A Tale of Two Battery Companies
The last few weeks have offered a fascinating object lesson for believers in Benjamin Graham's theory that "In the short run the market acts like a voting machine, but in the long run it acts like a weighing machine." Since January 4th I've watched in awe as Exide Technologies (XIDE) lost roughly 30% of its market value and Ener1 (HEV) lost closer to 40%. The difference is that Exide took a voting machine beat down because it lost a well-known but financially immaterial customer while Ener1 seems to be caught in the early stages of a weighing machine meltdown. I don't want to sound like either Pollyanna or a nattering nabob of negativism, but bargain hunters need to understand that some price declines create opportunity while others do not.
Exide is a global leader in the lead-acid battery business that just reported a nine-month loss of $52 million on sales of $2 billion. While the loss was in line with expectations, the stock declined by 30% on unanticipated news that Wal-Mart Stores (WMT) had decided to shift over to Johnson Controls (JCI) as a sole-source supplier of transportation batteries. The press reports invariably described Wal-Mart as a major customer of Exide's Transportation Americas group and painted a dire picture. During Exide's quarterly conference call, however, it became clear that Wal-Mart represented roughly 5.5% of Exide's total revenue and while the loss was inconvenient, it was far from devastating. While I expected the conference call to result in a fairly sharp rebound, it seems that the pen is mightier than the conference call and stock market voters still don't understand that the long-term impact will probably not be material.
Over the years I've known a lot of businessmen who signed supply contracts with Wal-Mart. Interestingly, they all told the same 'boat owner story' where the two most memorable days in their careers were the day they got the Wal-Mart contract and the day they lost it. Everything in between was low-margin misery accompanied by incredible working capital pressures. While Exide's management team was circumspect in their discussion of the Wal-Mart relationship, my sense is that they're not wasting any time crying over spilt milk and have simply re-focused their attention on developing new customers to maintain or improve capacity utilization rates. In any event, it's clear to me that the market has over-reacted to a relatively insignificant event and last Friday's closing price of $5.37 represents an attractive entry point. After all, it's not often that one can scoop up a company like Exide for 15% of sales while Johnson Controls and Enersys (ENS) trade for 64% and 69% of sales, respectively.
For as long as I've been writing this blog Ener1 has been my poster child for lithium-ion battery hype. Its market capitalization has always exceed tangible book value by a factor of 10x to 20x and the widely touted revenue growth that was just around the corner 20 months ago is still just around the corner. To date, the bulk of Ener1's reported revenues have come from its October 2008 purchase of Enertech, a Korean subsidiary that manufactures batteries for cell phones and consumer electronics. The following table summarizes Ener1's quarterly revenues and net losses for the last two years.
|2009 Net Loss
|2008 Net Loss
The big problem with an inflated market price is that it's an impediment to future financing. Ener1 has not had a truly attractive balance sheet since Q-2 of 2008 when it reported $32 million of working capital and $35 million of net tangible assets. Over the next 15 months it accumulated $64 million of goodwill and intangible assets and by Q-3 of 2009, its working capital was a paltry $2.4 million. After penciling in disclosed fourth quarter financing and investment activity and likely fourth quarter losses, I figure Ener1 will finish the year with a small working capital deficit and net tangible assets of $50 to $60 million.
In late January, Ener1 entered into a $60 million open market stock sales agreement with Jefferies & Company that mirrored a $40 million open market stock offering it conducted over a four-month period in the summer of 2008. Unless the current offering is wildly successful over the next 45 days, it's easy to imagine some bare-knuckle discussions with the auditors over the wording of their next opinion letter. The more important issue, however, is that the open market stock sales agreement cannot reasonably be expected to provide enough working capital to offset future losses and provide an additional $60 million for capital expansion, which is an absolute requirement of the DOE grant Ener1 was awarded last August. Without an underwritten financing of at least $100 million, I don't see how Ener1 can provide matching funds for the DOE grant and cover its losses during the construction period. With an ugly year-end balance sheet and a market capitalization that represents 8x to 10x net tangible book value, I have a hard time imagining a happy outcome for investors who try to catch this falling knife.
Disclosure: Author owns a small long position in Exide.