Flawed Technology, Bloated Market Cap - Amerigon's an Attractive Short

Amerigon (ARGN) designs, develops, and markets products based on proprietary thermoelectric [TE] technologies for heating and cooling applications. The company's only commercial product is the Climate Controlled Seat [CCS], a system that provides active heating and cooling to automotive seating surfaces.

CCS is currently offered on 21 vehicle models from Ford Motor Company (F), General Motors (GM), Hyundai, Nissan (NSANY), and Toyota (TM). The company's R&D is focused on developing and commercializing TE technologies for additional applications.

Investment Thesis

ARGN offers a compelling short opportunity because investors are incorrectly valuing the potential of ARGN’s R&D efforts and future product pipeline. ARGN has only one commercial product which is the CCS, using the most generous multiple possible, I estimate this business is worth $8 per share yet the stock trades at $18.20 which means that 56% of the market cap is attributed to ARGN’s product pipeline. The short opportunity is that the technology in the pipeline is impractical and unlikely to be economically worthwhile. In addition, ARGN sells into the very challenging auto industry where their customers (OEMs) have a lot of power over suppliers and volumes are unlikely to see meaningful growth. Finally, ARGN is highly exposed to GM and Ford auto volumes and there has been heavy insider selling lately.

• Investors overvaluing ARGN’s pipeline, R&D efforts for impractical technology

ARGN has one commercial product which is the CCS which allows passengers to control the heating and cooling of their seat. Using the most generous multiple possible, I estimate that this business is worth $8. Please see below for additional detail.

This suggests that investors are attributing $10 per share (56% of market cap) to ARGN’s pipeline which is based on thermoelectric power generation technology. ARGN’s technology sounds very cool but the resulting economic benefit is so disappointing that I think it renders it economically unviable. The technology involves capturing waste heat from vehicle exhaust and using a thermoelectric generator to create electricity which can be routed back to the vehicle for subsequent use. While it sounds great the actual fuel efficiency improvement of this technology is surprisingly low (+10% or 2-3 miles per gallon).

Keep in mind that this 10% improvement is a targeted goal and attained only if ARGN is able to achieve their targeted thermoelectric efficiency gains. Traditional thermoelectric devices are not widely used because they are inherently inefficient. ARGN’s targeted efficiency goal (needed in order to capture the +10% fuel efficiency improvement) is dependent upon ARGN improving thermoelectric efficiency by a factor of 4, currently ARGN has improved thermoelectric efficiency by a factor of 2. So ARGN is only half way to their targeted goal (arguably the easier half) and even if they reach this goal the final outcome is still only a +10% increase in mpg or 2-3 mpg improvement.

In addition, a car needs to be equipped with 3 large and clunky generators to make this work. ARGN is investing lots of money into R&D for this technology but I doubt it will ever see widespread adoption because the payoff is so little, I think there are many other technologies with greater potential (hybrids, biofuels, etc.) and I doubt that OEMs will rework their designs to add these generators to get an extra 2-3 mpg. Given this view, ARGN shares appear ~50% overvalued.

• Only one product, high customer concentration

ARGN has only one commercial product, which is the CCS, so the company is completely levered to the adoption of this product. My research indicates that the CCS is a standard feature on only 4 of the 21 models and the optional feature appears fairly discretionary with an average price of $700-900 to the consumer. In addition, ARGN customers are highly concentrated with 95% of sales coming from three customers; NHK (30%), Lear (29%), and Bridgewater (26%). From an end market perspective, ARGN is highly exposed to GM and Ford with 30% and 28% of 2007 sales respectively.

• Highly exposed to US auto volumes, tightening credit will likely hurt volumes

ARGN is highly exposed to US auto volumes (58% of sales directly to domestic OEM but a high percentage of the Asian business gets shipped back to the US) which have been trending down and should likely continue in a weak economy. Last week, the head of Nissan Motor Co. said even if the United States is not in recession, its auto industry is. "We are very lucid on the situation of the industry that there is a recession in the United States, at least in the car market," Chief Executive Carlos Ghosn told reporters. As you can see below, NA auto volumes have shown no growth over the past 3 years.

On a yr/yr basis, the trend continues to show weakness as only 3 months out of the past 13 months have shown positive yr/yr growth. Furthermore, GM announced February sales were -13% yr/yr and Ford announced -7% yr/yr.

In addition, US auto production for the year could fall further as rising delinquencies in auto lending will lead to tightened credit standards which could freeze out some buyers. I am comfortable with shorting ARGN because the overall pie is not growing which will make it exceeding difficult for ARGN to grow sales +35% year after year.

• Heavy insider selling since November 2007

Combing through SEC filings shows that since November 2007 4 insiders including the CEO and also the Chairman of the Board have been selling shares at a brisk pace. Insiders have sold $5.6m in shares during this period which equates to 1.36% of shares outstanding or 16% of all insider shares. The average price for these transactions was $19.08. My rudimentary understanding of behavioral finance tells me that people do not generally sell things that they expect to appreciate in value. Furthermore a good deal of these options did not expire until 2012 which means insiders are willing to forfeit the option value to sell.

• Risks
  • Auto sales improve dramatically which would bolster the existing CCS business on existing platforms. This does not appear to be happening anytime soon as GM and Ford both announced a significant yr/yr decline in sales for February 2008.
  • CCS introduced on more vehicle platforms than expected. I see this threat as minimal given the overall “pie” is not growing and we are already assuming +36% revenue growth yr/yr in both 2008 and 2009 and still are arriving at $8 per share valuation.
  • Government regulations mandate thermoelectric generators on cars. Highly unlikely but would certainly help adoption of the thermoelectric generator product.

• Timeline (click to enlarge image)

Disclosure: I am short ARGN

Comments

[Rep07]

Great article and analysis! Quality stuff.

[Rep07]

Excellent article! Great analysis... thanks.

[User 127691]

very nice article, but what do you make of all the analyst saying that the proper comp for this company is GNTX which has historically traded at a high multiple.

[User 127691]

What do you make of all the analyst who cover them saying that the right comp is Gentex, a company who's historicall traded very high, and well through recessions. also, FCF seems pretty decent.

[autoguy99]

There are now vehicles with GM that have heat cools not supplied by amerigon. The buick enclave, GMC acadia, chevy traverse. now that they have real competition what will happed.

[america_f_yeah]

This was an awesome short, thanks.