American Superconductor Is A House Of Cards Set To Blow Over By A Gust Of Wind - $7 Price Target

Summary

• American Superconductor stock has risen over 100% since July 2018 on little progress in its businesses. We expect a fade back to $7 or less.
• The company has had significant losses for the past 19 out of 20 years with its grid and wind businesses, a pattern we foresee continuing for many years to come.
• Most of AMSC’s rally has come from puffy PRs and hype regarding its resilient electric grid and ship protection services government businesses.
• We believe both of these businesses, which are in the trial stage, are impractical, and we don’t believe the government will spend a significant amount of funds on them.
• There has never been a cyber or terrorist attack on an electric grid in the US. Ocean mines have not been an issue since WWII.

American Superconductor (NASDAQ:AMSC) has risen over 100% since it was trading at $5 less than nine months ago in July, 2018. We believe this is an undeserved, overexuberant rally. The rally has mainly come from puffed-up headlines, not from solid revenue increases or projections. As new investors start getting bored of the puffy headlines and notice the company continues to report poor revenues and continual cash burn, we predict the stock will slide down to the $6-7 range within a year. We give AMSC a generous $7 price target.

We Believe American Superconductor’s 100% Rally+ Into Today Was Unjustified And The Stock Will Retrace Back To $7 Or Less

The following is a 1-year chart of AMSC stock price:

Source: Yahoo Finance

As shown in the chart above, AMSC was trading at around $5 in July 2018. We believe there hasn’t been any news or changes in the company’s business that merits a rally of the share price to over $12 today. Since July, 2018, AMSC’s market cap has increased by almost $200 million. We believe the stock will give most of that increase back within a year. AMSC still has the same unprofitable and impractical businesses that it has been trying to promote for years. To the company’s credit, it has made initial progress with its two government business segments, but we don’t believe they will generate much revenue for the company.

American Superconductor’s Sinovel Settlement Gave It An Unsustainable P/E Ratio

At first glance, an uneducated investor might think AMSC is doing better than it is. On financial data websites such as Yahoo Finance, it shows that the company’s PE is 9.92, as shown below:

Source: AMSC Yahoo Finance Page

As shown in the financial statistics above for AMSC, the company has a trailing P/E of 9.92, yet a negative Forward P/E. This is because AMSC was the recipient of a one-time settlement from its former Chinese wind energy customer Sinovel of $57 million, which it received in the second half of 2018 and is non-recurring. Even with this large settlement, the company’s P/E ratio was only 9.92 from $10.5 million in losses the first two quarters of 2018.

American Superconductor Has Had Heavy Losses Over Many Years - We Believe This Will Continue

The following are AMSC’s revenues and income over the past 20 years:

Source: SEC filings

As shown in the above table, the only profitable year for the company was 2010. The reason for the big drop in revenues in 2011 was its loss of Sinovel as a customer. Revenues declined considerably the past two years for AMSC, mainly because of its wind business decline. In 2016 total revenues were $96 million, and in 2018 it had declined by half to only $48.4 million.

Since 1998, AMSC has lost a total of $926.9 million! A truly impressive figure of value destruction.

As we show in this report, AMSC’s poor performance is partially due to the top players in the wind energy industry gaining market share at the expense of smaller players like AMSC. We expect this trend to continue. AMSC has been trying for years to expand to other businesses, like its Resilient Electric Grid (REG) and Ship Protection Systems (SPS) segments. Recently, there has been some traction there; however, those two businesses are producing a minuscule amount of revenues, as they are in the trial stage, and we believe it’s unlikely they will ever grow significantly. Even if they do grow significantly, as AMSC bulls are betting on, it would be over many years' time, and we believe the company will likely continue taking losses every year.

Constant Attention By 3^rd Tier Investment Banking Firms Suggests A Possible Future Equity Raise

3^rd tier sell-side analysts such as Oppenheimer, Roth Capital, and Craig-Hallum have consistently published new reports on AMSC over the past few months with higher price targets. The following are the company’s sell-side analyst price targets as shown on TipRanks:

(Source: TipRanks.com)

As shown above, the highest sell-side analyst price target is $16. The stock reached above those numbers at the peak of the hype rally before starting its decline to today’s level.

AMSC also just presented at the 31^st Annual Roth Conference on the morning of March 18^th. The CEO, Dan McGahn, was there presenting. These signs of sell-side analyst attention and presenting at their conferences suggests that AMSC will eventually do an equity raise, in our opinion. The company reported $80 million in cash in the quarter ended 12/31/18. If McGahn was confident the company would become profitable before burning all its cash, we don’t believe he would be presenting at the Roth conference. AMSC is a clean energy company with a novel technology. If it flipped to positive earnings, then investors would come on their own without needing to present at conferences.

We didn’t attend the Roth Conference, so we didn’t see AMSC’s presentation. A colleague of ours attended and said the company did a presentation in question and answer format. They first spoke in detail about their government businesses. These are the Resilient Electric Grid and Ship Protection Systems business segments. It makes sense that the company would discuss these business segments in depth because they are finally gaining traction for the company in the trial stage. We believe these businesses are fueling the stock’s recent rally and are what new investors are interested in. Only at the end of the presentation did the company speak about its wind segment, and very little was said here. We can understand why, as the wind segment is a declining business for the company. In the next section, we discuss AMSC’s government businesses and why we believe they will fail to deliver the results investors are hoping for.

We Believe American Superconductor’s Government Business Segments Will Fall Flat

Later in this report, we analyze AMSC’s businesses. The company’s wind revenue has continually declined, and we believe will continue falling. Its grid revenue has stayed mostly flat.

We believe the most influential reason for the rally is from news flow and investor hype regarding AMSC’s government businesses: its Resilient Electric Grid and Ship Protection Systems. On 11/12/18, Roth Capital raised its price target on AMSC to $15 from $10. Roth’s stated reason for the price target raise was:

SPS (Ship Protection Systems) and REG (Resilient Electric Grid) are real, and there is true commercial demand.

We disagree with Roth and don’t believe there is commercial demand for these businesses. We believe these businesses are impractical and don’t give the government a compelling return on investment. We aren’t alone in our sentiment. For example, in this Seeking Alpha article from 7/11/18, a commenter makes the following good points:

Stay away will burn through cash haul. Degaussing is a tiny business opportunity. Asking for municipalities to make huge investments in REG without a credible payback is wishful thinking. Did they publish a cost benefit analysis?

Lately, the government theme has been on cost cutting, not cost adding. A government is not going to advocate spending money on something that their voter base doesn’t want. Government spending decisions move at a snail’s pace, and we don’t expect much progress to be made in the near future on AMSC’s two government endeavors. Going forward, we expect the government to continue to move at a sluggish pace due to recent controversy about where to allocate funds.

Disagreements about the wall and government shutdowns do not work in AMSC’s favor. The Department of Homeland Security (DHS) is supposed to pay $10 million for AMSC’s REG installation in Chicago. The DHS was urging Congress and Trump for additional funding during the government shutdown. Right now, it is spending a lot hiring new border patrol agents, and its available funding is tight.

Analyzing The Return on American Superconductor’s REG Product

The idea of a resilient electric grid is to interconnect the different parts of the grid so that one backs up the other in case of an outage, e.g., a cyber or terrorist attack, or from destructive weather or an earthquake.

Public utility commissions have a very strict investment methodology. They have to justify what they put in on the basis of how it benefits the users. They are typically very skeptical of investments like this. AMSC’s REG isn’t an investment that is going to make power cheaper or more reliable on a daily usage, it’s just to protect against a worst-case scenario from happening.

But major power outages rarely happen in the US. Here, it shows all of the major power outages in the past few years have only happened in other countries. We would ask, would citizens rather their city spend tens of millions of dollars to protect against a temporary electrical outage that will probably never happen, or could they find many better uses for those funds?

We don’t believe many people are concerned about a terrorist or cyberattack that would shut off their electricity. They are correct not to worry. As explained in this article, national security experts have been warning of terrorist cyberattacks for 15 years, but it has never happened in the US. From the article:

Officials may well warn about the possibility of a major cyberterror event for another 15 years with no incident.

One thing that protects an electrical grid, for example, is the complexity of the systems that comprise it, said Robert M. Lee, who founded and runs the industrial-cybersecurity company Dragos, and who helped investigate a 2015 Russian hack that shut down part of Ukraine’s power grid.

“When we think of a single power plant, it’s not that complex, and so having an effect on one power plant is entirely doable in a way that’s easier than people realize,” he said. “But when you talk about a portion of a grid, you’re talking about hundreds of utilities and power sites—now you’re talking about an overall complex system.”

Using superconducting cable is a high-tech solution which is very expensive and a risky proposition. AMSC's superconducting cable requires cryogenic cooling throughout the entire route, which has never been done before on an electric grid and will drive up installation, operations and maintenance costs.

The Electric Power Research Institute (EPRI), the research institution for the power utility industry, did a study on resilient technologies for the electric grid. The study analyzes the application of AMSC’s technology, which is high temperature superconducting (HTS) cable technology. The study came to two conclusions that are negative on the technology:

• Uncertainties in wire cost and system reliability need to be resolved before demand for grid superconducting equipment can begin.
• Manufacturers will need to step up to demonstrate reliability “to underwrite the development of such a first-of-a-kind technology, which one manufacturer estimated at US$100 million.”

Resilient Electric Grid Trial Installation In Chicago

AMSC has been talking about installing a REG in Chicago for over four years, since 2014. Here is a PR dated 7/16/14 announcing that the company is partnering with ComEd to develop it. The deal has recently been approved by the city, as this PR over four years later on 10/31/18 states that AMSC will partner with ComEd to install the REG in Chicago. That PR confirmed that all parties have agreed to proceed with the REG project.

This will be a relatively small $10 million deal over three years, and most of the payment to AMSC will be on the back end. It’s a trial run by Chicago to see how it goes. If Chicago wanted to go forward with making its entire grid resilient, the entire project would likely cost over $100 million.

Right there, there is no other city looking into having a REG installation with AMSC. If there was, then we believe the company would have announced it, like it announced the discussions with Chicago in 2014. For another city to eventually do a deal with AMSC, they would likely first see how the Chicago deal worked out. The company has a long period of waiting for more possible REG business without much revenue to show for it.

Even if AMSC does finally receive paid contracts after many years from its REG and SPS businesses, we don’t expect it to be a significant amount. We expect the stock price to deflate from the hype of these two businesses later this year, to settle around $7 per share.

Ship Protection Systems

AMSC’s Ship Protection Systems is a restructured way for navy ships to detect ocean mines. Ships already have mine disruptor devices on board, but they are made of copper and heavy. AMSC’s SPS would be a lighter replacement.

As detailed on Wikipedia, ocean mines, or naval mines, are bombs floating hidden in the water that blow up on contact with a ship. These were a big problem during WWII, and there were a couple cases of ocean mines detonating in the 1980s, during the Iraq war. However, right now ocean mines aren’t around anymore. The US is currently not engaged in a major war. Therefore, we don’t think it’s the Navy’s priority to invest in a new technology to defend against ocean mines.

An AMSC PR from April 2015 states:

For the past several years, AMSC and the Navy have collaborated on AMSC's advanced HTS degaussing system. The core components of the degaussing system are transferable to other applications being targeted for ship implementation. AMSC is continuing its work to expand HTS technology into the fleet through a variety of applications for power, propulsion, and protection equipment. AMSC refers to its HTS-based products for the Navy as "Ship Protection Systems."

The PR also says:

These systems require significantly less power to operate and can reduce the overall degaussing system weight by 50-70%.

AMSC doesn’t say how much a degaussing system weighs. We are skeptical that this would play a big factor in the Navy’s decision to purchase the SPS. Naval ships are large and can hold a lot of weight. For example, the company’s first SPS deployment will be on the new build USS Fort Lauderdale, LPD. At a full load, this ship weighs a whopping 25,000 tons.

There are also alternatives to the company’s product. The US Navy tested a High-Temperature Superconducting (HTS) degaussing coil system back in April 2009.

AMSC spent the entire first section of its Q318 earnings call for quarter ended 12/31/18 discussing its SPS business. Some quotes from the call:

Let’s look at our ship protection system product in detail. Beginning with the Navy and our opportunity in support of its fleet electrification program, defense spending has increased over the past two years, as the U.S. Military moves to rebuild and retool for competition against other powers, the new multi-threat reality.

In fact in the spring of 2018, the Department of Defense submitted the Navy’s 2019 shipbuilding plan to Congress, covering government fiscal years 2019 to 2048. In September 2018, the Navy’s fleet numbered 285 ships. The Navy’s requirement as stated in its 2019 shipbuilding plan is to build and maintain a larger fleet of 355 ships.

As of today, the Navy has only ordered from AMSC a trial run and install the SPS on newly built ships. The company has a contract with the Navy to install its SPS system on two ships, the LPD 28 and the LPD 30. It will receive about $10 million in revenues for each ship, which is expected to take about two years to install. That isn’t much revenue for AMSC, considering it's over two years and will come at a high cost for the company to install.

Events Fueling American Superconductor’s Recent Rally From July 2018 To Today

AMSC’s recent rally started not long after the company announced a settlement of $57 million with Sinovel Wind Group on 7/3/18. This settlement was because Sinovel had been found guilty in a Chinese court of stealing AMSC’s wind turbine design after they stopped doing business together. However, the market took this settlement news as negative, likely because it expected a greater settlement. The stock fell from $7.06 on July 3^rd to a low of $4.90 on July 17^th. For quarter ended 6/30/18, AMSC had a book value of only $43 million. With the additional $57 million of expected cash from the settlement, that would put total book value at about $100 million. With total diluted shares outstanding of 20.2 million at the time, trading at under $5 per share on 7/17/18, that put the market cap of the company at only $101 million. Therefore, the market valued AMSC’s businesses to be almost worthless, as the market cap was almost equal to the book value of the assets after accounting for the $57 million settlement.

What events happened from July 2018 to today to cause its current 100%+ rally? Let’s look at the stock price and company’s history from that time period. As shown in the stock chart above, much of the rally started happening in December, as the stock rose above $10 per share.

On 7/18/18, AMSC announced $11 million in new D-VAR system orders. But the market didn’t appear to be impressed by that news, as the stock barely moved.

The stock then started trending up a little bit for the next few months. It took a big 26% jump from $5.99 on 10/31/18 to $7.55 on 11/1/18 on the company’s announcement of the agreement with ComEd to install a REG system in Chicago.

Then, on 11/7/18, the stock jumped to $9.35 from $7.54 the previous day. This appears to be from the quarter ended 9/30/18 earnings report beating expectations. However, guidance was below expectations for quarter ended 12/31/18. Craig-Hallum raised its price target to $15 from $11 on that day, stating, “the company has turned a corner after many tough years.” Craig-Hallum had an $11 price target on AMSC just a week earlier on 11/1/18.

Between the days of 11/23/18 and 12/3/18, AMSC rose from $8.36 to $10.77 for a whopping 29% gain. This gain was mainly from the company’s announcement on 11/28/18 that it was awarded a contract to install a Ship Protection System on ship LPD 30. The stock trended upwards on that news. The stock continued to be hot and trended upwards to a 52-week high of $12.32 on 12/19/18. Then the next day, for no apparent reason, it plummeted to $9.72 for a 21% drop.

AMSC trended back upwards again from late December to reach $13 on 2/1/19. It reached that level on news that it was awarded a delivery contract of an SPS for ship LPD 28. However, this was actually old news. This contract was announced back in 9/6/17, as it states in the PR. It took a year and a half from the initial order to enter into a delivery contract. That’s how slow the US Navy moves.

From there, the company continued its uptrend to over $15 and even $16 on quarterly results on 2/5/19 that missed expectations on revenues and earnings, and even guided down the next quarter’s expectations. It has since faded back down to the high $12s. We believe this is the beginning of a retrace that will continue through the year to take AMSC back to $7 as the company continues to miss its revenue and earnings estimates.

We Believe American Superconductor Will Continue To Be Unprofitable In The Distant Future

We have analyzed all of AMSC’s business segments. They have been unprofitable in the past, and we believe they will remain unprofitable for many years in the future. In this section, we will take a close look at the company’s Wind Energy and D-VAR (Voltage Management/Optimization) business segments.

Wind Energy

Wind energy has historically been AMSC’s bread-and-butter business. The company doesn’t have any wind customers in the US or Europe. It only has two meaningful customers: Inox Wind (INOXWIND.NS) in India and Doosan in South Korea.

AMSC’s wind turbine sales have been continually declining over the past few years, as the company has trouble competing with the big players.

The CEO, Daniel McGahn, alluded to this in a recent interview. In a video interview from Yahoo Finance on 1/17/19, he was asked:

Is the wind sector going to be your growth area in the US? Because out west more states are passing regulations which require more eco-friendly electric generation. And wind accounts for 30% of your revenue right now.

McGahn gave a long-winded answer (no pun intended) about AMSC’s wind revenue. Then, he said:

But we’ve made a conscious decision to have our growth through our grid business. Which is principally in the US. And we also have a nascent business with the US Navy as our main customer, to protect ships and sailors in harm’s way.

We believe the above answer is a tactful way of saying the company’s wind business won’t have growth. McGahn suggests its other businesses will have growth.

The global wind turbine industry is dominated by four manufacturers who account for 57% of the industry. These are Vestas (OTCPK:VWDRY), China’s Goldwind (OTCPK:XJNGF), GE Renewable Energy (GE), and Siemens Gamesa (OTCPK:GCTAF). And these four are expected to take more market share over time, at the expense of smaller turbine producers such as AMSC. Vestas accounted for 22% of global market share in 2018, up from 16% in 2017. As stated in a Seeking Alpha news article, Vestas has taken the global lead.

The Stock of Inox, American Superconductor’s Main Wind Energy Customer, Is Declining

Inox Wind sells wind turbine generators in India. Inox’s market cap in USD is only $231 million. That’s even smaller than AMSC’s market cap of over $250 million.

As with AMSC over the past few years, business hasn’t appeared to be going well for Inox either. It booked a loss last year. The following chart shows the stock’s declining price action over the past few years:

Source: Yahoo Finance

As shown in the chart above, Inox has been in a continual downward slide over the past few years. The company was trading as high as 450 in 2015 and declined to 250 in 2016. Today, it's trading at about 74.

Inox has net debt in USD of $95.2 million. Having so much debt might prevent it from deploying many wind turbines. The wind business is very capital-intensive, and its debt could be constraining the company from capital spending. That could be the reason for AMSC’s declining wind turbine revenues.

AMSC’s only other wind turbine customer is Doosan in South Korea. South Korea’s wind energy capacity is small - it was only 1.1 GW in 2017. Compare that to the United States' wind capacity of 89 GW in 2017, India’s 34 GW in 2017 and China’s whopping 164 GW in 2017.

D-VAR (Voltage Management/Optimization)

D-VAR is grid equipment for neighborhoods. It connects the wind turbines to power the grid. AMSC sells these to its own wind turbine customers and other wind turbine users. But the company is competing with big players like ABB Ltd. (ABB), Siemens (OTCPK:SIEGY), Schneider Electric (OTCPK:SBGSF), GE and Sumitomo (OTCPK:SSUMF). These companies can undercut AMSC to their own wind turbine customers. For example, if Siemens sells its wind turbines to a customer, it can then offer its D-VAR at a discount, 30% for example. In this case, the customer would save money by buying the D-VAR from Siemens over AMSC. We believe AMSC will continue having a hard time in the DVAR business because of the tough competition.

Smart Money Energy Investors Are Not Investing In AMSC

If you look at the institutional holders of AMSC, you won’t find many smart money energy funds. AWM Investment Co. is the largest holder. They own a diversified portfolio of 94 different stocks. They are a “special situations” fund that could sell at any time.

Kevin Douglas is another big investor in AMSC. As shown here, he owns over 2 million shares since 2015. He has been a major holder for many years, and his investments in clean tech include colossal failures like WPRT, QTWW and UNXL. He may have made money in other areas, but energy tech is clearly not his thing.

Excessive Executive Compensation

AMSC’s top executives, primarily its CEO Dan McGahn, are egregiously overpaid, in our view. Despite the company having big losses in 19 out of the last 20 years, the executives are making out like bandits. In fiscal year 2017 alone, the top four executives made a total of $3.2 million. AMSC lost over $32 million that year.

The following table shows the top four executives’ salaries over the past three years:

Source: SEC filings

Dan McGahn, today at just 47 years of age, has been the CEO of AMSC since 2011. Before he became CEO, he was the COO and General Manager, and he received a high salary as well. From AMSC’s 2010 Def 14a filing:

Source: SEC filings

As shown above McGahn got paid a total of $5.9 million in the years 2008-2010. He earned a whopping $4.1 million in 2010. Between the years 2008 and 2017, McGahn was compensated a total of $19 million, as shown below:

Source: SEC Filings

As shown above, McGahn’s positions at AMSC have made him a very wealthy man. One would assume that he has made AMSC shareholders a large return on investment in order to deserve that level of compensation. In reality, the opposite has occurred. Under McGahn’s reign, a considerable amount of value destruction has happened to AMSC, as shown at the beginning of this report.

Despite huge annual losses, McGahn gets paid over $1 million almost every year, and in some years over $2 million. It’s clear that from an incentive perspective it’s not necessary for the company to be profitable for McGahn to reap big financial rewards. He benefits as long as the gravy train keeps rolling, and that requires money to fuel it. It doesn’t matter if that money comes from equity offerings or profits.

American Superconductor’s Cyrogenic Wiring Is Mostly Inefficient To Maintain

American Superconductor is named that because they use superconductive wires. As explained in this article:

Superconductivity could not happen without the use of cryogenic systems. The wires must be kept at low temperatures to reach a superconducting state.

This article states:

Superconducting materials known today, including both high temperature superconductor (HTS) and low temperature superconductor (LTS) materials, need to be cooled to cryogenic temperatures in order to exhibit the property of superconductivity.

It is difficult and expensive to keep superconductivity wires at the needed cryogenic temperature. It is very expensive to maintain the wires in a cryogenic state. A freezer must be maintained to keep the wires at that low temperature. That's why it is a mostly inefficient technology. Wikipedia states that gas is cryogenic if it can be liquefied at or below -150 degrees C, or -248 degrees F. It states:

Cryogenic cooling of devices and material is usually achieved via the use of liquid nitrogen, liquid helium, or a mechanical cryocooler (which uses high pressure helium lines).

Conclusion

After many years of big losses and value destruction, AMSC keeps rolling on. Its wind business revenue is declining, and grid connecting revenue is uncertain. Over the past six months, the share price has risen over 100%. We find that the main reason for its rise is from investor excitement over the company possibly gaining traction with its two government businesses: its Resilient Electric Grid and its Ship Protection Systems.

We showed in this report that both of those businesses are impractical, and we don’t believe the government will significantly spend its limited funds on those products. The government might just pay for its initial trials of both products and stop there. Government departments move at a snail’s pace when it comes to funding decisions. We foresee investors realizing this and losing enthusiasm for AMSC as it continues to miss quarterly revenue and earnings estimates. Over the next year, we predict the stock’s recent rally will deflate, and it will return to $7 per share or lower.

Analyst’s Disclosure: I am/we are short AMSC. 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 disclaimer: http://whitediamondresearch.com/disclaimer/