Plug Power: Is The Dilution Worth It For Shareholders?

| About: Plug Power, (PLUG)


The expected cash burn figures of $10-$15 million for the current year might become conservative if the company is able to win more contracts.

Plug Power remains reliant on external sources of cash for its working capital, as well expansion needs.

The current valuation of the stock might prove to be conservative if the company is able to develop a robust market for its product over the next two-three years.

Plug Power (NASDAQ:PLUG) has had a good run over the last three weeks - the stock finally broke the $5 barrier, after falling below at the end of April. However, it was not able to maintain its position, and again fell below $5 the next day - since then, the stock has been trading around $4.50, with 10-15 cents swings in both ways.

Plug Power has been one of the most volatile stocks, and it has allowed some savvy traders to make considerable profits. Furthermore, those investors who bought the stock a year ago are sitting at a profit of over 1,400%, despite a massive fall from its 52-week high in March this year. Plug Power's technology is finally getting traction, which makes us optimistic about the future of the company. The product is still at the early stages of the industry lifecycle, and the company needs to develop a market; however, the interest from the major players in the sector such as Wal-Mart (NYSE:WMT) is encouraging.

There have been concerns about the management's eagerness to issue new shares in order to raise capital. It has been pointed out that the company's total shares outstanding have increased by 11 times in the last three years, going up from 12.5 million shares in 2011 to just under 144 million. This is a massive increase, and shows that the company has been largely dependent on outside capital. However, for most development-stage companies, it is normal to depend on outside capital and report losses in the early stages. The mode of the outside capital can differ for every company, but most of the early-stage companies depend on outside sources for cash.

Let's now look at the cash position of the company. It is important to analyze the sources and uses of cash - we have seen that the issue of new equity has been one of the major sources of cash for Plug Power over the last three years. The biggest use of cash has been the funding of operations - the company has been raising cash through debt/equity in order to meet its working capital needs. Normally, when a business issues new equity or debt, it is for two purposes: meet working capital and operational needs, or expand operations through acquisition or new projects. Raising cash to meet working capital needs shows that either the company's product is failing to generate enough sales or cash, or the company is in the development stage of the product and a robust market for the product does not exist. Plug Power falls in the second category - companies operating in the first category are more risky, and the chance of bankruptcy is greater for businesses that have falling sales.

By the end of last year, Plug Power had accumulated losses of about $850 million, which is expected to go even higher by the end of this year. For the current year, the expected cash burn for the company was between $10-15 million. However, if the company is able to secure one or two more contracts, the cash burn might go up, as PLUG will need more cash to procure raw materials and increase its inventories. The company has recently made demonstrations to FedEx (NYSE:FDX), which might result in further orders and push its revenues up for the full year. The following excerpt is taken from the most recent 10-K of the company, and shows the sources and uses of cash.

One of the most important figures here is the change in the fair value of stock warrant liability - this figure has also resulted in doubling the net loss of the company. Stock warrants are usually inserted in debt to sweeten the deal for lenders - the company gives the lender an option to buy shares at a specific price in exchange for debt. Warrants create a dilemma for the shareholders if the stock price is rising. In PLUG's case, the stock price has spiked over the last twelve months, which made warrants more attractive and increased the warrant liability of the company - the net loss per share for PLUG stands at just $0.33 without the warrant liability, down from $0.82 per share reported for the year. It shows how these instruments impact the financial results of the company. The warrant liability results in higher than the actual loss and sends a negative signal, as the stock price is affected if the company misses the analyst estimates. Furthermore, it results in dilution for current shareholders, as the company converts its debt into shares. Without the warrant liability losses, PLUG would have reported better results than the last year - so, it can be said that the impressive performance of the stock in fact became a negative for the financial results.

The following image shows the results of operations, and I believe investors should pay more attention to the trend in this image.

During the last year, the cost of product revenue has shown a sharp decline - at the current rates, cost stands at 110% of the revenue, down from 122% a year ago. It shows that the company is selling the product at a loss at the moment, although the loss is coming down, and if the trend continues, it might be able to report a gross profit soon. However, in order to achieve this, the company will need to grow its revenues substantially and increase its customer base. Furthermore, PLUG will also need to control the manufacturing cost of its products in order to make a gross profit. The recent acquisition of ReliOn is expected to result in synergies and a reduction in manufacturing costs.

Let's now move onto the valuation of the stock - based on the fundamentals, the stock is overvalued, as the company has never reported a profit. The rise in the stock price has mainly been due to the optimism of investors and the eagerness to hold stock of a company that might change the dynamics of a sector. The level of optimism is still considerably high, which has resulted in PLUG maintaining its current price levels. However, the current optimism is backed by the promise shown by the company and the prospect of the technology going mainstream in the near future. If that happens, the current valuation of the stock might prove to be conservative.

Bottom Line

We believe Plug Power is a very good speculative play with a solid potential for trading gains. Furthermore, we are optimistic about the prospects of the technology, and we believe the company will be able to grow its customer base and develop a market for the product. However, substantial risk exists due to it being the early stages of the market. Moreover, we believe the company will need to depend on external sources to meet its cash needs in at least the short term. So, we will not be surprised if Plug Power decides to sell more shares or take on more debt.

Additional Disclosure: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.