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Since Oct. 15, I've watched in horror as the stock of A123 Systems (AONE) collapsed from $0.24 to $0.06 in the wake of its Chapter 11 filing and then rebounded into the delusional $0.11 to $0.19 range as speculators began chasing the most fabled of stock market unicorns -- the Chapter 11 bankruptcy that will leave significant value on the table for legacy stockholders. As of yesterday's close, the market valued the stockholders equity of a bankrupt company at some $50 million.

It's not going to happen!

A123's stock is worthless. The speculators who are buying A123 with reckless abandon will lose their money because they don't understand what all the background machinations between the stalking horse bidder, Johnson Controls (NYSE:JCI), and the debtor in possession lender, the Wanxiang Group, really mean.

Let's start with some basics. As of June 30, A123 had $70.5 million in working capital and $107 million in equity, and there were 147 issued and outstanding common shares. After June 30, A123 raised another $6.8 million in a toxic equity offering and then started printing stock faster than Ben Bernanke prints money. By Oct. 1, the share count had rocketed to 313.9 million. Based on trading patterns between June 30 and Oct. 1, my best estimate of the total share count on Oct. 15 is 340 million -- a number that does not include any shares that might be issuable to the Wanxiang Group if it did something incredibly stupid like converting its secured creditors position into common equity.

The first issue that needs clarity is the nature of the previously announced Wanxiang investment that would have given Wanxiang the right to acquire 80% of A123 for a total of $465 million. Everything you've read in the mainstream press notwithstanding, it wasn't an equity investment and it wasn't a fixed amount of money. Based on the Form 8-K that A123 filed on Aug. 16, 2012, the individual elements of the proposed Wanxiang investment included:

  • A $75 million senior secured bridge loan facility that provided for an initial $25 million advance, consisting of $15 million in cash and a $10 million letter of credit and two follow-on advances of $25 million each;
  • A Bridge Loan Warrant that would give Wanxiang the right but not the duty to acquire 24.9% ownership after the first $25 million cash advance, 39.9% ownership after the second $25 million advance, and 49.5% after the third $25 million advance;
  • A $200 million block of secured notes that would be convertible into common stock at a fixed price of either $0.60 or $0.24 per share, depending on the survival of certain grants and tax credits; and
  • A Convertible Note Warrant that would give Wanxiang the right but not the duty to invest $115 million for an indeterminate number of common shares that would bring its ownership to 80% on the exercise date.

If you add all those numbers together, you get to a thoroughly impressive $465 million for an 80% ownership stake, but for the foreseeable future it was all debt. To put it a little more bluntly, it was all secured debt and Wanxiang had no duty to contribute any equity capital to A123 unless it chose to do so at some indeterminate future date.

Wanxiang was in the catbird seat of being a first priority secured creditor if things went badly and a major equity holder if things went spectacularly well. The legacy stockholders, in contrast, would be the first to suffer future losses and have very little upside potential in the event of a turnaround.

Starting from a June 30 base of $70.5 million in working capital and $107 million in equity, the July offering and the Wanxiang transaction increased working capital by $31.8 million and increased stockholders equity by $6.8 million. Operating losses between June 30 and the Oct. 15 Chapter 11 filing reduced both working capital and stockholders equity by roughly $90 million, leaving net working capital of roughly $12 million and net stockholders equity of roughly $24 million on the filing date. Total long-term debt on the filing date, including the $25 million initial advance from Wanxiang, was approximately $235 million.

In its stalking horse bid, JCI offered $125 million for all of A123's property, plant, equipment, and contract rights. The only asset that would have remained with A123 is an exclusive license from JCI that would allow A123 to use certain technology and intellectual property in grid, commercial, and government business. At the end of the day, A123 would be an empty bag with a license from JCI and over $110 million in unsatisfied creditor claims.

Media reports indicate that JCI is standing firm with its stalking horse bid of $125, and that Wanxiang intends to file its own bid in an attempt to take the deal away from JCI. Since JCI already has a $600 million lithium-ion battery manufacturing facility in Holland, Mich., that is reportedly not thriving, I have to believe that JCI is not terribly interested in upping its bid to buy another troubled lithium-ion battery manufacturing plant.

The original Wanxiang agreement would have left less than $120 million in equity for legacy shareholders if things went perfectly and all the secured Wanxiang debt was converted to equity. Wanxiang may well overbid JCI in the bankruptcy court, but the odds that it will overbid JCI by an amount sufficient to pay:

  • All of A123's creditor claims;
  • All of A123's Chapter 11 administrative costs; and
  • All of A123's operating losses during the pendency of the case

are remote beyond reckoning. A123's technology is just not that impressive. With an estimated 340 million shares outstanding and a stalking horse bid that will return less than $0.50 on the dollar to creditors, paying anything for A123's common stock is sheer lunacy.

Source: Why A123 Systems Is A Sucker's Bet