Active Power (ACPW) is a defensible business that's likely to trade at a multiple of the current price over the next several years. It'll pay to get to know what it's all about and to understand the changes it's driving in the space for energy storage.
Description of business and company background
The continual, exponential expansion in the volume of data (e.g. think of the number of email accounts being created, credit card transactions being processed, YouTube videos being uploaded, etc) is driving a secular expansion in the build-out of datacenter facilities, which house and store data. With new datacenter facility build-outs as its #1 end market, not only is Austin-based Active Power well-positioned to capitalize on this trend, it's also revolutionized how consultant engineers think about continuous power
Datacenter facilities have a zero tolerance for energy blackouts, which can lead to revenue losses, customer defections, etc. Uninterruptable Power Systems (UPS'), which protect these facilities against voltage fluctuations and provide ride-through power to bridge the 8-15 second gap between power outage and diesel generator start-up, are necessities in the build out of datacenters: They are essentially insurance on continuous power. Active Power is a leading manufacturer of flywheel-based Uninterruptable Power Systems (UPS’s) - insurance.
Unlike most of its competitors which utilize lead-acid battery based technology in their UPS’s, ACPW’s products utilize a patented flywheel-based UPS system which stores kinetic energy by spinning a compact steel wheel (“flywheel”) at several thousand RPM while the utility power is running normally. Then, if the utility power fluctuates or is interrupted, the flywheel’s inertia causes it to continue spinning. The resulting kinetic energy of the spinning flywheel generates “bridging power”.
We have developed a high degree of comfort from numerous conversations with customers, industry experts and competitors that ACPW’s flywheel products provide many competitive advantages over conventional battery-based UPS systems, including a lower total cost of ownership, substantial space savings, higher power densities, “green” energy storage, and higher power efficiencies (and hence, lower total cost of ownership).
This product's been around for a long time - about a decade - and it takes these engineer-types a really long time to put their necks out in terms of trying something new. And this is the story here. There is enough data at this point to have proven the flywheel's benefits over conventional energy storage, and the company has taken enough market share at this point that we believe market adoption to have hit an inflection point and to be on a steep rise.
We have prospected the company’s manufacturing facility in Austin and have been engaged in a frequent and ongoing dialogue with the CEO and CFO since the beginning of 2009. Jim Clishem was named CEO in 2006 and John Penver CFO in 2005. Since they took the helm, the company's made substantial strides in creating a viable business and is currently on the path of growth through the disintermediation of market alternatives... yeah, it's expanded its sales footprint into new global markets; expanded its direct sales distribution channel (previously distribution was primarily driven by OEM Caterpillar (CAT)); increased focus on generating recurring, high-margin service revenues; and has facilitated the improved market acceptance of flywheel technology. To sum this up, we like management.
Active Power has traditionally sold into a UPS target market that measures $2.1 billion and that through 2008 was expanding at an annual growth rate of 12-14%. Over the period 2006-2008, ACPW grew its sales at a compound annual growth rate of 34%, indicative of expansion of share.
The credit crisis and resultant economic uncertainty led many companies to delay their build-outs of new datacenters. We believe the market was at the time already nearing capacity and that as of 2010 it entered a state of under-capacity in the US, with demand continuing to build. As such ACPW’s full year 2009 sales came in flat relative to 2008’s at ~$42MM. This said, 2010 has been a banner year for the company and recent action in the stock price tells the story: Revenues will exceed $60MM this year and we are expecting significant top-line growth over the years to come. I view 2009 as the recoiling of a spring, as happened with Intel (INTC) way back in the day. (Don't ask me about Intel's story because I've forgotten the year I'm referring to and am not about to waste time researching for it.)
ACPW recently introduced a containerized, all-in-one continuous power solution product (“Powerhouse”) that is being sold alongside Sun Microsystems’ and HP’s (HPQ) modular datacenter solutions. By integrating ancillary products alongside its UPS’, this product has expanded ACPW’s addressable market potential by about 4x, to ~$6 billion.
ACPW competes primarily with conventional battery-based UPS manufacturers (i.e. Emerson/Liebert, Eaton/Powerware and APC/MGE) – this is the competitive inferior – and KE-based rotary systems producers (i.e. Pillar, Eurodiesel, and Hitec). The rotary systems producers command almost half of ACPW’s UPS market segment. Their product is similar to a flywheel type of system, but with key differences in how the wheel is linked to the backup generator. ACPW competes with these companies based on the decoupling of power storage and backup, as well as modularity. Rotary companies compete on their strong brands, service and better distribution.
Based on the sum of our due diligence, when it comes to UPS, KE storage technology is indeed superior to that of batteries and we anticipate seeing continued market share gains from lead-acid counterparts. This will be the ‘low hanging fruit’ going forward – continued growth in market acceptance and market entrenchment of battery alternatives. And, it’s plausible that the well-capitalized battery suppliers eventually make acquisitions to deal with the continual decline in their piece of the pie. Liebert, Eaton, APC – they will all need to remain competitive in the +100kW energy storage space. As the rotary providers continue to grow, the flywheel manufacturers are well-positioned as targets -- eh emm. By that I mean that ACPW might be well-basted turkey on Thanksgiving.
ACPW is a relatively early-stage story on the verge of breaking a profit this year. Most companies don’t appear on many investors’ radars until reaching profitability; we have found that identifying those approaching that inflection point particularly rewarding in the past.
Its break-even point depends on its sales mix. It has to sell the equivalent of 125 flywheels per quarter at an average unit price of $80k to break even. Alternatively it can hit break-even by selling 100 flywheels and 2 Powerhouse units. (As the Powerhouse business grows, revenue expands while gross margin per flywheel declines, partly offset by an associated rise in high margin consulting and maintenance services.)
- The company IPO’d in August 2000 at $17/share, raising a net $126MM. Lead underwriter Goldman Sachs at the time prognosticated $120MM in revenue for the company by 2002; at the time ACPW’s revenues over the previous twelve months totaled $2MM. As it were, revenue peaked at $22MM in 2001 before falling to $8MM by 2003. By this time, the funds raised in the IPO had already been used to lease/equip a 127k sq ft manufacturing facility to support projected sales volumes. Simply put, there is a lot of unabsorbed overhead embedded in the company’s gross margins, currently on a run rate of 25-30%. As it expands, ACPW should benefit from a high degree of operating leverage and has the capacity to support revenues of $200MM with little incremental capital expenditure.
- Management is increasingly focused on growing its direct sales channel. Historically, most of ACPW were made indirectly through OEM partner Caterpillar. Caterpillar is ACPW’s primary OEM customer and its largest single customer. CAT accounted for 35%, 31%, 40% of total revenue in ’06, ’07, and ’08, respectively. By selling away from CAT, directly into its end markets, ACPW is able to build a service book. The recurring, 50-60% contribution margin service business is the hidden gem here. Over the long term, management expects to be able to drive servicing fees to 20-25% of total revenue.
Ownership / Board
The period 2003-2006 was marked by headcount reductions and a management / board shakeup. Led by founder Joseph Pinkerton, previous management came into the company with tremendous intellectual property and a great patent portfolio but had failed to successfully commercialize product. With new leadership, ACPW would emerge with increased emphasis on sales and marketing on a worldwide basis.
On a fully diluted, combined basis, insiders own 8.5% of the company. Several directors as well as the CEO purchased material amounts of stock over the course of 2008 and 2009.
We started looking at this company when it traded at $.30/share and acquired our position at prices between $.72 and $.80 per share. At this point the shares are a bit rich. The sell-side's been upping their price targets and liquidity has flown into the company's shares. I think the hot money's got to come out and would suggest accumulating shares as the company cheapens, perhaps below 1.60/share should it again touch those levels. At the end of the day, this is a company to be owned for a long time. A long long time.
We believe the company can grow to exceed $150MM in revenue over three to five years (and if things go really right for it, revenues can go way higher), over which time we expect the adjusted net income margin to increase to 11%. We also expect over this time the company will have accumulated cash of $25MM (including $17MM from the exercise of options). We attach a $25MM value to the company’s $180MM in net operating loss carryforwards and value the operating assets at 20x fully-taxed earnings, resulting in an EV of $330MM and market cap of $380MM, resulting in a per share price of ~$4.50... again over the next few years. A 20x multiple is warranted ACPW's substantial competitive advantage, attractive growth prospects, clean balance sheet, and a business model with a significant chunk of recurring, high-margin revenues.
We believe the key risk to the company lies in an intensification of competitive pressures and therefore pressures on product pricing and margins. Should battery based technology become more competitive or should the rotary suppliers develop a technological edge versus flywheel mechanics, we would expect end market demand to respond accordingly. Additionally, given the early-stage nature of this company, results are likely to be volatile and clumpy. The company may in the future need to raise additional equity capital which could dilute the stakes of current shareholders, but I'm doubting it will have to to get to where I think it's bound to go.