This past week, Wall Street whooped up the higher top-line revenue number from American Superconductor (AMSC), and rewarded it with an immediate 25% gain, plumping its market cap to well over a billion dollars. All this for a company that has done nothing but over-promise and under-deliver for years.
Citron seeks to answer a key question: Was this increase in revenue gained through legitimate arms-length transactions, or was there another explanation - some undisclosed related party transactions? You be the judge. If we look to the insiders for guidance, they have already rendered their verdict, in the form of insider selling at a furious pace. Read on and enjoy a true tale of Wall St.
While alternative energy stocks have become Wall Street darlings, it is important to differentiate those who are players in the space to those who play like they are in the space. General Electric (GE) and Siemens (SI) are legitimate industry players in wind power and then you have AMSC, who through a series of press releases and a funky acquisition wants Wall Street to forget that their superconductor business has fallen off a cliff (down 30%) last year and to forget about the $400 million already pumped down the drain at the end of that dream.
A Little Background
For those of you who are not familiar with American Superconductor, they have been one of those perennial money losing “dream technology” companies who promise everything and deliver nothing. Here are a few snippets from their 10-K’s of years gone by.
- 2000-“We believe that our existing capital resources, including the proceeds of our March offering, will be sufficient to fund our operations until we reach profitability and have positive cash flow”
- 2002 “We believe that our existing capital resources will be sufficient to fund our operations until the end of fiscal 2005, at which time we expect to reach corporate-wide profitability”
- 2005 - “We expect to continue to incur operating losses until at least the end of fiscal 2007”
- 2006- “We expect to continue to incur operating losses until at least the end of fiscal 2009 and there can be no assurance that we will ever achieve profitability.”
In fact, this company has delivered a string of unblemished losses stretching back 14 consecutive years – without ever turning a single profit. Not just marginal losses, either - $400 million in total … and none of this developing wind power, rather Superconductors.
AMSC 15 Years Financials [PDF]
2007: Into the Wind
Coming into 2007, American Superconductor needed a new story to boost their stagnant stock price. In the first month of the year AMSC acquired Windtec in order to enter the highly competitive wind power market. The cost of the acquisition was $0 cash and $13 million in stock. It is 15 months later and the company is claiming that Windtec has become the primary revenue engine for the entire company, with one of Windtec’s customers accounting for 52% of AMSC’s $74 million total revenue, or about $37 million for the 9 months ending Dec 31.
“Revenue growth in the nine months ended December 31, 2007 is being driven largely by our acquisitions, particularly Windtec. AMSC Windtec’s largest customer is Sinovel Wind, in China. For the nine months ended December 31, 2007, Sinovel accounted for approximately 52% of our total revenues. If Sinovel cancelled contracts, or discontinued future purchases from us, we might be unable to replace the related revenues.”
Then they trumped that with a 4th quarter 8-K, announcing record $38.1m revenues, and massive backlog growth to nearly $200m, a 167% increase since March 2007. The concentration of orders from Sinovel is undisclosed, but among other things, we can’t wait to see what they come up with for that data point in their upcoming 10-K.
It seems the acquisition of Windtec was so good that AMSC gets a free entry into the wind systems business without even doing any R&D. AMSC’s R&D expense companywide was a paltry $3.7 million last quarter companywide. This is down year over year and most of that still goes into the money losing superconductor business.
So who is Windtec?
Well, if Windtec can justify the majority of revenues for a billion dollar company they must have been a real solid company pre-acquisition … NOT! Windtec had been a small customer of AMSC since 2005. Admittedly, Windtec was an engineering design firm, not a manufacturer of wind systems.
On the 8-K filed 3/27/2007, we get a glimpse into the real Windtec. Founded in 1995, this is what the company looked like after 11 years in operation (all numbers in Euros)… NOT thousands either.
All figures in Euros
Machinery and Equipment: 1,100,000
Accounts Receivables: 2,000,000
Accounts Payable: 1,700,000
Short Term Borrowings: 335,000
12-month R&D: 1,500,000
Amount due to AMSC: 292,000
So basically, AMSC took a customer who owed them almost 80% of all their cash and saved them by acquisition…
Let the Games Begin
In no time, Windtec became the darling of the company as multi-million dollar orders came rolling in from China. Namely one customer – Sinovel. This one customer gave a series of orders to Windtec in 2007 that totaled over $100 million. Not bad for Windtec, a company who just months beforehand had only $196,000 in inventory.
As quoted above, Sinovel currently accounts for more than 50% of all AMSC revenues and the majority of their backlog. What makes this even shadier is how this long-standing customer could start giving Windtec these multimillion dollar orders only months after Windtec was acquired for peanuts.
Sinovel has become so crucial to the existence of the company that they even disclose,
“If Sinovel cancelled contracts, or discontinued future purchases from us, we might be unable to replace the related revenues. This would have a serious negative impact on our operating results and financial position.”
It is the opinion of Citron that Sinovel is a related party and American Superconductor has not disclosed the true nature of the relationship. This spells big problems for AMSC.
Let us start here - at the Sinovel homepage: www.Sinovel.cn
Here we see the name of the company is not Sinovel Wind, but rather Sinovel Windtec. Furthermore, we see numerous mentions online to a joint company called “Sinovel Windtec”. The notion of an undisclosed relationship between the two companies is even more compelling after we see that a company called Sinovel Windtec existed and was marketing products in 2006 (pre-acquisition). [link]
This as yet defined relationship between Sinovel and Windtec not only exaggerates gross margins for the company but more importantly it is the only way to explain how a sleepy design engineering firm with the balance sheet of a pizza store can become more than 50% of the revenues and the driving force behind a $1.3 billion company.
Companies making related party transactions have the burden of extra disclosure so investors can make informed valuation decisions. The SEC is very clear about recording revenue from related party transactions with Regulation SX and FASB statement #57. Management must explain to shareholders the true nature of these relationships.
Why? Related party transactions can be loaded in all different ways, distorting their true economic value and rendering them invalid in an apples-to-apples comparison with arms-length transactions.
AMSC discloses relying on “percentage completion” accounting for “certain contracts”, there are even more uncertainties regarding this one huge customer, its burgeoning receivable, and the true nature of its business relationship to AMSC. Or have they explained it through their insider selling?
From the date of the first Sinovel/Windtec (only a year ago) announcement to the present, CEO Greg Yurek has sold over $8 million worth of stock. That figure dwarfs his stake in the company – basically he immediately runs his options to market as soon as they vest – next to the losses, it’s the most predictable transaction in AMSC’s filings. The selling has come as recent as $140K worth of stock last week. This is the most rampant selling we have seen by the CEO in his tenure.
You’d think Wall Street would have learned a lesson from the catastrophic valuation destruction inflicted on investors in the bubble collapse of 2000 and 2001. Yet some of the same perpetrators get resurrected and refinanced every time Wall Street has a new story to sell. We now have a company who out of the clear blue is generating revenue from another company who seems to have common ownership. Someone has a lot of explaining to do!
Citron says don’t get burned.
Cautious investing to all.
Disclosure: Author is short AMSC.