The recent bankruptcy filing of A123 Systems, Inc. (AONE) on Oct. 16, 2012, sparked the usual sell-off of its stock as investors attempted to salvage what was left of their investments and short sellers weighed in. The stock had already lost over 87% over the year and was trading at about $0.24 per share before it dropped to a low of $0.06 per share. Then boom! A lifeline from Johnson Controls (JCI) suddenly appeared.
Coincidence? Who knows, but it was certainly a blessing for those who were still holding the stock. The stock went from $0.06 to $0.08 on Oct. 17 for a 33% gain. It went to $0.12 on Oct. 18 for an additional 50% after the Chinese automaker Wanxiang Group vowed to top Johnson Controls' offer. Then the stock closed on Friday, Oct. 19, for another 58% pop. The stock has since pulled back to a $0.14 close on Oct. 26, which is still an impressive 133% recovery from the $0.06 low.
So why is there so much interest in this stock? Many long-term stockholders have lost so much money in it that it just doesn't make any sense to sell it now. Of course, some tried to salvage what was remaining after the big drop by selling -- but they soon regretted that after the recovery. And now there is hope in the air. But "hope" is not the best investment strategy. Even though it seems to sometimes work, I would vigorously challenge any claim of a real correlation. Well, I would most likely just dismiss it. But hope can be an important part of conviction when the data points needed to properly manage opportunity and risk are not known.
What's left is trying to determine the legal implications of the bankruptcy and if there will be anything left for shareholders after all the creditors are paid off. The outcome will be dependent on the value of the assets of the company. These are obviously very complex issues subject to the changing legal decisions and negotiations.
What most already know is that A123 Systems filed for Chapter 11 bankruptcy, which permits reorganization or restructuring. This is in contrast to Chapter 7, which goes straight to a liquidation of assets. But as with Chapter 7, the assets of the company will go to pay the creditors first, and if there is anything left it goes to the owners of the organization. For a public company, the owners are the shareholders. Forget about Chapter 13, which is mostly used by individuals for reorganization.
Now, what I think is important for A123 Systems is that (in my interpretation) what the debtors gain in Chapter 11 is the ability to obtain loans with favorable terms for the new lenders. These terms would include placing the new lenders before previous lenders. They can also terminate contractual obligations with court approval. This allows new investors to come in and not incur the total risk of the crippled organization. The bad part about this for shareholders is that this adds creditors, which can erode shareholder value. The good part is that it allows for the entity to continue operations for some time period and possibly create future value.
A123 Systems reported total assets of $494,965,000 in its Aug. 8, 2012, 10-Q filing. The filing also listed the company as having 147,141,066 shares outstanding as of June 30, 2012. So with these figures you could extrapolate a share price of $3.36 per share. For another data point, Wanxiang had offered to buy 80% of the company for $465 million, which would put the company's value at $581.2 million and would put the share price at $3.95. Yahoo Finance shows a one-year target estimate of $3.50. I don't know how this was calculated or when it was last updated. Of course, the company has still been losing money since August and hasn't traded anywhere near this range since November 2011, but valuation examples above would suggest that the company is worth much more than where it's trading at now. In a bankruptcy where assets can easily be divided, the sum of the parts can be worth more than the whole. And some are saying that Wanxiang's offer will be even higher.
Many are worried that the stock will be canceled. At this point no one knows for sure whether that will happen or not. But from a legal perspective, any remaining value after all creditors are paid belongs to the holders of the shares. One of A123 Systems major problems seems to be cash flow. Much of this can be attributed to a campaign the company launched to replace defective battery modules, which was estimated to cost $51.6 million in March when it was launched. The company also had to fix inventory and took a $15.2 million charge to facilitate the recovery. The effect of this problem was expected to last several quarters. Certainly some of the stock's decline can be attributed to the blunder.
But A123 still has value and utility that has attracted the attention of businesses both foreign and domestic. Wanxiang is the 800-pound gorilla in the room, and Johnson Controls seems to be strategically positioning itself to acquire portions of A123 without involving itself in protracted legal wrangling as demonstrated by them backing away from becoming the debtor-in-possession lender.
Wanxiang wants to own A123 but won't be allowed to purchase the defense related assets. Johnson Controls could provide for the Wanxiang purchase of most of the assets by absorbing the defense portions of A123. Fisker has also weighed in with a request for delay in proceedings to allow for interested parties to participate in the bidding of assets to ensure that more of A123's value can be realized. A123 is a Tier One supplier for Fisker Automotive and it needs the production of A123's battery packs to supplement its current inventory, which is only expected to cover the first quarter of 2013.
Wanxiang has been very aggressive in its pursuit of A123, but it has had to work through some government and political resistance. One must ask why they are it so persistent in acquiring a company with such financial woes. Wanxiang is a Chinese company and most certainly tuned into the Chinese government's promotion of electric vehicles (EVs) to reduce traffic congestion and smog in the country. The Chinese government recently released a policy letter, discussed here, that reveals China's determination to promote EVs. Kandi Technologies (KNDI) seems to be the favored provider to the masses as it has been successful in gaining support and promotion for its 20,000 vehicle lease project and 100,000 vehicle public transportation projects.
Kandi Technologies is just one company in China that will need batteries to support expansion into EV Asian market. Ford (F) is investing in significant infrastructure to engage this growing market. So while Wanxiang's interest in the U.S. market is warranted, its willingness to purchase the company without the lucrative government contracts can be better understood. Some political rhetoric and industry media have suggested that it would move some assets overseas to facilitate production in China. I would certainly think that it would be strategically positioning to take advantage of the growth within its own country.
A123 Systems most likely will not survive intact. But the strength and value of the pieces of the company can and will survive due to their value and maturity. Shareholders both long and short will go back and forth as the value is subject to much speculation. But all should note that it sure didn't take long for major industry players to place A123 firmly in their crosshairs. If discussions intensify and evolve into a bidding war, some unexpected value could be realized for the company's assets.
Disclaimer: Any legal opinions are my own and are based on my own interpretation. Seek legal counsel concerning any legal matters and professional advice concerning your investments and portfolio risk.
Disclosure: I am long KNDI, AONE.