(Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.)
On May 8, 2013, Axion Power International (NASDAQ:AXPW) announced the closing of a $10 million PIPE transaction that my colleague Tom Konrad characterized as a "death-spiral" in a July 25th article for Forbes. The PIPE transaction was painful for Axion's stockholders who watched helplessly as the stock price slid from $0.26 on May 7th to $0.09 at yesterday's close. While I was a little more optimistic than Tom and thought the stock price had hit bottom in the $0.16 range in late July, there are times when things don't work out the way I think they should.
Over the last couple months I've spent a good deal of time pondering the question of whether the PIPE investors are likely to change their selling behavior, and if so, when.
While part of my motivation was the morbid curiosity of a large stockholder who sees Axion trading for less than 10% of his average cost, my more pressing motivation was the inability to mentally reconcile the number of shares issued through the date of Axion's last quarterly report on Form 10-Q with the number of shares that should have been issued based on the deal terms embodied in the original contracts.
Yesterday I decided the only way to resolve the unanswered questions would be to go through the exercise of creating an Excel workbook for the PIPE using daily VWAP figures collected by H.T. Love in an effort pull the details together for followers of Warren Buffet's philosophy that, "Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful."
The results surprised me on a couple fronts. The first thing I discovered was that at least $1 million in accelerated PIPE conversions occurred in September and October of last year. The second was that as of yesterday, the PIPE investors have no incentive to continue pressuring the stock price. While I've uploaded a copy of the full Excel Workbook to my Dropbox for readers who want to dig into the grisly detail, this article will simply summarize my conclusions.
The PIPE notes are terribly convoluted documents that specify a due date for each installment; require a pre-installment issuance of conversion shares twenty trading days before the due date; require a true-up issuance of conversion shares on the due date; and use a look-back period of forty trading days for all conversion price calculations. The basic rule through the end of last year was that the conversion price for each stock issuance would equal 85% of the numerical average of the twenty lowest volume weighted daily average prices during a forty trading day look-back period. While the formula was changed to 80% of the numerical average by a recent amendment, the overall impact of that change is modest.
After creating a pro-forma amortization table for the PIPE debt that included interest accruals at an 8% rate and specified the installment due dates and the associated pre-installment calculation dates, I assembled a second pro-forma table that used H.T. Love's daily VWAP data to calculate the number of shares that should have been issued on each pre-payment date and the number of true-up shares that should have been issued on each installment date.
When I compared the number of shares that should have been issued at various dates with the number of shares that were actually outstanding on those dates, the actual numbers were much higher. At September 30th the difference between pro-forma and actual was roughly 2.85 million shares and by November 7th the difference had grown to about 6.47 million. The only possible explanation is that the PIPE investors had exercised their rights to accelerate the conversion of about $1 million in principal prior to November 7th. Since I initially focused on $212,500 in early control account releases that occurred prior to the filing of Axion's most recent Form 10-Q, the true magnitude of the accelerated conversions evaded me until I assembled the workbook.
While I can't say whether additional accelerations occurred after November 7th, the relatively heavy trading volume over the last three months suggests that there may have been additional accelerations that aren't reflected in Axion's most recent Form 10-Q.
The bottom line takeaway is that after giving effect to the known accelerations and yesterday's pre-installment share issuance for the March payment, the remaining principal balance of the PIPE debt is insignificant.
More importantly, the look-back provisions in the PIPE agreements create a dynamic where there is no further incentive for the PIPE investors to pound stock into the market without regard to price. The last scheduled PIPE installment is due on April 1st. The pre-installment calculation date for that payment will be February 27th and the forty-day look-back period will extend from December 30, 2013 through February 26, 2013.
The month of January included twenty-one dismal trading days that pushed the look-back VWAP calculation to its lowest point ever. After giving effect to accelerated conversions in September and October, it's clear that the PIPE investors have already received their last big block of conversion shares. Since the month of January will be included in the look-back period for all remaining installments, the PIPE investors have nothing to gain and everything to lose by selling their last big block of shares at depressed prices. The dynamic might have been different without the accelerated conversions, but when you take the principal accelerations into account it becomes clear that Axion has already moved out of the PIPE and into the light.
Over the last two days I've noticed a pattern where a large percentage of the trading activity is occurring in the high end of the trading range and the sellers seem to be pulling the price up rather than pushing it down. If that pattern develops into a trend it will provide additional confirmation of my thesis that the bleeding is over and the healing has begun. Since markets have a lot in common with Pavlov's dogs and they tend to get skittish when you whack them on the nose every day, it may take a while for Axion's stock price to recover from the punishment of the last nine months. While I believe the PIPE investors still have several million shares that they want to sell, I don't believe they have tens of millions with more big blocks coming.
Axion is still undercapitalized and it will need to seek additional financing later this year. In its most recent 10-Q Axion said that its available resources would be sufficient to support "current operations, working capital, and capital expenditures into the beginning of the fourth quarter of 2014." While I expect Axion to go back to the market this summer, it looks like the stock price will have several months to recover before the next financing round. Since doing a variable conversion price PIPE is a lot like peeing on an electric fence and once is more than enough for any rational management team, I don't expect a sequel to last May's financing.
LATE BREAKING UPDATE: After today’s close Axion filed a resale registration statement for the balance of the PIPE shares. This registration statement disclosed that a total of 196.6 million shares were issued and outstanding on January 28th. My pro-forma worksheet shows that a total of 183.8 million would have been outstanding on January 28th without any early conversions. My actual worksheet show that a total of 178.3 million shares would have been issued on January 28th if there were no additional conversions after November 7th. In light of the new information included in the registration statement, I believe that substantially all of the PIPE debt has been paid and no additional shares will be issuable to the PIPE investors.
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.
Additional disclosure: Author is a former director of Axion Power International (AXPW) and holds a substantial long position in its common stock.