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FuelCell Energy: Opportunites, Uncertainties, And Risks

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About: FuelCell Energy, Inc. (FCEL), Includes: FCELB
by: Wayne Olson, CFA
Wayne Olson, CFA
Deep Value, special situations, long only, CFA
Summary

The future of FCEL remains uncertain, but there have been encouraging developments in recent months.

The toxic convertible preferred stocks are gone, the Hercules and NRG Energy facilities have been repaid, and Generate has been replaced.

Tulare in CA is in commercial operation and could be sold. Groton in CT has made progress as well.

The 32.4 MW of LIPA transmission-level generation is moving forward at NYISO. The other 7.6 MW is on a faster track.

Risk and uncertainty remain and investors should do their own due diligence.

FuelCell Energy, Inc. (NASDAQ:FCEL) may now be on the road to do very well indeed over the next few years given the financial integrity that they have at present. This may translate into earnings and cash flows that benefit FCEL investors via potential market price appreciation and the possibility of common dividends down the road. FCEL has an investor conference call scheduled for January 14, 2020. The purpose of this article is to provide information that is helpful to new and existing investors as they scrutinize FCEL's future prospects.

FCELB is a cumulative preferred stock that pays a five percent dividend and currently trades at about 33.8 percent of its $1,000 face value, which results in an indicated dividend of about 14.8 percent. A successful FCEL may lead to FCELB trading at prices closer to face value.

One could make the argument that FCEL is now on the road to achieving what they had hoped to achieve circa May 2017. Thus:

  • Opportunities. FCEL has a backlog of $1.5 billion (83.1 MW backlog) and $600 million of awarded projects and the opportunity to win additional projects.
  • Uncertainties. From an economic standpoint, uncertainties have to do with imperfect and asymmetric information. Simply put, investors don't know everything about the future prospects of an industry or a company. There are a lot of uncertainties facing investors that are interested in investing in FCEL, e.g., market demand for fuel cells, competition, government policy with respect to renewables, etc.
  • Business and financial risks. Business risk has to do with a company's ability to succeed in its market. Financial risk has to the various risks associated with how a business is financed, notably including the risk of default. For existing common stock investors, earnings attrition associated with new issues of common stock at prices below book value per share (BVPS) has been a major problem and it will be important that future issues be priced well above BVPS. I will address the earnings-attrition issue in a future Seeking Alpha article.

The purpose of this Seeking Alpha article is to highlight some of the opportunities, uncertainties, and risks facing investors in FCEL and FCELB. It appears that FCEL's stock price has already begun to recover and thus now me a good time to begin to reconsider FCEL's upside prospects. Nevertheless, FCEL faces many business and financial risks and I certainly would encourage investors to do the necessary due diligence before investing in FCEL and/or FCELB.

I. Opportunities and Challenges

The purpose of this section is to summarize the business opportunities that FCEL may have going forward, assuming it retains access to needed financial capital.

FCEL now appears to have the necessary financial integrity to succeed. Previously, FCEL was attempting to succeed in a business environment that requires "deep pockets" even though it didn't have deep pockets. By mid-2018, its weak financial integrity and lack of better alternatives led to the issuance of the Series D toxic convertible preferred stock. Successfully exiting its workout situation may have positioned FCEL to succeed.

FCEL's future appears bright. California has been important to FCEL recently, but New York, Connecticut, Toyota (NYSE:TM), Exxon Mobil (NYSE:XOM), Exelon (NASDAQ:EXC), Drax (OTC:DRXGF), and so on will also be important to the future of FCEL - not to mention South Korea. Thus:

  • California Dreaming. It appears that the disputes between FCEL and Southern California Edison or SCE have been resolved in a fashion favorable to FCEL. Tulare is up and running and FCEL may be able to either sell or retain its equity interest in the plant while realizing the tax benefits associated with renewable generation and continuing to service the plant over the 20-year life of the PPA with SCE. While uncertainty remains, it appears reasonably probable that the dispute between FCEL and SCE regarding the Toyota project may soon be resolved. There is also the 5 MW Bolthouse Farms project that is underway in California, which will provide reliable and green firm electricity to serve the Bolthouse Farms bakery operations in conjunction with a solar array. Events in CA have led to robust increases in FCEL's stock price in recent days.
  • New York on My Mind. FCEL already has a signed power purchase agreement or PPA with LIPA in New York for a 7.4 MW fuel cell project at the distribution level, but progress has been slower at the transmission level. Nevertheless, FCEL's 32.4 MW of new fuel cells have been moving toward the top of the transmission queue over the last year or so, which bodes well for getting signed PPAs fairly soon. Given the size of FCEL's 39.8 MW project with LIPA, achieving signed PPAs for the remaining 32.4 MW will be an important milestone for FCEL.
  • Everything is Awesome. FCEL faces many challenges at the present time but it's not hard to type up a shortlist of items that could move FCEL's stock price upward at some point. These include: (1) the two-year agreement with Exxon Mobil could be worth as much as $60 million to FCEL, but it's unclear how quickly a pilot project at one of Exxon Mobil's sites will move forward, which would provide an early lesson on how FCEL's carbonate fuel cells could support cost-effective carbon capture and sequestration; (2) in Connecticut, the 7.4-MW Groton plant is moving forward, the 20 MW of PPAs with the CT utilities for Derby and Hartford are in place, and there remains the possibility that the 60-MW Beacon Falls plant might eventually be built to serve demand that has been met by the Millstone 2 and 3 nuclear units; (3) FCEL's solid oxide electrolizer fuel cell technology could eventually be used by Exelon or others to convert electricity into hydrogen and vice versa, which could become an effective way to "store" electricity to help deal with the duck curve problem; and (4) POSCO (OTCPK:PKXFF) and FCEL have settled some issues regarding their dispute in South Korea, but, given the importance of S. Korea in the utility-scale fuel cell business, it would be highly desirable that FCEL and POSCO find a way to move forward together (and it's not obvious how POSCO could succeed without FCEL).

FCEL's current access to needed capital could lead to further success over the longer-term (five or 10 years) given the potential applications of its fuel cell technology.

Many obstacles remain. One obvious difficulty for legacy equity investors in FCEL is the massive earnings dilution that resulted from FCEL issuing massive amounts of common stock at prices below book value per share or BVPS over the last two years. I wrote about the potential problem with earnings dilution here.

II. Recent History

Investors in FCEL and FCELB need to have a good understanding of FuelCell Energy's recent history. I will begin by discussing FCEL's common stock and warrant issuances in May 2017, followed by a discussion of the Series D toxic convertible preferreds that it issued in July 2018, and the workout situation that began with the hiring and involvement of Huron on June 2, 2019, and ended on October 31, 2019.

On May 3, 2017, FCEL issued 12 million shares of common stock at $1.28 per share, Series C warrants to own 12 million shares of FCEL at $1.60 per share (five-year term), and Series D warrants to own 12 million shares of FCEL at $1.28 per share (one-year term). Given the 1-for-12 stock split that was announced on May 8, 2019, and that took effect the next day, one could say that the common shares and Series D warrants were priced at $15.36 and that the Series C warrants were priced at $19.20 per share.

Unfortunately, however, this was a one-shot deal. While investments in electric utility infrastructure, such as FCEL's fuel cells, require companies to access the financial markets frequently, the investment banks and investors appear to have failed to be ready and able to assist FCEL in raising new common equity capital when it was needed in 2018 to fund its need to deliver on its backlog of business opportunities.

Investors in the common stock and warrants FCEL issued in May 2017 may not have fully understood FCEL's business market environment and opportunities. Most of FCEL's business opportunities are for independent power projects or IPPs that are non-utility generators or NUGs. While IPPs/NUGs are not regulated in the way that typical investor-owned utilities or IOUs are, that is not to say that they don't face challenges in bargaining with their potential customers as well as regulatory challenges. FCEL has to work through a maze of business and regulatory issues to get their projects completed. Delay is inevitable. The recent holdups of the Tulare and Toyota projects in CA are good examples of this - the projects were held up for months because of opposition from the IOU that would be obligated to buy the electricity from the projects under the PPAs that aren't used by Tulare and Toyota themselves. Eventually, it seems that SCE must have received guidance that they were misinterpreting the California Public Utilities Commission's policy and the holdup went away.

With the benefit of hindsight, by mid-2018, it appears that FCEL's financial flexibility was essentially nonexistent. The best that FCEL could do to raise capital was to issue, with the assistance of Oppenheimer, the Series D toxic convertible preferreds. Thus, FCEL raised $30.8 million via the sale of its Series D Convertible Preferred Stock. The Series D toxic convertible preferreds did not pay a common dividend and were initially convertible into FCEL common shares at $1.38 per share. However, Series D preferred holders could convert at various times with the price based on a recent 10-day-average FCEL stock price. It appears that this pricing structure was attractive to investors that were willing to strive to drive FCEL's price down as low as possible in the hope of buying FCEL common stock on the cheap. Eventually, this led to FCEL entering a "workout" situation, with guidance from Huron, which focused on figuring out how to pay off the debtholders such as Hercules and get the Series D preferreds converted.

Table 1 shows what happened to FCEL's stock price beginning with the issuance of the Series D toxic convertible preferred on August 29, 2019, and ending on January 3, 2020.

TABLE 1: FCEL Monthly Stock Prices (August 29, 2018 to January 3, 2020). All stock prices reflect the impact of the 1-for-12 split on May 9, 2019.

Date

FCEL price

Aug. 29, 2018

$12.96

Aug. 31, 2018

$14.04

Sept. 28, 2018

$12.84

Oct. 31, 2018

$10.20

Nov. 30, 2018

$8.40

Dec. 31, 2018

$6.60

Jan. 31, 2019

$6.12

Feb. 28, 2019

$5.64

Mar. 29, 2019

$3.00

Apr. 30, 2019

$3.12

May 31, 2019

$1.19

June 28, 2019

$0.18

July 31, 2019

$0.34

Aug. 30, 2019

$0.34

Sept. 30, 2019

$0.33

Oct. 31, 2019

$0.24

Nov. 29, 2019

$0.68

Dec. 31, 2019

$2.51

Jan. 3, 2019

$2.06

The toxic convertible preferreds - and the underlying problems that FCEL had that resulted in FCEL's decision to issue the Series D toxic convertibles - led to a serious financial crisis for FCEL. Huron was hired to help FCEL and its board of directors find ways to resolve, survive, and eventually thrive.

Huron was actively involved in working with FCEL from June 2, 2019, to October 31, 2019. Table 2 focuses on the 8-Ks that FCEL issued during and after this period. My purpose is simply to provide basic resources to help investors get up to speed on what FCEL has gone through since July 2018 and the potential upside down the road if things continue to work out reasonably well for FCEL. Interested readers can go to the FCEL website to find these 8-Ks.

TABLE 2: FCEL 8-Ks during the period June 2, 2019, to December 20, 2019

DATE

TOPICS IN FCEL 8-Ks

December 20, 2019

Material Definitive Agreement: $3 million of additional CT Green Bank financing for Bridgeport

December 12, 2019

Special Shareholder Meeting canceled

Nov. 6, 2019

Material Definitive Agreement: Joint Development Agreement with Exxon Mobil, credit facility with Orion Energy Partners and related agreements,

Oct. 25, 2019

Amendment to Fifth Third Bank facility (Groton) and issuance of common stock

Oct. 4, 2019

B. Riley agreement re the sale of FCEL shares

Oct. 2, 2019

Amendments re NRG and Generate, termination of Hercules facility, conversion of D preferreds and other topics

Sept. 12, 2019

Management changes, sales of common stock, payments to Hercules

Sept. 9, 2019

3Q2019 Financial results

Aug. 20, 2019

Huron Amendment, management changes, and related topics

Aug. 13, 2019

Amendments re NRG, Generate Lending, Fifth Third Bank, and other topics

July 30, 2019

Employment agreements

July 25, 2019

Hercules amendment, other topics

July 24, 2019

Management changes

July 22, 2019

Disclosure on stock issuances

July 19, 2019

Delisting risk (Jan. 14, 2020)

July 12, 2019

Miscellaneous topics

July 12, 2019

Risk disclosure

July 12, 2019

NRG Amendment

July 10, 2019

Settlement of arbitration with POSCO

July 3, 2019

Generate Amendment

June 12, 2019

License agreement with Exxon, Hercules Amendment

June 12, 2019

Management changes

June 5, 2019

FCEL former CEO Chip Bottone was fired

June 5, 2019

Huron hired, management changes

III. Conclusion

Having followed FCEL for a few years now (I've been an investor in the FCELB preferreds since 2015 and an investor in FCEL since 2017), I've long thought that FCEL had a viable business model and great technology, but it lacked the deep pockets needed to really succeed. Now, FCEL has the funding to move forward successfully.

FCEL is doing better at getting its story out to the market. On January 6, 2020, for example, FCEL issued a press release touting its apparently successful efforts to improve the stack life of its fuel cell plants. This is extremely important as FCEL's "project finance" arrangements for its operating fuel cell plants are extremely highly leveraged, which means that it is very important that module replacements be as orderly and cost-efficient as possible. I've already highlighted a number of opportunities that FCEL is now better able to pursue.

Getting back into the S. Korea market is probably FCEL's most important unrealized market opportunity going forward. POSCO seems to be interested in exiting the fuel cell business, but FCEL may currently lack the financial resources to acquire POSCO's legacy fuel cell business in S. Korea. It would be awesome if FCEL can somehow emulate Doosan's success in both the U.S. and S. Korea, which I've discussed here. Of course, just succeeding in the U.S. by building out its backlog and awarded projects would be a huge success for FCEL.

The long-term effects of FCEL's massive sales of common stock at prices below BVPS are something I want to write about in a future article. I will discuss the issues with FCEL's past and potential sales of common stock at prices below BVPS.

Disclosure: I am/we are long FCEL AND FCELB. 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.