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A123 IPO Analysis

|Includes:A123 Systems, Inc. (AONEQ)

I have been doing some work on A123 in preparation for the IPO and thought I would share my conclusions.  First, there are some real experts on the battery sector on this forum, so I won't even attempt to add any industry insights here.  Rather, let me say that I am very bullish on the battery industry over the next decade and have been looking for a way to participate in my portfolio.

To cut to the chase, I am planning to buy shares in AONE if I can get them under $9.  I probably won't be able to get shares at the offering price and I think there is a good chance I won't get a shot at $9 given the strong market environment and the cash coming back into the markets.

The reason I am hesitant to pay more is that this is a riskier investment case than I originally thought and the risks I was expecting are meaningful.  I think the loss of the Volt contract is a big deal.  GM is able to perform much deeper analysis on the merits of A123's product than I can do, and they chose LG Chem.  The reasons for that could be fixable (example, they were worried that there would be capacity constraints) or it could be more substantial.  I don't know, but it certainly raises the risk profile since they have to win contracts in order for me to make money.  Second, this is a one-trick-pony in the sense that they offer a specific technology.  If their lithium phosphate chemistry doesn't gain traction for any reason, the stock is in trouble.  There is not a profitable existing business to provide any downside protection unlike several other battery companies.  As such, the chances that AONE ends up a zero is higher than it is for most companies in my opinion.  Third, I don't like the litigation overhang from Hydro-Quebec and UT.  If these lawsuits go poorly for AONE, it is likely to push back breakeven, which really hurts my valuation.

Despite that, I agree with some of the other writers on this site, that the battery industry growth is likely to be big and broad enough to lift a lot of technological boats.  The upside for AONE is massive and worth some risk of course.  I think the stock has an intrinsic valuation of just under $10 per share, and could easily trade to $12 or more on sentiment.  That $10 intrinsic value requires revenue of $525m by 2012 and break even operating margins by 2011.  I am assuming 5% margins in 2012 and 10% thereafter.  Sharecount is assumed to be 111 million.

Given the risk profile, growth potential, and my industry stance, I would like to buy the stock below $9.  I hope I get the chance.

Disclosures: I have read through the S1 but have not seen the roadshow and don't have a way to evaluate the quality of management.  I like this sector, but my expertise is the financial sector, not industrials.  I am going to call my broker, but am very unlikely to get shares at the offer price.

Stocks: AONEQ