Battery Maker Drops Like Lead

06/23/2011 3:13 pm EST


Jim Jubak

Founder and Editor,

It’s time to remove A123 Systems (AONE) from Jim’s Watch List.

A short-term trade could work, maybe, on hopes that projected second-half revenue will materialize. But long-term, the company—a developer and manufacturer of lithium-ion batteries for electric cars and the smart utility grid—has a serious chicken-and-egg problem.

No matter how good the company’s battery technology may be, the electric-car market has been much slower than expected in getting off the ground—and without that market, A123 Systems just doesn’t have enough customers to sell to.

A123 Systems went public in 2009. Investors immediately bid up the stock, believing that the company had revolutionary technology and that rising oil prices would lead consumers to adopt electric cars.

The stock opened at $13.50, and quickly ran up to $28 a share. But two years later, it sits below $5.

The problems at A123? The company built out aggressively for future growth—and in the hope that higher production volumes would help reduce its costs.

But orders to fill that production capacity haven’t materialized. The company ran at just 20% of capacity last year, and projects that it will run at just 30% of capacity in 2011.

The company currently has negative gross margins, meaning that it costs more to produce a battery than it can sell the battery for. That’s led to a horrific cash burn rate—A123 needed to raise $254 million in additional capital earlier in 2011. That has led to serious dilution of shareholders' stake in the company.

It’s not that the company doesn’t have potential—just that the potential has taken much longer than expected to turn into real revenue.

A Partnership Problem
The company now expects revenue to take off in the second half of this year, as Fisker Automotive finally begins production on its well-reviewed Karma luxury sedan. However, investors have good reasons to wonder if Fisker will significantly grow A123’s revenues this year.

The Karma was originally projected to come to market in late 2009. That deadline was pushed back to September 2010. And then to June/July 2011. It now stands at August.

On the plus side, the delays are becoming shorter in duration. But if I were the CEO of A123 Systems, I wouldn’t want my revenue growth to depend on a company that has never produced a vehicle, is running significantly behind schedule, and is charging upwards of $100,000 for a base-model electric vehicle.

A123 does have contracts with established auto companies such as General Motors, BMW, Daimler, Navistar, and Volvo, but those contracts are—repeat after me—taking longer than expected to go from development partnerships to significant revenue.

The company has been talking about a “sole development partnership for a major US automaker” since 2010, for example, and now says that deal should bear fruit in 2013.

In the meantime, the company has greatly improved its cash position by raising funds earlier in the year. It still has $173 million in government grants outstanding, and an additional outstanding loan of $233 million available from the Department of Energy.

NEXT: Where to Invest


Where to Invest
As you might expect, the stock is down 50% year-to-date. As you might not expect, Wall Street calls it a buy and expects the shares to double.

That’s not completely impossible. With 20% of its shares outstanding sold short, any good news should provide a temporary—but quite possibly sizable—pop for the stock. If the Fisker revenues do materialize in the second half of the year, that could be all the shares need for that kind of short-term move.

Longer-term, A123 remains a show-me story. Sales of electric cars are small, and it’s anyone’s guess what a long-term growth rate might be, or when electric cars turn from curiosity to consumer product. Even if revenue picks up in the second half of 2011, the company may need to raise additional capital in 2013.

If you’re looking an investment in fuel efficiency, rather than a shoot-the-moon (Hearts players will know what I mean) bet on a still-emerging market and technology, I’d suggest that you take a look at Ford Motor (F).

The company offers 12 vehicles that lead their sales segments in fuel economy, including four vehicles with 40 miles per gallon or better EPA fuel-economy ratings—a claim no other full-line automaker can match, according to Ford’s vice-president of marketing.

The shares have sold off 30% since disappointing fourth-quarter 2010 earnings were released in January. The company has faced additional pressure from rising input costs and a $2 billion judgment handed down by an Ohio judge in a class-action lawsuit filed by commercial truck dealerships.

Formal labor negotiations with the United Auto Workers are expected to begin in late July, and could prove to be an overhang for the stock. However, the union has indicated it is open to profit sharing as opposed to fixed pay increases.

With the stock trading at less than eight times projected 2011 earnings per share, the market seems to have priced all this bad news into the stock. But the share price doesn’t seem to reflect the likelihood that Ford bonds will earn an upgrade to investment grade later in 2011, after paying off $14.5 billion in debt in 2010 and another $5 billion in the first two quarters of 2011.

Ford is also likely to reinstate a dividend this year, which would make the shares attractive to more portfolios.

This post was reported and written by Peter Butkus. He is an MBA student at the UCLA Anderson School of Management, and is interning at Jubak Asset Management this summer.

Full disclosure: I own shares of Ford in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this column. The fund did own shares of Ford  as of the end of March. For a full list of the stocks in the fund as of the end of March, see the fund’s portfolio here.

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