Lithium Phosphate A Lead Acid Replacement

 |  Includes: AONEQ, FH, JCI, VLNCQ, XIDEQ
by: Josh Franklin

Over the past five years, the battery market sector dominated by lead acid, such as car batteries, has begun to see some serious competition for the first time. Lithium phosphate batteries have arrived on the scene. After numerous years in development, they are now tried, tested, and ready to replace their lead-acid alternatives. This is not surprising when you compare lithium phosphate and lead acid batteries side by side (see table below). In addition to competing with lead acid batteries, lithium phosphate companies are carving out new markets for themselves in products used in demanding environments where lead acid batteries haven't performed strongly. As a result, a great opportunity has arrived to invest in companies that may be about to take a big slice of the lead acid battery market which Global Industry Analysts estimate will be $15.5 billion by 2015.

Lithium Phosphate Battery Lead Acid Battery
Average Operating Voltage 3.3V 2V
Voltage Change Keeping Steadiness Decreasing Gradually
Cycle Life >3,000 Cycles 150-300 Cycles
Calendar Life About 10 years About 1-2 years
Usable Capacity 99% 50%-60%
Self-discharge Rate/Month 1-3% About 30%
Fast Charging Performance 1C-3C 0.2C
Maximum Discharge Current 10C-30C 1C-5C
Operating Temperature -20°C - +75°C -20°C - +55°C
Weight Light (about 1/3 of Lead-Acid Battery) Heavy
Installation Direction Any Direction Be Fixed
Safety Performance Safe Boil and Leak
Impact on the Environment Pollution-free Serious Pollution
Click to enlarge

Further indication of the arrival of lithium phosphate as an alternative to lead acid is the fact that several industry giants are now entering the lithium phosphate market. In December 2011, LG and SudChemie announced that they had joined forces to build a lithium phosphate plant in South Korea which will have a 2,500 tonne/year capacity. Then in March German conglomerate BASF signed a long-term licensing agreement for the production and sale of lithium phosphate. An earlier entrant to the lithium phosphate market was Sony which is selling a line of lithium phosphate batteries for back-up storage and power tools. With these powerhouses backing lithium phosphate, I believe that over the next five years we should see lithium phosphate become an industry standard and as a result the growth curve could be tremendous.

One microcosm of a market where lithium phosphate is making headway is the medical cart business. The medical carts that you see in every hospital room usually have a lead acid battery at the base of that cart. Five years ago, the medical cart makers viewed the battery as a commodity and simply wanted to pay the lowest price. Now, using total cost of ownership analysis medical cart makers can see the savings in using a lithium phosphate battery that they can recharge more than 3,000 times and which will last 10 years, as opposed to a lead acid battery that can only be recharged 150 to 300 times and will die after two years. Sometimes these carts lie idle, if there is a lead acid battery in the cart then with its high discharge rate the battery will be drained in a few months. With a lithium phosphate battery and its minimal discharge rate, a cart that has been idle will still be 99% charged. By switching to a lithium phosphate battery that same medical cart is now more efficient, reliable and dependable as well as being lighter and environmentally friendly. As a result, we are beginning to see medical carts running on lithium phosphate batteries make their appearances in hospital rooms. As examples like this become known we can expect to see lithium phosphate spread to other markets. I see medical carts as the first domino to fall.

This summer, I will be keeping an eye on activity at the lead acid battery companies such as Johnson Controls (NYSE:JCI) and Exide (XIDE). Will executives and sales reps from the lead acid companies make a move, along with their extensive customer contacts to the faster growing lithium phosphate companies? I have heard that lithium phosphate companies are targeting their competitor's employees in their battle for market share. Why send in a new rep to sell a new battery, when they can send in the existing rep who will just be selling a better battery. It is also entirely plausible that JCI or XIDE sensing a threat to their markets could buyout a lithium phosphate company in order to get their hands on the technology and patents. The threat to them is very real!

I have isolated two companies that trade on the Nasdaq that have their core competencies in the production of lithium phosphate batteries and trade at basement levels. The two companies are A123 (AONE) and Valence Technologies (VLNC). Here's my view on these companies in the near future:

A123 went public in 2009 with a hot IPO underwritten by Morgan Stanley and Goldman Sachs with financial backing from General Electric (NYSE:GE) (a top 3 holder) and the support of the Obama administration. Their shares began trading at $13.50 per share and shares went as high as $28.20 giving them a $3 billion market capitalization. It has been gaining all the media attention, government support and institutional investor backing with their focus on the automotive battery market and their deals with BMW, General Motors, Geely, Fisker Automotive, Via Motors and McLaren to name but a few. Despite their numerous contract signings the company's stock price has cooled off considerably. The company had a major production gaffe that cost them in excess of $50 million and placed major concerns around the company's chances of survival. As a result it recently raised $50 million through a convertible note (6% interest and paid bi-weekly via cash or stock) with warrants attached, and it announced that it is pursuing numerous other avenues to raise additional funds. One analyst from Wunderlich predicts that A123 will need to raise $400 million over the next 18 months to survive while another analyst from Stifel predicts it need to raise $75 million by the fourth quarter. A tall order by anyone's measure, so the question remains, how will it raises funds and how dilutive will it be to shareholders?

A123's major problem may be their model of producing batteries in the United States. It built manufacturing facilities in Michigan after receiving large loans (approximately $250 million) from the U.S. government. Most battery production in the world is done in China and looking at A123's finances it may not be long before it is forced to either squeeze savings out of their Michigan plant or close it and move their production overseas. A123 loses $35-$50 million per quarter, has negative gross margins and has a $350-$400 million breakeven run rate. A far distance from the $11 million it recorded last quarter and the $20 million it has guided for this upcoming quarter. In addition to improving their finances it still needs to prove that it can handle a large volume production ramp without incident and also retain customers to give it that ramp. A successful ramp on increased orders will propel the shares to the $2-$3 level over the next 12-18 months providing it raises funds in a reasonable fashion. On the flip side, a failure to raise funds, a failure to produce reliable batteries or a desertion by its customers will cause the company to risk bankruptcy and reorganization.

A lithium phosphate battery maker you may not be aware of as it has been operating away from the glare of media attention and have seen limited institutional investor involvement is Valence Technologies . Valence was founded by billionaire Carl Berg. For over 22 years he has funded the company, providing over 50% of their cash needs. Four to five years ago when he believed that Valence truly had the rights to its lithium phosphate patents along with the best production technology, he made a conscious decision to run a lean company. In addition to funding Valence, he funded an Electric truck company in California, EVI, which is using Valence batteries exclusively. He is also on the board of Via Motors which is producing a GM Chevy pick-up truck that is all electric. Berg joined the board and now owns 40% - 50% of the company after he stepped in to save the company from extinction with a $5 million investment. Via currently uses A123 batteries, but many people are waiting to see if VIA founder and CEO, Kraig Higginson, returns Berg's favor by switching to Valence batteries.

One of the reasons I think A123 may move their production facilities overseas, is that VLNC was in a very similar position to A123 back in 2003. In their case, Valence had their manufacturing facilities in Northern Ireland (after receiving huge tax incentives), but after mounting costs it moved its production facilities to China. This effort has paid dividends as it has cut losses from $38 million per year in 2003 to $8-$9 million today. Moreover, gross margins have risen from 0% to 22% and revenues have gone from $2 million to $44 million over the same time period. As a result, the company has taken its breakeven from $350 million annually to $70 million annually. I see this transformation as a clear sign of a company that is lean and determined to make their business model a profitable one sooner rather than later. I believe Valence sits one to two customers away from cash flow breakeven. You cannot control the market, but you can control your operations.

Besides controlling the company's operations Valence has been busy lining up future revenue streams from a growing list of large to small customers. In the commercial fleet world EVI's electric trucks landed UPS (100 truck order), Frito Lay (10 trucks) and PG&E. In March I had the chance to visit EVI at a truck show and I can tell you that I witnessed Navistar, FCCC and others being very impressed with the truck's performance on test drives. I wouldn't rule out a future partnership as both large trucking OEMs are behind the 8 ball in the electric vehicle (EV) push. It could be why FCCC hasn't commented on their 3,000 EV truck order that it said will start shipping no later than the third quarter 2012.

In France, Valence is supplying batteries for Renault through Valence's supply agreement with PVI. PVI has a partnership with Renault and develops and manufactures commercial electric vehicles including electric buses under the Gepebus brand and trucks under the Renault Trucks brand. Very recently, PVI became a 10% customer of Valence (past 2 quarters) and has since updated their supply agreement with Valence. I personally believe this event has big revenue potential from PVI/Renault as it sees initial demand increasing as it doubled the number of truck models it sells with Valence batteries from two to four.

Another long standing customer is Segway, since 2006, Valence batteries have been powering this popular personal transporter. I believe Segway is due to update or improvise with a totally new transporter in the months ahead.

Two weeks ago, Valence signed an agreement with Enovate to supply lithium phosphate batteries (the next generation of batteries) for medical carts. I believe Enovate could be at a $4-$6 million annual run rate 12 months out. This will be the fourth medical cart company joining existing customers Rubbermaid and Howard Medical. Management is aggressively pursuing the remaining competitors in this market and I feel confident that it is close to landing them.

The near term could be very exciting to Valence. Valence has been working with Wrightbus and Siemens for the past three years to produce the Routemaster. The Routemaster is a new electric London double-decker bus. There are currently eight of these buses doing the rounds of the streets of London as the three companies work out all the kinks before proceeding to mass production. What makes me so excited is that in the recent mayoral election, these Routemasters were a campaign issue. Mayor Boris Johnson, who won re-election on May 3, 2012, is a prominent supporter of these buses and he has pledged to have 600 Routemasters on the streets of London within 4 years. I believe that this happens imminently and as a result we could see Valance land a potential $20-$30 million contract from Wrightbus. With London about to be in the world's spotlight with the London 2012 Olympics about to begin, the Routemaster will be in the spotlight too. I also believe that Wrightbus is being courted by dozens of municipalities and private bus companies, both in the U.K. and overseas about producing an electric bus for them. The Routemaster's platform is interchangeable so it can be easily designed for other types of buses. I believe that the street has yet to factor in the ramp up by Wrightbus and their impact on pushing Valence to breakeven for the first time in its 22-year history in the next six to nine months.

One of Valence's key assets that has been overlooked and undervalued is its intellectual property (NYSE:IP). In today's market, a company with IP is worth a lot more than they were two years ago. Google's purchase of Motorola for their patents, jump started the patent portfolio craze. Following on the heels of Motorola, Vringo (VRNG) popped from $1-$5 on rumors that they owned a huge patent portfolio on search that could fetch billions from either Google (NASDAQ:GOOG) or Yahoo (NASDAQ:YHOO). Interdigital (NASDAQ:IDCC) was bid up from $40 - $70 on rumors that someone would buy them for their patent portfolio -- Intel (NASDAQ:INTL) recently acquired a small number of their patents for $374 million. Even Research in Motion (RIMM) has been rumored to be a take-over candidate for their patents. Valence could be next: Valence recently finalized 8 years of litigation. As a result of this litigation, I believe that Valence has a bullet proof patent portfolio in two key areas: First, on their carbon thermal reduction process which they say is the cheapest and most profitable way to manufacture lithium phosphate. I believe that once the large players start producing lithium phosphate they'll be hard pressed to go around Valence's core processes and will eventually sign a licensing & royalty deal. Secondly, learning from their patent experience with lithium phosphate, Valence has deliberately built an iron clad wall around vanadium -- their next generation technology -- to avoid any potential loopholes in their defense. Valence's CEO Bob Kanode at the DB conference in late May said that Valence held 301 patents (U.S.: 135, foreign: 166) with 167 patents pending (U.S.: 30, foreign: 137). In lithium phosphate it is second only to Sony in patents held. He also confirmed that the company was pursuing joint ventures and licensing deals with multiple companies including China/Asia. The CEO must have known something because within 30 days they finalized their legal issues. I believe investors are sleeping on this company because it can easily be the next VRNG, which went from $0.68 to $5.45 in a few days, if LG, Sony, BASF, Samsung or Johnson Controls decides it's time to bet on Valence.

As you can see, lithium phosphate is fast becoming a standard with LG, Sony and BASF announcing their financial backing of this once vague chemistry. Just 5 years ago, no one knew the difference between a lithium-ion oxide battery (laptop/cell phone) and a lithium phosphate battery or the advantages of displacing lead acid with phosphate. All that has changed and I believe phosphate will take a large piece of the $15 billion lead acid market, but more importantly, they'll create a massive market in EVs that could be 3 to 5 times bigger than lead acid in the next 10 years.

In summary, it's a tale of two companies: A123 just ran from $0.85 to $1.60 on news that they had a new battery technology, so I'm inclined to wait and see where the shares settle and how they raise funds and handle their production ramp over the next two quarters before initiating a position. On the other hand, since 2005 over 60,000 electric trucks, buses, commercial delivery vehicles, scooters, motorcycles and personal mobility vehicles powered by Valence have hit the road. Valence seems poised for cash flow breakeven after the recent signing of a new customer (Enovate), settling costly litigation while strengthening their patent portfolio (resulting in lower expenses ~$3mm/lower breakeven) and the potential of large revenue growth with an updated supply deal with PVI/Renault. Furthermore, the company's stock is in very secure hands (Berg owns 85 million of the 170 million shares outstanding) while the short interest resides at 14 million shares or 31 days to cover. A large order, a non-dilutive or reasonably dilutive equity raise (10-20 million secures a path to breakeven) or a joint venture for their patent rights will send the shares soaring to new four year highs. Valence unlike A123 took their medicine in 2003 and now deserves the attention of the hundreds of institutional investors that viewed their conservatism as weakness. You decide where your lithium phosphate replacement will be.

Disclosure: I am long VLNC.