Just three weeks ago, I published an article discussing Fuel Cell Energy's (NASDAQ:FCEL) potential short- and long-term business drivers and at that time I did not expect to return with another piece on the company so soon.
But this morning the company surprisingly announced a new equity offering. Of course, long-term FCEL investors should be well used to this pattern as the company has more or less constantly accessed the equity markets for more than two decades in order to replace the capital burned through in the company's ordinary course of business. In fact, the company has amassed more than $720 mln in tax carryforward losses over time with still no end in sight.
To be fair, FCEL's last equity offering was almost two years ago, when the company raised $35 mln from NRG Energy (NYSE:NRG). But to put things into perspective, the split-adjusted offering price at that time was $23.90. Ouch.
Two years ago, NRG's $35 mln investment amounted to a roughly 5% stake in the company, while today's $40 mln placement gives the new institutional investor an almost 20% holding in Fuel Cell Energy.
I was quite surprised about this rather large offering as the company was just recently forced to tap the high yield debt markets (as evidenced by a $25 mln loan agreement signed with Hercules Capital at the end of April) in light of the lingering uncertainties around an extension of the fuel cell investment tax credit (FTC) beyond the current expiration date at the end of 2016.
I was even more surprised when I learned that the entire offering was purchased by a single institutional investor. This transaction makes it by far the company's largest shareholder, solidly ahead of long-standing business partners Posco Energy (roughly 8%) and NRG Energy (roughly 5%).
While it would be quite interesting to know who puts that much faith in a company still lacking a sustainable business model and burning through tens of millions in cash each fiscal year, the offering was actually orchestrated in a very special way in order to prevent the identity of the investor from getting revealed.
To avoid crossing the reportable 5% ownership threshold, the company sold just 1.474 mln shares to the investor while the rest of the offering contained 5.387 mln so-called "prefunded" Series B warrants that will be exercisable at virtually no additional cost at any time up to five years after issuance.
As a sweetener, the investor also got a whopping 8.233 mln in Series A warrants that will be exercisable during the period commencing six months after the date of original issuance and ending five years thereafter at an exercise price of $5.83 per share.
Assuming a full exercise of the entire 13.620 mln Series A and B warrants over time, the institutional investor would end up with a roughly 32% stake in Fuel Cell Energy.
So while issuing new equity and moreover a staggering amount of sweetener warrants for a potential more than 30% dilution with the share price being close to all-time lows isn't exactly something to get too excited about, I actually applaud this move.
To put things into perspective, Fuel Cell Energy's business is currently approaching crossroads as the company's long-standing partner Posco Energy is in the process of ramping up its own production facility in South Korea and is not expected to purchase further fuel cell kits from the company thereafter. While FCEL will collect a 3% license fee and some additional royalties for future sales and module replacements from Posco Energy, the potential revenues to be realized under the new partnership structure will not make up for the expected substantial top-line loss, given that 67% of the company's FY2015 revenues were derived from Posco Energy. So far in FY2016, Posco Energy still accounted for almost half of the company's revenues.
With the end of the current Posco Energy relationship getting closer, the company has recently changed its business model and instead of just constructing and selling turnkey solutions now offers its customers so-called "power purchase agreements" (PPAs) under which Fuel Cell Energy will construct, operate and maintain the fuel cell power plants for up to 20 years.
Technically the PPA structure is in fact very close to an operating lease.
Unfortunately, due to its limited capital resources, the company is not in the position to finance this type of business model without raising major amounts of capital going forward.
Moreover the company is widely expected to soon be awarded the giant 63 MW Beacon Falls Energy Park project which would require large additional financing:
As announced previously, the 63 MW Beacon Falls Energy Park was bid for the tri-state RFP in January of 2016. We feel this clean energy project is very competitively priced and brings benefits to the tri-state region as competing bids do not.
It provides ratepayers with affordable and ultra-clean power generation in the region, enhancing the resiliency of supply. This project also drives and pays for desirable natural gas, electrical and water infrastructure for the state and region that will help with adjacent economic development and directly benefits ratepayers.
In comparison, many competing bids will require the construction of transmission lines, to connect the region to distant power generation sources. Beacon Falls is the only fuel cell project bid into this RFP, illustrating our focus on utility scale applications.
The Beacon Falls Energy Park also presents a superior economic development profile versus competing submissions. Because of the unique operating characteristics, fuel cell projects like these can be installed in densely populated environments where they provide significant benefits for regional economics.
This project will generate property and sales tax. And because it is located in a region and utilizes locally manufactured equipment, it provides income and payroll tax benefits as well. Competing technologies manufactured overseas and installed outside the region cannot begin to provide this level of regional economic impact.
If awarded, the Beacon Falls Energy Park will generate an estimated $90 million in tax revenue at local and state level for the life of the project, about three times the tax revenues that will be generated by competing solar projects of similar size. It will also generate approximately five times the amount of renewable energy credits or RECs as a similar sized solar array due to low availability for solar in the region. RECs assists states in reaching its renewable energy portfolio standards and represents significant monetary value for a project.
The potential revenue value of the Beacon Falls project to FuelCell Energy is more than $500 million, including both equipment and services revenue. According to the wording of the tri-state RFP, the valuation phase of the process will be complete by the end of July, bidder notification and contract awards are scheduled to occur subsequent to the evaluation phase, likely in late summer or the fall of 2016. If awarded, we expect the project will be executed multiple phases, beginning in 2016. Project financing discussions are in progress.
Investors should be cautioned that with regard to the ongoing uncertainty around the potential extension of the FTC, the project award will not be a given by any means. A delay or even a loss would almost certainly cause the stock to greatly accelerate its latest, seemingly unstoppable descent.
In fact, Washington's ongoing failure to extend the FTC beyond 2016 has hit the company at the most inopportune moment, as the uncertainty is causing potential customers and providers of capital to delay their investment decisions. This is very much evidenced by the company's recent major guidance revision alongside its Q2/FY2017 earnings report.
So just like other companies in the space, particularly Plug Power (NASDAQ:PLUG), a company I have covered extensively in the past, Fuel Cell Energy badly needs a timely extension of the FTC in order to pick up some new project awards and to potentially get access to cheap tax equity financing.
In the meantime, due to an obvious lack of other financing sources, the company has been forced to take out an expensive term loan from Hercules Capital in late April at a nominal 9.5% interest rate (after accounting for some charges, the effective rate is actually closer to 12%). Given the elevated capital costs, it is hard to imagine how the company would be able to support profitable projects this way.
But the company's new major institutional investor now provided the company with net proceeds of $37.6 mln with the chance to take in up to a further $48 mln upon the potential exercise of the Series A warrants.
In fact the offering greatly enhances the company's leeway until potential catalysts might finally kick in:
- The award of the Beacon Falls Energy Park project
An award would provide a major catalyst for the company's beaten down share price and would almost certainly cause the Series A warrants to get exercised next year.
- The extension of the fuel cell investment tax credit
The extension is actually almost imperative for the viability of the company going forward. An extension would greatly improve visibility for both customers and providers of capital. Access to financing at favorable conditions might improve substantially.
- Long anticipated further project awards from the company's current 125MW project pipeline
These awards have been delayed as of late and are now expected to be signed towards the end of the fiscal year.
Given these potential catalysts ahead, the motivation of the company's new major shareholder looks quite clear - he is simply betting of at least one (and hopefully even more) short-term catalyst to play out, with the Beacon Falls Energy Park project award most likely being the closest event.
Should the project not be awarded, the share price will of course take another major hit, but there are still the potential FTC extension and other project awards from the company's pipeline that could make more than up for the initial lost bet.
Should the Beacon Falls project indeed be awarded (as widely expected) AND moreover the FTC gets finally extended, there would be substantial upside to the company's share price which I would expect to easily double in case of both of these major catalysts playing out.
So even when calculating for a potential 50% haircut in case the company misses out on the Beacon Falls project, the risk/reward-ratio still looks weighted quite favorably towards a long position given the potential further catalysts ahead.
A quick back of the envelope calculation based on a doubling of the share price in case of catalysts playing out and a halving in case of failure shows a potential $90 mln gain for the institutional investor compared to a potential $20 mln loss.
So despite the company's dismal execution in recent years, the constant lack of a sustainable business model and the company currently being stuck between a rock and a hard place with regard to the ongoing uncertainties around the extension of the FTC, speculative investors might still want to consider placing a well-dosed bet alongside the company's new major shareholder.
Should the Beacon Falls project indeed be awarded within short notice, I would urge investors to at least partially take some profits into the expected major share price appreciation given the fact, that the award has been widely anticipated for quite some time now. Moreover the construction of the project will most likely require large amounts of new capital and the expected margin contribution remains unclear as of today. In fact, given management's remarks on the latest conference call about the project proposal being "very competitively priced", I am not exactly optimistic about the project economics at this time.
Fuel Cell Energy just gained a new major shareholder, who prefers to remain incognito for the time being but is nevertheless placing a rather bold bet on some of the potential major catalysts ahead discussed above playing out within short notice.
Indeed the risk/reward ratio looks quite favorable here, so speculative investors should consider placing their bets alongside the new institutional investor.
Investors should be cautioned though given the company's dismal execution history, the ongoing failure to develop a sustainable business model in more than two decades as a public company and the obvious need for additional financing further down the road. Should none of the catalysts come to fruition, the downside in the share price would be substantial.
As always, don't bet the farm particularly given the limited options for managing risk in this case - a stop-loss order does not look appropriate here given the almost "double or quits" situation when it comes to the Beacon Falls project award. While I am not an options guy, a hedge using put options might be a viable alternative here. If your bet should indeed prove successful, don't forget to take some profits along your way given the fact that the Beacon Falls project award has been widely expected for some time now.
If history will be any lesson, there's ample reason to remain skeptical on the company's ability to execute in the long term but fundamental concerns will have to take the backseat for the time being here given the slew of potential short-term catalysts ahead.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: As a daytrader I have actively traded the company's shares in the past on many occasions and might consider to do so going forward at any given time.