"A Disruptive Innovation is an innovation that creates a new market and value network and eventually disrupts an existing market and value network, displacing established market leading firms, products and alliances" ~ Wikipedia
We seem to be living in the heyday of disruptive innovation. Since the personal computer age and the advent of the internet, change seems to be the operative word as innovation comes at an increasingly rapid pace.
Starting with Microsoft and Dell in the PC space, followed by Cisco building the internet, and then more recently Google, Facebook and Amazon engaging consumers worldwide, disruptive technologies and business models have not only changed the world, but presented gifts for forward looking investors.
It is our contention that Aqua Metals' Aqua Refining Process represents a disruptive innovation. By recycling lead through a cheaper and cleaner process, Aqua Metals is on the verge of displacing a well-established $22B market. Yet, the shares of AQMS trade today at a market cap of only $320M.
Now, I can fully appreciate that stocks don't move in one direction. Every time a stock moves up, somebody will take some money off the table. If every stock traded at exactly fair value, there would be no trading. However, recent conversations have led to realize that many investors are not focused on the big picture at AQMS. This is creating what I believe to be a vast differential between fair market value and the current price of the shares.
In this article, I intend to lay out my thesis behind my own estimate of FMV. Before I do that, however, I'd like to share the three conversations that have led to me shaking my head and thinking that some people just don't get the ginormity of the word disruptive…
These guys are missing the big picture.
Maybe if we can just start with the current operations at the Nevada plant.
This first quote is from the recent company hosted conference call. It is actually THE FIRST question asked by the analyst community. And, it doesn't deal with the HUGE announcement of partnering with JCI. It doesn't deal with the rollout of future production facilities. It's all about trying to model the next couple of quarters. Really? We just signed a deal to work with the largest battery company in the world and that's your first question?
Is anyone concerned that they have not actually started production? It appears that they keep delaying and postponing start of any material size of output and this morning said the setup of the battery breaker and integration into with their Aqua Refining process is significant engineering (is this setting up for future excuses on additional delays?).
This quote is from Seeking Alpha's comments section below the most recent AQMS article posted on that site. It is one of many, totally focused on understanding if they are actually selling lead now or next month. The fact that JCI has agreed to buy all lead production seems to be missed by a lot of people who seem more concerned that Q1 numbers need to come down.
They don't have any revenues yet.
The final quote comes from a phone conversation I had with a well-respected analyst from a major bank. Now, he gets the big picture, but would like to see it work before he steps up and recommends the stock. His trepidation is not uncommon and very reflective of why this stock is cheap.
What is my FMV?
Aqua Metals is like a biotech stock in my opinion, only without the risk of a failed trial in front of it. In biotech, there's a known market size (in AQMS's case, $22B) and, if their product is better, you assume you'll capture significant market share. So, to value a biotech, one takes the future earnings, once they've taken market share, puts a P/E on it, then discounts them back at some discount rate.
Since their product is better (and at this point, with the blessing of JCI, I think it's safe to assume it is), we should view Aqua Metals as an industry disruptor and assume they will garner significant market share Let's go with 10% in 6 years, aggressive, but achievable with JCI's support. Based on this very rough revenue forecast, along with company guidance on margins, we can then back down to a Fair Market Value.
There are two ways to look at this. The first method is truly the "back of the envelope" method. You can base a valuation just off of a sky's the limit type analysis. This is good for some people but doesn't provide much granularity and doesn't allow you to see if they are actually on pace to hit the targets. However, it's simple and fun to do, so I've done it here, on my PG&E bill.
As you can see, I've come up with a stellar FMV of $1B for AQMS based on this analysis. Which, with 20 million shares outstanding as a good forecast for a few years out, would mean that the shares should be worth $50 each today. Simple. Fun. Great result. But, we can do better.
Thus, I've constructed a bottom's up financial model that takes into account all the guidance given by Dr. Clarke in the recent conference calls. The model has a number of variables, which are too numerous to highlight in this article for fear of boring the reader, so I've listed them at the bottom. Suffice to say, I've tried to be very conservative and to come in below his forecasts in every circumstance where possible; some situations, like timing and number of facilities, there has been no real concrete guidance, so there is an element of guesswork.
As I said, I'll provide all the intimate details of the model below, but in a nutshell, to get here, I'm assuming all 5 company facilities (800 tons per day total) are fully operational and that they have 16 licensed facilities in full operations, also at 160 tons per day each. The first number is company guidance, the second a guess, so you can back down the license revenue if you want (or boost it!). I've run this model through the year 2021, so it's a little different than the envelope work, but here's the result in terms of sales and EBITDA.
Based on these figures, I came up with a matrix of what the year end 2020 (forward looking) valuation of the shares might be on a Price/EBITDA multiple.
And, once again, using a 20% discount rate, I've put the matrix in FMV today.
The result of this work is that you can choose a price to EBITDA multiple and see what the FMV should be at the end of year's 2017-2020, and what that equates to in today's dollars. As an example, if you think a P/EBITDA multiple of 12x forward EBITDA makes sense (with a high margin license component growing rapidly, I think it does), you can see that the FMV of AQMS is somewhere between $4.80 a share and $48.94. The former if you want to value Aqua Metals on expected 2018 earnings, the latter if you choose 2021 numbers.
Did you know AMZN missed their earnings and was down 25%?
True story, AMZN disappointed Wall Street in the fall of 2005 and their stock got knocked down from $43 to $32. The most disruptive retail model created was sold by a ton of investors over concerns about their margins, sales growth, etc. Amazon was investing in the future and the shares suffered as a result.
Fast forward to today, and Amazon trades well over $800 per share, a nice 2,400% return from the fall of 2005. The point being, when you have a company that is a disruptive innovator, it's best to see the forest through the trees. A huge market is going to undergo a dramatic change. There will be a learning curve. There will be investment in the future. But, the end game is huge and investors need to monitor the pathway, but ignore the potholes in the road.
I assume you realize by now that my FMV on Aqua Metals shares is roughly $50. This is coincidentally the same price that my back of the PG&E envelope and my earnings model forecast for me. AQMS is a disruptive innovator and these don't come along often. Enjoy the ride.
Tailwinds' AQMS Earnings Model Assumptions
1. 5 company owned and operated facilities
a. 1st one has full production of 120 TPD starting Q1 2018, gets boost to 160 TPD Q3 2019
b. 2nd facility on line Q1 2019
c. Next three on line in Q3 2019, Q4 2019, Q1 2020
d. Each facility starts at 30 TPD and goes up by 30 TPD quarterly
e. Tolling price $600, going up by 5% per annum starting 2019
f. Tolling at 50%
g. Lead price at $2,000, going up by 5% per annum starting 2019
h. Lead at 48%
i. Gross Margins start at 5% and go up with production to peak at 25%
2. Leased facilities
a. 1st on line Q1 2019
b. 2 more on line Q1 2020
c. 5 more on line Q3 2020
d. 4 more on line Q4 2020
e. 4 more on line Q1 2021
f. All at 160 TPD, with same tolling and lead prices as company owned facilities
g. 3 revenue streams to AQMS
i. 6.5% royalty payment on gross revenue
ii. Equipment sales of $200,000 per Aqua Refining Unit at 35% gross margin
iii. Annual maintenance fee of 10% of Aqua Refining Unit sales cost
3. SG&A for years 2017-2021 of $2M, $4M, $8M, $12M, $16M
Disclosure: I am/we are long AQMS.
Additional disclosure: The content of this article is for information only. Readers fully understand and agree that nothing contained herein, written by Daniel Carlson of Tailwinds Research [TR] including but not limited to, commentary, opinions, views, assumptions, reported facts, estimates, calculations, etc. is to be considered, in any way whatsoever, implicit or explicit investment advice. Further, nothing contained herein is a recommendation or solicitation to buy or sell any security. The content contained herein is not directed at any individual or group. Mr. Carlson and TR are not responsible, under any circumstances whatsoever, for investment actions taken by the reader. Mr. Carlson and TR are not currently a registered or licensed financial advisor or broker/dealer, investment advisor, stockbroker, trader, money manager, compliance or legal officer, and they do not perform market making activities. Mr. Carlson and TR are not directly employed by any company, group, organization, party or person. Shares of Aqua Metals are highly speculative, not suitable for all investors. Readers understand and agree that investments in small cap stocks can result in a 100% loss of invested funds. It is assumed and agreed upon by readers that they consult with their own licensed or registered financial advisors before making investment decisions. At the time this article was posted, Daniel Carlson owned shares in Aqua Metals Readers understand and agree that they must conduct their own research, above and beyond reading this article. While the author believes he's diligent in screening out companies that are unattractive investment opportunities, he cannot guarantee that his efforts will (or have been) successful. Mr. Carlson & TR are not responsible for any perceived, or actual, errors including, but not limited to, commentary, opinions, views, assumptions, reported facts & financial calculations, or for the completeness of this article or future content. Mr. Carlson & TR are not expected or required to subsequently follow or cover events & news, or write about any particular company or topic. Mr. Carlson and TR are not experts in any company, industry sector or investment topic. At the time this article was posted, Daniel Carlson owned shares in Midwest Energy Emissions, Corp. Readers understand and agree that they must conduct their own research, above and beyond reading this article. While the author believes he's diligent in screening out companies that are unattractive investment opportunities, he cannot guarantee that his efforts will (or have been) successful. Mr. Carlson & [TR] are not responsible for any perceived, or actual, errors including, but not limited to, commentary, opinions, views, assumptions, reported facts & financial calculations, or for the completeness of this article or future content. Mr. Carlson & [TR] are not expected or required to subsequently follow or cover events & news, or write about any particular company or topic. Mr. Carlson and [TR] are not experts in any company, industry sector or investment topic.