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By Jeff St. John

A123 (AONE) may have solved its short-term financial problems by raising $50 million in debt on Saturday. But the price of saving the beleaguered lithium-ion battery maker's immediate concerns could lead to a "death by a thousand cuts" to its share price and long-term viability.

That's what some analysts are saying about A123's weekend announcement of a private offering of $50 million in senior unsecured convertible notes and warrants for institutional buyers. The notes carry 6% interest and, while they mature in July 2013, they come with bi-weekly payments that can come in cash or in shares of A123 stock, up to $25 million of the total.

A123 said early last week that it would seek the debt financing to help mitigate the crisis caused by its major recall of batteries from its Livonia, Mich. facility, the recipient of $249 million in federal loan guarantees and $100 million in state tax credits.

On Tuesday, A123 reported a record loss of $125 million for the first quarter of 2012, driven by costs associated with the recall. Those had grown to $66.8 million as of the end of March, with production set to comply with replacement batteries through much of 2012, the company reported.

All in all, it was enough bad news to push the company to issue a "going concern" statement in its Tuesday quarterly report, pointing out that it could be forced to stop doing business if things got much worse.

However, the $50 million in debt financing affects those short-term issues, there's little doubt that they're going to be a drag on future growth. John Anderson, writing at Seeking Alpha, provided the "death by a thousand cuts" analogy to explain what he thinks the $50 million deal will do to A123's stock.

A123 has agreed to either pay its share of 6% interest on the debt in 26 semi-monthly payments through July 2013, or to issue a corresponding amount of stock, at a conversion value that Anderson figured at 82 cents per share. That means that millions of new shares will be coming onto the market in bi-weekly installments. Those payees will be closely watching A123's share price to decide if they should take a profit, or earn back their investment, before it sinks further.

The problem is, anyone who starts selling their shares first will likely depress the price, pushing more to start selling, and depressing the price further, and so on. This will occur every two weeks or so, barring A123's ability to pay its debt in cash rather than shares, Anderson said.

A123 (AONE) shares closed at 88 cents Friday, and have since gained a penny in after-hours trading. The company held a long-term debt of $161 million as of this week, compared to a market valuation of $129.3 million. That's a pretty steep fall from the MIT spinout's 2009 IPO price of $13.50 per share and a peak market cap of some $2.3 billion in 2010.

A123 Chief Executive David Vieau said in a Tuesday statement that the defect that caused the recall has been corrected and that replacement production was underway. A123 customers include Fisker Automotive, General Motors (NYSE:GM), BMW (OTCPK:BAMXY), SAIC Motor Corp., Tata Motors (NYSE:TTM) and Smith Electric Vehicles, though the company didn't specify which were involved in the recall.

A123's defect did end up playing a role in problems for key customer Fisker and its plug-in hybrid Karma sports cars. A123 laid off about 125 of its 850 Michigan employees in November, a response to Fisker's slowdown in orders for the car and its own problems meeting the terms of its $529 million federal loan.

Transportation remains A123's most important line of business, although its grid storage business has been growing in the past year or so, with installations and orders that added up to 100 megawatts by the end of 2011, much of it in partnership with AES Energy Storage.

First-quarter revenue of $10.9 million was down 40% from $40.4 million in the fourth quarter of last year, when the company reported an $85 million loss. A123 also reduced its 2012 revenue estimates to $145 million to $175 million, down from a previous estimate of $230 million to $300 million.

A few months ago, a battery manufactured by A123 exploded and caused an injury at a General Motors battery lab. The battery leaked gases into a lab at GM's Warren Technical Center in Michigan and an explosion ensued that sent one employee to the hospital with chemical burns, according to the Wall Street Journal. A123 is also receiving its share of class-action lawsuits.

Its defective battery replacement campaign's price tag will be spread out over several quarters. Since A123 will continue to operate at a loss, it will have to raise significant capital to cover its losses, the recall, and a recently announced shareholder suit -- thus, the debt offering.

About a year ago, VC investor Vinod Khosla spoke to about 300 energy storage experts at the annual Energy Storage Association (ESA) meeting and predicted that A123 would not be around in ten years. He cited lithium's volatility and inherent safety issues. That news was less satisfying for the audience (which included A123).

Source: A123's $50M Desperate Debt Play