q3 & Q4 2013 is likely driven by the catch-up of postponed orders and is not a sign of strong secular demand.
The final assumption that we question is PLUG's ability to get material costs down to 67% of revenue. For the trailing 12 months, material cost was 110% of revenue. We give PLUG the benefit of the doubt in our model and assume it can attain a material cost of 69% of revenue in 2014, this is a generous assumption.
In summary, even if you take all of PLUG's aggressive assumptions for revenue and material cost, PLUG will still be unprofitable in 2014 by the tune of -$6m (operating margin -11%). Our more realistic forecast indicates PLUG is likely to lose between -$11m and -$15m in 2014. Whether it's -$6m or -$15m is not really the point. The point is that this business (after 17 years) still cannot generate an operating profit. This means PLUG will continue to consume cash. As Fact #1 pointed out in the previous article, PLUG needs to raise capital in the next 6 weeks and it needs to raise enough money to cover at least another year of operating losses.
Fiction #3: PLUG has proprietary technology
We think some investors are confused as to what PLUG does and what exactly its technological prowess is. The company does not own proprietary technology that will power the future. In fact, the 10-K outlines this clearly:
We believe that neither we nor our competitors can achieve a significant proprietary position on the basic technologies currently used in PEM fuel cell systems. However, we believe the design and integration of our system and system components, as well as some of the low-cost manufacturing processes that we have developed, are intellectual property that can be protected."
PLUG is an assembler of fuel cells. It buys the components from suppliers, assembles the cells, and sells them to customers. This company is not a Google think-tank.
Fiction #4: PLUG is an innovative R&D powerhouse
We think some investors hold a misperception about PLUG's R&D capabilities. As Fiction #3 points out, there is no proprietary technology at PLUG. We think some investors are under the impression that PLUG is continuously inventing new products. An analysis of the R&D spending puts this misperception to bed. PLUG spends almost no money on R&D; the company will spend approximately $3m on R&D in 2013.
How many technology powerhouses are able to innovate with a budget like this?
We think it's virtually impossible to create new innovative products with an R&D budget of $250k per month. We've actually heard of individual engineers with salaries higher than the entire R&D budget of PLUG. Bottom line, PLUG doesn't have the resources or expertise to create the next big innovation.
We also believe PLUG has been under-investing in capital expenditures over the past two years as financial pressures mounted. Annual CAPEX requirements have historically been $1.1-1.4m; however, PLUG only spent $77k in 2012 and $144k thru Q3 2013. We believe necessary CAPEX improvements represent another potential drain on cash.
Fiction #5: PLUG's technology is new and cutting-edge
The fuel cell technology (proton exchange membrane) that PLUG products use was invented in the late 1980's. As you can see from the R&D spending above, PLUG is not creating new products. Rather, they are attempting to use the same old technology and just make it cheaper to assemble. There is nothing wrong with this, in fact it's a good business move, but investors need to understand that this isn't a new technology that will revolutionize the transportation world. If this technology were cost-effective it would have much wider adoption by now. Fuel cells obviously work as a power source but a business model predicated on selling them to customers that have access to cheaper electric batteries is a flawed model.
Fiction #6: PLUG has products for the mass consumer market
This data point is silly but we've come across multiple people convinced that PLUG fuel cells are going to be put into BMW vehicles. To be clear, PLUG makes fuel cells for warehouse forklifts. These fuel cells last four hours and can't generate the power needed to accelerate a passenger vehicle. Very simply, PLUG's products are not applicable to the consumer market.
Fiction #7: PLUG could be acquired at or above this valuation
We see zero probability that PLUG could be acquired anywhere near the current valuation levels. PLUG previously tried to sell itself in March 2012 and retained Stephens as its investment banker. Back then PLUG could have been bought for under $50m. As we discussed in Fact #8, PLUG had an enterprise value of $6m last February and still no one made an offer for the company.
Industry players are obviously aware of PLUG given its long history. We find it extremely bizarre that a competitor, customer, supplier, company insider, or anyone else paying attention did not try to acquire PLUG for $6m or $50m if it is actually worth $680m.
The most comparable company to PLUG is EnerSys (ENS). EnerSys (market cap $3.2b) is the global leader in stored energy solutions for industrial applications. EnerSys trades at 10.6x EV/EBITDA and 1.37x EV/Sales. EnerSys is fairly active in the M&A arena and recently purchased two stored energy companies, Purcell Systems and Quallion LLC for $115m and $30m respectively. Purcell Systems annual sales are in excess of $100m, which means EnerSys was willing to pay 1.15x Sales for the business.
If we apply this multiple to PLUG's optimistic sales guidance of $58.6m, we arrive an enterprise value of $67m or $0.65 per share (this analysis excludes the dilution from the warrants, actual per share value would be lower).
Fiction #8: PLUG is a growth company
We think most investors caught up in the current euphoria believe they are buying (trading) a growth stock. The reality is that PLUG is not a secular growth company; it's a niche provider of forklift power supplies. The only true growth seen at PLUG over the past 16 years is the growth in the number of shares outstanding.
Since its IPO, PLUG has grown sales at a +9% CAGR versus a +34% CAGR in the number of shares outstanding.
No one would consider EnerSys a secular growth company yet it has grown sales at over 2x the pace of PLUG. Since filing public financial statements in 2002, EnerSys has grown revenue at a CAGR of +17.2% CAGR vs. +6.8% for PLUG.
Truly innovative growth companies with viable business models show massive secular revenue growth in their early years.
We do not see any evidence of growing adoption for PLUG's products.
The actual results simply don't support Mr. Marsh's continuously ebullient predictions.
"Plug Power had a quarter, and year, unlike any other," said Andy Marsh, CEO of Plug Power. "The market for fuel cell power solutions in material handling is opening up; we are witnessing a paradigm shift in how business is done in large distribution and manufacturing operations. Plug Power is honored to be leading the way into this revolutionary time for this industry."
"The sales momentum that the Company experienced in 2011 is continuing in 2012," said Andy Marsh, CEO at Plug Power. "The fuel cell industry is going through a full-fledged renaissance, as applications from lift trucks to automobiles to on-site power generation become more broadly deployed."
PLUG's sales declined -5.5% in 2012 vs. 2011….a renaissance?
Many of the bullish arguments for PLUG cite the customer list as validation for the business model and a reason to be positive on the future. Our view is that if you created a company that offered to sell Wal-Mart $10 bills for eight dollars, they'd take you on as a customer. In other words, the composition of a company's customers does not ensure the viability of its business model.
The important thing to realize is that these huge companies have been PLUG customers for many years. If PLUG had signed up Coke, Wal-Mart, and BMW in the past month, then, yes, perhaps this PLUG story is the real deal. But these companies have been customers for years and this hasn't materialized into a viable business model. Coke has been a customer for over 4 years, Wal-Mart and BMW for over 3 years. One of the PLUG customers we spoke with is technically "a customer" (his company is prominently displayed in PLUG investor material) but they have no intention of placing additional orders.
We don't find it surprising that multibillion dollar companies throw a few million dollars at a cool science project to see if it works. This happens all of the time in the business world. The evidence that PLUG does not offer a superior nor cost effective product is the fact that there has not been widespread adoption over its long history. Our conversations with PLUG customers support this view.
Nothing has fundamentally changed for PLUG over the past 6 months other than bankruptcy was taken off the table following the three rounds of equity raises. This was certainly positive news but is avoiding bankruptcy worth $670m of market capitalization?
The precarious financial condition of PLUG cannot be overstated. The company was so close to collapsing last year that it had to sell its building. The company now pays rent to a landlord for a building it had owned for years.
The stock's ride up was exhilarating but unsustainable; we see fair value for the stock at $1.00 - $2.50 per share which equates to an enterprise value of $138 - $356m. We see significant downside risk for the stock at its current level.
Additional disclosure: The author and/or employer may buy or sell shares in any company mentioned, at any time, without notice. The information contained herein is believed to be accurate as of the posting date. Readers should conduct their own verification of any information or analyses contained in this report. The author undertakes no obligation to update this report based on any future events or information. This article represents best efforts to convey a fact-based opinion. Our conclusions may be incorrect. This is not a recommendation to buy or sell any securities. This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein or of any of the affiliates of the Author.