Groucho Marx once quipped: "If we had some eggs we could have eggs and ham, if we had some ham."
In 2008, Groucho would probably work in the PR department of an alternative energy company where the logic often follows a similar path and the hype over advanced research projects, prototypes and vaporware can be intense.
I don’t mean to belittle the solid work that is being done by emerging companies in the alternative energy sector, but investors need to understand that there is a well-defined path from R&D to commercial production and there are several different classes of non-commercial devices that can accurately be called prototypes, including:
- Development Prototypes: Built for proof of concept and laboratory testing to optimize designs, evaluate reliability and estimate performance under specified operating conditions.
- Alpha Prototypes: Built for internal testing and evaluation using the same materials as a proposed product, but with non-commercial fabrication processes.
- Beta Prototypes: Built for comprehensive internal and external evaluation of full-featured devices that are built using well-developed fabrication processes.
- Pre-production Prototypes: Built in small volumes using final manufacturing processes to refine production methods and provide limited quantities of products to lead customers.
The development path for every new device must pass through all four of the prototype stages before it can proceed to commercial production on an assembly line. Until a new device is manufactured on a commercial scale assembly line, it cannot be properly referred to as a product. In an earlier post I noted that hard experience proves:
A PhD working in a well-equipped laboratory can always generate test results that are vastly superior to the best results one can expect from a factory staffed by high school graduates; which is why R&D companies rarely survive the transition from research to manufacturing.
To put it a little less delicately, the landscape of every technology-based industry is littered with laboratories, test equipment, prototypes and related detritus of disruptive and world changing technologies that didn’t survive beyond the prototype stage.
Like Howard Carter when he opened King Tut’s Tomb, I have seen “wondrous things” in my career including nano-scale lasers that disintegrate tissue without burning, monoclonal antibodies with noble metal tags, diamond electronics and a host of other bleeding edge R&D projects that stopped dead when amazing science crashed into the realities of industrial engineering. In my experience, the science rarely fails but the transition to a commercial product fails with alarming frequency. Without both, you can’t have a going concern.
A couple weeks ago I published a list of pure-play energy storage companies that seem well positioned for the rapid growth I foresee in the energy storage sector. The original list was broken down into categories based on the amount of time that their existing and proposed products would take to deliver stored energy. Today, I’m going to reorder the list and do a brief subjective analysis of the state of business affairs at each company. I know I’m wading into deep and troubled waters here and there will be room for honest disagreement, but I think this post will help clarify the situation for readers who are not financially or emotionally wedded to a particular technology or company.
Established Manufacturers. My established manufacturers group is limited to pure-play energy storage companies that reported more than $40 million in annualized product sales during the most recent fiscal quarter. Five of the companies made money and the other three lost money. The following table provides summary valuation metrics for each of the eight established manufacturers:
click to enlarge images
The table excludes A123 Systems ($8.7 million in Q-1 product sales) because its stock will not be quoted until after a planned IPO this fall. It also excludes Valence Technologies ($11 million in Q-2 product sales) because Valence had a negative stockholders equity of ($68.4 million) at June 30, 2008 and I classify it as a troubled company.
This eight-company group of established pure-play manufacturers accounts for about a third of the global market for batteries. The balance comes from a handful of large lead-acid battery manufacturers that are privately held or part of diversified concerns like Johnson Controls (JCI) and a plethora of Asian industrial giants. As the market comes to grips with the reality that sales of energy storage systems are expected to soar from $20 billion to as much as $100 billion over the next several years, I believe the established pure-play producers will likely see significant increases in both revenues and valuation ratios; which should make the current prices look like bargains when the scope of the expected changes becomes more evident.
The five profitable manufacturers carry P/E ratios that are reasonable based on historical earnings and do not carry big premiums for the immense growth potential in the energy storage sector. While I am less fond of the companies that are losing money, Maxwell seems to be faring better than the other two and it is the only manufacturer that focuses on supercapacitors. So if I wanted to build a personal portfolio of established companies in the energy storage sector, I think I’d probably stick with the five profitable manufacturers plus Maxwell.
Transition Manufacturers. My transition manufacturers group includes two pure-play energy storage companies that have not reported substantial revenue in the past, but expect to introduce and begin selling new products during the next twelve months. Since it is difficult to compare transition-stage companies based on pure financial metrics, the table reflects the book value, market prices and adjusted market capitalizations of the companies I would classify as transition manufacturers:
Ener1 is completing development of a lithium-ion battery that it plans to manufacture for use in electric vehicles (“EVs”) and plug-in hybrid vehicles (“PHEVs”). Through 2007, Ener1’s activities were focused on basic R&D. In early-2008, Ener1 delivered three pre-production prototypes (27 kWh each) for testing in the Th!nk City EV. The battery packs reportedly met all performance specifications. Ener1 has built a 92,000 sq. ft. manufacturing and testing facility for its EV batteries and plans to begin manufacturing before year-end. Since Th!nk plans to sell its base EVs and then lease the batteries under a separate contract with the buyers, I have not been able to find a reliable estimate of Ener1’s proposed selling price or the effective cost per watt-hour (“wH”) of its battery packs. However, buyers of Th!nk vehicles will be able to choose between optional battery packs manufactured by A123, Ener1 and a Swiss manufacturer. So I would expect Ener1 to offer its batteries at a competitive price and incur production costs that are roughly comparable to the $1.50 per wH that A123 incurs to manufacture smaller-format batteries in China.
Axion is developing a lead-acid-carbon battery/supercapacitor hybrid that it plans to offer as a low-cost upgrade for the conventional lead-acid batteries that are currently being used in a variety of industrial applications. Through 2005, Axion’s activities were focused on basic R&D. Since early 2006, Axion has focused on developing and refining manufacturing methods for the carbon electrode assemblies used in its PbC products. Two years of performance testing on pre-production prototypes have shown that PbC batteries have longer cycle-lives, higher power and faster recharge rates than conventional lead acid batteries. Axion recently manufactured several hundred pre-production prototypes that have an aggregate storage capacity of 225 kWh. These pre-production prototype PbC batteries will be used for a grid-connected utility upgrade deferral demonstration project that will be installed in New York later this year. Planned automated equipment additions for its electrode fabrication line are expected to increase Axion’s manufacturing capacity to 1,000 units per day by the first quarter of 2009. Since PbC batteries will be marketed as low-cost upgrades for industrial lead-acid batteries, Axion believes a broad base of likely customers for its PbC batteries already exists and its future will not depend on a limited number of potential customers.
Axion plans to sell a low-cost upgrade into existing industrials market while Ener1 plans to introduce an expensive new technology for a new and unproven class of consumer products (EVs). Even the most optimistic market forecasters predict that EV batteries will not represent more than 15% to 25% of the total market for energy storage devices for several years. So from a pure business fundamentals perspective, I think Axion’s PbC batteries have greater potential for rapid sales growth and lower risks of commercial acceptance than Ener1’s Li-ion batteries. Additionally, the lead-acid subsector has not received the intense media attention that has driven valuations in the Li-ion subsector for several years and Axion is relatively unknown despite a solid five-year track record. I believe that a rising tide lifts all boats and Ener1 will probably do very well over the short term. But experience tells me the biggest percentage gains from a rising tide are experienced in low-profile boats. In the interest of full disclosure, I’m a former director of Axion and a substantial stockholder, so my view cannot entirely free of bias or self-interest.
Advanced Research Projects. My advanced research projects group consists of pure-play energy storage companies that either have major technical hurdles to overcome or have no defined prospects for substantial product sales during the next twelve months. Since it is almost impossible to compare advanced research projects based on financial metrics, the following table reflects the book value, market prices and market capitalizations of the two companies I would classify as advanced research projects:
Altair is developing a lithium-ion battery that it plans to manufacture for use in EVs and electric utility applications. Through 2007, Altair’s activities were focused on basic R&D. In early-2008, Altair delivered two pre-production prototypes (250 kWh each) to AES Corporation for validation testing in frequency regulation for electric utilities. In mid-2008, Altair also delivered 47 pre-production prototypes (53 kWh each) to Phoenix Motorcars for use in a high-end EV roadster. While available information on the performance of these prototype systems has been spotty, Altair has reported that safety questions resulted in the cancellation of the Phoenix contract and performance data from the frequency regulation project will not be available for two or three years. While Altair has expanded its research and prototype fabrication facility from 30,000 to 70,000 sq. ft., it has not disclosed whether commercial manufacturing facilities are part of that expansion or announced any plans to begin manufacturing products for a specific customer. Since Altair’s manufacturing capabilities are unclear and it has no identifiable customers for commercial products, I think it is most appropriately classified as an advanced research project although some will undoubtedly argue that it belongs in the transition manufacturers class.
Beacon has spent several years developing a sophisticated flywheel energy storage system that it plans to use in company owned facilities that will be connected to the electric grid and provide frequency regulation services. If its company owned facilities are successful, Beacon plans to sell flywheel systems to others. Since inception, Beacon’s activities have focused on basic research and prototype development. Beacon has built and demonstrated beta prototype flywheel systems (2-kWh and 6-kWh) that were sufficiently successful to garner regulatory approval for a proposed company owned frequency regulation facility in New York State that will provide 5 mWh of storage and up to 20 MW of frequency regulation power for up to 15 minutes. Beacon’s SEC reports indicate that its frequency regulation facility cannot be built until it develops and tests a pre-production prototype (25-kWh/100-kW) of its flywheel system and fabricates 200 units for incorporation into the project. Due to the complex engineering issues that arise whenever a developer attempts to increase the capacity of sophisticated mechanical system, I am unwilling to assume that Beacon will be able to scale-up its flywheel prototypes to the required size and begin manufacturing operations during the next 12 months.
In the advanced research projects group, I think Beacon is probably the better opportunity. Altair has fine chemistry and some impressive prototype test results, but its’ pre-production prototypes were objectively expensive and it is far more difficult to increase the efficiency and reduce the costs of chemistry than it is to increase the efficiency and reduce the costs of a mechanical device. I don’t believe Beacon has an easy development path, but I think the path entails less risk than Altair’s.
Troubled Companies. My troubled companies group consists of pure-play energy storage companies that seem to be encountering significant business or financial difficulties.
Valence manufactures and sells Li-ion batteries for diverse applications including portable appliances and electric vehicles. At June 30th, Valence had sufficient liquidity to pay for roughly six months of anticipated losses, but it also had a ($68 million) deficit in its stockholders’ equity. In its Form 10-Q for the period ended June 30, 2008, Valence reported $10.8 million in sales, including $4.2 million to Tanfield; $4.2 million to Segway and $2.4 million to other customers. The Form 10-Q also reported that Valence had suspended sales to Tanfield, which will presumably have a negative impact on future revenue. Since a principal shareholder owns the bulk of Valence’s debt and redeemable preferred stock, the large balances due may represent a smaller risk than they would in the hands of unrelated third parties. But a cursory review of the financial statements is not encouraging.
ZBB designs, develops, manufactures and sells zinc-bromine flow battery systems that can be used by utility companies, renewable energy generators and commercial and industrial customers. The core component of ZBB’s systems is their ZESS 50 energy storage system, which has a rated discharge capacity of 50 kWh and can deliver up to 36 kW of standby power for periods of one to several hours. Since 2005, ZBB has delivered pre-production prototypes ranging from 50 kWh to 500 kWh to several users but the level of annual product sales has remained low and relatively stable. ZBB does not have any obvious constraints on its ability to increase production to meet increased demand. ZBB has neither filed its quarterly report for the period ended June 30, 2008, nor offered an explanation for the delinquency. This is not encouraging.
VRB designs, develops, manufactures and sells vanadium-redox flow battery systems that can be used by utility companies, renewable energy generators and commercial and industrial customers. The storage systems produced by VRB generally have relatively high storage capacities and are designed to deliver the stored electricity over a period of five or more hours. Since 2005, VRB has delivered pre-production prototypes ranging from 25 kWh to 120 kWh to several users but the level of annual product sales has remained low. At June 30th, VRB had sufficient liquidity to pay for roughly three months of anticipated losses. On August 27th, VRB announced plans for a rights offering to existing stockholders and the creation of an independent board committee to evaluate go forward strategic options. These are not encouraging developments.
Without a good deal more information than I currently have access to, I’d be inclined to stay away from the troubled companies.
The Road Forward. Over the next couple years, I think the sex, blood and media hype in the energy storage sector is likely to focus on the battle between A123, Ener1 and possibly Altair for supremacy in the EV markets. I also think the most impressive revenue growth is more likely to be concentrated in the established manufacturers group, Axion and possibly ZZB and/or VRB if they get their acts together. The established products may not be as hot and sexy as the Li-ion glamour girls, but there is significantly less technical and market acceptance risk. To paraphrase Groucho: “If we had safe, reliable and cost effective Li-ion batteries, we could have electric vehicles that go a hundred miles between charges, if anybody wants to pay a premium for a vehicle that can only go a hundred miles.” For potential energy sector investors, I remain convinced that it all boils down to a choice between today and someday.
Disclosure: Author holds a long position in AXPW.OB and is a former director of that company.