Abakan: An Overvalued Short Candidate

Jun.21.12 | About: Abakan, Inc. (ABKI)

Abakan (OTCPK:ABKI) is a publicly-quoted, development-stage company with the usual going concern warnings in its SEC filings. Companies like Abakan should really be private. Public-investor quarterly time horizons do not match the several years it will take for Abakan to develop into a substantial revenue-generating company. In my opinion, Abakan is unlikely to ever generate substantial revenues or profits. Thus, management has to revert to news hype and promotional marketing focused on less sophisticated retail investors to create stock price support, as there are no real revenues or earnings to boost the shares.

On a fundamental basis, ABKI is grossly overvalued with EV/commercial revenues of 3810x ($181M/$47.5K), and EV/company-defined revenues (of which the majority are non-recurring income and grants) of 81x. Based on SEC filings, LTM negative EBITDA was -$2.8M, with a net loss of -$1.7M. The company is also carrying $4M in net debt that it cannot currently support.

Abakan is a holding company that is seeking investments in advanced metal coatings companies. Thus far, it has acquired a 51% interest in a metal-cladding company MesoCoat, and a 41% stake in the parent materials company - Powdermet. But a closer look at both of these subsidiaries shows that most of the key intellectual property and knowhow was licensed from third parties such as Mattson Technologies and UT-Battelle, as opposed to being internally developed for sustainable long-term value.

Abakan's web site (see here) and promotional materials make several broad claims such as tests on CermaClad CRA products have confirmed six times better corrosion protection. But this and other claims lack any frame of reference and/or basis of comparison. Furthermore, Abakan does not provide any product specifications for either metal cladding or metallic composite materials. On the other hand, Nanosteel, a private, venture-backed peer, succinctly states its product specs (see here). In addition, Abakan's web-site home-page states a dubious $150B metal protection and life extension market opportunity. Unsubstantiated and exaggerated claims are the typical fodder of speculative OTCBB stocks.

Questionable claims are not only limited to product, but also to management's capabilities. CEO and Director, Robert Miller, states in his bio that he was the founder and director of Nanovation Technologies Inc., a developer of fiber-optic products which realized a market capitalization of over $500 million. Robert Miller was in fact an early investor, not an operator/founder, of Nanovation; and according to several sources such as (see here) - Robert Miller, and his Stamford International investment vehicle, contributed to the destruction of the $500M in Nanovation value that he claims to have created (I will not even touch Crystallex, a Venezuelan gold mine where Mr. Miller was a Director and Chairman). Robert Miller's stock promoter background, Abakan's offshore BVI subsidiary, and a small Abakan loan payable to a company controlled by Robert Miller's wife raises some more red flags.

Management states that Abakan has two competitive technology advantages that support its performance claims. First, the use of nanotechnology - noting that small amounts of nano-additives and related structural controls, lead to exponential performance improvements. But many companies use nanotechnology today including the many competitors of Abakan; whether it's Instagran's nanocrystalline "Nanovate" metals (see here) or Nanosteel's patented nano-alloys used for thermal spraying (see here), both assert the same microstructural advantages claimed by Abakan.

The second advantage claimed by management relates to two technology licenses with third parties. First and foremost, Abakan has an exclusive agreement to purchase plasma arc lamps from Mattson Technologies. These arc lamps provide a more efficient and stronger metallic curing process. First of all, the high-power plasma arc lamp was invented by Voric Industries (not Mattson) - so if this process does yield benefits, it is open to any of Abakan's competitors. Also, this agreement can be voided if Abakan does not meet fairly steep minimum purchase requirements including a $2M fee. Abakan also pays IP licensing and royalty fees to UT-Battelle labs for two patents.

The most relevant development for Abakan was its ability to leverage the customized plasma arc lamp benefits into a Cooperation Agreement with Petrobras. This is still early days, as the Abakan's MesoCoat subsidiary must carry out qualification tests for development of cladding materials on internal and external surfaces of pipes for an 18-month period that started in 2011. We still have no definitive feedback from management. So, the Petrobras announcement is very preliminary. The other potential customer announcements are even less consequential.

Why downplay Petrobras and other news releases? One issue is that the company has to raise enormous amounts of dilutive capital in order to set up manufacturing, and deliver claimed product capabilities under high-volume manufacturing (HVM). But with only 37 employees, almost all lacking in manufacturing experience, it will be very challenging for Abakan to transition to HVM. Secondly, competition will easily blow Abakan out of the water. In its main metal cladding sector, market leader JSW Steel is part of $15B conglomerate focused on steel, energy and materials. JSW is vertically integrated with such a tremendous cost advantage that it will be nearly impossible for MesoCoat to compete. Abakan's other subsidiary, Powdermet, competes against a plethora of metal composite material companies, with no barriers to entry, selling small amounts of these composite materials for limited revenues. Thus, Abakan is trying to enter a very competitive, low margin business.

Let's give Abakan the benefit of the doubt and assume the super-optimistic, albeit highly unlikely, scenario that Abakan trumps its multi-billion dollar nemesis and other peers, passes the Petrobras trials as well as an Alberta pipeline project, and somehow raises tens of millions of dollars and acquires the HVM expertise to actually deliver the product. Let's assume that Abakan obtains 20% of this $2B oil & gas industry metal cladding opportunity, equating to $400M in revenues. Realistically, it will take Abakan five to ten years to reach this level (NB: the agreement with Mattson expires in 2017, but we will ignore that for now, and let's assume five years to reach $400M instead of ten). Using the closest peer, market-leader JSW, provides us a net margin of 4%, and a P/E of 12x. We would also assume 30% equity dilution to raise capital and a 15% annual discount rate. Thus, the net present value of Abakan under this one-out-of-a-hundred scenario is $73M, 41% of ABKI's current fully-diluted market cap of $177M. And this is the longshot rosy scenario. The most likely scenario is that ABKI will end up close to zero.

ABKI is currently trading at $2.30. The company recently raised money at $1.25 per share at the end of March 2012, before hiring promoters (see latest 10-Q, Note 15) to pump the stock up to as high as $2.75. Technically, ABKI looks vulnerable with the pump scheme wearing off, and the lock-up expiring soon on the cheap $1.25 shares.

Disclosure: I am short OTCPK:ABKI.