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July 24, 2014

Charging Your Portfolio With Tesla's Gigafactory

By Jeff Siegel

Last week, Tesla (NASDAQ: TSLA) announced that its next electric offering — a competitively priced electric vehicle — will hit the market in 2017.

Dubbed the Model III, the 200-mile-range electric vehicle will go for $35,000.

Certainly this was big news for electric car enthusiasts — particularly those who can't afford an $85,000 Model S but yearn to drive one. But if you regularly follow trends in the electric vehicle space, at least the way I do, you know Tesla's announcement was just one of many big moves in the space over the past few months.

Truth is, the electric vehicle sector is hotter than ever. And despite continued empty criticisms by internal combustion apologists, electric vehicles are here to stay.

This is great news for those who love driving on homegrown electrons, and it's great news for investors who are looking for more than one way to make a few bucks in the energy space...

$50 Billion Bonanza

Around the same time we learned about Tesla's new Model III, we also got some fresh energy storage market data from the folks over at Lux Research.

According to the research firm's latest analysis, energy storage, driven largely by plug-in electric vehicles, will grow at a compounded annual growth rate of 8% to $50 billion in 2020.

That's less than six years away.

Researchers note that electric vehicles are the largest opportunity in transportation. With modest sales of 440,000 units, electric vehicles still will use $6.3 billion worth of energy storage — more than the micro-hybrids, which will have sales two orders of magnitude higher at 59 million units.

luxrpt[1].jpg

Internal Combustion Blues

One of the more intriguing bits from this recent report is the following statement...
“...incremental evolutions like start-stop technology are leading to significant changes in the energy storage market. With global sales of 59 million, a 53% market share and $6.1 billion in annual revenue, micro-hybrids will, for the first time, overtake the conventional internal combustion engine and emerge the most popular drivetrain by 2020.”
I have to be honest; I never thought I'd see the day when the most popular drivetrain would be something other than that of conventional internal combustion.

Of course, this doesn't mean internal combustion is going gently into that good night. Such a suggestion would not only be naïve, but also a bit dishonest. However, it is interesting to see how rapidly technology is transitioning the personal transportation market.

Heck, I remember when the Toyota Prius was the technologically superior vehicle when it came to fuel economy. In many ways, it still is. But it's so common now that we almost don't even notice those little hybrid superstars anymore. With more than 3 million units sold, such a thing is understandable.

So will the same be said for electric vehicles in another ten years? I think so.

My prediction is that Tesla will continue to be the most innovative and aggressive electric vehicle player in the market. Nissan and GM will continue to push their electric offerings, most likely with worthwhile upgrades by the end of the decade that'll enable increased range and lower pricing.

Asian players like BYD Company (OTCBB: BYDDF), Kandi Technologies (NASDAQ: KNDI), and Tata (NYSE: TTM) will also remain aggressive on non-conventional internal combustion offerings.

Of course, if you're looking for a way to profit from the growth in energy storage applications, look no further than Tesla's new Gigafactory.

GigaProfits!

If you're unfamiliar, the Gigafactory is a $5 billion battery manufacturing facility that Tesla is building right here in the United States.
When completed, the plant will be massive — capable of producing ten times the current production level available today. This equates to the production of 500,000 electric cars every year starting in 2020.

And with this production capability comes economies of scale that will allow Tesla to slash battery costs. Batteries, by the way, represent the most expensive component of electric cars.

My friends, Tesla's current Model S runs about $85,000. But with the new Gigafactory in place, the company will be able to sell you its next model — the Model III — for $35,000.

This is a huge game changer, and those who play it right will make a ton of money.

Now let me clarify: I'm not recommending investing in Tesla here. I'm talking about investing in the batteries — more specifically, the companies that will provide Tesla's Gigafactory with the key ingredients it will need to produce these batteries.

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Jeff Siegel is Editor of Energy and Capital, where this article was first published.

April 21, 2014

Don't Bet Against SolarCity

By Jeff Siegel

DISCLOSURE: Long SCTY.

SolarCity truck It wasn't an April Fool's Day gag when I said it was time to buy SolarCity Corp. (NASDAQ: SCTY) at the beginning of the month.

After a brief standstill, the company's battery-backed solar projects have begun to move forward again.

The State of California Public Utilities Commission has added an important item to its May 15 agenda that will make a huge difference for SolarCity. Utility companies may finally be blocked from imposing big fees on battery-backed solar systems.

For more than a year, California's largest utilities companies demanded that battery-solar systems undergo costly and time-consuming inspections to prevent them from “laundering” power they pulled off the grid.

Non-battery solar systems were not a concern for the utility companies, because that energy could be unquestionably verified as solar in origin as it was fed back into the grid. Battery systems did not provide an equal degree of certainty.

Each new battery-backed PV user had to submit an application to connect to the grid that cost $800 and required additional meters and hardware that cost as much as $3,700. Only a dozen of SolarCity's customers completed the application and approval process out of the more than 500 customers who had signed up.

In March, SolarCity had had enough. It halted its applications for interconnections to Southern California Edison, Pacific Gas and Electric, and San Diego Gas and Electric.

Now, the Public Utilities Commission seeks to exempt battery solar installations from these huge fees, so these customers can get their systems. SolarCity has resumed filing applications.

The Threat to Utilities

Energy companies expressed concern that solar batteries could store power from the grid rather than from solar panels, and feed it back into the grid for net metering billing reductions.

Net metering is a system that allows residential solar users to send their unused solar energy back into the grid and roll their traditional electric bills backwards. With this type of system in place, people can install solar panels on their home and not really rely on them to power anything except the grid.

Since solar batteries allow customers to store the power they generate, this means they can save their energy to use on themselves and not even have to participate in net metering if they don't want to.

It essentially rearranges residential power priorities into a pyramid with solar on the top, solar battery as the backup, and traditional grid as the backup to the backup.

Solar battery systems, therefore, threaten to slash customer reliance upon local power monopolies.

SolarCity, however, isn't positioning itself as a threat. It wants to work with the power companies.

In a blog posting entitled “Put Battery Storage in the Hands of Grid Operators,” SolarCity Co-founder and CTO Peter Rive said:
“While cutting the cord enables one household to be 100% renewable and self-sufficient, it limits what these technologies can do. In short, the grid is a network, and where there are networks, there are network effects. When batteries are optimized across the grid, they can direct clean solar electricity where (and when) it is needed most, lowering costs for utilities and for all ratepayers. This is true of homeowners’ behind-the-meter storage units, and it’s also true of larger commercial and utility-scale units.”

Despite SolarCity's apparent goodwill toward power companies, the threat this technology poses to power companies is still strong.

All in the Family

SolarCity was co-founded by brothers Peter and Lyndon Rive, and they have a very important cousin: Elon Musk, CEO of Tesla Motors (NASDAQ: TSLA).

Together, the family is pushing for a battery-powered future.

In the automotive sector, batteries mean drivers do not have to rely upon costly gasoline to get around, and in the residential power sector, it means users don't have to rely upon energy monopolies.

The combined effect of two battery-crazy companies in different sectors is a massive economy of scale.

Tesla's so-called “gigafactory” is going to produce enough lithium-ion batteries at such a high volume that prices will drop. Both Tesla and SolarCity will reap the rewards.

The Gigafactory is not expected to be built until early 2017, and production ramping will not begin until 2020. It may be a long way off, but think of what can be done in the meantime.

SolarCity has only existed for eight years, and it has grown in explosions. In the third quarter of 2013, it grabbed a 32 percent share of the solar installation market, and it expected to grow its number of installations by more than 80 percent in 2014. This means it could deploy upwards of 525 Megawatts of photovoltaic cells this year alone.

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Jeff Siegel is Editor of Energy and Capital, where this article was first published.

March 14, 2014

Turning Conventional Battery Tech into Unconventional Profits

by Debra Fiakas CFA

Near the end of February 2014, Highpower International (HPJ:  Nasdaq) announced its first order for large-format lithium ion batteries to use in electric vehicles. Its customer, Huizhou Yipeng Energy Technology will be integrating the batteries into buses destined for the sales outlets of China-based manufacturers.

The boost in sales for Highpower is likely to be meaningful.  Management estimates each bus will use as many as 288 of the company’s 20-ampere-hour battery.  Guidance for annual sales from Huizhou Yipeng alone is in a range of $4 million to $5 million.  In the most recently reported twelve months Highpower claimed $125.2 million in total sales.  That means the orders from Huizhou may boost annual sales by 3% to 4%.

Highpower has been earning a slim profit on its sales of nickel metal hydride and lithium ion battery technologies for motor bikes, power tools, and personal-care devices.  The company has production facilities in Shenzhen and Huizhou, China.  Its recent operating profit margin was 1.2%.  Still over the past for years the company has been successful in converting 3.1% of its sales to operating cash flow.

The ability to generate internal resources is vital for Highpower, which continues to invest heavily in capital projects and product development.  Operating profits are not sufficient for the company’s investment budget.  Thus cash resources continue to be important for Highpower’s strategic plans.  Cash at the end of September 2013, the last time the company reported financial results, was $37.1 million.

The company also has $68.7 million in short- and long-term debt on its balance sheet.  Debt is not the only balance sheet consideration.  Typical of China-based companies, Highpower carries significant accounts receivable and accounts payable on its balance sheet.  Days sales outstanding were 105 days at the end of September.  At least Highpower has managed to maintain good enough relationships with suppliers to leave 148 days of costs in payables outstanding.  Highpower maintains a relatively low inventory at only 62 days of sales.  Thus the company enjoys a favorable financing interval and actually receives 19 days of financial support from suppliers  - a  value near $5.3 million  -  instead of having to dig into cash resources to support working capital needs.

A review of recent trading patterns in HPJ shares suggests the stock has built up enough momentum to rise to the $8.00 price level.  Yet there appears to be some disagreement among investors about the company’s future.  In the final day of trading last week the stock completed the formation of what technical analysts call a ‘high pole warning,’ suggesting that lower prices may be ahead at least in the short term.  We believe this could be trading in HPJ shares illustrate the usual fascination with the strong growth that China offers, but the ever present concern that investors have for the veracity of financial reports from China-based companies.

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.  

March 06, 2014

Tesla's Gigafactory: Guessing Games

James Montgomery

Tesla Motors (NASD:TSLA) made a splash last week with its proposed $5 billion "Gigafactory" and its eye-popping numbers: a 10 million square foot facility on an entire land area of 500-1,000 acres, with output of 35 GWh/year of battery cells and 50 GWh/year of battery packs by 2020. That'll be enough to support 500,000 of the company's forthcoming Gen-3 vehicles, compared with a little over 20,000 annual demand for its cars today. By comparison, the entire lithium-ion battery supply-chain produced about 34 GWh in 2013, the vast amount going not to electric vehicles but consumer electronics.

That's a very big bet on future demand, so it makes sense for Tesla to have other plans in case the market doesn't quite take off and it's stuck with overcapacity. The answer: allocate some of that capacity to stationary energy storage systems for backup power, peak demand reduction, demand response, and wholesale electric market services. Speaking at a California Public Utilities Commission thought-leader panel, Musk reiterated that an unspecified amount of Gigafactory's capacity will be earmarked for "large-scale use of stationary storage." Since last year Tesla has been contributing batteries to SolarCity (NASD:SCTY) for incorporation into solar + energy storage systems for both residential and commercial customers. (Expansion of solar and wind, Musk added, is causing "strife" for existing utilities.)

The key to Gigafactory, for either cars or stationary storage applications, is in its sheer scale which is hoped to compress costs right from the start. Tesla says it will reduce battery pack cost/kWh by more than 30 percent by the time its third-generation vehicles ramp in 2017. Battery systems for stationary energy storage applications are a bit different -- air-cooled, a simpler battery management system, and it's all around a lot cheaper. It's not uncommon among Asian manufactures to have multiple variations of a battery cell coming off individual lines, pointed out Sam Jaffe, senior research analyst at Navigant Research. There's also the possibility that the company could tweak its battery chemistry used in Gigafactory, though probably still a variant of lithium-ion. A Tesla spokesperson declined to comment on any Gigafactory specifics.

Battery production by manufacturer

Credit: Tesla

Nor did the company explain the proposed gap between Gigafactory's 35 GWh in annual battery cell output vs. 50 GWh in battery packs. There hasn't been any confirmation of who Tesla's major partners will be in this new Gigafactory, but it's widely assumed that longtime battery cell partner Panasonic will be in, and maybe bring some of its supply-chain friends. Tesla and Panasonic have a long and deep connection, almost to the point of mutual codependency; it's the opposite of typical multi-sourcing strategy seen in other industries, and it's hard to imagine it *not* continuing with this Gigafactory. On the other hand, it's possible that Tesla is smartly keeping its cell supplier options open, in the belief that sheer volume will override its need to slash costs and dent suppliers' margins. "That's a really fine line to walk," Jaffe observed.

There's another angle here relevant to renewable energy: Tesla says it wants to "heavily power" the new factory with solar and wind. Battery manufacturing is very energy-intensive, running ovens and manufacturing equipment and charging the batteries at least one cycle as a final step, explained Jaffe. That equates to usage in the hundreds of megawatts. A drawing in the slide presentation shows both solar and wind farms located adjacent to the factory. One also could speculate that they could achieve that by purchasing RECs or by investing like Google (NASD:GOOG) in someone else's developments.

Where to put this massive factory is still being decided, but the shortlist is Texas, Arizona, New Mexico, and Nevada. The San Jose Mercury News' Dana Hull neatly handicapped the field and lists some advantages: the company's previous facilities-tirekicking in Arizona and New Mexico, proximity to rail and possibly Apple and some other energy-storage-hungry industries.) Certainly those U.S. Southwest locations favor solar energy; overlaid with strong wind energy areas might narrow that a bit further. Gigafactory construction is pledged to begin by this fall according to those same slides; it's not clear whether that includes the solar/wind contribution. Such utility-scale projects don't simply materialize in a couple of months, however, so one could speculate that a factor in Gigafactory's final location selection might be siting near existing projects or ones already well down the development path.

Jim Montgomery is Associate Editor for RenewableEnergyWorld.com, covering the solar and wind beats. He previously was news editor for Solid State Technology and Photovoltaics World, and has covered semiconductor manufacturing and related industries, renewable energy and industrial lasers since 2003. His work has earned both internal awards and an Azbee Award from the American Society of Business Press Editors. Jim has 15 years of experience in producing websites and e-Newsletters in various technology.

This article was first published on RenewableEnergyWorld.com, and is reprinted with permission.

December 17, 2013

Axion Power: Improving on the Conventional

by Debra Fiakas CFA

While the rest of the battery industry is trying to perfect new technologies, Axion Power International (AXPW:  OTC/QB) has been working on a fix for conventional lead acid batteries.   Low cost made the lead acid batteries popular even from the early days when a French scientist first introduced the configuration in the mid 1800s.  Lead-acid technologies represent about half of batteries made today. 

Unfortunately, lead-acid batteries have low energy-to-weight and volume.  Storage times are limited.  They also have corrosion problems.  The active materials in lead-acid batteries change physical form during charge and discharge.  This results in growth and distortion of the electrodes, as well as the shedding of electrode into the electrolyte.  Consequently, lead-acid batteries require significant maintenance and have a relatively short useful life.

Axion has by-passed some of these problems by replacing the negative electrode in the conventional lead-acid battery with a supercapacitor made of activated carbon.  Unlike the conventional battery, this carbon negative electrode undergoes not chemical reaction.  The result is a reduction in corrosion on the positive electrode and longer battery life.

The company has had some success in the market with its battery solution that is branded the SuperCube, but the company has yet to achieve profitability.  Sales in the most recently reported twelve months were $10.2 million.  This compares to $9.7 million in the year 2012 and represents 4.1% year-over-year growth.  However, the net loss was $8.8 million and Axion used $6.8 million in cash to support operations.  That is a concern since the company only had $1.1 million in cash on its balance sheet at the end of September 2013.

The company has other financial resources.  Axion completed a financing earlier this year, raising $10 million through a convertible note issue.  The offering was sold privately and provided for periodic withdrawals from a control account.  At the end of September 2013, approximately $5.4 million remained in the control account.

The company appointed a new chief financial officer in October.  Most likely his is focused on how to make the company limited cash resources last as long as possible.   One big plus for the company is a new order for its SuperCube battery valued at $320,000.  The SuperCube battery will be installed next to a solar panel system for storage and frequency regulation.  The company gets a down payment with the solar project order, which should help supplement Axion’s own working capital.  A few more orders like that and Axion’s financial picture should improve substantially.

Axion is priced below a dollar and for some may represent to much risk.  The terms of that convertible note also provided for a variable conversion rate.  Such terms typically invite a bit of manipulation to push the stock price lower so as to lock in more favorable conversion rates.  It will take some time for the company to work through this convertible note issue.  Expect continued share price repression for some time to come.     
 
Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

October 05, 2013

Metal-Air Battery Stocks

by Debra Fiakas CFA

Earlier this year, we added metal air batteries and the companies who are working to commercialize the technology on our list of promising acts to follow.  The Israeli battery developer, Phinergy, was added to our Mothers of Invention Index.  Back when I wrote the post “More in the Air than Spring” back in April 2013, Phinergy had attracted a bit of attention for a road test of Citroen C1 car outfitted with a technology far different than conventional lithium ion.  No one knows Phinergy.  It is too small and too foreign to impress U.S. investors.  I did not expect anyone to really pay much attention.

In June 2013, a U.S. company with a very high profile was awarded a patent related to metal air battery technology.  This has put the words ‘metal-air’ on the tongues of nearly every investor and pundit across the country  -  electric sports car phenom Tesla Motors (TSLA:  Nasdaq).  It seems quixotic for a small-fry like Phinergy to chase after unproven battery technologies.  However, when the arguably most financially successful electric car producer in the country stakes a claim on the same technology, it is time to take it seriously.

Notably Tesla’s patent addresses the linkage of lithium-ion with metal-air batteries as first and second battery packs for an electric car.   This is the same strategy that was being tested in the Citroen C1 by Phinergy.  The idea is to extend the driving range by making available a high energy intensity power source like the metal-air battery that is better equipped for the long trip.

Metal+Air+Battery[1].png  
 
International Business Machines (IBM:  NYSE) has the same idea in mind with its Battery 500 Project.  The group’s goal is to develop a lithium-air battery system with a 500-mile range per charge.  Most importantly the battery system is to be light weight  -  no heavier than a conventional combustion engine.

Getting a stake metal-air battery technology is challenging for the minority investor, especially U.S. investors.  Phinergy is a private, foreign company.  Tesla has publically traded stock but let's face it, the stock appears unaffordable at the current price level.  A stake in IBM is a play on all manner of technology and products, but batteries are a very small part of the bigger IBM picture.

In my April 2013 post I had offered Arotech Corporation (ARTX:  Nasdaq) as an alternative to play metal-air battery technology.  Arotech is profitable and trades at 9.8 times trailing earnings.  The company has concentrated on military applications for its rechargeable zinc-air battery technology, selling the Soldier Wearable Integrated Power Equipment System (SWIPES) to the U.S. DOD.  Combined, its lithium battery and zinc-air batteries and systems account for approximately one-fourth of total sales.  Earlier in September Artotech raised $6.0 million through an underwritten offering of its common stock.  Expect acceleration in Arotech’s development activity.  More likely Arotech will begin trolling for an acquisition that improves its position in the military market.

Metal-air battery technology still has a ways to go before it becomes common place.  However, Arotech has proven it commercially viable in a niche market.  Phinergy and apparently Tesla have proven it workable in the electric automobile.  It is only a matter of time before the rough edges are hammered out and a very large consumer car market becomes reality.
 
Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.  

August 04, 2013

Axion Power: Is There Light At The End Of The PIPE?

Tom Konrad, CFA

Light PIPE.jpg
A light at the end of the PIPE? Photo by Tom Check

In my last article, Axion Power’s Potential For Explosive Growth, I outlined a number of near-term business opportunities for Axion Power International, (OTC:AXPW) any one of which could catapult the company into profitability in 2014, and more than one of which could produce significant revenue growth this year.  While I’m quite bullish about Axion’s prospects, I concluded with a skeptical comment about Axion’s stock:

 [I]f I owned the stock today, I would be a seller at the current price of $0.17.

Down the PIPE 

How can I be so bullish about the company’s business but still want to sell the stock?  It’s all because of the recent private investment in public equity (PIPE) convertible note financing.  This is an unconventional convertible financing, because the conversion price of the notes falls with the market price.  Convertible financing of this type is variously known as “ratchet,” “toxic”, or “death spiral” because as the stock price falls, the convertible notes convert into more shares.  Because the convertible note holders end up owning more shares, existing shares represent a smaller percentage ownership of the company, and are worth less.  This sets up a vicous cycle, which frequently ends with the original shareholders owning only a small slice of the company.

There is also an element of the self-fulfilling prophecy: Because existing shareholders expect to be diluted, they sell the stock, which depresses the share price and leads to further dilution of those shareholders who held on.  It’s a sort of prisoner’s dilemma: if all shareholders would just hold on, or even buy into price declines, they can prevent the financing from creating a self-fulfilling death spiral.

Could Be Worse

That said, this is far from the worst such convertible financing I have seen.  For one thing, the conversion option is held by Axion: they can choose to pay in cash or shares.  For another, the note is payable in nine equal installments over nine months .   The conversion price is 85% of the lower of the price on the previous trading day, or the average price over the 20 trading days (approximately one month) for which the price was lowest  out of the last 40 trading days (two months) before each payment.  Many toxic convertibles are payable all at once .  This makes it very easy for the holders of the convertible to sell a large amount of stock during the period the conversion price is being set, artificially reducing the conversion price and awarding themselves more shares at conversion.

There was also a $1 million subordinated convertible note sold to company insiders.  Unlike the $9 million of convertible notes described above, this entire note (principal and interest) is payable at the end of the term, in cash or shares, at the company’s option.  Both sets of investors also received approximately 50% coverage of the notes with warrants that can be exercised after six months and before five years at $0.302.  If there is a future financing at better terms over that period, the exercise price on the warrants is reset to the price of the future financing.

The Next Round

According to Axion’s CEO, Thomas Granville, Axion has enough cash that it won’t need to return to the markets for additional financing until 2014.  If things go well (I recently argued that they could,) Axion may not need to return to the markets for additional financing any time soon.

On the other hand, if new business is slow to materialize, the prospects for an additional round of financing could put more pressure on the stock.

Incentives

The first convertible payment was made on July 3rd, at a conversion price of approximately $0.136 (by my estimate.)  That means the investors were paid with approximately 7.1 million shares of stock.  The second payment will be on August 3rd, and, given the 40 day look-back, we know that the conversion price will be at most  $0.131, with a minimum of 7.4 million shares issued.

AXPW trades an average of less than 10 million shares a month, so the market is simply not liquid enough to absorb all of this stock if they choose to sell.  That means that the investors have enough shares to force down the price of Axion’s stock quickly.  Since they can force down the price of Axion stock, it’s helpful to ask: Do they want to?

The reason to reduce the stock price is so that they will get more shares in future payments.  On the other hand, if the stock price remains low at the end of the nine months, most of the new stock issued will go to the company insiders who bought the $1 million subordinated notes.  A low share price at the end of the nine months would also likely mean a low share price in early 2014, when Axion will most likely need to raise additional funds.  If the share price is low then, Axion will likely be forced into another, even less favorable deal, and they will find themselves diluted just like Axion’s long term shareholders are now.

Finally, if the convertible note holders force the stock price “too low,” Axion might choose to pay them in cash rather than shares, betting that it will be able to raise cash from other sources on more favorable terms.  Management might also be forced to pay in cash because Axion is only authorized to issue 200 million shares without a shareholder vote.  114 million shares were outstanding in the first quarter, and an additional 5 million are reserved for options.  This leaves at most 81 million shares for payments to the note holders.

The 81 million authorized shares may not prove to be a hard limit.  If Axion were to run up against this share issuance limit, the company has the option to make the remaining payments in cash, or ask shareholders to approve the issuance of additional stock.  If cash were unavailable, as is likely, and shareholders were to fail to approve the issuance of additional stock, Axion would be forced to default on the notes.  Any default would likely lead to bankruptcy or a negotiated settlement with the note-holders.  Either would probably be worse for shareholders than the expected dilution from additional share  issuance.

Axion shareholders  should not be comforted by a seemingly parallel situation at  ZBB Energy Corporation (NYSE:ZBB).  While ZBB cancelled plans to hold a shareholder meeting needed to sell shares to Aspire Capital Fund because of lack of shareholder support, failure to obtain shareholder approval does not lead to default under ZBB’s agreement with Aspire.  It is the threat of default which would most likely lead shareholders to agree to additional share issuance, if necessary.

Axion dilution.png

In the chart above, I’ve run three possible scenarios of what might happen to Axion’s stock price over the next 8 months, and the resulting likely dilution of existing shareholders.

In my first scenario, the share price stays roughly where it has been for the last month (purple lines.)  In this case, the convertible note holders will end up owning approximately  79 million shares, or  41% of the company for their $10 million investment, or about  13 cents a share.  I don’t think this scenario is at all likely, but I included it as a baseline.

In my second scenario, which I consider most likely. the note holders will attempt to drive the share price down in the short term, when there are a lot of convertible payments ahead of them, but ease up in the later months to avoid destroying the value of a company they will own a substantial portion of.  In the scenario I modeled, they succeed in driving the price down below  6 cents in the September-October time frame, after which it begins to recover.  This would result in the issuance of  131 million new shares, more than are currently authorized.  However, as discussed above, it seems likely that shareholders would approve additional share issuance if the only alternative is bankruptcy.  This scenario would result in the note holders  being issued nearly  54% of the company for their $10 million investment, or about 7.6  cents a share.

In my third and final scenario (green lines,) a positive business development triggers a quick share price recovery in the near future.  Fears of dilution wane, creating a virtuous cycle, and the share price quickly rises above  $0.31, at which price note holders can choose to take payment in shares priced at $0.264 at their option, not the company’s.  This scenario results in the issuance of approximately 58 million shares (34% of the company) at  17 cents a share.

Strategy

I think the most likely result is some combination of scenarios 2 and 3.  The note holders will succeed in driving down Axion’s share price in the short term, but this process may be interrupted by positive news resulting from one of the business opportunities I outlined in the last article.

Hence, I think a small investors’ best approach is to sell or stay out of the stock now, and buy back in at the first sign of significant positive news.  If there is not any significant news in the next few months, I expect the stock will be considerably lower in the September-November time frame, at which point I will consider buying the stock.

Since the liquidity of the stock is limited, larger shareholders will have to sit tight.  There is also a concern that if all small shareholders rush for the exit at the same time.  John Petersen, a large shareholder and frequent Axion commentator, put it this way:

[A]ny significant incremental selling can only serve to drive the price down in the short term and exacerbate the problematic aspects of the financing. … [I]t’s like yelling fire in a crowded theatre.   Sometimes the only thing long investors can do is suffer through what may prove to be a difficult period.

For myself, I’m fortunate not to own the stock, which I sold last year (at a loss) when it became clear to me that Axion would be in no position to negotiate favorable terms on this financing.

I realize that this article could be construed as yelling “Fire” in a crowded theater, but I feel my first priority with my writing should be to give you, my readers, my honest opinion.  You’ll have to decide for yourselves if you want to find out if the light at the end of the PIPE is an all-electric NS 999 switcher locomotive, or get out now before being sucked down a death spiral.

Disclosure: No position in any of the securities mentioned.

This article was first published on the author's Forbes.com blog, Green Stocks on July 25th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

August 02, 2013

Axion Power's Potential For Explosive Growth

Tom Konrad, CFA

Axion Power International, Inc. (OTC:AXPW) has been developing its patented PbC lead-carbon battery technology, and in 2013 those efforts seem on the verge of paying off.   Unfortunately, Axion’s financing situation makes me unwilling to recommend its stock as an investment in the near term, but I do consider it one to watch.  This article will take a look at Axion’s technology and near term potential markets.  A follow-up article (published here) will discuss the company’s financing situation, and the things which will need to change before I consider the stock an attractive investment.

The Technology

PbC Battery.png

Axion’s PbC batteries are conventional Lead-Acid (PbA) batteries with the lead sponge negative electrodes replaced by a sandwich of a copper current collector protected by corrosion barriers which are in turn surrounded by carbon electrodes.  Not only does this reduce the lead used in the batteries, but, compared to PbA batteries, results in a much more durable battery capable of a much faster recharge rate.

While they cannot compete with Lithium-Ion batteries on energy density, PbC batteries require less complicated battery management, have better low temperature performance, are more cost effective to recycle, and have a much better safety record.  They deliver all these advantages at significantly lower cost.

ePower

According to Jay Bowman, the Chief Technology Officer at Axion customer ePower Engine Systems, it was as if Axion’s batteries had been specifically designed for ePower’s application.  ePower has developed a series hybrid drive system similar to that used in railway locomotives intended for retrofit into heavy-duty class 8 trucks.  Retrofit is a practical application for heavy-duty trucks because a heavy-duty truck’s engine is rebuilt several times during the life of the chassis.  Hence, ePower has the opportunity to achieve  significant penetration into the heavy-duty truck fleet without having to manufacture complete trucks.   The cost effectiveness of ePower’s hybrid retrofit is also enhanced because  much of its cost is offset against the cost of conventional engine replacement.

After two years of testing various types of batteries (both PbA and Lithium-Ion,) Bowman concluded that only Axion’s PbC batteries had the durability and recharging capacity required for a series hybrid drive in heavy duty diesel trucks.

Earlier this month, ePower ordered $234,000 worth of PbC batteries for retrofit into ten trucks.  It will be placing these truck with different trucking fleets to allow the operators to gain experience with the system and allay any concerns about durability.  Multiple operators have informed Bowman that, if the trucks perform as he expects, they will quickly begin placing orders in quantity.  The economics and fuel savings of ePower’s system are so significant that fleet operators will be compelled to use the system to compete, assuming durability concerns can be adequately addressed.

Norfolk Southern

NS_999-green_locomotive.jpgThe second generation NS 999 electric switcher locomotive uses Axion Batteries. Photo by Missy Schmidt.


Norfolk Southern Corporation (NYSE:NSC) released its 2013 corporate sustainability report on July 16th.   The report devoted most of a page (30 of 130) to the NS 999 all-electric switching locomotive, which uses Axion PbC batteries.  The NS 999 was the first of four “Alternative Power” projects mentioned, and was given considerably more space than the other three.  In contrast, Norfolk Southern’s 2012 report only mentioned the NS 999 prototype once, in its environmental timeline, where the prototype was mistakenly said to have been unveiled in 2010, rather than 2009.  The timeline was corrected in the 2013 sustainability report.

NSC’s second generation NS 999 is equipped with Axion PbC batteries, which the sustainability report describes as “more technologically advanced” than the lead-acid batteries the previous NS 999 had used, and with which NSC had  encountered “technical challenges” during trial field operations.

Axion completed delivery of the 1,080 batteries for the second generation NS 999 in January, generating $475,000 in revenue in the fourth quarter of 2012.

It seems reasonable to believe that the greatly increased prominence of the NS 999 in Norfolk Southern’s sustainability report reflects increased confidence on the part of NSC’s management that its previous “technical difficulties” may have been overcome.

Stationary Power

While Norfolk Southern and especially ePower could potentially produce orders which lead to explosive sales growth in coming years, Axion’s initiatives in stationary markets are most likely to lead to significant revenue and cash flow this year.

Axion’s PowerCube is an array of PbC batteries with associated control electronics mounted in a standard cargo container.  These can be quickly deployed to remote locations, and are being marketed to commercial, military, and utility operations especially on offshore islands.  Axion has responded to a large number of RFPs in these markets which could lead to orders and this year.  Since payment is typically up-front, any such orders would greatly help Axion’s financing situation.

Offshore islands and other remote locations, and military operations have very expensive electricity, since the marginal source of power is almost uniformly diesel generators.  That increases the value of grid stability and power-shifting services from stationary storage.  The fact that these applications are stationary makes PbC’s disadvantage compared to Lithium-Ion (higher weight and volume) much less significant.  Axion has preferred vendor status for a number of offshore island projects, and expects commercial sales to commence this year or in early 2014.

The scale of grid tied applications is also an advantage for PbC, since price becomes more significant at scale, and PbC batteries work well in long strings (high voltage installations.)  Operation in long strings is much more problematic with Lithium-ion (and other battery chemistries) because variability between batteries requires either complex battery management or significantly reduced performance and leads to early battery failures.  This sort of variability is why we are told to keep sets of rechargeable batteries together, and not mix batteries of different types, ages, or even manufacturers [PDF].

Stop-Start

I, and most of my readers, were introduced to Axion Power by John Petersen, Esq., an attorney and former board chair and general counsel for Axion.    From 2007 to 2012, John wrote prolifically about energy storage and the electrification of transportation for Seeking Alpha and my own website, AltEnergyStocks.com.  While he did write about the NS 999, ePower’s hybrid truck application, a more typical example of his articles was spent critiquing the economics of plug-in vehicles (with special attention to Tesla Motors (NASD:TSLA),) and talking up the economics of PbC batteries for Stop-Start hybrid vehicles.  Given all this background, I will not go into detail on the economics of Stop-Start technology, but simply refer you to Petersen’s article archive on Seeking Alpha.

In terms of Axion’s progress on stop-start, I spoke with Axion’s CEO Thomas Granville on Thursday.  BMW has completed third party testing on its prototypes, but does not want to adopt the technology if Axion is its sole supplier.  With an introduction from BMW, Axion is working with at least one major battery manufacturer to allow it to be a second manufacturer for BMW.

Like BMW, many potential customers will be unwilling to design PbC batteries into their own products until they can be certain there will be a supplier even if Axion Power, a microcap company with financing difficulties, goes bankrupt.   If Axion successfully negotiates a deal with a major battery manufacturer, it will open a lot of doors, and not just to inclusion in BMW’s Stop-Start vehicles.

Conclusion

I’m extremely optimistic about Axion Power’s business prospects over the next twelve months.  I anticipate a breakthrough in at least one of the four business areas I outlined.   Unfortunately, Axion was forced to raise money to fund its continuing operations in a $10 million offering of non-conventional convertible notes.  The conversion price of these notes is tied to Axion’s market price is based on the recent market price, and so a falling share price for the stock leads to greater dilution of shareholders and further stock price declines.

Even with Axion’s bright business prospects, the continuing issuance of new shares to repay these notes, and Axion’s likely need to raise additional capital next year make careful timing of any stock purchases essential.  I discuss my ideas on the most advantageous timing in a follow-up article.  But, if I owned the stock today, I would be a seller at the current price of $0.17.

Disclosure: no position in any of the stocks mentioned.

This article was first published on the author's Forbes.com blog, Green Stocks on July 23rd

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

July 22, 2013

What I Learned During Last Week’s Visit With ePower

John Petersen

Last week I spent a couple days with ePower Engine Systems working my way through a variety of business and technical due diligence issues. As always happens with new clients, it was a full immersion course in how ePower’s technology works, what the documented performance of the current tractor is, and how that performance is expected to change as ePower:
  • transitions from a four cylinder engine designed for stationary use to an EPA compliant six cylinder engine designed for the trucking industry;
  • automates a new charge control system that will opportunistically charge the batteries in a more fuel efficient manner;
  • evaluates the potential economic and performance advantages of using a rare earth permanent magnet generator instead of a conventional AC generator; and
  • evaluates the potential economic and performance advantages of using a rare earth permanent magnet drive motor instead of a conventional AC induction motor.
ePower’s original development work was done using a 197 hp John Deere diesel engine and a Marathon generator with a rated capacity of 115 kW that can be over-rated to 128 kW for brief intervals. In all but the most extreme conditions, the ePower tractor is designed to minimize generator over-rating by using an array of 56 PbC batteries from Axion Power International (AXPW.OB) for acceleration and hill climbing boost.

Since the current John Deere engine was designed for stationary use with a generator, it is not EPA compliant and its horsepower rating does not account for parasitic engine loads like power steering, air conditioning, airbrake compressor and other accessory and hotel loads. As a result, the maximum sustained generator output of the current tractor is about 93 kW.

ePower recently bought an EPA compliant 240 hp on-road Cummins diesel engine that was salvaged from a wrecked truck. Unlike the John Deere engine, the Cummins engine is rated on net useful horsepower at the flywheel after parasitic loads. It’s 32 pounds lighter than the John Deere engine and has an advertised fuel consumption of 6.8 gallons per hour at 1,800 RPM. With the Cummins engine, ePower believes they’ll be able to run their existing generator at full capacity without difficulty.

Over the last several months ePower has been conducting fuel economy testing of their current tractor in the Cincinnati region. The topography is best characterized as gently rolling hills with grades of 1% to 3% and typical altitude changes of up to 300 feet. The fuel economy tests were conducted according to SAE J1321 protocols using multiple trips over several 40 to 46.5 mile routes with city, suburban and highway profiles. Data was recorded at average speeds of 55 and 59 mph and any results that deviated from the average by more than 5% were excluded.

The blue bars in following graph show the documented fuel economy of the ePower tractor with a variety of loads ranging from empty to fully loaded. The red blocks at the end of the current fuel economy bars represent ePower’s estimates of the incremental fuel savings that should be realizable with (1) the six cylinder Cummins engine upgrade, (2) automation of the charge control circuitry, and (3) integration of a rare earth permanent magnet generator.

For purposes of comparison, the graph also includes a single line for the national industry average across all weight classes and the goals of the DOE’s Supertruck program.

ePower mpg.png

Since ePower’s ongoing work is by nature a research and development project, there can be no assurances that the planned tractor upgrades can be completed over the next several months or that the third generation tractor will meet current performance expectations.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock. Author has recently accepted an engagement to serve as legal counsel for ePower Engine Systems in connection with certain business planning and corporate finance activities.

May 05, 2013

Selling Exide

Tom Konrad CFA

320px-Exide_advert_in_Horseless_Age_1918-01-15_v43_p82[1].png
Electric Storage Battery Company advertisement for Exide batteries in the journal Horseless Age, January 15, 1918

I sold my position in Exide Technologies (NASD:XIDE) on April 25th after the company was forced to shut down its Vernon secondary lead recycling facility by the California Department of Toxic Substances (DTSC.)  In addition to the known arsenic furnace emissions, the DTSC cited the facility’s underground storm water system as not being in compliance with CA requirements.

When I last wrote about Exide, I felt that the problems at the Vernon facility were not as bad as most investors thought.  This forced shut-down, however, seems like it could be the proverbial straw which broke the camel’s back.  With the company’s liquidity already tight, the lack of revenues from the Vernon facility (in conjunction with the ongoing employee expenses and the expenses of fixing any problems) could rapidly mount.

On the other hand, they might be able to fix the problems in a few days, with minimal impact to revenue or cash flow.  Nevertheless, given the company’s existing difficulties, I feel that the downside risks for shareholders outweigh the possible gains from a quick resolution.

Only time will tell if this turns out to be a good move on my part.  Here are a few other factors behind my decision to consider when you make your own decisions:

  • Management is already under pressure to improve margins and cash flow, as well as negotiate with possible lenders the refinance debt.  Can they afford the additional distraction at Vernon?  Would the problems at Vernon have gotten this bad if management had been giving them the attention they deserved?
  • Even if Vernon can be reopened promptly, this episode has made Lazard’s job of restructuring Exide’s debt harder.  Exide needs to restructure its debt or sell significant assets if it is to return to a long term sustainable footing.

Given the company’s long term problems, my decision really was, “Should I sell today, or wait until the company’s next conference call, in the hope that some good news allows me to get out at a slightly better price?”

In the end, I decided not to wait, but I admit I don’t have a high degree of confidence it was the right decision.  We’ll probably know in a few weeks.

UPDATE

In the week and a half since this was first published, Exide's 2018 notes have dropped to 65 cents on the dollar, and Exide's stock has fallen from $1.03 when I sold it to $0.75 at the close on May 3rd. So far. getting out looks like a wise, if belated, decision.

Disclosure: No position in XIDE.

This article was first published on the author's Forbes.com blog, Green Stocks on April 25th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

April 19, 2013

Are Investors Right To Panic About Exide Technologies?

Tom Konrad CFA

Thursday Afternoon Panic

On Thursday, April 4th, battery manufacturer and recycler Exide Technologies’ (NASD:XIDE) stock plunged, starting around 2pm.  There was no press release or SEC filing from the company, or stories on the public newswires.  Likely short sellers were stoking rumors on the chat boards that the company had filed for bankruptcy, and that the story was on Reuters.

320px-Exide_advert_in_Horseless_Age_1918-01-15_v43_p82[1].png
Electric Storage Battery Company advertisement for Exide batteries in the journal Horseless Age, January 15, 1918

Intraday, panicked shareholders dumped their shares for as little as $1.16, down 56% from the previous day’s close.  Nasdaq circuit breakers stopped the plunge at 2:17.  I spotted the decline when I checked the market at 2:45, and began hunting for its cause.  The company’s IR contact line was busy, and I found nothing credible in the public newswires or chat boards. I knew the bankruptcy rumors were exaggerated in the absence of an SEC filing, and the fact that Exide has plenty of cash and capacity in its line of credit to meet its short term needs.

There was also an April 3rd story in the Los Angeles Times about LA council members irate about arsenic emissions from one of Exide’s lead recycling facilities in nearby Vernon, but the timing of this article did not correspond to the sudden stock drop at 2pm the next day.  Further, Exide seemed to be making best efforts to locate and prevent the emissions at the source, and to keep the public informed.  While possibly exposing as “many as 110,000″ people to unsafe levels of arsenic is clearly bad, it did not seem proportional to the $100 million plus decline in Exide’s valuation.

I bought two blocks of the stock at $1.40 and $1.42 in my managed account with  most aggressive mandate, planning to sell into the relief rally I expected Friday morning.

The News Comes Out

As the market closed, Exide confirmed that Debtwire had reported on the company hiring Lazard to explore debt restructuring.  With this additional confirmation that a bankruptcy was not immanent, I purchased additional shares at $1.40 in aftermarket trading in a number of managed accounts for sale in the expected Friday morning rally.

Short Lived Rally

Friday morning, the expected rally emerged with the stock opening at $1.77.    Although I expected the relief rally to continue into the low $2 range as the day progressed, short term market dynamics become harder to judge the more time traders have to process the news.  I took my 25-30% overnight profits from the short term trades in the first few minutes of trading, retaining my long term holdings.

The rally quickly began to fade, with the stock closing up only modestly at $1.57 on Friday.  Over the weekend and Monday I began a more in-depth investigation to re-assess my first impression that the bankruptcy fears were overdone, and to decide what to do with my long term holdings.  I contacted Debtwire to obtain a copy of their story, re-read Exide’s most recent earnings call transcript from February, and read the allegations of the class action lawsuits and news stories which are now coming out in relation to the stock decline.

Class Actions

By my count, there have now been four class action suits filed in relation to Exide’s stock decline.  While the law firms plan “to investigate securities claims” against Exide regarding the failure to disclose the arsenic emissions and restructuring, it is unlikely they have any information unavailable to investors.  Most of these law firms seem to be focusing on lack of disclosure around the arsenic emissions at the Vernon plant, but the Rosen Law Firm also plans to investigate allegations that “that it had  concealed information relating to its impending bankruptcy.” [Italics mine.]

Given the inaccessibility of the Debtwire story to non-subscribers, I suspect that some shareholders read Rosen’s statements as confirmation that bankruptcy is actually impending for Exide, and this fueled the panic around the stock.

Chances of Bankruptcy

Exide’s debt consists of a $200 million revolving facility, a $675 million 8.625% bond due in 2018, and a $55.7 million floating rate convertible note due in September.  Concerns about bankruptcy center around Exide’s ability to repay the September convertible note.  A hedge fund analyst anonymously quoted in the Debtwire story was quoted as saying that EBITDA for 2014 is expected to be $130 million, $96 million short of the $80 million of expected capital expenditures, $70 million of interest, $30 million of cash taxes and pension costs, and the $55.7 million maturity.

However, the analyst’s calculations do not include $80 million in cash on hand and $82 million of available credit which Exide had in their revolving in the most recent quarter, ended December 2012.  Furthermore, due to restructuring, Exide ended the quarter with cyclically high levels of inventory, which management intends to draw draw down over the coming quarters.  Total inventory stood at $548 million on December 31st.  With the shut down to two battery recycling operations, they should be able to reduce inventory below the $516 million seen at the end of 2011, freeing up an additional $32 to $50 million.  The approximately $200 million in liquidity from these three sources should be more than sufficient to cover the $96 million cash shortfall identified by the hedge fund analyst in the the Debtwire story.

The above calculations also fit with management’s stated intention of repaying the convertible note from available cash.   It seems unlikely that the September convertible maturity would send Exide into bankruptcy, even if Lazard is unsuccessful in restructuring the company’s heavy debt burden.   The current panic is also reducing the price of Exide’s debt in the open market, and may even be strengthening Exide’s position if it allows the company to purchase some convertible notes at a discount on the open market.

It’s worth noting that Exide’s earnings are currently under pressure from both high input prices for lead, and economic weakness in Europe.  Debt holders are unlikely to want to force Exide into bankruptcy now, before recent restructuring efforts and declining lead prices have a chance to improve the company’s cash flow and improve Exide’s ability to repay its debts.

Class Action Emanations

In terms of the other apparent investor concern regarding the arsenic emissions from the Vernon facility, these seem to have been primarily the result of the class action lawsuits.  Yet these lawsuits would not have been filed without the Thursday stock decline, triggered in turn by the Debtwire story.  Between the time the Los Angeles Times story was published the morning of April 3rd, and the Debtwire publication at 2 pm April 4th, XIDE declined only 8 cents or 3%.  The magnitude of the emissions has not yet been determined, but it would be extremely premature to take the alarm of local lawmakers an indicitave of the severity of the problem.  Their alarm is much more indicative of their need to be seen to be doing something than of the health risks, or any risks to Exide’s finances.

Nor did the news break on April 3rd.  Local papers carried stories about the emissions on March 25th and 28th.  The company’s obligation under existing environmental laws seem to be to reduce the emissions as quickly as possible, and to communicate with local communities about the risks and the steps taken to mitigate them.

The oft-repeated press report that 110,000 people may have been exposed also seems to overstate the real risk.  The local Air Quality Management Board identified the problem when a group of workers who work near the Exide facility showed increased cancer risk of 156 in 1 million, mainly due to the increased levels of arsenic emissions.   Since these workers were near the Exide facility, it seems very unlikely that the entire area of 110 thousand people were exposed to anything like the same level of emissions.  If even ten thousand people had a similar level of increased risk, we would expect only one or two extra cancer cases to result from the arsenic emissions.

In short, while any harmful emissions are a concern, the cost of complying with environmental standards and potential compensation which Exide might be liable for seem tiny relative to the enormous fall in the company’s market value.

Conclusion

Exide Technologies’ stock decline from $2.61 on April third to $1.44 where it is currently trading  seems completely out of proportion to the real chance of bankruptcy and the likely costs posed by arsenic emissions at the Vernon facility.

Reporters and analysts are right to be focusing on the bankruptcy risk as the primary cause of the stock’s recent decline, even if class action law firms and some investors are transfixed by the arsenic emissions.  Yet the fact that Exide has retained Lazard (the solid piece of information revealed in the Debtwire story) does not necessarily mean that bankruptcy risk has increased in any way.  If Lazard is successful, bankruptcy risk will be reduced.

Near-term bankruptcy worries seem overblown.  As Wedbush analyst Craig Irwin put it to StreetInsider, “the statements [suggesting Exide had failed to refinance its convertible notes] were aggressive, premature, and inconsistent with company communications.”

In the course of writing this story, I added to my positions in Exide.

Disclosure: Long XIDE.

This article was first published on the author's Forbes.com blog, Green Stocks on April 9th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

April 08, 2013

OMG! A Cheap Specialty Chemical Company

by Debra Fiakas CFA

Most investors probably pass over specialty chemical producer OM Group, Inc. (OMG:  NYSE).  It has a recent history of losses and by the usual multiples of sales and earnings its stock appears pricey.  I have taken a second look.  The modernization of the chemicals industry is a key step in attaining a sustainable and environmentally benign economy.

chemicals clip artOM Group has undertaken an ambitious reorganization.  Besides specialty chemicals, the company produces advanced materials and technologies for a variety of industries.  OM Group has held leading positions in cobalt-based and nickel-based chemicals.  Its advanced materials product list looks like the table of periodic elements:  iron, manganese, zinc, copper, barium, all the rare earth elements and more.

It’s products end up in everything from batteries to pharmaceuticals to semiconductors.  The renewable energy, waste clean-up and water filtration industries are particularly dependent upon high quality chemicals and materials and are thus becoming increasingly important markets.  The company claims over 4,000 customers in 50 countries.

OM Group had been ‘greening’ itself up with new recycling efforts for hard metals and battery scraps.  Indeed, residues and by-products had been important sources for cobalt supplies such that over half of OM Group’s cobalt material is now sourced from recycled material.  The thing is OM Group has sold off its Advanced Materials division including the cobalt business in March 2013 as part of an effort to get out of commodity markets.  Proceeds from the sale are being used to reduce debt.

One of the most interesting developments at OM Group in recent years is its participation in REACH, the European Community regulation on chemicals.  The idea is to protect health and environment through safer use of chemicals.  Use of dangerous chemicals is to be phased out.  This year the program is entering into the second phase of called registration.

As environmentally friendly OM Group is trying to be, it is probably not a justification for paying a premium price for the stock.  OM Group reported $1.6 billion in total sales in the last fiscal year ending December 2012, but registered a net loss of $38.6 million.  After two years of plump profit margins near 24%, in 2012 OM Group’s profitability slipped back to 2008-2009 recession levels near 19%.  The company also recorded $56 million in charges related to a mix of write-off, write-ups and assessments:  a step up in VAC inventory purchase accounting, pre-tax pension settlement expense of $2.5 million, $2.9 million pre-tax gain recognized on the sale of property in China, $6.5 million acceleration of deferred financing fees and an per-tax EPT escrow settlement of $6.0 million.  Whew!  Without laundry list of charges I estimate OM Group would have reported a small profit in the year 2012.

There is a handful of analysts following OM Group who seem to think profitability is in OM Group’s future.  The consensus estimate is $0.99 in earnings per share on $1.3 billion in total sales for the year 2013.  The consensus is composed of a small group of four analysts, so it is a limited read on investors’ collective thinking.  Still growth and profitability seem to be the common views.  That means OMG is priced at 22.5 times the 2013 consensus estimate.

Perhaps more important to the investor decision is OM Group cash flow.  In 2012, the company converted 12.7% of its revenue to cash.  Even with the significant change in business lines brought about by the sale of the advanced materials operations, OM Group is likely to remain a strong generator of operating cash flow.  Thus while the stock seems overbought on the basis of projected earnings, in terms of cash flow it is trading right in line with its specialty chemical peer group.
 
Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

April 04, 2013

Metal-Air Battery Stocks

by Debra Fiakas CFA

A small Israeli battery developer, Phinergy, is getting attention in the press for a road test of a Citreon C1 car outfitted with Phinergy’s metal-air batteries.  Confined mostly to military applications, metal-air batteries have not gained as much attention as lithium-ion applications. Indeed, the Citreon is principally powered by a lithium-ion power package that has been installed in the trunk.  Phinergy’s metal-air batteries are to be used as a range extender.

Long-use is really the metal-air battery’s main attraction.  Like regular batteries Phinergy’s metal-air battery has an anode.  It is made from aluminum plates.  However, here is where convention ends.  In conventional batteries, there is a cathode container of electrolytic material that supplies the oxygen needed for the electro-chemical process.  Phinergy’s cathode is decidedly unconventional, because it just taps the ambient air for the oxygen molecules. 

Phinergy’s calls it an “air cathode.” It is a porous structure that can absorb oxygen and reduce it into the electrolyte.  This capacity yields one of the metal-air battery’s most significant feature  -  low weight.  That is a key attraction for transportation solutions where every ounce of weight must be justified.

energy density for metal air batteries
Energy density of Zinc-Air batteries vs. conventional batteries.  Image source: NASA

It is no surprise that the Phinergy battery was installed on the Citreon to extend range.  Aluminum is an energy dense metal, which in turn gives Phinergy’s metal-air a second major advantage  -  long range use.  Phinergy has suggested its battery could add 1,000 miles to the trip in that Citreon C1!  That is significant since many lithium ion batteries have a range of 100 to 200 miles.

Unfortunately, metal-air batteries have some shortcomings.  The aluminum metal anode component entails some cost, especially since the metal is consumed in the electrochemical process and must be replaced.  Phinergy has made some progress in recharging its zinc-air batteries from the electric grid.

The only hint the company provides on its financial situation is the acknowledgement of government support for its battery development projects.  Phinergy is a private company so likely the only way for an investor to get involved is through a private placement.

For the rest of use, an investment in metal-air battery technology is confined to couples of public companies that have ventured into the field.  Rayovac offers zinc-air batteries to the U.S. military for specific applications.  Rayovac is owned by consumer brand manager Spectrum Brands Holdings (SPB:  NYSE).  Spectrum is a ‘small’ mid-cap stock that is trading at an intimidating multiple of 138 times trailing earnings.  This is because Spectrum has just returned to profitability after a series of net losses.  On a forward basis the stock is trading at 14.4 times the consensus estimate.  No matter how much the U.S. military might like the Rayovac metal-air batteries this stock is far removed from metal-air battery development.

A stake in Arotech Corporation (ARTX:  Nasdaq) is much closer to batteries and even metal-air batteries.  Arotech tested a zinc-air battery in a hybrid vehicle in 2004, but progress has been limited.  Instead Arotech has concentrated on military applications for its rechargeable zinc-air battery technology.  The company sells the Soldier Wearable Integrated Power Equipment System (SWIPES) to the U.S. military.  Combined, its lithium battery and zinc-air batteries and systems account for approximately one-fourth of total sales.  Arotech reported $80.1 million in total sales in 2012 compared to $62.1 million the year before.

Arotech is largely unnoticed by investors, probably because it has yet to achieve profitability.  The company occasionally produces positive cash flow from operations and so has staved off insolvency.  There was $1.5 million in Arotech’s bank account at the end of December 2012.  Consequently, ARTX trades a paltry 200,000 shares per day.  Then again, that shallow trading volume could be a blessing as it may be limiting stock price volatility.  ARTX beta measure is 1.00.

Metal-air batteries are now on my list of technologies to watch.  Phinergy and Arotech have both been added to our Mothers of Invention index of innovators of energy technology.
 
Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

January 30, 2013

A123's Sale Moves Ahead

Doug Young

320px-A123_Systems_cell_family_high_rez[1].jpg
A123 Systems battery cell products (Source: A123)
After a stormy 2012 that saw growing trade friction between China and the US, I'm happy to see that 2013 is getting off to a better start with Washington's approval of a potentially sensitive sale of a bankruptcy US technology firm to a Chinese buyer. Many readers will know that I'm talking about the case of A123 Systems (AONEQ), a former high-flying US battery maker that fell on hard times as new energy industries worldwide experienced a broader downturn in demand for their products.

In this case, Chinese buyer Wanxiang Group had won an auction for most of A123's assets in a US bankruptcy court, which should have been the final step for closure of the deal. But then some US politicians, prodded by one or more companies that lost in the bidding process, started pressuring the Obama administration to kill the deal, since it involved cutting-edge technologies used in lithium ion batteries.

In this case, I'm glad to report that the Obama administration has seen the light of reason, and the agency that reviews deals for national security concerns has just approved the sale, according to foreign media reports citing Wanxiang. (English article) The deal still requires one more government approval to close, but presumably it will receive such a green light after getting this first important approval.

I've been saying all along that this deal should get approved, as Wanxiang looked like it was in a good position to develop some of A123's technologies that otherwise may have been wasted if a suitable buyer couldn't be found. I'm also hopeful that this is a sign that cooler heads will prevail in Washington now that the US presidential election is in the past and politicians can get back to the business of governing rather than looking for opportunities to curry public favor by opposing China acquisitions on national security grounds.

Readers will recall that 2012 was a particularly bruising year for US-China trade relations, as US politicians took just about any opportunity to oppose any Chinese purchases of US companies based on national security concerns. Washington spent much of the year crafting a package of punitive tariffs against China's embattled solar panel sector, citing Beijing's unfair subsidies for the industry that put other global rivals at a disadvantage.

That dispute wasn't really related to national security, but still had plenty of anti-China overtones. The anti-China rhetoric reached a crescendo in October, just a month before the election, when the US government said that Chinese telecoms equipment makers Huawei and ZTE (HKEx: 763; Shenzhen: 000063) should be blocked from selling their products in the US due to national security concerns.  (previous post) Washington said that equipment from both companies presented a risk because Beijing could potentially use networks built by both Huawei and ZTE for spying.

Despite the heated rhetoric, reason did prevail to the north in Canada, where the government in December approved the sale of oil exploration giant Nexen to China's CNOOC (HKEx: 883; NYSE: CEO) after months of foot dragging. (previous post) But the government added that it might not approve similar deals in the future, again highlighting the sensitivity of such transactions.

Yet another sensitive deal is still pending, which has a Chinese group in negotiations to buy ILFC, the biggest US aircraft leasing company, from insurance giant AIG (NYSE: AIG). It's not clear if the Chinese buyer in that case will ultimately reach a deal to buy ILFC, which would then require US government approval. But now that the US election is behind us, I'm hopeful that the US will get back to the business of more governing and do less politicking with these cross-border acquisitions. If that happens, look for an uptick in cross-border M&A, with rhetoric from both Washington and Beijing fading as both sides get back to the business of promoting economic growth.

Bottom line: The US approval of the sale of a battery maker to a Chinese buyer could mark the beginning of a toning down in US-China trade friction in 2013.

Doug Young has lived and worked in China for 15 years, much of that as a journalist for Reuters, writing about publicly listed Chinese companies. He currently lives in Shanghai where he teaches financial journalism at a leading local university. He also writes daily on his blog, Young’s China Business Blog, commenting on the latest developments at Chinese companies listed in the US, China and Hong Kong. He is also the author of an upcoming book about the media in China, The Party Line: How The Media Dictates Public Opinion in Modern China .

December 22, 2012

How The Micro-hybrid Revolution Will Radically Change The Battery Market

John Petersen

In late October I gave a keynote presentation at Batteries 2012, one of the largest lithium-ion battery conferences in the world. During the conference, I was buttonholed for a couple hours by the chairman's global strategy team for one of the top three lithium-ion battery manufacturers in the world. They started by explaining that their Global 100 company is abandoning the plug-in vehicle market to focus on sensible applications where it can earn a reasonable margin. Then they started drilling down with a series of detailed and probing questions about whether any of the principal lead-acid battery markets might be an attractive opportunity for a company with their size, scale and stature.

While it may strike some of my readers as heresy, I told them that the lead-acid battery sector's biggest vulnerability was in the rapidly evolving micro-hybrid market where industry leaders Johnson Controls (JCI) and Exide Technologies (XIDE) were focusing on the battery products they wanted to sell instead of the battery solutions their customers needed. After all, if legacy industry leaders won't respond to changing customer needs, then it's high time for new leaders that will respond.

The micro-hybrid revolution


Micro-hybrids are the most sensible automotive fuel efficiency technology imaginable. The primary goal of all micro-hybrids is simple: turn the engine off when it's not powering the wheels. Last February, in a report titled “Every Last Drop: Micro‐ And Mild Hybrids Drive a Huge Market for Fuel‐Efficient Vehicles,” Lux Research segregated micro-hybrids into three broad classes:
  • Light Micro-Hybrids, which reduce fuel consumption by about 5%, are typically compact and sub-compact cars that offer limited stop-start functionality and don't have regenerative braking.
  • Medium Micro-Hybrids, which reduce fuel consumption by about 10%, are sub-compact through full-size cars that offer greater stop-start functionality and may offer limited regenerative braking.
  • Heavy Micro-Hybrids, which reduce fuel consumption by up to 15%, are usually mid- and full-size cars that offer the highest level of stop-start functionality, take full advantage of regenerative braking and offer a variety of advanced fuel economy innovations like high speed coasting.
While micro-hybrids are a new idea to most Americans, over half of new cars sold in Europe already use the technology and the U.S. is certain to follow suit over the next few years as automakers scramble to meet these short-term corporate average fuel economy standards.


Passenger Light Combined
Model Year Cars
Trucks
Fleet

(mpg) (mpg) (mpg)
2012 33.3 25.4 29.7
2013 34.2 26.0 30.5
2014 34.9 26.6 31.3
2015 36.2 27.5 32.6
2016 37.8 28.8 34.1

This graph from Lux shows how the global micro-hybrid market is expected to evolve over the next five years and grow from about five million units in 2011 to almost forty million units a year by 2017.

12.21.12 Lux Graph.png

On a regional basis, Lux forecasts that:
  • The European micro-hybrid market will grow from over 4 million units in 2011 to 12.6 million units by 2017.
  • The North American micro-hybrid market will grow from a standstill in 2011 to over 8 million units by 2017.
  • The Japanese micro-hybrid market will grow from about 400,000 units in 2011 to over 6 million units by 2017.
  • The Chinese micro-hybrid market will grow from under 300,000 units in 2011 to 8.9 million units by 2017.
It will be the fastest technology revolution in automotive history. The reason for the speedy ramp is simple. Micro-hybrid technology won't be a consumer option. Instead it will be standard fuel economy equipment.

The mechanical changes required to implement micro-hybrid technology are simple and cheap. One big challenge is that a micro-hybrid turns its engine off at every stop and turns it back on when the driver takes his foot off the brake. A second and even bigger challenge is that automakers want micro-hybrid systems to be transparent to their customers. The accessories have to keep working when the engine is off and they can't stutter or fade when the engine restarts. It's an immense challenge for the conventional lead-acid batteries we've all come to know and hate.

This graph from BMW shows the typical load on a micro-hybrid battery during an engine off event and the subsequent charge recovery cycle.

12.21.12 Duty Cycle.png

The block on the left (in red) represents the engine off period. The accessories draw 575 watts of power for a minute (34,500 watt-seconds) and the starter draws an additional 3,600 watts for one second. The car doesn't start re-charging the battery (in green) until it's done accelerating. Once the battery has recovered, the car draws 80 watts of power for another minute (4,800 watt seconds) before the next engine off event. In total, the duty cycle requires the battery to deliver and recover 42,300 watt seconds of power per cycle. With an average of one engine off event per mile, a micro-hybrid will demand 654,000 watt-seconds from its battery during a 16 mile commute where a conventional car would only need 6,000 watt-seconds.

The bottom line is that micro-hybrids require their batteries to do 100 times the work and if the batteries can't stand the strain, the mechanical systems can't deliver the fuel savings. Micro-hybrid systems that fail quickly because of feeble batteries are nothing more than green-wash. The automakers understand that problem and over the medium- to long-term they can't settle for less. There's always a bit of regulatory rubber when new technologies are being introduced and refined, but once a new technology becomes widespread the regulators get far more demanding.

Legacy manufacturers' initial response

Last week I wrote an exclusive article for Seeking Alpha that explained the differences between the two principal classes of lead acid batteries. It described flooded lead acid batteries as "Lead-acid 1.0" and AGM batteries as "Lead-acid 2.0." It further explained that the various types of enhanced flooded batteries are the equivalent of Lead-acid 1.x while various types of enhanced AGM batteries are the equivalent of Lead-acid 2.x. Since the analogy resonated deeply with many readers who were previously confused about the issue, I've decided to continue using that classification system.

This graph from a presentation at the recent European Lead Battery Conference shows what happens to the dynamic charge acceptance of three different types of AGM batteries over one year of simulated service using the BMW micro-hybrid duty cycle. The basic AGM battery, Lead-acid 2.0, is the blue line on the bottom. An enhanced AGM battery with graphite paste additives, Lead-acid 2.x, is the red line in the middle. A second type of enhanced AGM battery with expanded graphite and activated carbon paste additives, Lead-acid 2.x.y, is the green line.

12.21.12 AGM DCA.png

A brand new AGM battery that can accept a 50 amp charging current will take 72 seconds to recover the energy consumed during an engine off cycle. A one-year-old AGM battery that can only accept a 10 amp charging current will take 430 seconds to recover that energy. A micro-hybrid that can turn the engine off once a minute will always save more fuel than a micro-hybrid that can only turn the engine off once every seven minutes.

This graph is the main reason I told the lithium-ion battery manufacturer that the lead-acid battery industry was vulnerable in the micro-hybrid market. Instead of recognizing and accepting the reality that Lead-acid 1.x and 2.x will never be suitable for micro-hybrids, the industry leaders were stubbornly promoting improved versions of legacy products that can't provide the performance the automakers must have. Since my meeting in October the dynamic has gotten significantly better and if it continues, my concerns over vulnerability will rapidly pass.

Legacy manufacturers' evolving responses

The last two months have been a fascinating time as the two biggest legacy manufacturers started to back away from their earlier insistence that Lead-acid 1.x and 2.x would be ideal solutions for micro-hybrids.

The first legacy manufacturer to soften it's position was Exide Technologies, which announced a strategic alliance with Maxwell Technologies (MXWL) in mid-November. The two companies plan to jointly develop and market integrated battery-ultracapacitor solutions for a wide array of transportation and industrial applications. While the details remain sketchy, it appears that the Maxwell-Exide alliance will offer a micro-hybrid solution that's similar to a system launched by Maxwell and Continental AG in the fall of 2010. That system pairs an AGM battery from Continental with a 2,400 Farad ultracapacitor module from Maxwell. The combination is reportedly very good at avoiding voltage sags and accessory fade when the engine restarts, but it can't address the biggest energy drain in a micro-hybrid; the 60-seconds of accessory use during an engine off interval. Since the Maxwell-Continental system only addresses the engine restart loads, the problems with rapidly declining dynamic charge acceptance in the AGM battery remain and so do the performance deterioration issues.

The second legacy manufacturer to significantly change its position was Johnson Controls which surprised many during last week's "Strategic Review and 2013 Outlook Analyst Presentation." In that presentation the president of JCI's Power Solutions unit came right out and said that Lead-acid 1.x and 2.x were not adequate solutions for heavy micro-hybrids. He then went on to explain that JCI was planning to launch an integrated lead-acid and lithium-ion battery solution that would use a 12-volt lead-acid battery for the engine start load and a 42-volt lithium-ion battery for the accessory loads. Curiously, JCI continues to claim that Lead-acid 1.x and 2.x will be ideal solutions for light and medium micro-hybrids even though those vehicles just have a milder case of the battery problems that plague heavy micro-hybrids. I expect that position to evolve into something more reasonable over the next couple years.

The emergence of Lead-acid 3.0

Over the last decade immense progress has been made in the development of an entirely new class of lead-acid battery that integrates components from conventional lead-acid batteries and supercapacitors into an entirely new class of device. These asymmetric lead-carbon capacitors, Lead-acid 3.0, use normal pasted lead-grids for their positive electrodes and sophisticated carbon electrode assemblies for their negative electrodes. One of these devices, the PbC battery from Axion Power International (AXPW.OB) has proven to be a very promising solution for the power demands of micro-hybrids. This graph from Axion's recent presentation at the European Lead Battery Conference shows why.

12.21.12 PbC DCA.png

While a top-quality AGM battery starts out with the ability to accept a 50 amp charging current but rapidly fades over the first year of service, the PbC is able to accept a 100 amp charging current for almost five years without degradation and its charge acceptance doesn't fall into the 50 amp range for almost nine years. The PbC recently completed a three-year performance-testing regime at BMW, which has reportedly sent its results to a third-party for an independent peer review. The next logical step in the process will be fleet testing prior to a production decision. When BMW conducted fleet testing of AGM batteries for micro-hybrids in 2007, the work took six months. While testing of the PbC may take more time, it shouldn't take much longer because there's very little an OEM can learn in a car that it hasn't already learned in the laboratory.

Three years ago the PbC was a promising dark horse contender in the battle for position in the micro-hybrid battery space, but it hadn't proven its mettle in performance and validation testing by automakers. Today the principal validation and testing work has been completed and while there's a chance that fleet testing will reveal issues that weren't discovered in the testing laboratories, that possibility is remote. My inner optimist wants to believe fleet testing can be completed in time for a 2014 model year design win next September. My inner pragmatist thinks a design win for the 2015 model year is more likely.

The next likely steps

The recent actions of Exide and JCI evidence a dawning realization that the micro-hybrid revolution will require more robust and more costly energy storage systems than automakers are used to buying. In JCI's strategic review Mr. Molinaroli spent a good deal of time discussing the economic constraints on battery manufacturers. He said that while consumers were willing to accept a three-year payback on fuel economy systems, they weren't willing to pay more. That suggests that automakers will strive to reach the following price targets for the battery systems in the three classes of micro-hybrids assuming fuel savings of 5%, 10% and 15%, and gasoline prices of $3.50 and $4.00 a gallon.

Vehicle Class
Savings
$3.50 Gas
$4.00 gas
Light Micro-hybrid 5% $210 $240
Medium Micro-hybrid 10% $420 $480
Heavy Micro-hybrid 15% $630 $720

These are challenging price points, particularly when you get into systems that integrate two different types of energy storage devices and have to design sophisticated control electronics to accommodate the differences.

In all probability, Lead-acid 1.x and 2.x will be the only viable solutions for light-micro hybrids because the price targets are so low. The most likely solution will be dual battery system that uses a flooded battery for the engine start loads and an AGM battery for the accessory loads. The probability that a single battery system will survive over the long term is remote.

The medium micro-hybrid space presents a significant challenge for both the automakers and the battery industry. The dual battery systems that are likely to dominate the light micro-hybrid space won't be adequate for the heavier demands of medium micro-hybrids. In particular, the rapidly declining charge acceptance of Lead-acid 1.x and 2.x will preclude extensive use of regenerative braking which depends on the battery's ability to rapidly accept a regenerative charge during a short braking interval. While the capabilities of integrated battery-ultracapacitor systems are better than dual battery systems alone, the medium micro-hybrid niche is a natural target for the PbC once it finishes the performance and validation testing process.

The heavy micro-hybrid space is shaping up as a battleground between the dual chemistry systems proposed by JCI and Axion's PbC. Lithium-ion batteries have the high charge acceptance needed for large accessory loads and they can handle aggressive regenerative braking loads but they're expensive and very complex, particularly when you get into higher voltage batteries that require extensive changes to existing automotive control and accessory systems. In the heavy micro-hybrid market, I believe the PbC will enjoy a significant cost advantage.

Who benefits and when?


I love talking about the intricacies of battery technologies but understand full well that the primary question in the minds of investors is "who benefits and when?" The short sweet answer is every company in the sector.

Automakers are building micro-hybrids today and they want to build more aggressive micro-hybrids next year and the year after that. The only battery manufacturers who have the near-term ability to satisfy the automakers needs for better energy storage systems are the legacy leaders JCI and Exide. Both of these companies can expect significant increases in their per vehicle revenues and margins over the next few years. The rapid revenue and margin gains already baked into the business cake but they're not yet reflected in the stock prices. No matter how the micro-hybrid battery market develops, these legacy leaders will remain leaders for years to come.

Another near-term beneficiary is Maxwell which should see its ultracapacitor sales ramp rapidly as automakers strive to minimize voltage sags and accessory fade during engine restart cycles. The integrated AGM battery and ultracapacitor combination is not an ideal long-term solution to the dynamic charge acceptance problems that plague Lead-acid 1.x and 2.x, but it is a very good solution for automakers that want their micro-hybrid systems to remain transparent to drivers.

In the medium- to long-term, I believe Axion's PbC presents the greatest upside potential and the greatest risk. OEM testing has proven that the PbC offers extraordinary performance in the micro-hybrid duty cycle. While the test results have been great, the critical steps of fleet testing and contract negotiation haven't started yet, so the PbC is still a year or two away from a formal design win. First generation PbC batteries are relatively expensive, but the materials used in a PbC battery are no  more costly than the materials used in a conventional AGM battery. As Axion increases production from start-up volumes to credible commercial quantities, its opportunities for economies of scale and experience curve effects are tremendous. Over the longer term Axion wants to become a component supplier to the legacy leaders, rather than a competitor. While it will have to overcome a good deal of "not invented here" thinking, if the automakers demand the PbC's performance, their battery suppliers will have no choice.

While pharmaceutical and biotech investors understand that stock values change rapidly when R&D stage companies advance from Phase II clinical testing to Phase III efficacy trials, unique new battery technologies are rare enough that the market hasn't quite come to grips with the striking differences between where the PbC technology was in 2009 and where it is today. The last three years have been a veritable PR drought because there isn't much to talk about while OEM testing is being conducted. That dynamic will change significantly over the next year as first tier OEMs and battery users in automotive, railroad, heavy trucking and stationary applications launch a series of large scale demonstration projects as a prelude to rapid commercialization.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

December 13, 2012

US Should Approve A123's Sale

Doug Young

320px-A123_Systems_cell_family_high_rez[1].jpg
A123 Systems battery cell products (Source: A123)
In writing this blog, I generally try to keep my own views muted and focus instead on the latest news and what it means for the companies involved. But I'm making one of my occasional exceptions to that rule today to say that the US really should go ahead and approve the sale of bankrupt battery maker A123 Systems (OTC:AONEQ) to a Chinese company, since this deal seems to have few if any national security implications and blocking it would send a bad signal about Washington's commitment to fair trade.

Rather than bow to opponents of the deal, who appear to have their own agenda that's unrelated to national security, the US should follow the lead of Canada, which last week approved another controversial sale of energy exploration company Nexen (Toronto: NXY) to Chinese oil major CNOOC (HKEx: 883; NYSE: CEO). (previous post) Approval of that sale took a lot of courage from the administration of Canadian Prime Minister Stephen Harper, and now the US Obama administration should show similar determination to let the A123 purchase go forward.

Let's look at the latest reports on A123, which is making headlines that are far bigger than the deal would otherwise get due to the fact that the buyer of the company is Chinese auto parts seller Wanxiang Group. According to the reports, a US bankruptcy judge has formally approved Wanxiang's bid for most of of the assets of A123, which makes batteries used in alternate energy vehicles. (English article)

The judge in the case was unusually frank in his comments after approving the deal, saying he was concerned that another potential bidder, Johnson Controls (NYSE:JCI), might be working behind the scenes to kill the sale by asking Washington to block it on national security and other grounds. The deal is sensitive for 2 reasons. One of those is actually related to national security, since A123 sells some of its batteries to the US Defense Department. The other reason is more political, since A123 previously received a $250 million US government grant to develop lithium ion batteries.

Wanxiang has addressed the defense-related concerns by only bidding for the portion of A123's business that does not include the Defense Department contracts. As to the $250 million government grant, this point looks like a non-issue to me. Governments frequently subsidize companies that ultimately fail, and the reason for providing such subsidies is often because such companies can't get similar funding from commercial sources.

The fact that a Chinese buyer is acquiring the failed company's assets is irrelevant, and is simply the result of an auction driven by market forces. If Johnson Controls really wanted A123, it should have submitted a more competitive bid rather than trying to use this kind of tactic to get a bargain.

The US has already sent negative signals in its use of the national security excuse with its recent decision to block construction of a wind farm in the state of Oregon being built by a Chinese company, and its blocking of Chinese telecoms equipment makers from selling into the US. Both of those moves did seem to have real implications for national security, but this latest deal doesn't seem to meet that standard. Accordingly, Washington should stand aside and let the deal proceed, showing it will let commercial forces run the market except for in a handful of cases that truly do pose a risk to national security.

Bottom line: The US should approve the sale of bankrupt battery maker A123 to a Chinese buyer, to demonstrate it is committed to fair trade when national security isn't at risk.

Doug Young has lived and worked in China for 15 years, much of that as a journalist for Reuters, writing about publicly listed Chinese companies. He currently lives in Shanghai where he teaches financial journalism at a leading local university. He also writes daily on his blog, Young’s China Business Blog, commenting on the latest developments at Chinese companies listed in the US, China and Hong Kong. He is also the author of an upcoming book about the media in China, The Party Line: How The Media Dictates Public Opinion in Modern China .

December 06, 2012

ePower’s Series Hybrid Electric Drive – Unmatched Fuel Economy for Heavy Trucks

John Petersen

Over the last couple weeks there’s been a lot of message board chatter about ePower Engine Systems, a transportation technology company that has selected the PbC® battery from Axion Power International (AXPW) for its series hybrid electric drivetrain for over-the-road freight haulers who drive heavy Class 8 tractors. Since I introduced ePower to Axion and have tracked their progress for a couple years, I called ePower’s CEO Andy Claypole to ask his permission to share what I’ve learned about ePower’s hybrid electric drivetrain.

12.6.12 Tractor.png

After a series of phone calls and e-mails, Andy graciously sent me a technical presentation on ePower's series hybrid drive and gave me permission to share the presentation with readers and discuss ePower and its technology in greater detail. Click here to download a copy of ePower's presentation.

ePower Engine Systems LLC is a closely-held advanced transportation technology developer that’s using inexpensive off-the-shelf components to bring series electric drive, the mainstay of the nation’s rail transportation system, to highway transportation. Their goal is to narrow the fuel efficiency gap between 480 ton miles per gallon for railroads and 110 ton miles per gallon for heavy trucks.

In a truck with series electric drive, there is no mechanical connection between the engine and the wheels. Instead, the engine powers a generator and electricity from the generator powers an electric drive motor. This configuration maximizes fuel efficiency by running the engine at its optimal RPM and eliminates the need for complex heavy truck transmissions while delivering the instantaneous peak torque of an electric motor.

In furtherance of their goal to maximize fuel efficiency, ePower takes series electric drive a step further by sizing the generator for steady vehicle state operations at highway speed and using an array of 52 PbC batteries to provide additional power for acceleration and hill climbing, and increased energy savings from regenerative braking. The ePower drivetrain is a true series hybrid electric drive and a first for the trucking industry. The design is suboptimal for mountainous routes with substantial elevation changes, but it’s extremely efficient in flatter terrain.

12.6.12 Schematic.png

While a typical Class 8 tractor operating in the US with an 80,000 pound gross vehicle weight achieves fuel economy in the 5.2 mpg range, the same truck with an ePower system will deliver fuel economy of 10 to 14 mpg, values that crush the DOE’s 2018 SuperTruck target of 6.8 mpg for conventional heavy trucks. It works out to an annual fuel savings of roughly 11,500 gallons per vehicle.

During the startup phase, ePower has focused on the retrofit market because around 37% of the 2.7 million trucks in the US-fleet are more than five but less than twelve years old. These trucks have outlived their original drivetrain warranties and are often less efficient than newer trucks, but they have substantial remaining useful life in their chassis, bodies and other components.

The cost of converting a tractor with a conventional diesel drivetrain to a series hybrid electric drivetrain is approximately $70,000 (batteries included) and ePower believes its retrofits will pay for themselves through fuel savings alone in 18 to 24 months.

Currently, ePower is doing all required retrofit work in its own facility. Once its system is fully developed and proven, ePower intends to provide the necessary conversion components in kit form for sale to certified installers including fleet operators and other service entities. It also hopes to license its technologies and systems upstream into the OEM market.

ePower’s original design used absorbed glass mat, or AGM, batteries to provide acceleration and hill climbing boost. Unfortunately, the AGM batteries were poorly suited to long-string use and ePower was not satisfied with the frequency of battery failures. The AGM batteries also tended to degrade rapidly, which impaired acceleration and hill climbing boost while diminishing the efficiency of regenerative braking systems. ePower believes the long-string behavior and high dynamic charge acceptance of Axion’s PbC battery will overcome both of these challenges.

The PbC batteries were delivered to ePower in mid-November and installed in swappable battery boxes that will give ePower the ability to switch back and forth between the old AGM batteries and the new PbC batteries in a couple of hours. During the first week in December, ePower plans to conduct a series of benchmarking tests to compare the on-road performance of the two battery systems in the same vehicle. It will then devote the rest of December to a road show for potential customers. In early January, the first PbC powered truck will be delivered to ePower’s customer and a second AGM powered truck will be brought back into the shop for a PbC upgrade.

I believe the ePower system is intriguing for several reasons. Firstly, it’s a frontal assault on fuel costs, the biggest expense burden in the trucking industry. Secondly, ePower’s initial marketing efforts are directed at medium to large fleet operators who are more inclined to assume the risk of testing an idea in real world conditions instead of devoting years to laboratory work. Thirdly, the ePower system is an extremely efficient use of batteries. Finally, it doesn’t take much market penetration in a million-unit fleet to represent a substantial revenue base for ePower and Axion.

If results from ePower’s prototype demonstrations are favorable, there is a significant likelihood that several large freight operators will purchase multiple retrofits for similar testing programs to determine where series hybrid electric drivetrain would fit into their operations. ePower’s series hybrid electric drive system is not a silver bullet solution for all truckers and all routes, but the economics can be very compelling for firms with established routes and schedules where a series hybrid electric drivetrain can do the required work at a lower cost.

Disclosure:
Author is a former director of Axion Power International (AXPW) and holds a substantial long position in its common stock.

November 21, 2012

Exide: Many Alliances, Fewer Results

Debra Fiakas

bigstock-Alliance-Concept-7892178.jpg
Alliance photo via BigStock
 Exide Technologies (XIDE:  Nasdaq) is one of the largest transportation and industrial battery suppliers in the U.S., vying for market share with Johnson Controls (JCI:  NYSE) and EnerSys (ENS:  NYSE) among others.  Batteries are a competitive business, even as the automotive sector has attempted a recovery from the 2008 free fall in new car sales.  Electric vehicle and renewable energy storage applications have helped expand addressable market.  However, for a conventional battery producer capturing a share of these markets requires new technology.

A long-time lead-acid battery supplier, Exide makes a show of its research and development effort, but fails to disclose the amount the company spends on R&D.  It could be hidden away in Selling, General and Administrative expenses.  Exide reports SG&A near 14% of sales over the past four years.  If this expense category includes the company’s R&D effort, it is less than impressive.

Of course, internal development programs are not the only way to build a technology base.  In late 2008, Exide acquired Mountain Power, a privately-held developmental-stage company that had a proprietary battery management system with additional monitoring features for proven lithium-ion cell technologies.  This appears to be Exide’s first foray into lithium technologies and represented a big leap from the company’s lead-acid history.

Then in early 2009, Exide entered into a technology development agreement with privately held NanoTerra, a developer that claims particular expertise in the design of nano-materials and their application to surfaces and bulk materials.  It is not clear whether Exide has deployed NanoTerra’s findings in any of Exide batteries.

In the same year, Exide signed a memorandum of understanding with Axion Power Technologies (AXPW:  Nasdaq) for the future purchase of Axion’s PbC batteries and the license of Axion’s lead-carbon electrode technologies.  Exide never got around to formalizing the relationship or ordering Axion batteries, but a few months after the MOU was signed the affiliation made good reading in Exide’s application for Recovery Act funds from the Department of Energy.  The application named Axion as a partner and promised to increase manufacturing capacity at its Columbus and Bristol facilities where Exide was to produce Absorbed Glass Mat (AGM) batteries “using lead-carbon electrodes for micro-hybrid applications.”  In recent discussions Exide has begun referring to the ARRA-funded capacity augmentation in terms of batteries “with or without” lead-carbon technologies  -  enhancements that Axion was ostensibly to bring to the party.

Exide was busy making friends in 2009.  The company also entered into a cooperative research and development agreement with Savannah River National Laboratory and the University of Idaho.  The troika was set up to study the benefits of hollow glass microspheres in lead-acid batteries.  Researchers in Idaho have found that among other benefits the use of these glass microspheres could reduce battery weight, a big plus for the large battery systems needed for electric vehicles and renewable energy storage solutions.

More recently Exide has entered into a “strategic alliance” with Maxwell Technologies (MXWL:  Nasdaq).  The two have pledged to work together on integrating Maxwell’s ultra-capacitor technology with Exide’s batteries for use in storage applications.  It seems like a tall order as the two technologies could not be more diverse.  Ultra-capacitors store energy in an electric field while batteries produce and store energy by means of a chemical reaction.  Like the Axion relationship, there is nothing binding on either Maxwell or Exide.  The press release is probably longer than the ‘alliance’ paperwork, so if any new technologies arise from the collaboration, the two will have to work out who owns what.

Exide is not the first manufacturer to rely on third-party relationships for research and development.  However, if Johnson Controls is successful in acquiring the automotive assets of bankrupt A123 Systems’ (AONEQ:  OTC/BB), Exide may be under more competitive pressure.  The deal would involve the transfer of supporting technologies and could give Johnson Controls an edge over Exide in the transportation market that appears to be centering on lithium ion technologies.  That means Exide will need to do more than bootstrap its reputation as an innovator with press releases and MOUs.
 
Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

November 18, 2012

Axion Power – A Battery Manufacturer Charging Forward

John Petersen

Last week Debra Fiakas of Crystal Equity Research published an article titled "No Battery Producer Left Behind" that was based on old information about the relationship between Exide Technologies (XIDE) and Axion Power International (AXPW) and reached several erroneous conclusions. Since I'm a former Axion director, the stock is my biggest holding and I follow the company like a hawk, Tom Konrad asked me to clarify the record and present a high level overview of Axion's business history, stock market dynamics and technical accomplishments over the last four years.

Since Tom's request is a tall order, the article will run longer than usual, but it will tie together several themes I've discussed in the past.

Axion's price chart since September 2009 has been a vision from investor hell. However, I believe the market performance is 180 degrees out of synch with technical and business realities. I've been an Axion stockholder for nine years and my average cost per share is in the $1.25 range, but I've never felt better about my risk-reward profile than I do today.

11.18.12 AXPW Price.png

Business History

Axion was organized in September 2003 for the purpose of conducting basic research and development on a new lead-carbon battery technology. Axion's PbC® battery is a third generation lead-acid battery that eliminates the primary cause of lead-acid battery failure, the rapid accumulation of lead sulfate crystals on the negative electrodes. It does this by replacing the lead-based negative electrodes with carbon electrode assemblies. The PbC battery is basically a hybrid device that's half lead-acid battery and half supercapacitor. It has a number of unique performance characteristics, including:
  • Lower energy density (±25% to 40%) because carbon stores fewer ions than lead;
  • Five to ten times the cycle life because carbon electrodes eliminate sulfation;
  • Ten to twenty times the charge acceptance because carbon electrodes act like supercapacitors; and
  • Self-equalization in long battery strings that reduces the need for complex battery management systems.

Unlike most R&D companies, Axion went public at a very early stage because there were several groups that claimed partial interests in the technology and the only way to consolidate ownership was in a publicly held entity. Like most R&D projects, expectations were high at the outset but faded over time as the challenges of developing a completely new battery technology and proving its value to cautious and skeptical users became clear. The process took far longer than we thought it would, but the market potential turned out to be far greater we originally anticipated.

From 2003 through the spring of 2009, Axion's R&D efforts focused on optimizing the performance of its materials and components, designing an electrode assembly that could be used as a plug-and-play replacement for the conventional lead based electrodes used in battery plants around the world, developing automated manufacturing methods for the electrode assemblies and characterizing the performance of manufactured pre-commercial prototypes.

The first clear sign of R&D success arrived in April 2009 when Axion entered into a multi-year global supply relationship with Exide. The second and more convincing sign of R&D success arrived in August 2009 when the Department of Energy awarded a $34.3 million ARRA battery manufacturing grant to "Exide Technologies with Axion Power International" for the purpose of producing "advanced lead-acid batteries, using lead-carbon electrodes for micro and mild hybrid applications."

The market reacted well to both events and in August 2009, Axion's stock price peaked at $2.75 per share while its market capitalization peaked at $97 million. It's been a long downhill slide ever since.

Axion's relationship with Exide was always complicated because of size disparities. As an R&D company Axion ran a tight ship and in April 2009 it had $8.4 million in assets, $6.1 million in equity and  $1.8 million in annual revenue. Exide, in comparison, had $1.9 billion in assets, $326 million in equity and $3.3 billion in annual revenue. The ARRA grant made a complicated relationship more difficult because Exide didn't want to share the grant proceeds without extracting a pound of flesh and Axion believed its technology was the fundamental justification for the DOE's decision. By the summer of 2010 it was clear that Axion and Exide had different visions and would be following different paths. Current relations between the two companies are competitively cooperative, but far from close.

Stock Market Dynamics

While Axion's technical prospects were bright in the fall of 2009, its financial condition was grim. In its Form 10-Q for the period ended September 30, 2009, Axion reported $283,000 in working capital and $3.6 million in adjusted net assets. With the equity markets still reeling from the impact of the 2008 crash, there was substantial doubt about Axion's ability to survive another quarter. Those uncertainties persisted until late December when Axion announced a $26.1 million private placement of common stock that saved it from imminent collapse and gave it a sound financial footing for the first time in its corporate history. Axion's 10-day moving average price was $1.65 before the offering and the deal was priced at $0.57, a painful 65% discount. The deal terms were hard, but they weren't unfair for a private placement transaction of that magnitude.

I was thrilled when the 2009 private placement came together because 70% of the stock was bought by four big investors who each acquired blocks that were roughly equal to Axion's total reported trading volume for 2009. When one big investor takes 70% of a deal, you need to worry about the stock flowing back into the market. When four big investors split 70% of a deal and they each buy blocks that represent a full year's trading volume, it's generally safe to assume that they're swinging for the fences and the shares won't flow back into the market for years. Unfortunately, things didn't quite work out according to plan.

The market reacted reasonably to the 2009 private placement and during the month immediately following the offering, the price drifted down into the $1.15 range. Based on my prior experience with substantial private placements by public companies, it looked like the market was reacting normally and the retail price for liquid thousand-share blocks would stabilize at roughly twice the placement price for illiquid million-share blocks.

Axion's market dynamic started to get ugly in late-April and early-May when liquidation trustees for two legacy stockholders that held a combined total of 3.5 million shares started to aggressively compete for buyers by dropping the offering price in a market that traded about 45,000 shares a day. By mid-July, the stock price had fallen by 50% while the average daily volume doubled. That price decline spooked other stockholders and increased the selling pressure, which drove the stock price to new lows. The extraordinary selling pressure continued in 2011 and 2012 as one large stockholder after another began to liquidate their positions for reasons ranging from secondary repercussions of the 2008 crash, to fund management changes and even an accidental death. As a result, the annual trading volume progression over the last four years was:

Calendar 2009
7.2 million shares
Calendar 2010
22.0 million shares
Calendar 2011
77.7 million shares
2012 to Date
76.6 million shares

Axion may have been a very illiquid stock that traded by appointment in 2009, but it has developed a solid liquidity base over the last three years. More importantly, information from SEC reports filed by certain large holders combined with daily short sales data published by FINRA has left me highly confident that substantially all of the Axion shares that were previously held by large stockholders who wanted to sell have been absorbed by retail investors who did their homework, climbed their personal walls of worry and accumulated shares despite Axion's dismal market performance. While market activity over the last three years has been dominated by a few large holders that were willing to sell at any price, I believe the future market will be dominated by a large number of retail investors who were greedy when others were fearful and bought Axion's stock based on the fundamental economic potential of the PbC technology.

Technical Accomplishments


Axion's basic research and development work on the PbC technology was substantially complete by the end of 2009. It had advanced the PbC technology from a glorified science fair project to a manufactured pre-commercial prototype that was suitable for delivery to potential customers who wanted to conduct their own testing and determine whether the PbC battery suited their needs. Axion used a portion of the proceeds from the 2009 offering to build a fully automated second generation production line for its carbon electrode assemblies and upgrade its principal manufacturing facility, but most of the proceeds were used to support customer testing activities and pay for a variety of demonstration projects in the new evolving markets summarized below.

Automotive Idle Elimination Systems In response to new emissions control and fuel economy regulations, the auto industry is in the midst of a fuel economy renaissance. The world's automakers are all implementing proven fuel economy technologies at a torrid pace on a fleet-wide basis. One of the most cost-effective fuel economy systems available to automakers is also one of the most sensible – turn the engine off while a car is stopped in traffic and restart it automatically when the driver takes his foot off the brake. Depending on the manufacturer, these stop-start or micro-hybrid systems improve fuel economy by 5% to 15% for a few hundred dollars in incremental cost.

The biggest challenge of idle elimination is that powering accessories during engine off periods and restarting the engine when the light changes puts tremendous strain on the battery and today's best starter batteries simply aren't up to the task. The batteries begin to degrade as soon as they're placed in service and within a few months a car that turned the engine off at every light when it was new can only turn the engine off once or twice during a commute. Idle elimination systems that don't function properly because of weak batteries can't save fuel.

In the summer of 2009 Axion began quietly working with BMW, which wanted to test the PbC battery for possible use in its mainline vehicles with the EfficientDynamics fuel economy package. The first 15 months of testing were conducted in deep secrecy. Axion's stockholders didn't learn about the existence of the BMW relationship until September 2010 when Axion and BMW jointly presented the preliminary results of their testing at the European Lead Battery Conference in Istanbul.

The following graph is an updated and annotated version of the graphs Axion and BMW used in 2010 to show the superiority of the PbC battery in a stop-start duty cycle. They grey lines relate to the left-hand axis and show changes in the dynamic charge acceptance of the batteries as they age. The black lines relate to the right hand axis and show the amount of time the batteries needed to recover from one engine off event in preparation for the next engine off opportunity. As you look at the graphs, it's important to remember that:
  • The "Charge Time" scale for the AGM graph is 10x the scale for the PbC, and
  • The "Equivalent Drive Time" scale for the AGM is stated in months while the PbC scale is stated in years.
11.18.12 PbC v AGM.png

BMW completed its laboratory and vehicle testing of the PbC this summer and was pleased enough with the results that it hired an independent testing organization to confirm them. If the confirmation testing is successful, Axion believes the next logical step will be fleet testing to demonstrate the PbC's performance in a variety of climate and traffic conditions. Based on the stellar results BMW obtained during its three-year testing and validation program, several other automakers have skipped the preliminaries and gone directly to advanced testing of the PbC for their idle elimination systems.

While US automakers are just beginning to implement idle elimination systems, industry consensus holds that the technology will be used in 34 million vehicles a year by 2015 and substantially all internal combustion engines by 2020.

Battery-Powered Locomotives
Freight and passenger railroads in the US use roughly 3.7 billion gallons of diesel fuel per year, which gives them a huge incentive to reduce their operating costs by using fuel more efficiently. Moreover, like other transportation sectors, the railroads are subject to increasingly stringent emissions regulations, particularly for rail yards in urban areas. In 2007 Norfolk Southern (NSC) launched an ambitious program to develop a battery-powered locomotive that could be used as a switcher in urban rail yards, or combined with conventional locomotives to create a hybrid train that would use battery power to augment the conventional locomotives during acceleration and hill climbing and recover a portion of the energy that's currently wasted in braking and downhill grades. Since NS used 476.6 million gallons of diesel fuel in 2011, it believes the potential economic and environmental benefits of battery-powered locomotives are extremely attractive.

In September 2009, NS introduced its first battery-powered switching locomotive, the NS 999. While the early demonstrations showed that the NS 999 could do the required work, the AGM batteries they selected for the locomotive were not able to withstand the tremendous regenerative braking loads of a switching locomotive. When the original batteries quickly failed, NS began its search for a better energy storage alternative. After discretely testing hydrogen fuel cells and nickel metal hydride, lithium iron phosphate, sodium beta and a variety of lead-acid batteries, NS decided that Axion's PbC battery was best suited to its particular needs. Axion announced the initiation of a development relationship with NS in June 2010.

Over a period of two years, NS conducted a grueling sequence of performance tests using its in-house development staff, Penn State University and Axion to obtain double redundant results. In addition to showing that the PbC could handle the regenerative braking loads from a battery-powered locomotive, the testing program also explained why the first generation prototype failed.

Whenever conventional batteries are connected in series, the resulting battery string is only as strong as its weakest link and as the string ages the differences between batteries get harder to control. Unlike all other batteries, strings of PbC batteries tend to self-equalize over time because of their unique charging behavior. The following graph highlights the differences between the long-string performance of conventional AGM batteries and Axion's PbC batteries.

11.18.12 String Behavior.png

In April of this year, NS ordered $475,000 of PbC batteries for their planned rebuild of the NS 999. Their goal is to have the locomotive working this winter. Upon completion of the NS 999 rebuild, NS plans to build a larger six-axle locomotive for testing in long haul hybrid train applications. If the two planned prototypes perform as expected, the next logical step will be statistically valid fleet testing throughout the NS system. Norfolk Southern's locomotive fleet includes 240 switching and auxiliary units and 3,900 multipurpose units. Collectively, the nation's Class I railroads operate a total of 23,500 locomotives.

Stationary Storage Products In November 2011 Axion commissioned its PowerCube stationary energy storage system. While stockholders knew that the product was being developed, they didn't know that Axion, in cooperation with Viridity Energy, had taken all necessary actions to qualify the PowerCube as a behind the meter frequency regulation resource in the PJM Interconnection, the regional transmission organization for Pennsylvania and twelve other States. In September 2012, Axion unveiled a small version of the PowerCube for residential and small commercial customers.

Over the last couple years grid-based energy storage has become a hot topic and most battery manufacturers are launching products for utilities, renewable power producers and commercial and residential power users. It's an intensely competitive market where the principal differentiators are likely to be reliability, total cost of ownership and customer service. Axion's stationary storage systems perform well and respond in milliseconds, but they don't necessarily perform better than products from Axion's competitors. The self-equalizing behavior of PbC batteries in long string applications should be as attractive in stationary systems as it is in rail applications.

As near as I can tell the key features that will differentiate Axion's products are low maintenance and user-centric design. Axion developed the PowerCube in cooperation with Viridity with the primary goal of maximizing the economic benefit to commercial users who want to reduce their power costs while avoiding costly interruptions. Similarly, Axion developed its residential PowerHUB in cooperation with Rosewater Energy with the primary goal of optimizing performance and minimizing maintenance for small-commercial and high-end residential customers who need reliable, stable and clean power for their sophisticated security, entertainment, climate control and other electronic systems.

Trucking Industry Products In October of this year, Axion made a presentation at the SAE's Commercial Vehicle Congress in Chicago that outlined its plans to introduce specialty products for the trucking industry. The first planned product will be battery systems for the auxiliary power units that are quickly becoming industry standards as most states adopt laws and regulations to restrict idling while trucks are parked for driver rest periods. To date, industry experience has shown that AGM batteries fail quickly in APUs and a better solution is needed. Axion's SAE presentation used this graph to highlight the performance differences between AGM batteries and PbC batteries over a six-month period in a simulated APU duty cycle.

11.18.12 PbC APU.png

The primary target-market for APU battery systems is the 650,000 heavy-duty trucks that haul the nation's freight. In 2006, the average long-haul truck idled for 6 hours per day and total national fuel consumption in idling trucks was estimated at 665 million gallons, or a little over 1,000 gallons per truck. Fuel costs alone make four-battery APUs a compelling economic proposition.

In its SAE presentation Axion said that it planned to begin field testing of PbC-based APU systems by 2013, which suggests that a formal announcement of the testing program and its development partner will be made in the next few weeks. Since the SAE presentation used Freightliner's ParkSmart™ System as an example of the target market, I think there's a pretty good chance that Freightliner will be the development partner.

A second trucking initiative Axion briefly discussed in their last conference call was the shipment of 52 PbC batteries for a prototype Class 8 tractor that combines a small diesel engine with a series hybrid drive to deliver fuel economy in the 12 to 14 mpg range, as opposed to the 5 to 6 mpg performance that's currently prevalent in the industry. Preliminary test data from this project is expected this year.

Risks and Uncertainties


Production Capacity Axion's electrode fabrication line was designed to produce enough electrodes for about 150 batteries per shift. While Axion has not disclosed its cost of building and installing the production line, news stories and financial statement disclosures lead me to believe an estimated cost of $3 million per line is reasonable. By the time you account for efficiency differences in a multi-shift operation, I'd estimate the maximum capacity of the single electrode fabrication line at 350 batteries per day, which is adequate to support testing and evaluation activities, but inadequate for commercial sales. When demand for PbC batteries increases, Axion will need up to $50 million in additional capital to expand its electrode fabrication capacity from 350 to 3,500 PbC batteries per day.

Production Costs Axion's electrode fabrication capacity is very limited, which means that it has no significant negotiating power with suppliers and the fixed costs of its electrode fabrication facility are spread over a small number of units. In combination, these factors make current versions of the PbC objectively expensive. I've done some back of the napkin calculations on the bill of materials for a PbC battery and compared those numbers with the bill of materials for an AGM battery. The bottom line is basically a wash when you substitute ounces of expensive carbon for pounds of cheaper lead. Once demand for PbC batteries ramps, Axion should enjoy a stronger bargaining position with suppliers and derive substantial savings from the more efficient utilization of its physical plant. Additionally, the current electrode fabrication line is a second-generation version. As Axion works its way down the normal learning curve for manufacturing enterprises, additional cost savings are almost certain to arise. While management has scrupulously avoided making promises about future cost reductions, the opportunities for real and substantial economies of scale cannot be overlooked.

Anticipated Financing At September 30th, Axion had $4.2 million in cash, $6.8 million in working capital and $13.3 million in stockholders equity. It will require additional operating capital by the end of Q1-2013. Axion's Form 10-Q disclosed that management is currently seeking additional capital from sources that are in alignment with its business objectives and long term strategy. During the recent conference call, the CEO explained that the next financing transaction would probably be a 2013 event and disclosed that the investors who provided $8.6 million of additional capital in February of this year are willing to participate in another round if an appropriate strategic partner is not identified. Since the terms of a future offering will not be negotiated until immediately prior to closing, they're a significant uncertainty.

Investment Conclusions

In a normal case I would have expected Axion's stock price to stabilize in the $1.15 range after the 2009 offering. I would also have expected the price to slowly appreciate from that base level in response to the following significant technical accomplishments:
  • The June 2010 announcement of a relationship with Norfolk Southern;
  • The September 2010 announcement of a relationship with BMW;
  • The November 2011 commissioning of the PowerCube as the first behind the meter frequency regulation resource in the PJM Interconnect;
  • The decision to use the PbC in Norfolk Southern's battery powered locomotive prototypes;
  • The successful completion of BMW's testing activities; and
  • The September 2012 launch of the residential PowerHUB;
While each of these events would have been big news in a typical micro-cap company, they didn't register on Axion's price chart because of the extremely unusual market dynamics that prevailed when the announcements were made. While Axion's stock has been "broken" for the last three years, I believe the market dynamic that caused the problem has been resolved and the only thing that's holding the stock at present levels is fear that higher prices will only give rise to another round of heavy selling. After three years of unrelenting selling pressure despite an increasing body of proof that the PbC is an extraordinary new battery technology, I understand the fear. I also know that Axion has arrived at a key transition point and is poised to shed the R&D company market dynamic that prevailed for the last nine years as the PbC earns a place in several billion-dollar niche markets where competitive battery technologies simply can't do the work.

11.18.12 Gartner.png

Most R&D companies that enter the valley of death never emerge. For the fortunate few that do, the hard times last longer than anyone expected. The one trait all entrepreneurs share is unbridled optimism. The three traits all survivors share are determination, focus and fiscal restraint.

After nine years of hard work, adversity and limited financial resources, I believe Axion has finally arrived at the "Innovation Trigger" for the next stage in its development.

Disclosure:
Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

November 15, 2012

No Battery Producer Left Behind

by Debra Fiakas CFA

In late 2009, nine companies in the battery sector were recipients of American Reconstruction and Recovery Act (ARRA) funds awarded by the Department of Energy to jump start manufacturing capacity.  By the end of December 2011, six of them had made enough progress to begin production.  Three were lagging behind, including Exide Technologies (XIDE:  Nasdaq) and its partner Axion Power International (AXPW:  OTC/BB).  
512px-ESB-Exide%27s_Sundancer_electric_car[1].jpg
Exide's Sundancer Electric Car, October 1973. Exide and Axion are not looking so quick today.  Photo by Frank Lodge, EPA. Public Domain

Conventional battery producer and recycler, Exide was awarded $34.3 million by the DOE to advance the production of advanced lead-acid batteries at Exide’s facilities in Bristol, Tennessee and Columbus, Georgia.  The batteries would use lead-carbon electrodes for micro-hybrid applications such as so-called Start-Stop batteries.  By the end of 2011, when the General Accounting Administration last checked in on all the projects funded by Recovery Act funds, Exide had been able to install and commission all the equipment intended for the facility in Columbus.  This is where Exide was to produce its Absorbed Glass Mat (AGM) flat plate batteries.  Exide’s Columbus facility had been a lead recycling plant that was taken out of service in 1999.  It is now part of a larger operation including lead-acid battery manufacturing lines.  The Company has confirmed completion of the new AGM production capacity at Columbus and started shipping out its AGM flat plate batteries in the March 2012 quarter.

When the GAO completed their report, the Bristol facility equipment had been installed and commissioned for production of Exide’s lead-acid batteries, but the company was still validating equipment to be used in production of its Absorbed Glass Mat (AGM) ‘spiral wound’ batteries.  We note Exide is transferring its standard flooded battery production lines to facilities it operates in Salina, Kansas and Manchester, Iowa.  Management refers to these moves as the ‘closure’ of the Bristol facility, but as recently as the Exide’s second fiscal quarter conference call in early November 2012, indicated they are on schedule with installation of a ‘spiral wound’ battery production line at Bristol.  Earlier in 2012, management had expressed confidence in that ‘spiral wound’ AGM batteries will be produced at Bristol yet in 2012 and they have not backed away from that timeline.

Exide is closing certain facilities for the sake of reducing costs.  The company has been historically profitable, although it did report a net loss of $106.5 million on $693.4 million in sales in the June 2012 quarter, after establishing a valuation allowance for future tax allowances of $87.6 million.  Exide has produced positive operating cash flow in each of the last five fiscal years at a rate averaging 3.4% of total sales.  

It is Exide’s partner Axion Power that has real cash flow issues.  The lead-carbon electrodes Exide is using in it AGM batteries is ostensibly based on technology from Axion Power.  The two formed a partnership of sorts in 2009.  Axion has developed advanced ‘five-layer’ electrodes made from micro-porous activated carbon.  Use of Axion’s electrode assembly makes it possible to recharge batteries at a faster rate, a capability particularly for the transportation and industrial batteries Exide produces.

Axion raised $9.5 million through an offering of common stock in February 2012, bringing to $60 million the total amount of equity capital Axion has raised since inception.  At the end June 2012, Axion had $6.3 million in cash on its balance sheet.  I estimate Axion is burning as much as $2.0 million per quarter.  If I am right, Axion will be out of money by the end of the first quarter 2013.  That is, of course, if its fortunes do not improve.

In early August 2012, Axion announced a new distribution agreement with Rosewater Energy, which is targeting the residential energy market.  Axion will provide Rosewater with a battery storage and management system complete with electronics.  Axion has received interest from several corners, including Norfolk Southern for an all-electric, battery powered locomotive.  However, the initial order from Norfolk was $475,000 and there is no visibility on future orders from Norfolk or any other rail operator.  The company has also received a consistent flow of orders to its flooded lead-acid batteries over the past year and recently indicated it expects to continue receiving orders at least through the first quarter 2013.

The DOE appears to have made its grants with the idea of leaving no battery producer behind.  However, investors have to wonder about the ability of Axion to keep up when its order flow is sporadic and one of its most important partners is playing it safe in tough demand conditions.


Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

November 12, 2012

Tax Payer Investment in Advanced Batteries

by Debra Fiakas CFA

For better or worse various government agencies in the United States have provided significant financial support for advanced battery development and production.  The federal government has a goal of deploying one million plug-in hybrid electric vehicles by the year 2015.  The replacement of gas-burning cars and trucks is expected to reduce economic dependence upon foreign oil and reduce carbon emissions that threaten our health and climate.  We all understand this line of reasoning.

Public funds for battery development have been channeled through a mix of contracts for products and services, research grants, loan guarantees and indirectly through tax credits.  Indeed several of the companies mentioned in my last few posts on advanced battery developers have supplemented shareholders’ capital with proceeds from government contracts, grants and loans  -  A123 Systems (AONE:  OTC/BB), Valence Technologies (VLNCQ:  OTC/PK), Johnson Controls (JCI:  NYSE).

A special report published in August 2012 by the U.S. General Accounting Office found six public agencies involved in advanced battery development in thirty-nine different programs.  In the fiscal years 2009 through 2012, these agencies invested just over $1.3 billion dollars in the battery sector.  A significant portion of public support appears to have been focused on lithium-ion technologies for electric vehicles.   There were also awards for stationary power storage, air space and under-water vehicles.  Government agencies have also supported a range of storage ideas, including flywheels and capacitors.


Public Agency # Programs Awards
Department of Energy (DOE) 11 $853.0 Mln
Department of Defense (DOD) 14 $430.3 Mln
National Aeronautics and Space Administration (NASA) 8 $20.8 Mln
National Science Foundation (NSF) 4 $8.6 Mln
Environmental Protection Agency (EPA) 1 $3.3 Mln
National Institute of Standards and Technology (NIST)
1 $1.4 Mln

Source: Fiscal Year 2011 Annual Progress Report for Energy Storage R&D, January 2012, GAO

Additionally, beginning in 2009 the DOE invested $1.5 billion in twenty projects for advanced battery manufacturing and battery recycling.  These funds were made available through the 2009 American Recovery and Reinvestment Act (ARRA).  The $2.8 billion provided by the 39 agencies and the ARRA represented approximately 0.03% of federal spending in the last three fiscal years.  To put that in perspective that would be equal to $15.42 out of the pocket of an individual making the U.S. median income of $51,413 (beginning of 2012).

As a middle-income taxpayer, as an investor what would you expect for $15.42?

As usual the GAO has been looking out for tax payers to determine if their money is being invested wisely.  In preparing its last annual report on funding for advanced battery development, the GAO paid particular attention to whether disbursements by the six agencies and thirty-nine programs were duplicative.  The GAO found plenty of overlap in terms of technology areas and applications.  However, each project appeared to have fulfilled agency-specific requirements, bringing to an end any concerns for duplication and waste.  Like investments in space travel, computer networking and geo-positioning, much of the resulting technology is expected to eventually end up in the private sector.

Taxpayers want to know more than just whether government agencies duplicate each other’s efforts.  They also want to know if the monies actually accomplished policy objectives.  This takes us to yet another GAO report about the twenty programs funded by the 2009 ARRA called the Fiscal Year 2011 Annual Progress Report for Energy Storage R&D published in January 2012.

It turns out all projects were initiated for battery and materials manufacturing facilities funded by the ARRA.  As hoped for, production was launched at several facilities by the end of 2011.

  •     General Motors (GM:  NYSE) pack assembly facilities in Brownstown, MI
  •     A123 Systems (AONE:  OTC/PK) systems cell and pack assembly in Livonia, MI
  •     Johnson Controls (JCI:  NYSE) cell and pack assembly in Holland, MI
  •     Saft Group (SGPEF:  OTC/PK) cell and pack assembly in Jacksonville, FL
  •     EnerDel (private) cell and pack assembly in Indianapolis, IN
  •     East Penn Manufacturing (private) advanced lead-acid battery plant in Lyon Station, PA
  •     Celgard separator material production at Charlotte, NC
  •     Toda America (cathode production plant in Battle Creek, MI
  •     Pyrotek anode production plant in Sanborn, NY

There were also some technology and performance achievements among the development programs receiving public funding.

  •     K2 Energy Solutions reached energy density targets with 45-Ah energy cells based on LiFePO4.
  •     LG/CPI demonstrated prototype lithium-ion cells using advanced magnesium-rich composite cathode materials, resulting in increased cell density over LG Chem’s previous baseline.
  •     Johnson Controls (JCI:NYSE) developed a new plug-in hybrid electric vehicle prismatic cell system that offers twice the all-electric vehicle range.
  •     Quallion achieved 30% higher specific power with a hybrid battery with separate high power and high energy modules.
  •     SK Innovation achieved exceptional cycle life with a production-ready 25-Ah high-energy electric vehicle cells.
  •     Maxwell Technologies (MXWL:  Nasdaq) developed an asymmetric capacitor with greatly increased energy density with proprietary dry process electrodes.

There is a much longer list of technology achievements in the GAO report, which in sum provides a bit of solace for two constituencies.  Taxpayers can rest assured their hard earned tax dollars have nudged our country a bit closer to an economically independent nation with a healthier, cleaner environment.  Perhaps these accomplishments are not enough, but ‘something’ has been accomplished and ‘something’ represents a positive return on invested tax payer dollars.

Investors are the other constituency that should be ‘all over’ the GAO report.  It provides insight into key sources of demand for advanced batteries.  More importantly the report sheds some light on a few companies with technologies that are heads above products on the market today.    
Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

November 01, 2012

The Rocky Road to Lithium Ion Battery Commercialization

by Debra Fiakas CFA

A bit of history…
Li battery diagram
Schematic of a Lithium Ion Battery by Materialsgrp, via Wikimedia Commons


Lithium ion batteries are a relatively recent innovation.  Scientists and engineers first began working with lithium applications in the 1970s.  A number of companies and laboratories worked through the next decade to perfect lithium ion batteries, using various materials for the business ends of a battery  -  the anode and the cathode.  It was not until the mid 1980s that developers settled on cobalt as an electrode material, which ultimately enabled industrial-scale production of lithium ion rechargeable batteries.  In 1996, Sony introduced the first commercial battery to the market.  Fifteen years later lithium ion batteries accounted for 66% of all portable battery sales worldwide.

Cobalt is not the last word on lithium ion batteries.  Known as LiCoO2 or LCO for short, lithium cobalt oxide is now only one of several solutions for battery cathodes.  Cobalt offers high capacity for its cost.  Manganese (LiMN2O4 or LMO) is used on its own or in combination with nickel and cobalt (LiNiMnCoO2 or NMC).  These materials afford the safest battery application as well as long life, but have lower capacity than cobalt alone.

Some battery producers have tried combining cobalt with nickel and aluminum (LiNiCoAlO2 or NCA).  High specific energy and power densities and long life span have the attention of electric vehicle producers for powertrain applications.  However, high cost and safety issues still need to be addressed.

A few developers have taken an entirely different approach, using lithium titanate (Li4Ti5O12 or LTO) to replace the graphite in the battery anode.  LTOs offer excellent low-temperature discharge, high capacity and lengthy lifespan.
 
The perfect paring…

Cobalt wins the capacity contest, but when it comes to thermal stability and power or load characteristics lithium iron phosphate chemistry (LiFePO4 or LFP) is heads above cobalt.  For powertrain and electric grid applications, safety and cycle life are more important than capacity.  Thus electric car manufacturers cozied up to LFP developers and the race to build the perfect automotive battery began.

A123 Systems, Inc.(NASD:AONE) tried to commercialize LFP and ended up in bankruptcy court.  I estimate A123 spent more than $300.0 million on research, development and engineering activities since the company was founded in 2001.  A123 did not begin spending heavily on production capacity until after the company’s first product launch in 2006.  At the end of June 2012, A123 reported just over $145 million in property, plant and equipment net of accumulated depreciation and government grant off-sets.  Gross property, plant and equipment on the balance sheet at the end of June 2012, was $425 million, matching closely the $419 million reported capital spending in the last six and a half years.  The company claimed manufacturing capacity to produce 645 megawatts annually.

To its credit, A123 Systems had landed customers before filing for bankruptcy protection in September 2012 and agreeing to a buyout by Johnson Controls, Inc. (JCI:  NYSE).  In the transportation market A123 supplied batteries for Fisker Automotive’s Karma, BMW’s ActiveHybrid, General Motor’s (GM:  NYSE) Chevrolet Spark and SAIC Motor’s Roewe 750, among others.  AES Corporation (AES:  NYSE) and Vestas Wind Systems (VWS:  DE, VWDRY:OTC) had also purchased A123 System battery packs for grid applications.

In early 2012, production problems with A123 Systems’ prismatic battery innovation resulted in a recall and replacement of some batteries packs produced at the company’s Livonia, Michigan facility.  The prismatic battery was being shipped to Fisker Automotive and four other undisclosed automotive producers.  The company claims the problem was not related to its LFP battery technology, but was instead traced to sloppy work on battery cell packs.

Innovation on a budget…

The demise of A123 Systems, does not appear to have cast too dark a shadow on other LFP battery applications.  However, that does not mean others pursuing phosphate chemistries for lithium ion batteries have had smooth sailing.  Valence Technology, Inc. (VLNCQ:  OTC/BB) has been at the development bench since 1989, several years longer than A123 Systems.  Valence began with lithium iron phosphate and later added a vanadium wrinkle (LiVPO4F or LVPF).

Vanadium-enhanced batteries have greater charge capacity. Futhermore, LVPFs can recharged in less than an hour, compared to five to 10 hours for conventional lithium ion batteries.  Vanadium is relatively cheap and abundant, but it is not as inexpensive as iron or magnesium.  BYD Company in China and Subaru in Japan are also using vanadium in their EV battery applications.

Since inception, Valence has reported a total research and development spend of $96 million.  Having spent far less on research and development than one of its nearest competitors, investors might think Valence would have no product on the market and no presence in the market.  However, Valence launched its first battery in 2002 and has growing customer list.  In fiscal year 2012, Segway was Valence’s largest customer, accounting for 21% of total sales. Smith Electric Vehicles, Rubbermaid Medical Solutions, Howard Technology Solutions and truck manufacturer PVI each contributed 12% of revenue.

What is more Valence has managed to turn out products with a significantly lower investment in plant and equipment.  Instead of building to own, Valence leases approximately 173,000 square feet in production space in China.  I estimate the company put a grand total of $148 million in capital investments since the get-go in 1989, to outfit production facilities with equipment and otherwise go into commercial operation.

Unfortunately, even a frugal budget has not spared Valence.  The Company filed for bankruptcy protection in July 2012 and is now operating as a debtor-in-possession.  In September 2012, Valence was able to arrange a $10 million credit facility for working capital.

Valence shares are trading at a penny a share.  Some might consider this an option on management’s success in bringing the company back from the brink.  As enticing as a cheap stock might seem, this one seems to carry a bit more risk than is palatable.

I would like to see management assume bit of that risk themselves with greater personal stakes in Valence.  Valence reports that insiders own a total of 86.5 million or 51% of the company’s 170 million shares outstanding.  After stripping away the options and convertible preferred stock from the calculation, insiders are found to own 42% of the common stock.  Nearly all those shares are owned by Chairman of the Board Berg and his employer, West Coast Ventures.  Less than 1% is owned by the other directors and senior officers.  

When insiders buy VLNCQ, it will be a clear signal the stock offers return for the risk.  Of course, given the present circumstances the window on insider transactions might be closed.  A handy alternative is for Valence to use direct shares as a means of compensation rather than piling on more options.

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

October 30, 2012

Flux Powers into Battery Management

by Debra Fiakas CFA

Flux logo.png  Proper electric and thermal management of advanced battery packs is imperative.  During operation, voltage and temperature differences in the battery cells can lead to electrical imbalances and decrease system performance.  A good battery management system can ensure strong power delivery and extend battery life.  Dozens of battery management systems have cropped up to fill this need for the lithium ion batteries used in new electric vehicles and alternative energy applications.  The highly populated field has not intimidated the newest competitor, Flux Power Holdings, Inc. (FLUX:  OTC/BB).

Flux is a 2008 spin-off of sorts of LHV Power Corporation (formerly HiTek Power Corporation).  The two companies still have common management as Flux’s chief executive officer is the president of LHV Power.  A series of distribution, development and manufacturing agreements also link the two companies.

LiFe_Silver24[1].jpg
The Wheego LiFe. Wheego Electric Cars was Flux Power Holdings' first customer in 2010. Photo credit: Wheego
  The Flux product line consists of a battery management system (BMS), battery modules and chargers.  The first prototype was shipped in 2010 and the next year Flux landed its first customer, electric vehicle producer Wheego Electric Cars.  Four new customers in the electric vehicle market have come along over the last year:  Greentech Automotive, Epic Boats, Artisan Vehicle and Boulder EV.

Battery modules represented 74% of total sales in the fiscal year ending June 2012 and sales of BMS represented 17% of total sales.  The technology behind Flux’s BMS was acquired in late 2009 from Joseph Gottlieb, notably of the pinball Gottlieb family.  He served as Flux’s chief technology officer for a time.  Seven patent applications are pending covering among other achievements, a method and apparatus for management of individual cells in a battery system and the composition of the BMS as a cell, a microcontroller, a bleed-off resistor and an analog circuit with a powered gate.

No patents have been awarded yet, so any technological edge relied upon by Flux hinges on trade secret protection.  Many technology companies benefit from being able to sequester critical process knowledge within the group that cannot be duplicated even if an employee or two decides to go out on their own.  With only four years of experience behind it, Flux probably does not yet have that ‘technological fortification.’

Flux has yet to turn a profit.  Total sales in fiscal year 2012 were $5.9 million, of which $1.5 million was sidelined on the balance sheet as deferred revenue.  Investors should also note that $1.1 million of 2012 sales were to Epic Boats, which is 35% owned by Chris Anthony of member of Flux’s leadership.  Flux reported a negative 37% net margin in the year and used $2.2 million in cash to support operations.

It is no secret that cash is in short supply at Flux.  The company had $812,000 on its balance sheet at the end of June 2012, just after completing a $1.1 million private placement of 1.7 million shares of common stock and warrants.  Since the fiscal year closed Flux has raised another $950,000 and issued 2.3 million new shares.  A disclosure in the company’s annual report indicates Flux management plans to continue trying to raise capital.

Besides limited resources, Flux management has to worry about competition from a host of lithium ion battery producers.  Flux’s battery is not particularly differentiated from any other lithium ion offerings.  The company markets it as a lower-cost alternative to lead-acid batteries.

In the battery management space, Flux competes with Ricardo Plc and Atieva, Inc. , along with at least a dozen other developers.  Even electric vehicle producer Tesla Motors, Inc. (TSLA:  Nasdaq) has a BMS.  Also of note is International Rectifier (IRF:  NYSE), which markets an algorithm-based system for heavy duty battery applications under the brand name Evaira EMS.

Investors might note that Flux Power has spent $972,000 on research and development over the last two fiscal years.  Of course, the company acquired a good portion of its technology in 2009 from Gottlieb Inventions through the issuance of an unspecified number of options to acquire common stock.  Flux Power reported in its fiscal year 2012 annual report that Gottlieb owned at least 782,997 options with an exercise price of $0.04 per share.

Flux Power became public through a reverse merger earlier this year.  Insiders own 83% of the company’s 46.3 million shares outstanding, giving them complete control over the company’s strategic direction.  The control issue is made particularly salient given that there are a number of related party arrangements with customers and suppliers that are also control by members of management.  Two suppliers, Current Ways and LHV Power, are owned and/or managed by Flux’s CEO James Gevarges and Chairman of the Board Chris Anthony is a significant owner of Epic Boats, a customer.  At least insiders have signed lock-up agreements, which sequester their shares for eighteen months from the date of the reverse merger.  This gives minority shareholders some protection from a flood of shares coming on the market.

As a closely held company, it is not surprising that Flux Power shares rarely trade.  That leaves a wide spread between bid and ask prices and few shares available to build positions.  This is never a good situation for minority investors.  Flux Power has moved into the advanced battery market at top speed.  Investors will have to move at a much slower pace to accumulate FLUX positions. 

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

October 27, 2012

Altair Nano: Advanced Battery Sellout

by Debra Fiakas CFA

altairnano[1].png Advanced battery developers have not had an easy time of it in recent years, or at any time for that matter.  There have been three bankruptcy declarations this year alone.  Ener1 and A123 Systems (AONE:  OTC/PK) were rescued by deep-pocketed buyers, who scooped up technology, contracts and relationships.  In this second post in the series we look at another advanced battery sellout.

Altair Nanotechnologies (ALTI:  Nasdaq) has managed to avoid court rooms.  However, it did have to put itself up on the block, selling a majority of its shares to China-based Canon Investment Holdings.  Its operations will ultimately be moved to China, where the company plans to establish a manufacturing capacity.

Some investors might think there is no rush to lease a facility.  So far Altairnano has recorded only nominal product sales.  That said, the company does have customer relationships. Altair has a development agreement with AES Energy Storage, a subsidiary of AES Corporation (AES:  NYSE), and put two 1-megawatt large-scale battery systems for electrical grid applications.  The success of the demonstration helped Altair win two orders in the frequency regulation market.  Altair was chosen to supply a turn-key 10 MW advanced battery system for frequency control at a power station in El Salvador.  The project is waiting for regulatory approval.

Altair also has a long-term agreement with Proterra, Inc., the maker of heavy duty drive systems, to supply advanced lithium-ion battery modules for Proterra’s all-electric and hybrid-electric buses.  Proterra has big plans to scale production capacity to 1,500 buses per year.

Proterra accounts for a significant portion of Altair’s sales, which were $2.9 million in the twelve months ending June 2012.  The balance of sales was to Yintong Energy Company Ltd. in China.  YTE had been buying Altair’s proprietary nano lithium titanate materials and battery cells and purchased a one-megawatt ALTI-ESS system.  Materials purchases have been suspended indefinitely, but the agreement can come back to life with minimum materials purchases.

Altair recently entered into a joint marketing agreement with Indiana-based EnerDel, now privately held by a Russian investor.   The idea is to leverage respective contacts and product capabilities.  EnerDel’s claim to fame is a prismatic cell design and modular stacking architecture for its batteries.  Altair uses a proprietary nano-scale processing technology to create lithium titanate materials for battery anodes.  The chemistries lead to a battery life as much as ten times longer than conventional lithium ion batteries.  It also makes possible faster discharge and charge sequences.

Investors should note that Altair reports a deficit of $214 million, suggesting that it has managed to let slip through its fingers nearly all of the $246 million in capital investors have put into Altair.  The company has spent a pinch over $80 million to perfect its lithium titanate technology since the company’s inception in 2000.  The balance of the loss is associated with production, selling and administrative activities.

Altair has been awarded twelve U.S. patents and 42 foreign patents.  They are evidenced on the balance sheet at a whopping $312,000 in value.  With so little visibility in future sales and cash flows, that amount may not be far off the mark.

The company still has a bit of time to drum up new business and make good on its technology investments.  Based on cash usage in the last twelve months, it appears Altair needs approximately $15.0 million a year to stay in business.  Altair has $35 million in cash on its balance sheet, providing it with support for another two years.
 
Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

October 24, 2012

Last Battery Developer Standing

by Debra Fiakas CFA

battery clip artAdvanced battery producer A123 Systems, Inc. (AONE: Nasdaq) has flamed out, with the cinders of its lithium ion technologies snapped up by Johnson Controls, Inc. (JCI:  NYSE).  Much has been written in the financial press over the past few weeks about the fate of A123 and the next step by Johnson Controls.  What is more, because A123 had received government loan assistance, the political pundits have taken advantage of the company’s embarrassment to make their case for or against government in general and public alternative energy investment in particular.

What really has me wondering is what this turn of events means for the other upstart battery producers.

Two prominent advanced battery developers have sought bankruptcy protection already.  Ener1, Inc. (private, previously HEVVQ:  OTC/PK) filed for bankruptcy protection in early 2012.  Ener1’s operating subsidiary EnerDel survived through an acquisition by Russian investor Boris Zingarevich.  Valence Technology, Inc. (VLNCQ:  OTC/PK) filed for bankruptcy protection in July 2012, and is currently operate its business as a debtor-in-possession.  That final chapter in that story has not been written.

That leaves still standing at least three other developers which are attempting to commercialize advanced battery technologies:  Altair Nanotechnologies, Inc. (ALTI:  Nasdaq), privately-held Winston Battery in China and Maxwell Technologies, Inc. (MXWL:  Nasdaq).  Flux Power Holdings, Inc. (FLUX:  Nasdaq) is another recent entrant to the lithium ion race.  Maxwell Technologies, Inc. (MXWL:  Nasdaq) is trying to challenge all the lithium ion battery makers with ultracapacitors. 

A123 Systems spent $186 million on research and development over the last three and a half years and ran up a $329.1 million loss on $151.9 million in sales in the company’s last fiscal year ending June 2012.  Numbers like those could lead an investor to suspect mismanagement.  Have the others operated with greater prudence?

In a new series on advanced battery technologies, we will look at spending on research and development by these companies and make some comparisons of operating strategies.   
 
Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

October 01, 2012

Energy Storage: Q4 2012 Winners and Losers

John Petersen

In late June I wrote a forward looking article that identified several companies in my energy storage and vehicle electrification group that I expected to perform well or perform poorly during the third quarter. Since short-term market changes are notoriously hard to predict, it’s worthwhile to look back and see where I got things right and where I got them wrong. So I’ll start today with a quick summary table and assess the relative accuracy of my Q3 calls, and then turn my attention to Q4, which is shaping up as a time of bright opportunity for some companies and continuing risk for others.

9.30.12 Q3 Performance.png

My list of expected Q3 winners included Exide Technologies (XIDE), Active Power (ACPW) and Axion Power International (AXPW.OB). I was wrong on all three counts because Active Power lost 1.2%, Exide Technologies lost 7.7% and Axion Power lost 20.6%

My list of expected Q3 losers included Valence Technologies (VLNCQ.PK), which lost 98.4% when it filed a voluntary petition under Chapter 11 of the Bankruptcy Code, and Tesla Motors (TSLA), which lost 6.4%. While I was right on both counts, Tesla didn’t perform as poorly as I expected and just last week it completed a $195 million secondary offering that should keep it out of the ditch for a couple more quarters. While I rarely have glowing praise for Tesla’s business model or product line, its management team deserves double kudos for pulling off a critical eleventh hour financing transaction on better terms than I would have thought possible.

Q-4 Winners

Exide Technologies was on my list of likely Q3 winners and it remains on my list of likely Q4 winners. Over the last five years, Exide has reported total earnings of roughly $35 million after restructuring and impairment charges of almost $210 million. Since its earnings were so bad for so long, Exide trades at a 10% discount to book value and 8% of sales while its peers trade at an average of 1.6 times book and 44% to 70% of sales.

I maintain long-term price tracking charts on all the companies I follow and believe Exide's chart is signaling a turn to the upside in the fourth quarter. If you look at the chart you'll see that the 10-, 20- 50- and 200-day weighted moving average prices are clustered in a $0.13 range and during the third quarter the 10-, 20- and 50-day averages all moved up through the 200-day average, signaling the beginning of a new trend. Similar chart patterns existed in the summer of 2009 and the fall of 2010. While I'd be reluctant to estimate the next peak, Exide's past performance is enough to convince me that a double is likely and a good deal more is possible.

9.30.12 XIDE.png

Active Power was on my list of likely Q3 winners and it remains on my list of likely Q4 winners. Since the end of June the 10-, 20-, 50- and 200-day averages have all drifted down a couple cents and are currently clustered in a two-cent range. Active Power's historical stock price behavior is enough to convince me that a double is likely, if not a triple.

9.30.12 ACPW.png

Axion Power International was on my list of likely Q3 winners and it remains on my list of likely Q4 winners. The last couple years have been very difficult for Axion as one legacy holder after another decided to liquidate for reasons that had little or nothing to do with Axion’s business and technical progress. As near as I can tell the legacy holders, as a group, are down to something less than a million shares. Since much of the buying over the last couple years has come from readers of my blog, I expect the market dynamic to quickly reverse from a supply driven downtrend to a demand driven uptrend. In addition to price data like I provided for Exide and Active Power, my Axion chart includes a fifth line that tracks 50-day average trading volume to highlight periods of intense selling pressure since January 2010.

9.30.12 AXPW.png">

Last week I had the pleasure of delivering a keynote presentation for the 13th European Lead Battery Conference in Paris. For readers who are interested, an online version of my ELBC presentation with voiceover is available here.

While other lead battery manufacturers who presented at the ELBC talked about improving their charge acceptance rates from 0.05 to 0.1 amps per amp-hour of rated capacity, Axion was presenting charge acceptance rates of 2.0 to 3.0 amps per hour of rated capacity with four to five times the cycle life. These are not modest incremental gains like one typically sees in the battery world. Instead, they’re disruptive step changes that have several first tier OEMs and battery users making substantial direct investments in the kind of redundant validation testing that always precedes the adoption of a new technology for use in mass market products. While Axion’s PbC is not a silver bullet for all battery applications and the company still faces a variety of manufacturing, commercialization and financing risks, the principal technical risks of developing an entirely new class of energy storage device have, in my view, been successfully overcome.

In addition to my three primary picks, I’m seeing interesting chart patterns develop for Altair Nanotechnologies (ALTI), Johnson Controls (JCI), Maxwell Technologies (MXWL) and UQM Technologies (UQM). The stock prices for all four of these companies have been beaten down this year and could well be poised for a turnaround.

Q-4 Losers

The scariest company in my tracking list is A123 Systems (AONE) which peaked shortly after its IPO and has been on a downhill slide ever since. In May and June of this year, A123 announced a pair of toxic financing deals that had variable conversion rates and seemed likely to be highly dilutive. In August A123 announced that China’s Wanxaing Group had agreed to provide up to $450 million of additional financing in exchange for an 80% ownership stake. The combination of these three transactions has had A123 printing stock faster than the Fed prints money ever since.

On June 30th A123 had a total of 147 million shares outstanding. By August 6th the total had climbed to 170 million and by August 23rd the total had climbed to 202 million. The reason for the explosive ramp in the number of shares outstanding was a decision to leave the toxic securities in place, instead of redeeming them, and to alter the terms of the Wanxaing financing to provide for a variable conversion rate that’s tied to a percentage of ownership rather than a fixed stock price.

During the period from June 30th through August 23rd, total reported trading volume in A123’s stock was 305 million shares, or roughly 5.5 times the number of newly issued shares. Since August 23rd, another 491 million shares have traded. Since it’s impossible to tell whether the proportionality between new share issuances and total trading volume has held steady over the last three months, it’s also impossible to estimate the total number of shares currently outstanding. At a minimum I’d expect A123 to report 300 million shares outstanding on September 30th, but the actual number could be far higher. Based on the terms disclosed for the Wanxaing transaction, that would imply a fully diluted share count in the 1.5 billion range.

9.30.12 AONE.png

In light of the production problems it’s experienced to date and a recent brush with insolvency that will be clearly visible on the face of its September 30th financial statements, I continue to believe that Tesla Motors will soon pass its peak of inflated expectations and begin a descent into the Valley of Death that resembles the A123 experience. I don't want to denigrate Tesla's accomplishments as the first fledgling automaker to bring a new car to market since DeLorean, but it seems like all of the possible good news is already priced into Tesla's stock while the bulk of the execution risks and disappointment opportunities have become frighteningly imminent.

I get hundreds of comments every time I mention Tesla's name. The enthusiastic readers I hear from expect rave reviews, expect high reservation conversion rates, expect demand to skyrocket, expect the Model S to perform flawlessly in heavy daily use and expect Tesla to avoid the delays, defects and missteps that plague even seasoned manufacturers who launch a completely new product. I may be cynical when it comes to the applicability of Moore's Law in the battery and auto industries, but I'm a firm believer in Murphy's Law, fondly known as the fourth law of thermodynamics, which states: "If anything can go wrong, it will."

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

September 22, 2012

Exide Technologies: Anatomy of a Mistake

Tom Konrad CFA

On June 1st, in the lead up to Exide Technologies’ (NASD:XIDE) first quarter earnings announcement, I made one of my better calls so far this year.  I wrote that the Exide stock was in the “bargain basement” and “ready to pop.” That day, XIDE traded in a range of $2.25 to $2.36, within spitting distance of its 52 week low of $2.22.  Four months later, the stock is up 45% at $3.25, despite two earnings misses in the meantime.

My Mistake

Unfortunately, I missed out on a good chunk of that gain.   A week later, Exide announced disappointing first quarter earnings, but the stock popped.  The company had made good efforts reducing expenses and improving operating margins in its reorganization, and cash flow was also improving, but this did not seem sufficient to explain the big stock price pop when we would normally expect at least a small price decline.

I eventually settled on the theory that it was due to some press confusion between XIDE and Indian auto parts manufacturer Exide Industries (NSE:EXIDEIND, BSE:EXIDEIND,) combined with short covering.  I sold my stock at $2.80 in the expectation that the market would soon sort this out, and another buying opportunity in the low $2 range would soon emerge.

I was wrong.  Over the last five months, XIDE only briefly fell below $3, because of another negative earnings surprise in August and accompanying analyst downgrades.  Yet XIDE resumed its rally, propelled by recent news like a new contract with Pep Boys (NYSE:PBY).

What Really Happened

I think I was right about the stock pop, but I was not the only one to spot Exide as a turnaround story.   Despite the unexpected rise in June, Exide was still a good value at $3, as I wrote in a comment to a reader.  While I was expecting short term market dynamics to propel the stock down, analysts at Wedbush raised their price target and a prominent newsletter upgraded Exide as well (I read about this in an news interview with the newsletter writer a month later, but unfortunately, I can no longer find a copy of the article or recall which newsletter.)

Eventually, I repurchased my stake at an average price of $3.07.

Conclusion

My decision to trade XIDE on short term market dynamics cost me 12% of the potential 45% gain so far from my June 1 call.  This is why I usually avoid short term trading: it adds to expenses, and new information (in this case the upgrades) can lead to rapid changes in market dynamics.  I’ll try to remember that next time I come up with an equally compelling story explaining short term market dynamics.

Disclosure: Long XIDE

This article was first published on the author's Forbes.com blog, Green Stocks on September 6th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

August 19, 2012

A123′s Deal With China’s Wanxiang Would Value the Stock at $0.55 a Share

Tom Konrad CFA

320px-A123_Systems_cell_family_high_rez[1].jpg
A123 Systems battery cell products (Source: A123)

 It was no secret that A123 Systems (NASD:AONE) was desperate for money.  It’s also no secret that Chinese companies are interested in buying Western companies, especially when they can acquire useful technology in the deal.  So this morning’s announcement that Wanxiang Group Corporation, a Chinese largest autoparts manufacturer which has significant US operations, had signed a non-binding memorandum of understanding to invest up to $450 million in A123 through a combination of bridge loans, convertible notes, and warrants seems like good news for both companies.

A123′s stock rallied initially on the deal, but has since fallen back.  As I write, the stock has fallen back to $0.48, up only one cent from yesterday’s close.  The lack of gain puzzled me, especially since A123′s liquidity problems are the main reason it’s been trading at it’s current depressed level at 37% of book value ($1.27 a share.)

While regulatory and shareholder approvals need to be met, and some existing convertible notes will need to be repurchased and retired, it seems likely to me that this deal will go through.   Although the US government has a track record of paranoia when it comes to the Chinese,  regulators have to know that A123 will likely go bust without a big injection of liquidity, and American investors have not exactly been pounding on A123′s doors.

If the deal is not blocked, I expect Wanxiang will make the whole investment.  After all, this investment for Wanxiang is almost certainly about acquiring A123′s technology and business contacts at a discount, not about short term cash flow.  Weiding Lu, CEO of Wanxiang Group, said,

A123 offers industry-leading technology for vehicle electrification and grid-scale energy storage, as well as strong manufacturing and systems engineering capabilities in Michigan and Massachusetts. We think this creates important synergies with Wanxiang, which has been involved in this field for 12 years and has strong R&D and manufacturing capabilities in China, especially as we continue to expand on our strategy of investing in the automotive and cleantech industries in the U.S.  This MOU is the first step toward a longer-term agreement through which we plan to build on the foundation A123 has established in the U.S. and help expand the company’s capabilities both domestically and internationally, which we believe would create long-term value to the customers, investors and other stakeholders of both companies.

Since I think Wanxiang is likely to make the full investment, I think the price they are likely to pay is a good short term target for AONE stock.  As long as the stock is lower than that, Wanxiang will have an incentive to buy the stock on the open market, rather than exercising their conversion option or warrants, which should provide price support.

Reading the details of the release, $75 million of the investment is to be a short term bridge loan, which does not involve the purchase of A123 stock.  The rest is to consist of $200 million in convertible notes (which can become stock) and $175 million which might be invested with the exercise of warrants.  An exercise of all these warrants and the full conversion of the convertible notes would result in Wanxaing controlling 80% of the company, or about 680 million shares, based on the 170 million shares A123 had outstanding at the end of July.  Doing the math, and assuming that the initial $75 million bridge loan is not used to purchase shares, that’s 55 cents a share.

The current price of $0.48 makes a certain amount of sense, but unless this deal is blocked, Wanxaing has indicated its interest in buying A123 at $0.55 a share, which should put a nice floor under the share price, along with a lot of potential upside as the deal gives A123 new financial stability to execute on existing opportunities and tackle new opportunities in China.

It may also be the case that the conversion price of the notes is not the same as the exercise price of the warrants.  If that’s the case, then some of the expected note conversion or warrant exercise would have to take place above $0.55 a share, and this would in turn increase Wanxiang’s incentive to buy stock on the open market.

Given all that, I just bought a little A123, which I expect to rally as the various barriers to this deal are overcome.  It’s still a small investment, since there is still no guarantee that the deal will go through, and if, for some reason the deal does not got through, AONE will almost certainly continue its slide.

UPDATE: After reading this article, I decided that Petersen is right, and any investment in A123 bears careful watching.  Since I was going on vacation, I sold my stake at a small profit.

Disclosure: None.

This article was first published on the author's Forbes.com blog, Green Stocks.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

August 10, 2012

The Wanxiang Transaction Is Not Necessarily A Permanent Solution For A123's Problems

John Petersen

On Wednesday A123 Systems (AONE) announced the execution of a Non-binding Memorandum of Understanding with the Wanxiang Group that will, if successfully implemented, restore A123 to a sound financial footing. Since the basic deal terms are a good deal more complex than the reports one reads in the mainstream media, I think a drill down into the detail may be helpful for investors who want to understand what a restructured A123 will look like. The critical document for this analysis is the MOU included as Exhibit 99.2 to A123's recent report on Form 8-K.

The basic business deal has three distinct structural elements:
  • A $75 million senior secured bridge loan facility with associated warrants;
  • A $200 million senior secured convertible note financing; and
  • A block of warrants that will, if exercised, generate up to $175 million of additional equity.
The bridge loan facility will be secured by substantially all of A123's assets and has been separated into two tranches. The first $25 million, which includes $15 million in cash and a $10 million letter of credit, will be immediately available to A123 upon execution of definitive agreements. The $50 million balance will be funded when certain first tier conditions are satisfied, including:
  • receipt of a favorable determination from the Committee on Foreign Investment in the United States;
  • receipt of Chinese government approvals;
  • retention of the R&D and engineering teams; and
  • other usual and customary conditions.
Barring a mass exodus of the R&D and engineering teams, I think there's a high probability that the entire $75 million bridge loan facility will become available to A123 over the next couple months; Wanxiang will obtain a reasonable level of de facto control; and A123 will get enough breathing room to finish a more comprehensive restructuring.

The senior secured convertible note financing will be more complicated and time consuming. Wanxiang's commitment to buy $200 million in notes is subject to several second tier conditions, including:
  • reasonable assurances that A123's government grants and tax credits will remain available;
  • stockholder approval of the restructuring transaction;
  • conversion or repurchase of at least 90% of $143.8 million in convertible notes that were issued in April 2011;
  • conversion or redemption of the $50 million in convertible notes that were issued in May 2012;
  • an increase of the number of directors from seven to nine and the election of four directors designated by Wanxiang;
  • compliance with Hart-Scott-Rodino and other antitrust laws; and
  • continued listing of the Common Stock on Nasdaq.
It's clear from the MOU that the retention of A123's government grants and tax credits is a critical valuation issue. If the grants and credits remain in place, the exercise price of the bridge financing warrants will be $0.425, but the exercise price will be reduced to $0.17 if the grants and tax credits are lost. Similarly, the conversion price of the senior secured notes and the exercise price of the related warrants will be $0.60 per share if the grants and tax credits remain in place, but they'll both be reduced to $0.24 if the grants and tax credits are lost.

Under the circumstances, I think A123 will probably get the necessary government assurances and approvals. It should also be able to negotiate the redemption or repurchase of its outstanding debt on reasonable terms. While investors may grumble, particularly if the proxy statement for the required stockholder approvals includes a reverse split to solidify A123's Nasdaq listing, there really isn't an alternative so they'll eventually go along.

While the series of transactions have been described as a $450 million rescue in media reports, the only funds Wanxiang will be required to invest are $75 million for the bridge loan facility and $200 million for the senior secured convertible notes. If one assumes that no additional shares will be issued in connection with A123's outstanding convertible debt, the bridge loan warrants will give Wanxiang the power to obtain 51% voting control by tendering that debt in payment of the exercise price. While conversion of the notes would increase Wanxiang's voting control to 75% if it chose to exercise its rights, a reasonable risk manager could conclude that voting control coupled with $200 million in secured debt was a more advantageous position for Wanxiang given the uncertainties of A123's business.

I've always believed that prudent investing begins with a worst case analysis. In the A123 - Wanxiang transaction I believe the worst case is a $75 million equity infusion that will increase A123's book value to $188.8 million, or $0.544 per share, and give Wanxiang voting control. While the $200 million senior secured convertible note financing will increase A123's liquidity, a substantial portion of the cash will be used to redeem or repurchase A123's other debt securities.

I believe it's safe to assume that the holders of the $143.8 million in convertible unsecured subordinated notes that A123 issued in April 2011 will be willing to accept a haircut in connection with an early redemption. I don't, however, have any basis to predict what the haircut might be. While holders of the $50 million in convertible unsecured senior notes that A123 issued in May 2012 might also be willing to accept a haircut in connection with an early repayment of the $39.6 million balance, I'd expect their negotiating position to be more aggressive. In a worst case scenario, the bulk of the $200 million in proceeds from Wanxiang's senior secured convertible note financing will be used to retire junior debt.

On balance I believe the Wanxiang transaction is a positive development for A123's stockholders because it will stop the issuance of additional common shares under the 2012 notes and help alleviate the intense selling pressure that's resulted from the issuance of 23.4 million new shares since June 26th. It will also restore A123's stockholders equity to a more reasonable level and give the company time to restructure its affairs. The transaction is not, however, a permanent solution to A123's problems and any number of uncertainties are yet to be resolved.

While I don't see anything in the deal structure that would justify a rush to the exits. I believe investors who decide to hold or buy A123's stock must pay careful attention to future releases that quantify the current uncertainties. This is not a good time for irrational exuberance.

Disclosure: None.

July 28, 2012

A123 Systems, An Object Lesson In Toxic Financing

John Petersen

July has been a ghastly month for stockholders of A123 Systems (AONE) who've watched in horror as the stock price collapsed from $1.30 on July 5th to $0.49 at Friday's close. While there was unfavorable news of a director resignation yesterday, all the other news over the last month has been positive, at least at first blush. In my view the market activity was both predictable and directly attributable to recent toxic financing transactions that will have A123 printing stock faster than Ben Bernanke is printing dollars for the foreseeable future. I'd love to be able to tell A123 stockholders their pain is over, but it's not.

Toxic note and warrant financing

On May 11th, A123 announced that it had closed a $50 million offering of convertible notes and warrants. The principal was payable in 26 semi-monthly installments commencing on July 1, 2012 and could, at the company's option, be settled with cash or with shares of A123's common stock valued at the lesser of $1.18 per share, or 82% of the volume weighted average price, or "VWAP," of the common stock for the five trading days immediately preceding a settlement date, but in no event greater than the VWAP of the common stock on the last trading day before the settlement date.

Since the number of shares issuable upon conversion of the notes and exercise of the warrants exceeded the limits of A123's Certificate of Incorporation and the transaction required formal shareholder approval under Nasdaq listing rules, $30 million of the offering proceeds were deposited in a segregated bank account pending:
  • Stockholder approval of the note and warrant transaction;
  • Stockholder approval of an increase in the company's authorized shares; and
  • Effectiveness of a resale registration for the common shares underlying the notes warrants.
The necessary stockholder approvals were received on June 29, 2012 and the resale registration statement was declared effective as of 4:00 p.m. on July 5th. By the time the registration statement was declared effective, the payment terms had been modified slightly to increase the number of installments to 29 and increase the amount payable in each of the first three installments to 1-2/3 the base amount, but the other terms remained unchanged. The segregated funds were promptly released to the company.

The notes are a classic example of "death spiral financing" where payments are made with discounted shares of common stock and the number of shares required for a payment increases as the stock price declines. At an assumed stock price of $1.30 a share, A123 would be able to make a $2 million installment payment by issuing 1,876,173 new shares of common stock. At an assumed stock price of $0.65 a share, it would take 3,752,345 new shares of common stock to make the same $2 million payment. In both cases, the market value of the stock used to make the payment would be about $2.4 million, but only if the noteholder who received stock instead of cash sold quickly enough to capture the current market price.

Toxic equity financing

On July 6th A123 announced that it had signed agreements to sell 7,692,308 shares of its common stock, together with warrants to purchase additional shares of common stock, for gross proceeds of $10.0 million. While the press release had the look and feel of an ordinary financing transaction, I was troubled by a sentence that said, "The number of shares of Common Stock issuable upon exercise of the warrants (which have a nominal exercise price) is based on a fixed 18% discount to the volume-weighted average price, or VWAP, of our common stock on specified trading days during two measurement periods over the next three weeks." Since I was surprised that the offering went off without an obvious discount to the previous day's closing price, I decided to dig a little deeper in an effort to better understand what the "real deal" was.

I found my answers in the SEC registration statement for the equity offering, which included copies of the Prospectus and the associated warrant agreement.

When I read the Prospectus I learned that the "nominal exercise price" of the warrants was $.001 and the structure included an automatic cashless exercise for the warrants. So the investors were effectively buying 7.7 million shares on day one and expecting to receive two additional tranches of "free shares" on the 12th and the 30th of July.

Using the formulas in the Prospectus and warrant agreement, I calculated that 843,628 additional shares would be issued in each tranche if the market price remained stable at $1.30 per share through the exercise dates. By the time I accounted for the warrants, it was clear the original deal would result in the issuance of 9,379,564 shares for gross proceeds of $10 million, or an effective price of $1.07 per share.

In light of A123's recent troubles, I didn't find a discount of 18% from the market price particularly troubling. I was, however, concerned that the terms might create an incentive for aggressive investor behavior, so I made a mental note to re-run the numbers at the end of the month to see how it all worked out.

The outcome was a textbook example of what can happen when the number of shares to be issued in the future is contingent on the future market price of the underlying stock.

During the period between the closing date and the first warrant exercise date, A123's price fell to $0.88. So the VWAP used to calculate the number of free shares issuable to warrantholders was approximately $0.9167 instead of $1.30. When I ran that VWAP value through the calculations specified in the Prospectus and warrant agreement, I got to a net cashless issuance of 2.8 million shares, compared to the 843,628 shares that would have been issued if the price had stayed stable.

By the second warrant exercise date, A123's price had fallen to $0.49. So the VWAP used to calculate the number of free shares issuable to warrantholders was approximately $0.5367 instead of $1.30. When I ran that VWAP value through the calculations specified in the Prospectus and Warrant Agreement, I got to a net cashless issuance of 7.5 million shares, compared to the 843,628 shares that would have been issued if the price had stayed stable.

Between the original issuance and the two warrant tranches, A123 ultimately sold 18 million shares of common stock for gross proceeds of $10 million, or an effective price of $0.56 per share. The market did not respond well to the rapid increase in the number of shares in the hands of willing sellers.

An Excel spreadsheet with the key Prospectus disclosures and important warrant agreement terms, along with market price data and detailed exercise price calculations can be downloaded from my Dropbox.

What it means for stockholders

My first, last and only experience with a price linked conversion formula was in the late 80s when one of my clients sold a preferred stock that was convertible into common stock for 75% of the market price on the conversion date. The investor that provided the financing proved to be far less friendly than management expected. A few months after the offering the investor grew disenchanted with the way things were going. Instead of selling its preferred stock, it began to aggressively sell common stock into the market, which drove the price down to a very distressed level. It then converted the preferred stock into common stock for 75% of a bargain basement price. By the time the smoke cleared, the investor was my client's biggest stockholder and management was seeking new employment.

I've seen dozens of comparable proposals since then and my clients have wisely rejected them all.

The big problem with price linked conversion ratios is that aggressive selling behavior has no negative consequences for the investor. If aggressive selling drives the price down, the investor simply gets more shares at an even lower price. The outcomes aren't always catastrophic for existing stockholders, but they're invariably painful.

Over the last couple months, A123's financing activities have created two scenarios that are likely to result in a year of market problems. While the worst may be over from the equity offering, it's impossible to tell whether the warrantholders have already sold the 7.5 million shares that will be credited to their accounts on Monday. While the equity offering was a problem because it created two discrete opportunities for aggressive selling, the debt offering created 26 opportunities that will come along every other week for the next year.

I'm usually bullish on stocks that have been beaten down to unreasonably low levels by misfortune and unforeseen events. In A123's case, however, the financing structures the company put in place to help it overcome its business problems have created a toxic supply overhang that virtually guarantees significant future price erosion.

Under the circumstances, I believe A123 is not a suitable investment for anybody but professionals.

Disclosure: None

July 17, 2012

EVs, Batteries and Tales From The Valley of Death

John Petersen

Today is the fourth anniversary of my blog on investing in the energy storage and electric vehicle sectors. Over the last four years I've penned 275 Articles and 45 Instablogs on topics ranging from technical minutiae to broad macroeconomic trends. Since most of my work focuses on challenges and risks instead of lofty and optimistic goals, I'm often derided as a curmudgeon who doesn't understand the dream. Truth is I've been a guide in the Valley of Death for over thirty years and while I love panoramic scenery, I can't overlook the dangers of old mine shafts, cactus patches and the poisonous critters that live in the valley. So I while occasionally gaze in awe at the majesty of the landscape, my big concern is always the next step.

The scary part is knowing that companies I praise rarely live up to my lofty expectations but companies I criticize always perform worse than I think they will.

Most companies that enter the Valley of Death don't emerge. For the fortunate few that do, the difficult times usually last longer than anyone expected. The single character trait all entrepreneurs share is unbridled optimism. The three character traits all survivors share are determination, focus and fiscal restraint. The following graph from Osawa and Miyazaki is a stylized view of the cumulative losses companies suffer as they transit the Valley of Death.

7.17.12 Valley of Death.png

The next graph from the Gartner Group is a stylized view of the Hype Cycle, a well-known but frequently misunderstood market phenomenon that gives rise to extreme overvaluation during a company's early stages that’s frequently followed by a period of extreme undervaluation in later stages when the major development and commercialization risks have been overcome, cash flows are about to turn positive and stockholders have grown so weary of waiting for good news that they're willing to sell at distressed prices despite improving business fundamentals.

7.17.12 Hype Cycle.png

The graphs are not perfect overlays on a horizontal time scale, but they're close, and that's where the dangers lurk. The reason for the differences between the two graphs is a curious split personality of investment markets that was first described by Benjamin Graham who observed, "in the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine." Stock prices always peak in early stages of a product launch because the dream is so beautiful. At the Peak of Inflated Expectations, the voting machine personality is firmly in control. When the day-to-day difficulties of building a successful and sustainable business become obvious prices begin an inexorable slide into the Trough of Disillusionment. As they reach the bottom of the trough, the weighing machine personality assumes control.

In combination, these graphs are the reason for Warren Buffet's oft quoted wisdom that "Investors should remember that excitement and expenses are their enemies, and if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful."

That's why truly successful investors who understand the Valley of Death usually follow one of two strategies:
  • Venture capitalists buy during the Innovation Trigger and plan on selling during the Peak of Inflated Expectations.
  • Vulture capitalists buy during the Trough of Disillusionment and plan on holding for the long term.
Everybody else is betting on the greater fool theory of investing which holds that no matter the price paid by a fool, there will always be greater fool who's willing to pay an even higher price. The lucky ones can make a few bucks but those who press their luck frequently learn the identity of the greatest fool of all.

As I confessed above my record at predicting short-term success is spotty at best and many companies that I've praised over the last four years have been mired in muddle through survival mode for longer than I would have thought possible. With the sole exception of C&D Technologies, however, they've all survived and they continue to make solid business progress. Companies in the survivor group include Active Power (ACPW), Exide Technologies (XIDE), Maxwell Technologies (MXWL), ZBB Energy (ZBB) and my old teammates at Axion Power International (AXPW.OB). These companies have all had their ups and downs, but they've avoided catastrophic errors and grown their businesses through determination, focus and fiscal restraint. I continue to believe that all five will emerge from the Valley of Death as formidable competitors in their respective sub-sectors and provide market-beating returns for patient investors.

Turning to the other side of the ledger, my track record has been flawless when it comes to identifying companies that were riding the Hype Cycle but unlikely to survive the Valley of Death. Beacon Power, Ener1 and most recently Valence Technologies (VLNCQ.PK) were complete and utter failures that ended up in Chapter 11. Altair Nanotechnologies (ALTI) avoided a total loss by selling control to a Chinese company after its stockholders lost 90% of their value. A123 Systems (AONE) is on the deathwatch and seems unlikely to survive the year after watching its market capitalization shrivel from $2.3 billion in December 2009 to $123 million at yesterday's close. The one trait they all shared was an errant belief that the glory days would last forever and that bullish press releases could obviate the need for determination, focus and fiscal restraint.

Over the last several months I've become increasingly vocal about the risks Tesla Motors (TSLA) faces as it launches its first credible consumer product and begins a long and arduous trek through the Valley of Death. Adherents and advocates are certain that I don't understand the dream. Truth is I understand the dream perfectly but I know that no company can overfly the Valley of Death on the wings of a dragon. The only way through the valley is on foot in sweltering heat.

At March 31st Tesla had $123 million in working capital and $154 million in stockholders equity. Unless it slashed spending during the second quarter, its June 30 financial statements should show working capital and stockholders equity of roughly $65 and $85 million, respectively. At yesterday's close, Tesla's market capitalization was an eye-watering 45 times its estimated net worth, or about ten times higher than it should be at this stage in the company's development.

Tesla is entering the most cash intensive period in its business history where it will have to make cars instead of talking about them. Unless management acts quickly, Tesla will run out of cash this quarter. I was surprised that Tesla didn't close a substantial capital raise during the second quarter because its financial statements were looking so weak at the end of March. Now that we're two weeks into July with nary a peep about additional fund raising, I have to believe Tesla is facing difficult market conditions and significant investor skepticism over immediate execution risks that can't be overcome with happy talk. The potential investors have the upper hand in this particular waiting game because they know that Tesla is trapped between the rock of a down-round financing and the hard place of a going concern qualification on the Form 10-Q it has to file by August 9th.

The clock is ticking.

As a long-term guide in the Valley of Death I've been in that position before and know how the game is played. This is not an opportune time for retail stockholders who aren't paying attention to the carrion birds circling overhead.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

July 04, 2012

When Will Polypore Payoff?

by Debra Fiakas CFA

 
Diagram_of_a_battery_with_a_polymer_separator[1].jpg
Diagram of a battery with a polymer separator.
Lithium ion batteries make it possible to recharge your smart phone, camera and a multitude of other have-to-have-with-us-every­-moment devices.  Yet the average person knows very little of the inner workings of something so important to our daily lives.  One little item in a battery is a highly specialized membrane that fits neatly between opposing electrodes  -  the positive and negative poles that make an electrical charge.  This membrane manages the charge and discharge process.

These membranes are so vital and the technology so particular, battery makers rely on membrane experts like Polypore International, Inc. (PPO:  NYSE).  Polypore operates under the Celgard and Daramic brands in this market.  Last year Polypore announced a $105 million expansion of its lithium ion separator manufacturing capacity.  The expansion is expected to be completed in 2013 and become operational in 2014.  Polypore had already expanded production capacity for its polyethylene battery separators used in lead-acid batteries.

With demand for batteries increasing each year, the news should have ignited shareholders.  Instead Polypore shares are trading 46% off the 52-week high.  High net profits and strong cash flows cannot be the problem.  Polypore earned $98.3 million in net profit or $2.08 per share on $751.1 million in total sales over the last year.  Operations generated $137.0 million in cash.  That represents a net income margin of 13.1% and a cash conversion rate of 18.2%.

Shareholder’s tepid response to expansion could be Polypore’s balance sheet.  At the end March 2012, long-term debt was $706.2 million, making Polypore’s debt-to-equity ratio 1.33.  That may not seem particularly weighty, but cash stood at a paltry $79 million.  For some investors, Polypore may appear to have a little financial flexibility.

If there was a time that Polypore needed to be agile it is now. The company has competitors coming at it from all sides.  Besides energy devices, Polypore’s membranes are used for filtration in medical devices such as those that perform hemodialysis and blood oxygenation processes.  Polypore’s filtration membranes also have applications for industrial equipment to clean sub-micron particulates from liquids or gasification processes.  Polypore has competitors in each group.  Asahi Kasei Chemicals Corporation based in Japan is one of the few that competes in with Polypore in all markets.

PPO is currently trading at 19.4 times trailing earnings.  However, analysts following Polypore have plenty of enthusiasm for the company’s future.  They have pegged next year’s earnings at $3.09 per share, implying a forward price earnings ratio of 13.1.  That is a compelling valuation for a stock with a beta of 0.45.

I do not have a precise timing for when Polypore shares will pay off for investors.  However, at the current depressed price level should give investors with the patience for a buy-and-hold strategy to find out.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. PPO is included in the Storage Group of Crystal Equity Research’s Mothers of Invention Index.

June 30, 2012

Energy Storage: Q-2 2012 Review and Analysis

John Petersen

While I jumped the gun last week and published my third quarter outlook for the energy storage and vehicle electrification sectors early, it's worthwhile to take a look back and see how my tracking list of companies performed over the last quarter and examine the past to see what the tea leaves in the bottom of the cup portend for the coming quarter. So without further delay I'll present my price performance table for the second quarter that ended on Friday.

6.30.12 Price Table.png

Q-2 was a dreadful quarter for Maxwell Technologies (MXWL) and ZBB Energy (ZBB) as their prices fell by 64% and 41% respectively. While the declines were precipitous, they were also one-off events and I believe both companies are trading at very attractive prices for investors who want to position their portfolios for the mean reversion upswing that usually follows fast on the heels of a painful downturn. My long-term tracking charts for both companies show distinct bottoms forming and I believe they're both likely to trend up for the rest of the year.

It was also an ugly quarter for UQM Technologies (UQM), Valence Technology (VLNC) and Tesla Motors (TSLA). While I believe UQM is attractively priced, I'm convinced that Valence and Tesla are only seeing the beginning of storms that are likely to get more severe through the summer and fall months.

The following table tracks several key financial metrics for the companies I follow. Today I'll try to explain why I track this data and show how I use peer group comparisons to identify stocks that are either overvalued or undervalued. If you want to understand the balance of this article, you should pay close attention to the table instead of simply blowing past the data and focusing on the words.

6.30.12 Metrics Table.png

The first metric I consider when analyzing any company is working capital adequacy. I see development stage companies that don't have at least twelve months of working capital as problem children because as sure as the sun will rise tomorrow, they'll be going back to the market for more money within a few months. The two companies with the worst working capital positions are A123 Systems (AONE) and Tesla. Both had less than six months of working capital at March 31st, even after adjusting A123's numbers for a recent $50 million toxic debt offering, and both will look truly dismal when their June financial statements are released in early August. Wunderlich Securities recently cut its price target on A123 to $0.50 and I think they're being generous. Absent a major turnaround, I expect A123 to follow the path blazed by Solyndra, Beacon Power and Ener1. While Tesla has a couple more financing rounds left in its bag of tricks, I don't expect the terms to be particularly generous to existing stockholders because the execution risks are so massive and so immediate.

The second financial statement metric I key on when trying to distinguish overvalued from undervalued is the difference between a company's market capitalization and its book value. That number is a good proxy for the value the market puts on a company's technology, customer base and other intangibles that don't show up on the balance sheet. When the market premium is a low or negative number, it indicates either opportunity or risk. When market premium is an objectively high number, it's a sign of extreme price risk – much like a robotic voice screaming "Danger Will Robinson, Danger!"

Turning to the table, A123 is trading at a modest discount to book value that doesn't fully reflect the risks it will face over the next six months as it tries to recover from a simple calibration error that gave rise to roughly $70 million in warranty costs and inventory write-offs. A123's cash needs will be huge and the best they could do in their last financing round is a death spiral note that's payable bi-monthly and convertible at 85% of market. Possible future product offerings in the micro-hybrid and aviation markets aren't even interesting because neither is soon enough or large enough to materially improve A123's operating results over the short-term.

Next on the list is Valance technology, which has had a deficit in its stockholders' equity for years. A bad capital structure has finally caught up with Valence and it will probably lose its Nasdaq listing sometime in July. Valence's LiFePO4 battery technology is proprietary, but it's not all that different from A123's proprietary LiFePO4 battery technology. With both companies needing major equity infusions, I see more risk in Valence than I do in A123 because the market values its technology, customer base and other intangible assets at a $167 million premium to A123. Frankly I just don't see a good reason for the discrepancy.

The only company in the table with an obviously low market premium is Exide Technologies (XIDE) which trades at a 35% discount to book value because the market has grown weary of exaggerated losses flowing from a multi-year business restructuring that's finally coming to an end. Once the bleeding stops, I expect Exide to perform very well.

On the extreme bleeding edge of the market premium spectrum we have Tesla which trades at a silly level of 21.4 times book value while every other company I follow trades at three times book or less. That valuation excess is solely attributable to the Hype Cycle, which seems to be running its course. Over the last two years Tesla has been driven higher and higher as the delivery date for its first Model S cars drew nigh. The long anticipated event finally happened a week ago Friday and the Model S drew spectacular reviews from the automotive press. Despite the good news, the price fell by 7% last week.

The reason is simple. The market expected the deliveries to go off without a hitch and it expected rave reviews. So there was no "good" left in that news. Now, however, the business dynamic has changed. Instead of sounding like a politician and focusing on how good it's going to be, Tesla will have to begin dealing with day-to-day business realities like actual reservation conversion rates, actual production problems and actual manufacturing cost overrruns. While I suppose Tesla could be different from every new manufacturer in the history of business, I see very little in the way of unexpected good news that could lift its stock price while Tesla's business of making electric cars is entering a target rich environment for sequential disappointments that could crush its stock price. This is not a favorable risk reward dynamic for investors who care about their portfolio value.

The thing I like best about the market premium metric is that it lets an investor assemble a hierarchy of opportunity to compare the different companies in a sector. The following table is a simple example that excludes several outliers and shows market premium as an absolute number, and as a relative number compared to book value, my "BS to Book ratio."

6.30.12 Premium Table.png

I'm not a fan of electric cars because the entire sector has been mercilessly over-hyped while the real economic costs and illusory environmental and national security benefits are just now coming to light. If I did want to make an EV investment that had a good chance of significant appreciation instead of an outsized risk of loss, I'd pick UQM and Kandi Technologies (KNDI) over Tesla. Kandi is profitably selling low cost transportation for the masses in China, a country that's striving to raise living standards for all of its people. Kandi has a healthy working capital balance and a low BS to Book ratio. UQM is still reporting modest losses, but its balance sheet is strong and its BS to Book ratio is one of the lowest in my tracking group. The risk-reward dynamic for both companies is quite favorable because the potential for additional price deterioration is modest while the potential for future price appreciation is substantial. In other words, they're both polar opposites of Tesla.

The same kind of analysis holds in the middle range where Axion Power (AXPW.OB), ZBB, Active Power (ACPW) and Maxwell carry market premiums that range from $14.3 million to $72 million and have BS to Book ratios of 2.0 or less. A blog like this one is not a good place to  slice and dice the respective technical strengths of four companies that are focused on different products that have different applications that don't really compete with each other. But all four of them are one or two solid announcements away from market premiums in the $200 to $400 million range which A123 and Maxwell both carried at some point in the last twelve months.

When you're betting on trees to grow, you don't pick the tallest one in the forest because it's the one most likely to get struck by lightning. You don't pick the diseased trees because of their high mortality risks. Instead you pick healthy young trees that have modest mortality risks but are poised to enter a period of sustained growth. For my money all four of these mid-range companies have that kind of significant growth potential for this year, and through 2015 and beyond.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

June 26, 2012

Will A123's Batteries Make the Great Leap from Design Bench to Store Shelf?

by Debra Fiakas CFA

Bagdad BatteryIn my last post Paper Power I outlined the attempt to develop a battery using carbon nanotubes and paper.   The materials seemed a bit unbelievable and it sent me into the history books to look at the battery.  In the mid-1700s Ben Franklin may have been the one who first coined the term battery to describe the capacitors had strung together for his experiments.  We all know about the scientist, turned politician.  What is less well known is that the ancients may have also attempted a battery-like instrument now called the “Baghdad Battery.”

The so-called battery was found in a village near Baghdad, Iraq and is dated roughly between 250 BC to 224 AD.  It is a simple terracotta pot in a cylindrical shape.  Inside is a copper tube made from a rolled up copper sheet wrapped around a single iron rod something like a nail.  Now we know copper and iron form an electrochemical pairing.  If an electrolyte is introduced, potentially an electrical voltage can be produced.  There is speculation that the Baghdad Battery contained wine or lemon juice that served as an acidic electrolyte.  The design has been tested and found to produce modest electrical charge.

Archeologists have suggested that the instrument may have been used for electroplating gold onto silver objects something like a galvanic cell.  Lending credence to this idea is the existence of very fine silver objects in ancient Iraq that were plated with very thin layers of gold.  Others argue strongly against the electroplating theory since it appears Iraq ancient silver smiths may have been using conventional fire-gilding with mercury instead.  Acupuncture and electro-stimulation for religious experience was two alternatives.

It is less clear whether the Baghdad instrument successfully served its intended purpose.  Perhaps those inventors were as frustrated as the developers as A123 Systems, Inc. (AONE:  Nasdaq), claims an important breakthrough in lithium ion battery technology using nanophosphate chemistries to render batteries safe even at high temperatures.  Thermal runaway has plagued A123 Systems and other developers chasing electric car and communications markets, both of which require large battery installations that must work under high temperatures.

The news could not come any too soon for shareholders of AONE.  The stock has languished and is trading closer to its 52-week low than the high to the period.  A123 has consistently grown sales, which reached $159 million in the year 2011.  However, costs have been experiencing their own “thermal runaway” and the company’s losses have grown even faster.

Most investors following the company focus their attention on A123’s technology, but I think it is time to consider the reality of the balance sheet and whether the company still has the juice to support its scientific pursuits.

A123 has also been working its way through a cash hoard.  At the end of March 2012, there was $116.2 million left.  This might be considered a hefty sum by others but will not last the year if A123 does not trim its cash burn.  In the year 2011, the company used approximately $21 million in cash per month to support operations.  In the first quarter the burn rate had been reduced to about $15.5 million per month.  Even at that much lower rate, current cash in the bank will only support operations for another six months.

We do not know much about the Baghdad Battery, but one thing is clear, people have been focused on power for a long time.  The jars may not have delivered anything close to what its inventors intended.  With a dwindling bank account, A123 Systems may be less sanguine about the success in bringing their nanophosphate chemistry off the design bench and putting it into stores.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

June 25, 2012

One, Two, Three Uses for A123's New Batteries

Tom Konrad CFA

320px-A123_Systems_cell_family_high_rez[1].jpg
 A123 Systems battery cell products (Source: A123)

A123 Systems′ (NASD:AONE) announcement of a new battery technology able to operate at both extremely high and low temperatures has the  headline writers dreaming of cheaper electric cars.

Electric cars may be dreamy, but they are just one application of the technology.  There are at least two more, with significant near term potential.

1. Is it really about electric vehicles (EVs)?

Sure, it would be nice to be able to trim $600 of the price tag of a Tesla (NASD:TSLA) Model S or a Nissan Leaf (NASD:NSANY), but how much difference would that make on a $58,000 or $36,000 car?  It’s nothing compared to the federal $7,500 tax credit, and (surprise!) as EVs get cheaper, governments will become a lot less generous supporting them.  Or such subsidies will be cut before the cars get cheaper, a real possibility in these budget-cutting times. We’ve seen it happen time and time again with solar and wind subsidies.  Why should EVs be different?

In short, A123′s new technology (which applies tweaks to the electrodes and electrolyte of lithium-iron phosphate batteries), may give it an advantage over other battery makers in the electric car market, but investors should be much more excited about the other markets it opens up.

Two of those markets are replacements for lead-acid starter batteries, and remote back-up power.

2. Start-Stop

The engine compartment of a typical car is much too hot for conventional lithium ion batteries, which is part of the reason (the other is price) we’re still using lead acid batteries to start our cars.  But the drive for better fuel efficiency is driving automakers to look at inexpensive stop-start technology, which turns off a car’s engine when it would otherwise be idling at a stoplight or at a drive-through window.  Conventional lead acid batteries are simply not durable enough for the quick, repeated charging cycles stop-start requires.  Automakers are looking at a number of more advanced options, including lithium-ion batteries, battery-ultracapacitor hybrids from Maxwell Technologies (NASD:MXWL) and collaborators, and lead carbon batteries from Axion Power (OTC:AXPW).

Lithium-ion batteries are the most expensive of these options, but they also have the advantage of lighter weight and a quicker charging rate.  Ultracapacitor-battery hybrids are only now seeing their first commercial applications, and while lead carbon batteries have shown great performance in testing, they are not yet being used commercially.   A lithium ion battery able to withstand the heat of the engine compartment might appeal to auto manufacturers looking to add stop-start technology to existing models with minimal redesign using a more familiar technology.

Early stop-start vehicles using advanced lead acid batteries work well in the beginning, but get worse mileage as the batteries degrade in a matter of months.  A drop-in replacement based on high temperature lithium ion batteries would be a quick fix for any of these vehicles already on the road.

3. Back Up Power

Most exciting to me is the possibility of using these new batteries as backup power in cell towers or areas without reliable power supply from the grid.  The problem with using lead acid batteries in these applications is that lead acid batteries charge slowly, meaning that diesel generators must run for a long time to charge them.  In places like India with unreliable grid power, lithium ion batteries might allow the diesel generator to be dispensed with altogether, while in remote power situations, it could be run for shorter periods of time.

Removing the diesel generator from a back-up power system would likely require far fewer lithium ion batteries than removing the gas engine from a car, and so the equivalent barrels of oil saved would be much higher for every kWh of lithium ion batteries.  The economics would likely be much more compelling than the economics of electric vehicles as well.

Conclusion

It’s worth getting charged up about the potential of these new batteries from A123.  If the technology works as well as the company says it does, they will enable significant savings of both money and fuel.  But most of those savings won’t be found on  the affordable electric vehicle superhighway.

The chances of real fuel savings aren’t as remote as the chances of a cheap electric car. Stop that thought, and start thinking about anti-idling technology and cell phone towers.  The back up power opportunity may be in remote markets, but its chances aren’t remote at all.

Disclosure: Long MXWL, AXPW

This article was first published on the author's Forbes.com blog, Green Stocks.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Paper Batteries

by Debra Fiakas CFA

Vendum battery
diagramA comment left recently on one of my earlier articles mentioned Vendum Batteries, Inc. (VNDB:  OTC/BB), a developmental stage company working on battery power solutions.  When looking into Vendum I expected the usual flowery promises investors hear from every other battery developer  -  some new metal alloy for the electrodes, an alternative electrolyte, or maybe a creative form factor.    However, Vendum is not just any battery “wanna-be.”

Ok, Vendum does have an alternative electrode, but it is not just a tweak of the usual metal mixes.  It also has an alternative form factor, but even that is a drastic break from convention.

The Vendum battery electrodes are made from carbon nanotubes  -  hollow cylindrical structures with walls formed by a one-atom-thick sheet of carbon.  The nanotube electrodes are wrapped in a sheet of cellulosic fiber very much like paper.    One of the most intriguing elements of the battery is its disposable nature  -  none of the heavy metals or toxic solvents found in conventional batteries.

Vendum claims its prototype sheet of battery-paper can generate about 2.4 volts with a power density of about 0.6 milliamps per square centimeter.  Stacking sheets of the battery one on top of the other could increase voltages.

The flexible structure of the Vendum battery design makes it ideal for small or irregularly-shaped electronics applications.  Those singing greeting cards are near the top of Vendum’s initial list of target markets, but the company has even more ambitious applications in mind.  For example, scaled up the batteries could be used to power side-impact airbags.

VNDM is the true penny stock  - share price less than a dime,  wide bid-ask spread, limited trading volume.  It is a highly speculative security and thus only appropriate for investor with a steely-eyed tolerance for risk.    Vendum has proven very little so far and while in compliance with SEC filing requirements even the most skilled investors will be challenged to complete adequate due diligence on Vendum.

All that said, we are adding Vendum to the Storage Group in The Mothers of Invention Index.  It is worthwhile watching whether the Vendum group can get this technology offer the bench to the market. 

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. VNDM is included in Crystal Equity Research’s The Mothers of Invention Index.

June 23, 2012

Energy Storage: Q3 2012 Winners and Losers

John Petersen

I usually write a quarterly recap to summarize what happened in the energy storage and vehicle electrification sectors, but Q2 was a tough enough period that I don't see much sense in dwelling on the bloodletting. So instead of focusing on the past, I'll offer a quick summary table with lots of red ink and turn my attention to Q3, which is shaping up as a time of bright opportunity for some companies and profound risk for others.

6.23.12 Q2 Performance.png

I expect three companies in my tracking group to perform very well in Q3 – Exide Technologies (XIDE), Active Power (ACPW) and Axion Power International (AXPW.OB). All three look terrible if you only look at historical performance, but when you dig deeper into business history and market dynamics it becomes clear why all three have market-crushing potential over the next three to six months.

Q-3 Winners

Exide Technologies has been the Rodney Dangerfield of the battery industry since emerging from Chapter 11 in 2004. The reason is simple. While Exide had solid prospects after its bankruptcy reorganization, it was not a healthy company and it was burdened by a lot of dead weight. During the four years I've been following Exide they've been restructuring their operations, closing marginal facilities and paring fat wherever possible. Over the last five years, Exide has reported total earnings of roughly $35 million after restructuring and impairment charges of almost $210 million. Since its net earnings were so bad for so long, Exide currently trades at a 38% discount to book value, 4.4 times earnings and 8% of sales while its peers trade at 1.5 times book, 11 times earnings and 70% of sales.

Restructuring costs are an accounting oddity. If a company builds a new plant to increase earnings, the costs of that plant are added to the balance sheet and depreciated over time. If a company closes an unprofitable plant to increase earnings, the associated restructuring costs are charged against net income. When a company like Exide embarks on a multi-year restructuring program, the positive earnings impact of the restructuring is not obvious until the restructuring is complete and earnings morph from dreadful to spectacular in very short order. Exide has reached the end of its restructuring and expects to emerge later this year. When the write-offs are old news and the positive impacts of the restructuring become obvious, the market's perception of Exide should change dramatically.

I maintain long-term price tracking charts on all the companies I follow and believe Exide's chart is signaling a sharp turn upward in the third quarter. If you look at the chart you'll see that the 10-, 20- and 50-day weighted moving average prices are clustered in a narrow range below the 200-day average and have already turned sharply upwards. When they push up through the 200-day average, Exide will have a classic golden cross to mark the beginning of a new uptrend. Similar chart patterns existed in the summer of 2009 and the fall of 2010. While I'd be hard pressed to estimate the next peak, Exide's historical price performance is enough to convince me that a double is likely and a good deal more is possible.

6.23.12 XIDE.png

Active Power is a classic Valley of Death stock. It went public in 2000 right before the tech wreck and reached a high in the low $70s before falling to its all time low of $0.25 in late 2008. Since then Active Power has been working its way out of the Valley of Death and getting stronger with each quarter. Like Exide, Active Power's chart is right on the verge of a golden cross like we saw in the spring of 2009 and the summer of 2010. While I'd be hard pressed to guess the next top, Active Power's historical stock price behavior is enough to convince me that a double is likely, if not a triple.

6.23.12 ACPW.png

Axion Power International is another Valley of Death stock that looks like a very ugly duckling until you dig down into the business fundamentals and understand the market dynamics that crushed the stock price over the past three years. Axion went public through a reverse merger in late 2003 when it was still an early-stage R&D company. During its first five years as a public company Axion's stock traded by appointment and total reported trading volume for 2009 was only 7.7 million shares, or about 3.8 million shares on the sell side and 3.8 million on the buy side.

In late 2009 Axion closed an immense private placement of 45 million shares, or the equivalent of 12 years of trading at historic levels. While I believed that the four anchor investors in the private placement were swinging for the fences with venture capital investments in a stock that offered no reasonable prospect of a short-term liquidity at a decent price, an unfortunate series of events including the death of one buyer, management changes in two more and unrelated financial problems in three legacy stockholders forced huge blocks of stock into a market that couldn't handle the selling pressure.

In addition to price data like I provided for Exide and Active Power, my Axion chart includes a fifth line that tracks 200-day average trading volume and highlights the seventeen-fold increase in daily trading volume over the last three years. When I contemplate the sheer mass of shares that have moved during that period, I'm amazed that the price didn't collapse completely.

6.23.12 AXPW.png

In spite of a dismal price chart, Axion's business execution over the last three years has been flawless. Its PbC battery has progressed from a pre-commercial prototype to a production ready energy storage solution that beat all contenders including nickel metal hydride, lithium-ion, sodium metal chloride and fuel cells in two and a half years of testing for battery-powered locomotive applications, was used in the first behind the meter frequency regulation resource in the country, is a front-runner in energy storage for micro-hybrid vehicles and has recently set its sights on hybrid solutions for the long-haul trucking market. I can still account for a few million shares in the hands of likely sellers, but once those shares are absorbed the future market price will be in the hands of the patient long-term investors who have been buying Axion's stock over the last two years and squirreling it away in their sock drawers. Unless trading volume collapses, the selling pressure can't continue for more than another month or two.

Q-3 Losers

After years of supporting a $150 to $200 million market capitalization with a negative stockholders equity it looks like Valence Technology (VLNC) will lose its Nasdaq listing within the next few weeks and be downgraded to the OTCBB. While the listing could be saved with capital infusion in the $60 million range, that possibility seems pretty remote.

While it's riding a wave of euphoria after the delivery of its first Model S sedans last week, I continue to believe Tesla Motors (TSLA) will pass its peak of inflated expectations in Q-3 and begin a dizzying descent into the Valley of Death. I don't want to denigrate Tesla's accomplishments as the first manufacturer of a high production volume electric vehicle and the first fledgling automaker to bring a new car to market since DeLorean, but it seems like all of the possible good news is already priced into Tesla's stock while the bulk of the execution risks and disappointment opportunities have become frighteningly imminent.

I get hundreds of comments every time I mention Tesla's name. The enthusiastic readers I hear from expect rave reviews, expect high reservation conversion rates, expect demand to skyrocket, expect the Model S to perform flawlessly in heavy daily use, expect Tesla's financial resources to be adequate for its foreseeable needs and expect Tesla to avoid the delays, defects and missteps that plague even seasoned manufacturers who launch a completely new product. I may be cynical when it comes to the applicability of Moore's Law in the auto industry, but I'm a firm believer in Murphy's Law, fondly known as the fourth law of thermodynamics, which states: "If anything can go wrong, it will."

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

June 18, 2012

Micro-hybrids And The Multi-Billion Dollar Battery Battle

John Petersen

Last week the stock of A123 Systems (AONE) soared 52% in a day after it announced that an enhanced chemistry would improve the cold and hot weather performance of its LiFePO4 batteries, reduce the need for ancillary temperature control systems and make them more competitive in a rapidly evolving micro-hybrid battery market that's dominated by lead-acid battery manufacturers like Johnson Controls (JCI) and Exide Technologies (XIDE). Investors seem to understand that micro-hybrids will generate several billion dollars of incremental annual revenue for battery manufacturers by 2015, but they haven't quite figured out who the winners will be. Today I'll try to clarify some of the issues.

The idea behind the global shift to micro-hybrid technology is simple and sensible – there's no good reason to run a four, six or eight cylinder engine while a car is stopped in traffic. It wastes fuel and pollutes the air while doing nothing to move the car from Point A to Point B. The solution is to turn the engine-off when it's not powering the wheels, a solution that's quickly finding its way into emissions control and fuel economy regulations worldwide. The problem is that turning the engine-off at a stoplight, carrying accessory loads during engine-off periods and restarting the engine when the light changes color puts immense strain on the battery.

The following graph comes from a joint presentation that Ford and BMW made at an industry conference in 2010. While there's way to much detail for most investors, the core lesson is simple – over 90% of the battery load during a one minute engine-off interval comes from the accessories while less than 10% comes from restarting the engine.

6.17.12 DCAT.png

In a car without stop-start, the battery has to start the engine when you leave for work and it can use the entire commute to recover the 400 to 600 amp-seconds of energy used by the starter. In a micro-hybrid with stop-start, the battery has to start the engine when you leave for work and it has to provide another 3,600 amp-seconds of energy for each engine-off event. In a typical 15-mile commute, a micro-hybrid requires its battery to do 100 times more work than the battery in a car without stop-start. This is not a modest change. It's an immense technical challenge.

The next graph comes from the same Ford-BMW presentation and shows how the performance of a high-quality AGM battery degrades in a micro-hybrid duty cycle. The downward curving blue line near the bottom is the amount of current the battery can accept as it ages. The upward curving black line in the middle is the amount of time required for the battery to regain an optimal state of charge in preparation for the next engine-off opportunity. Once again the core lesson is simple – a micro-hybrid with a new battery can recover from an engine-off event in under a minute, but a micro-hybrid that has 5,000 miles on the battery will need five minutes or more to prepare for the next engine-off event. Micro-hybrids that can't turn the engine off because they're waiting for the battery to recharge can't save fuel or reduce air pollution.

6.17.12 VRLA.png

Automakers understand the problem and their current solution is to disable the stop-start system when the battery hasn't returned to an acceptable state of charge. They also know that a short-term patch is not a long-term solution. Once you understand these two graphs, you'll understand why enhanced flooded batteries and even AGM batteries must eventually lose the battle for the micro-hybrid market. They just can't stand the strain.

The most important word in that last paragraph is "eventually." Automakers plan to build about ten million micro-hybrids this year and global production should ramp to 35 million micro-hybrids a year by 2015. There are several new battery technologies that are better suited to the micro-hybrid duty cycle, but they can't be manufactured in big enough volumes to make a difference over the next few years. That means automakers will be forced to settle for batteries they can buy in volume until the newer batteries are available at relevant scale. For the next several years, enhanced flooded batteries and AGM batteries will win the battle for short-term market dominance, even though they can't win the war.

In the emerging battery technology group the leading public company contenders are A123 Systems and Axion Power International (AXPW.OB). A123 will try to win the hearts and minds of automakers with an LiFePO4 battery solution that is superior to flooded and AGM batteries in most respects. Axion will try to win the same hearts and minds with its PbC® battery, a hybrid lead-carbon battery. Both of these new batteries have strengths and weaknesses, so it's too early to pick a winner. To help investors understand the issues, the following paragraphs will compare A123's LiFePO4 technology with Axion's PbC technology.

Battery weight – A123's LiFePO4 battery is the hands-down winner when it comes to battery weight, but it can only shave 40 to 50 pounds off the weight of a 3,000 to 4,000 pound vehicle. For some automakers the weight savings will be important, but I don't see weight as a mission critical issue in micro-hybrids.

Battery cost – Axion recently charged a customer $400 per battery for a thousand unit PbC order. Based on historic costs, it looks like A123 will have to charge about $800 for an engine start battery. Despite widespread rumors that the cost of manufacturing lithium-ion batteries is falling rapidly, A123's production costs have been stubbornly stagnant for years. As the PbC technology matures and Axion's production processes improve, significant cost savings and other economies of scale seem likely. So for now, at least, it appears that the PbC will enjoy a major cost advantage.

Dynamic charge acceptance Automakers need a micro-hybrid battery that can accept currents of up to 100 or 150 amps, the maximum power their alternators can generate. While the DCA of AGM batteries falls to less than 10 amps in a couple months, both of the new batteries boast DCA in the 100 to 200 amp range. While both batteries offer ten to twenty times better DCA than AGM batteries, neither has a clear advantage over the other in micro-hybrid applications.

Cycle-life – Automakers need a micro-hybrid battery that will last for at least three-years, and preferably longer. The data released by A123 and Axion indicates that both batteries can handle a five-year service life without breaking a sweat and may last the entire life of the vehicle with only modest performance degradation. While both batteries will last five times longer than AGM batteries, neither has a clear cycle-life advantage over the other in micro-hybrid applications.

Materials availability and recycling – Lithium-ion batteries are made from highly refined metals that are widely used in other consumer and industrial products. They can't be economically recycled but they don't pose any particular disposal risks. Lead-acid batteries are made from raw materials that don't have significant alternative uses. They're also the most recycled product on the planet and generate significant profit to recyclers. Lead is hazardous if it's disposed of improperly, but used batteries that contain $70 to $100 of recoverable metal are simply too valuable to throw away.

Capacity constraints and expansion – If all of A123's manufacturing capacity was devoted to stop-start batteries, it could make about 900,000 units a year. Axion will need to spend about $30 million to bring its annual production capacity up to the 900,000-unit level. Since PbC electrode assemblies are designed to work as plug-and-play replacement components in other lead-acid battery factories and Axion ultimately wants to become a component supplier, ramping PbC production will cost about $50 million for a million units of incremental capacity. Ramping LiFePO4 production will cost about $400 million for a million units of incremental capacity because the underlying technology can't leverage existing infrastructure.

Testing and validation – When it comes to their mainline vehicles, automakers are obsessive about performance and quality testing for both components and suppliers. For simple commodity components like flooded lead acid batteries from a new supplier, the process usually takes twenty-four months. For more complex components and systems, testing and validation can take significantly longer. Several automakers began evaluating the PbC for use in micro-hybrids in mid-2009. A123 will not have samples of its enhanced battery chemistry available for testing and validation until later this year. I expect the process to be less time consuming for A123 because several automakers have evaluated its products for use in specialty vehicles and some portion of that earlier work will apply to using LiFePO4 batteries in micro-hybrids. I believe, however, that Axion has a solid head start that should offer a first mover advantage.

Entrenched competition – Lead-acid batteries have owned the automotive starting, lighting and ignition market for almost a century and the industry has an immense and diversified global footprint of installed production and recycling capacity. Over the short-term, lead-acid battery manufacturers will resist innovations like Axion's PbC electrode assemblies because it's easier and cheaper to continue with business as usual. When alternatives like A123's LiFePO4 batteries threaten to encroach on their bread and butter markets, I think leading lead-acid battery manufacturers will quickly change their tune and eagerly embrace technologies that can protect their market position from interlopers. If the lead-acid battery industry rises to the micro-hybrid challenge, I believe automakers will be reluctant to change to more costly alternatives that offer no significant performance advantages beyond a modest weight savings.

Over the next three to five years enhanced flooded and AGM batteries will be the only products that are available in large enough volumes to serve the needs of the micro-hybrid market, so manufacturers like JCI and Exide will thrive as their per vehicle revenue doubles and their per vehicle gross margins triple. During that period advanced batteries like Axion's PbC and A123's LiFePO4 will establish toeholds in the heavy micro-hybrid sector that's expected to ramp to about eight million vehicles a year by 2015. As the performance differences between the new batteries and legacy technologies become clearer, and production capacity for the advanced batteries ramps, demand will shift from the legacy technologies to the newer batteries. When the lead-acid battery industry begins to view lithium-ion batteries as a credible threat in a major market, the rush to third generation lead-acid technologies like Axion's PbC will begin in earnest.

Readers who are looking for a silver bullet technology to dominate the energy storage sector always amaze me. Frankly, I don't think such a technology exists. Energy storage is a sector where you get no extra credit for cool and the only things that matter are price, performance, quality and serving the customers' needs. In that kind of market, the best anybody can hope for is silver buckshot. I do believe, however, that every company that can bring a cost-effective product to market in relevant scale will have more demand than it can handle.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

June 11, 2012

Exide: Bargain Basement Battery Stock Ready to Start

Tom Konrad CFA


512px-ESB-Exide%27s_Sundancer_electric_car[1].jpg
Exide's Sundancer Electric Car.  Photo by Frank Lodge, EPA.  Public Domain

NOTE: Since this article was first published, Exide Technologies (NASD:XIDE) stock has risen 22% from $2.31 to $2.82, but much of that rise was due to media confusion about a positive Credit Suisse research report on the unrelated Indian company Exide Industries, Ltd.  Details here.

Exide Technologies (NASD:XIDE) is shutting down its battery recycling plant in Frisco, Texas, and selling the surrounding 180 acres to Frisco Community Development Corp. for $45 million.  The move is part of Exide’s ongoing multi-year restructuring, and is good news in that there is a ready buyer for the land.  Exide will retain ownership of the plant itself, and will proceed with environmental clean-up.  Years of this protracted restructuring and earnings misses have XIDE  in the bargain basement, with a trailing P/E ratio if 4.2, a forward P/E of 4.7, and a price to book ratio of just 0.43.

Insiders seem to think the stock is cheap here.  Although there has only been one buy (at $3.02 in February), they are holding on to almost all of the stock they get from exercising options.   At below half book, and plenty of liquidity ($1.34 cash per share even before the additional $0.58 per share infusion from the sale of the Frisco land, for a total of $1.92 per share), Exide seems ready for a strong rebound on any hint of good news, such as an upside earnings surprise when the company reports on June 8.  It’s hard to see how even an earnings miss could send the stock down much from the current price of $2.31.  After all, the company is profitable, has no need to go to the markets for additional equity funding, and the stock price is closing in on cash on hand.

Stop-Start Ready to Start

I own Exide because I consider it a cheap way to speculate on the widespread adoption of  stop-start technology.  Stop-start is the less glamorous but far cheaper cousin of hybrid vehicle technology, and is taking off by stealth as automakers look for inexpensive ways to meet increasingly stringent fuel efficiency requirements.

Stop-start vehicles generally use much larger, more robust lead acid batteries than those used in traditional vehicles, although the lack of durability of these batteries is leading auto manufacturers to look at alternative technologies such as battery-ultracapacitor hybrids (from Maxwell Technologies (NASD:MXWL) in conjunction with traditional lead-acid battery makers), lithium-ion batteries, and lead-carbon (PbC) batteries from start up Axion Power (OTC:AXPW.)

All three new technologies are likely to grab slices of the enormous stop-start pie from lead-acid batteries, but only relatively expensive lithium-ion batteries would wholly displace lead-acid manufacturers.  As the second largest lead-acid battery manufacturer worldwide (the first is Johnson Controls (NYSE:JCI),) Exide seems set to benefit from the trend.  Exide is also well placed to benefit from the adoption of Axion’s PbC technology, since the two companies have worked closely together in the past.

That said, I own Maxwell and Axion as well as Exide, since I think all three are quite cheap and will benefit from the stop-start opportunity.  (See this recent article on Maxwell.)  The only reason I don’t currently own Johnson Controls is that I am uncomfortable with the company’s negative free cash flow.  With a trailing P/E of  12.5, a forward P/E of 9, and a price to book ratio of 1.8, JCI is not expensive, but it’s not nearly as deep in the bargain basement as Exide.

Disclosure: Long XIDE, AXPW, MXWL

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

May 29, 2012

Anti-Hype in Lithium-ion Batteries Foretells Doom for Electric Cars

John Petersen

Despite billions of dollars in private investments and public subsidies, lithium-ion battery technology has progressed at a snail's pace for years and battery developers have recently started to emphasize the importance of baby steps. For the first time in memory, anti-hype is becoming a dominant theme in stories about lithium-ion batteries.

Examples from this month include:
  • An interview with Wards Auto where the business manager of the DOE's Kentucky-Argonne Battery Manufacturing Research and Development Center explained that it takes about ten years to put a battery innovation into production and all of today's EVs are powered by technologies that were developed at least a decade ago.
  • An article from National Defense which predicts that lithium-ion battery research will soon hit a brick wall because batteries can only be as small and lightweight as their materials allow and immutable laws of physics and chemistry limit the number of electrons that can be stored in a given mass of battery material.
  • An article in Nature that discussed ways nanotechnology can improve battery performance by increasing surface area, but took pains to explain that nano-materials must be produced in carefully controlled environments and the high cost of manufacturing nano-materials usually outweighs the benefits derived from using them.
  • An article in Design News that focused on the harsh reality that battery development is hard, slow work because batteries require a wide variety of costly materials to work together as a system; there are limitless ways that things can go wrong; and throwing loads of money at research can't make progress happen overnight.
  • An article in Waste Management World that explains the complex technical and economic challenges that must be overcome before lithium-ion battery recycling can progress beyond a few pilot plants and become a cost-effective industrial reality, as opposed to a hopium-laced talking point.
  • An article in the MIT Technology Review that reads like a premature obituary as it discusses the triumphs and tragedies at A123 Systems (AONE) and their ongoing search for strategic alternatives.
My personal favorite is a strategy memo from the National Alliance for Advanced Technology Batteries that focuses on the problems at A123 Systems and the failures of Ener1 and International Battery. It's classic spin control that ultimately blames the debacle on government policy. Since the irony is so rich, I'll annotate the last three paragraphs by highlighting text that I find particularly entertaining in bold type and adding some observations [in brackets].

"If criticism intensifies, which is likely, it will be important to communicate an important point: Government funding of new energy technologies is meant to support those technologies, not the companies that develop them [or the investors who bought the hype that's part and parcel of government support]. The failures of Ener1 and International Battery, and the troubles of A123 Systems, are business failures, not technology failures. Companies come and go. Corporate assets get bought, sold and reorganized [while investors lose their shirts]. None of that should matter to taxpayers. What should matter is whether the technologies that A123 and Ener1 owned at the time they received their grants has been advanced and pushed closer to commercialization [while politicians promised cost-effective products]. Indications in both cases are that they have been [but unsubsidized demand hasn't materialized].

If the FOA-26 program can be criticized for anything it is that the program focused on funding immediate deployment of advanced automotive battery technology rather than its longer term development. Many pointed that out at the time [and we were lambasted as neo-luddites]. The [entirely predictable] problems at A123 Systems and the failures of Ener1 and International Battery are powerful testimony to the fact that the market for that technology in 2009 was critically immature [just like the underlying technology]. A better use of the funds would clearly have been investing them in the development of new, next-generation battery technologies that could facilitate the development of a market for advanced automotive batteries in the future rather than cater to one that did not fully exist.

In fairness to the Department of Energy, the emphasis on immediate deployment and “getting shovels in the ground” was a political directive motivated by a critical economic crisis, not a considered policy decision. As a consequence, DOE funding of advanced battery technology over the past three years has not been as efficient as it might have been. But that is not to say that it has been a failure. Steady progress on increasing energy density, decreasing battery cost and improving battery system management continues to be made [at a snail's pace]. The market we hoped for in 2009 is not here yet and some of the original players in the market may not make it to the finish. But that market is substantially closer than it was three years ago, and by that fact the success or failure of the FOA-26 program is more properly judged."

The core message of this new anti-hype campaign is clear. The promised improvements in lithium-ion battery technology have not materialized and they're not likely to evolve from existing technology and architecture. We may see a doubling of energy density over the next decade, but the six- to seven-fold gains that Energy Secretary Chu has called for are not possible with current technology. The dream of quantum leaps in performance accompanied by precipitous cost reductions is not in the cards, or for that matter on the horizon. Breathless promises of cost-effective electric cars that will clear the air and deliver us from the tyranny of oil dictators are snake oil cures that will enrich the hucksters for a time, but end in tar, feathers and a ride out of town on a rail.

Battery mythology developed for the sole purpose of supporting electric car mythology. Battery developers tried mightily and failed. Now battery developers are seeking shelter from the backlash that inevitably comes back to haunt companies and industries that promise more than they can deliver. The next dominoes are companies like Tesla Motors (TSLA) that can't possibly build cost-effective electric vehicles without better and cheaper batteries. Tesla may survive for a time by making toys for the ideologically committed and mathematically challenged rich, but the congenital birth defect that's doomed every generation of electric cars to the scrap heap remains.

The electric car industry can't survive without a thriving and profitable battery industry that can make products that meet or exceed expectations. The battery industry is on record saying they can't meet the ambitious goals they embraced in the recent past. Things might change in my lifetime, but the change is not going to happen in the next decade. Meanwhile the real auto industry is digging into its toolbox and rapidly implementing technologies that weren't cost-effective in another economic era but are today.

Disclosure: None

May 22, 2012

Stop-Start Realities and EV Fantasies

John Petersen

Last week Johnson Controls (JCI) released the results of a nationwide survey that found that 97 percent of Americans are ready for micro-hybrids with stop-start idle elimination, the most sensible automotive innovation in years. A micro-hybrid turns the engine off to save fuel and eliminate exhaust emissions when it's stopped in traffic and automatically restarts the engine when necessary. While the overwhelmingly positive consumer response didn't surprise me, JCI's short-term growth forecast for micro-hybrids did.

I've been writing about the rapidly evolving micro-hybrid space since 2008 and during that time the market penetration forecasts have built quietly like a tsunami in the open ocean.
  • In October 2008, Frost & Sullivan predicted that global micro-hybrid sales would ramp to 8 million vehicles a year by 2015 while EVs would remain an inconsequential niche.
  • In April 2010, the EPA and NHTSA predicted that stop-start systems would be standard equipment on 39% of new cars sold in the U.S. by 2016 while EVs would remain an inconsequential niche.
  • In June 2011, JCI predicted that up to 22 million vehicles a year would be sold with stop-start systems by 2015 while EVs would remain an inconsequential niche.
  • In February of this year, Lux Research forecast micro-hybrid sales of 25 million vehicles a year by 2015 and 39 million vehicles a year by 2017 while EVs would remain an inconsequential niche.
  • Last week JCI upped the ante once again with a new forecast that 35 million vehicles a year will be equipped with stop-start systems by 2015.
The most fascinating aspect of the JCI forecast is that it's not based on some fuzzy results oriented analysis of what consumers might want. Instead, it's based on planning discussions with automakers that are firming supply chains for their 2015 models. The contracts won't be signed for a couple years, but the decisions have already been made. Stop-start is following the same path as power steering, catalytic converters, anti-lock brakes and air bags. It will be standard equipment within a couple years and the most unexpected technology development in a decade.

A basic stop-start system will add about $300 to the price of a car and save its owner 5% on his fuel consumption. For 35 million vehicles worldwide, the incremental cost will be about $10 billion and the annual fuel savings will be 700 million gallons. To put those numbers into perspective, my favorite toymaker Tesla Motors (TSLA) hopes to ramp its production to 20,000 EVs a year if it can find that many mathematically challenged buyers. The electric drive systems in those EVs will cost at least $800 million, but they'll only save eight million gallons of gas per year.

When you turn the crank on the fuel efficiency numbers, it costs $14 to save a gallon of gas per year with stop-start while it costs $100 to save the same gallon of gas with electric drive. I'm sure the eco-royalty won't mind a paying a 600% premium for flashy fuel savings as long as smarmy politicians are willing to squander public funds on direct and indirect subsidies and give them special perks like HOV lane access. When you look past the hype, however, it’s clear that real companies that deliver real, sensible and affordable value to the mass market will generate the business earnings.

Two publicly held battery manufacturers, JCI and Exide Technologies (XIDE), will be the first to benefit from the rapid global implementation of stop-start technology. They'll each see their per vehicle revenue double while their per vehicle margin triples. In JCI's case, the incremental revenue and margin from stop-start batteries will just make a good company better. In Exide's case, the incremental revenue and margin should turn a long string of losses and disappointments into a healthy stream of future profits.

At Friday's close, JCI was trading at 48% of sales and a 200% premium to its March 2009 lows. In contrast, Exide was trading at 6% of sales and within pennies of its March 2009 lows. There's no doubt that rapid implementation of stop-start technology will lift both boats. Given the big differences between their relative valuations, the percentage impact on Exide's stock price should be several times greater than the percentage impact on JCI's stock price.

While JCI and Exide will be early leaders in the stop-start battery space, there is a persuasive and growing body of proof that conventional lead-acid batteries, including the "enhanced flooded" and AGM batteries both companies are touting as stop-start solutions, aren't durable or robust enough to succeed in the long term.

The basic problem is that a car equipped with a stop-start system needs a battery that can carry the accessory and starter loads when the engine turns itself off in traffic, and then recharge quickly in preparation for the next engine off event. In city driving conditions, conventional lead-acid batteries can't charge fast enough and a few months rapid cycling leads to an unavoidable decline in battery performance that quickly renders the mechanical components inoperable.

The following graph from Axion Power International (AXPW.OB) highlights the dynamic acceptance issue by comparing the performance a high quality AGM battery with the performance of its serially patented PbC® battery, a third generation device that replaces the lead-based negative electrodes in a conventional AGM battery with carbon electrode assemblies.

5.21.12 DCA.png

In both graphs, the grey line represents dynamic charge acceptance measured in amps. While dynamic charge acceptance of the AGM battery plummets from 50 amps to 5 amps within a couple months, the PbC can accept charging currents of 100 amps for five years before its performance begins to degrade. The black lines represent the time needed for the battery to recover from an engine off event. While both batteries start out with a charge recovery time in the 30 second range, the recovery time for the AGM battery increases to about 4 minutes after six months while the PbC stays in the 30 to 50 second range through eight years of use. Additional advanced energy storage solutions that are targeted at the particular performance requirements of stop-start vehicles include a lithium-ion starter battery from A123 Systems (AONE) and a hybrid system that pairs an AGM battery with a supercapacitor module from Maxwell Technologies (MXWL).

The stock market doesn't understand that several billion dollars of incremental revenue from stop-start batteries is already baked into the cake for 2015. It doesn't understand that two established battery manufacturers are the only companies that have enough manufacturing capacity to respond to the demand. It doesn't understand that a handful of advanced technology developers will be nipping at the big boy's heels with energy storage systems that are better suited to the needs of stop-start systems, or that each one percent of market penetration can represent $100 million of incremental revenue.

The die is already cast. The market for high performance stop-start batteries is going to be a free-for-all where unlimited demand chases limited supply from a small number of established manufacturers and emerging energy storage technology developers. Every company that brings a cost-effective energy storage solution to the stop-start market over the next three years will have more customer demand than it can possibly satisfy. Patient investors who position themselves in front of this rapidly developing tidal wave of demand for high-margin energy storage systems are in for a fun ride.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and owns a substantial long position in its common stock.

April 28, 2012

Battery-powered Locomotives – Compellingly Green Economics

John Petersen

For the last two years I've been paying increasingly close attention to trailblazing work by Norfolk Southern (NSC) in the field of battery-powered locomotives. My interest was piqued in June of 2010 when Norfolk Southern hired Axion Power International (AXPW.OB) to develop a battery management system that would allow rail locomotives to run on battery power and recharge their batteries through regenerative braking. I believed the decision was positive news for Axion because nobody hires a battery manufacturer to design a BMS for somebody else's product. My enthusiasm was tempered, however, by knowing that an earlier Norfolk Southern retrofit, the NS 999, was unveiled in September 2009 and quickly proved to be an insurmountable challenge for the AGM batteries that were used in the original design. I also knew that a technical development project for a Class I Railroad would require a couple years of work before a rational implementation decision could be made.

A key milestone was reached this week when Axion announced that NS had ordered $475,000 of PbC® batteries that will be installed in the NS 999 over the next couple months. The two companies are also moving forward on a parallel development track for a larger and more powerful long-haul locomotive that will use twice the battery power.

Now that I have a clear data point on battery costs for both the switcher and a long-haul locomotive, I can finally dig into the fundamental economics of what Norfolk Southern is trying to accomplish with this project.

The raw unsubsidized numbers are amazing!

The technical case for a battery-powered switching locomotive is easy to make because they operate in urban rail-yards assembling and disassembling trains, which means travel distances are short and charging infrastructure is both easy and cheap to install. On average, a switcher spends about 75% of its time idling and only 25% of its time working. While it's a little dated, this 2004 graph from the Argonne National Laboratory summarizes daily fuel consumption for a GP38-2 switcher, the locomotive platform Norfolk Southern used for the NS 999.

4.27.12 Switcher.png

While the exact numbers used to generate the graph are not available, my best estimate of total fuel consumption is about 340 gallons per day, or 85,000 gallons for a 250-day work year. At the current price of around $3 per gallon for off-road diesel, the annual fuel cost for a switching locomotive is $255,000. Since switching locomotives are already equipped with electric drive, dynamic brakes and power control systems, the biggest cost of converting a locomotive to battery power is pulling the fuel tanks, diesel engine and generators and replacing them with a big rack of batteries and a custom BMS to keep things in balance.

I can't accurately estimate the power subsystem costs for a locomotive conversion, but I'm certain that it will be less than the $400,000 per MW that Sandia National Laboratories recently estimated for grid-based power subsystems that use expensive inverters for AC-DC conversions. Using a high-side estimate of $400,000 for the balance of system costs on a switcher retrofit, the cash-on-cash payback period from fuel savings alone will be about 3-1/2 years. Using a more conservative mid-range estimate of $200,000, the cash-on-cash payback period will be closer to 2-1/2 years. When you factor in collateral environmental benefits like 875 tons of annual CO2 abatement and the elimination of diesel emissions from urban train-yards, battery-powered locomotives offer compelling value and utility.

The planned long-haul locomotive, which will cost twice as much but save about 170,000 gallons of diesel fuel per year, should offer similar economic and environmental benefits.

The following table provides summary information on the locomotive fleets operated by the four largest North American Class I Railroads.


NSC
CSX
UNP
BNSF
Multiple purpose units
3,904
3,579
7,632

Switching units
123
322
426

Auxiliary units
116
215
155

    Total locomotives
4,143
4,116
8,213
6,900

In light of the economic and environmental benefits of battery-powered locomotives, it seems reasonable to assume that at least half of the switcher fleet and up to 20 percent of the freight locomotive fleet would change to battery power over the next decade if the second-generation NS 999 and the planned long-haul locomotive perform as expected. The batteries required to support such a transition would cost something on the order of $4.4 billion.

Today, the biggest question on everybody's mind seems to be "since laboratory testing took two years how much longer will it take to test the two prototypes before implementation begins in earnest?"

To understand the likely deployment timeline, you need to understand what the laboratory testing accomplished. As I noted above, a typical switching locomotive spends 75% of its time idling. In a battery laboratory, much of the idle time can be eliminated and a company can pack the equivalent of three or four year's use into a single testing year. It can also stress the batteries with extreme load profiles that go beyond the normal operating range.

In a situation like the Norfolk Southern project where parallel testing was conducted concurrently in three battery laboratories, a company can condense the equivalent 18 to 24 years of application experience into two years. So by the time the batteries are installed in a prototype vehicle, the battery manufacturer and the user know how they're going to perform and the principal goal of the prototype testing is to identify any complications that were missed during the laboratory phase.

In light of Norfolk Southern's prior experience with the NS 999 and the extraordinary amount of laboratory testing that was conducted over the last two years, I expect the next round of prototype testing to be measured in months rather than years. While I'd be pleasantly surprised to see significant implementation beyond the planned freight locomotive in 2012, the ramp rate in 2013 could be impressive because the market is so large and the economic and environmental values are so compelling.

In the November-December 2009 issue of its employee magazine BizNS, Norfolk Southern explained that the biggest challenge was developing "an energy management system that allows us to take maximum advantage of kinetic energy," emphasized that "advances in battery technology will be the primary driver for widespread industry use of electric locomotives" and observed that it was "eying the use of lithium-ion and nickel based rechargeable batteries, as well as improved lead-acid batteries."

Two and a half years later, there's only one contender left standing, Axion's PbC®.

Battery-powered locomotives are a potential billion-dollar niche market where size and weight are not mission-critical but cost and performance are. There are several comparable niche markets in automotive applications like micro-hybrids and stationary applications for power generation, distribution and use. I expect the PbC to be a formidable competitor in many of those markets.

Disclosure. Author is a former director of Axion Power International (AXPW.OB) and has a substantial long position in its common stock.

April 21, 2012

Is Lithium-ion a Borgia Battery?

John Petersen

I’ve recently learned that lithium-ion batteries might be a triple threat – Borgia batteries – cherished by eco-royalty, poisonous in the extreme, and explosive enough to wreak havoc in a $25 million laboratory that was built to safely manage battery explosions.

Is it a battery or a WMD?

On April 11th five employees of the advanced battery laboratory at the General Motors (GM) Technical Center in Warren, Michigan were hurt when extreme testing of a prototype lithium-ion battery pack from A123 Systems (AONE) released chemical gases that exploded inside a testing chamber. Four were treated at the scene and one was taken to a local hospital. The injuries were not life threatening.

About 1,100 employees who work in the Warren facility were evacuated while a HAZMAT team spent four hours taking air samples inside and outside the building. While most of the evacuees were able to return to work, it’s unclear how long it will take to repair about $5 million of damage to the battery laboratory and resume operations.

GM quickly advised the media that the incident didn’t involve a battery for the GM Volt and technically there was no battery explosion at all. Engineers were simply conducting extreme overcharge tests on a prototype battery and it failed, which is exactly what you’d expect.

Or is it?

The fact that there was a battery failure and vented gases ignited doesn’t surprise me. The fact that the explosion was violent enough to cause major structural damage to a purpose-built facility that was designed to safely manage the occasional battery explosion is very troubling. The chemical composition of the gas that allegedly caused the explosion is a nightmare. The terrifying aspect is that these issues are being ignored, or at least swept under the rug, to protect the tarnished image of GM’s Volt.

On Friday the 13th, Torque News reported:

“The battery involved in the Wednesday morning explosion didn’t actually explode but rather gases created in the testing chamber ignited and caused the massive explosion. During the extreme testing process, hydrogen sulfide gas collected in the testing area and when that cloud of gas ignited – we had the massive explosion that injured five and did significant damage to the Alternative Energy Center testing area including blowing out windows and at least one 8” thick door. Afterwards, the reports indicate that the battery pack itself was still intact.”

It may just be my lawyer's fascination with words and sentence structure, but the second sentence of that paragraph sure sounds like an unattributed direct quote from somebody in the know at GM.

I’m not a chemist, but I have substantial oil and gas experience including three years as legal counsel for Boots & Coots, the largest oil field disaster response firm in the world. Because of that experience I know that hydrogen sulfide gas (H2S) is:
  • The reason rotten eggs stink;
  • Explosive at concentrations of 43,000 to 460,000 PPM; and
  • One of the deadliest poisons known to man.
In the US, Occupational Safety and Health Regulations prohibit exposure to H2S concentrations above 100 PPM without a full facepiece pressure demand self-contained breathing apparatus.

A Wikipedia search shows that an H2S concentration of 150 PPM paralyzes the olfactory nerve, killing the sense of smell; 800 PPM is the lethal concentration for 50% of humans with five minutes of exposure; and concentrations over 1,000 PPM can cause immediate respiratory arrest after a single breath.

That makes H2S sudden death by poisoning at 2.3% of the concentration required for an explosion.

If a comparable failure occurred in a moving car, the driver would be incapacitated in seconds while his vehicle careened into a crowded latte bar before exploding.

I know there’s nothing inherently dangerous in the anode and cathode materials for today’s advanced lithium-ion batteries. In fact I was surprised by the reports that a lithium-ion battery could generate enough H2S gas to cause an explosion. When I started to ask questions, however, I learned that any number of electrolyte additives, separators, binders, fillers and ancillary cell materials could release highly toxic fumes from a failing cell or battery pack.

The active materials may be wonderful in their own right, but everything that goes into a cell must be carefully evaluated for its capacity to chemically interact with other cell materials and pose a serious threat to human health and safety.

We know the process failed at least once.

GM’s “industrial accident” may be a one-off oddity if it was testing an exotic lithium-sulfur battery or something else that's radically different from conventional lithium-ion batteries. It may also be just the tip of an iceberg, the first example of unintended interactions between cell components that can render large format lithium-ion batteries too dangerous for use in passenger vehicles or other enclosed spaces.

100 years ago the Titanic was heralded as an engineering marvel until a completely unexpected turn of events in April 1912 forced engineers to question their basic assumptions. I believe the GM explosion should at least force some soul searching.

For four years I've heard nothing but safety talk from lithium-ion battery manufacturers, ideologues, politicians and would-be end users. This is the first report I've seen that threatens to burst the bubble. If H2S gas was generated in GM’s advanced battery laboratory we need to know how much H2S gas was generated, how it was generated and how long the process took. We also need to know to a certainty whether similar problems might exist in large format lithium-ion batteries from other manufacturers. I understand that every battery manufacturer wants to keep its secret sauce recipe proprietary, but there comes a time when customer safety has to take precedence over competitive advantage.

I'm the first to admit profound confusion over the facts that have been reported so far. But there seems to be a consensus that a poisonous gas was generated by a failing battery, concentrations rose to explosive levels in the testing chamber, and the resulting explosion caused major structural damage to a facility that was built in 2009 and designed to withstand catastrophic battery failures.

Under the circumstances, I’m convinced that somebody who doesn’t have a political, ideological or economic interest in the safety of lithium-ion batteries needs to get on the ball and conduct a comprehensive independent investigation to find out exactly what happened and whether comparable risks exist in the battery packs used by Fisker Motors, Ford (F), Tesla Motors (TSLA), Nissan (NSANY.PK), Toyota (TM) and others. I can only hope that an upcoming NHTSA technical symposium with battery manufacturers and automakers will mark the beginning of more rigorous regulatory oversight.

Borgia battery? Inaccurate descriptions from reporters? Prototype testing of a truly unique battery chemistry? Or simply a conventional automotive grade lithium-ion battery that was pushed beyond design limits and failed spectacularly? The difference has to be understood before we go much further.

4.21.12 BI Toon.jpg

This article was first published in the Spring 2012 issue of Batteries International Magazine and I'd like to thank editor Mike Halls and cartoonist Jan Darasz for their contributions.

Disclosure: None.

April 15, 2012

Hybrid Locomotives, Vehicle Electrification at Relevant Scale

John Petersen

Last month Ricardo PLC (RCDOF.PK) published a report titled "GB Rail Diesel Powertrain Efficiency Improvements" that it prepared for Great Britain's Department for Transport. While most of the fuel efficiency technologies Ricardo evaluated for the report were mechanical systems, its analysis of the fuel efficiency benefits of stop-start and hybrid systems for locomotives offered an intriguing view of a cost-effective vehicle electrification opportunity that can be implemented at relevant scale within a few years. The two types of locomotive systems Ricardo evaluated for the report were simple stop-start idle elimination and full hybridization. The following table compares the relative fuel economy benefits of these alternatives for local, intercity and freight trains in Great Britain.

Technology level
Local
Intercity
Freight
Stop-start idle elimination
up to 7%
up to 4%
up to 41%
Hybrid powertrain
up to 22%
up to 14%
up to 41%

While raw percentages are fascinating, they can't give you a feel for the magnitude of the potential fuel savings. On its website, the Electro-Motive Diesel unit of Caterpillar (CAT) helps put the Ricardo numbers into perspective by showing how a basic stop-start system can offer 10-year savings of up to $357,308 for a switcher duty cycle and up to $222,740 for a line-haul duty cycle. With full hybridization, the fuel savings can be even more striking.

For the last couple years General Electric (GE) has been preparing to launch its Evolution™ Hybrid Locomotive, which will save approximately 440,000 gallons of fuel over a 20-year useful life, or roughly $1.3 million based on an assumed diesel price of $3 per gallon. In February, Japan Freight Railway Company introduced a hybrid shunting locomotive that slashes fuel consumption by 36%. Both of these hybrids are diesel-electric locomotives that were redesigned to capture the energy dissipated during braking and store it batteries. The stored energy can then be used on demand to reduce fuel consumption. The Evolution hybrid uses a GE variant of the Zebra sodium nickel chloride battery that was originally developed by Daimler and refined by FZ Sonick. JR Freight's hybrid shunting locomotive uses a surprisingly small (67.4 kWh) lithium-ion battery pack from Japan's GS Yuasa (GYUAF.PK).

Between now and 2020, Pike Research forecasts that cumulative sales of new hybrid locomotives will approach 500 units worldwide and require roughly 500 MWh of batteries. While Pike expects new hybrid locomotive sales to ramp rapidly through the end of the decade, the larger near-term opportunity will involve retrofitting the existing global fleet of about 100,000 diesel-electric locomotives to save fuel, reduce emissions and improve the bottom line performance of the world's cheapest land-based transportation networks.

Most developers of hybrid locomotive technologies have followed the path blazed by automakers and tried to build all necessary elements of a hybrid system into a single chassis. The exception to the general rule has been Norfolk Southern (NSC), which is focused on developing a pure battery electric locomotive that can be:
  • Charged from the grid and used as a stand-alone locomotive for yard switching operations; or
  • Combined with one or more conventional diesel-electric locomotives to create a "hybrid train."
Norfolk Southern's battery electric locomotive technology is described in US Patent No. 8,136,454, which issued on March 20th of this year. The beauty of the patent is its inherent simplicity and flexibility. Designing a single-chassis hybrid locomotive is a very complex engineering and space optimization challenge. When the battery elements of the system are separated from the internal combustion elements, however, the engineering and space optimization hurdles get lower while overall flexibility increases.

There are very few industries that can compare with the railroads when it comes to calculating the amount of fuel needed to move a train over a given route. The route data is all computerized with precise grade and speed profiles for every foot of track. If a route needs a five to one balance between diesel and battery power, a railroad can configure a six locomotive consist with five diesel electrics and one battery electric. If another route can handle a one to one balance, a railroad can configure a six locomotive consist with three diesel electrics and three battery electrics. That ability to mix and match locomotives to suit the precise requirements of a particular route simply can't happen with single-chassis hybrids.

The concept even makes the retrofit process cheaper since a railroad can convert its least efficient locomotives to battery drive, keep its most efficient locomotives as diesel-electrics, and effectively upgrade the entire fleet by retrofitting a small percentage of the rolling stock.

Norfolk Southern's first battery-electric locomotive, the NS 999, was publicly launched in September 2009 but severe charge acceptance problems in the AGM batteries it used for the original vehicle had Norfolk Southern actively searching for better batteries by the time the November-December issue of its employee magazine,"BizNS," was published. Since 2010, the primary focus of Norfolk Southern's battery evaluations has been the PbC battery from Axion Power International (AXPW.OB), an asymmetric lead-carbon battery that offers the cycle-life, charge acceptance and power of lithium-ion batteries at a lead-acid price point. While the two companies have been tight-lipped about their progress, Axion has reported that the PbC is meeting all expectations in double redundant long-string testing at Axion, Norfolk Southern and Penn State University. In a presentation at last October's William W. Hay Railroad Engineering Seminar hosted by the University of Illinois at Champaign-Urbana, Gerhard A. Thelen, Norfolk Southern's Vice President of Operations Planning & Support, spoke highly of the PbC's performance and offered an upbeat outlook for Norfolk Southern's battery-electric locomotive plans. Prototype trials of switching and long-haul battery-electric locomotives are anticipated later this year.

Stop-start idle elimination and hybridization of railroad locomotives and other heavy freight vehicles will never have the sex appeal of a Fisker Karma, but for companies like Norfolk Southern that spend $1.5 billion a year on fuel, knocking ten or fifteen points off the fuel bill with stop-start and hybrid locomotives is a compelling strategy.

Disclosure. Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long interest in its common stock.

April 04, 2012

Grid-scale Energy Storage: Lux Predicts $113.5 Billion in Global Demand by 2017

John Petersen

Last month Lux Research released a bottom-up evaluation of the cost effectiveness of eight energy storage technologies in six grid-scale applications throughout 44 countries, including all 50 U.S. states. Their report titled "Grid Storage under the Microscope: Using Local Knowledge to Forecast Global Demand" predicts that annual global demand for grid-scale energy storage will reach an astounding 185.4 gigawatt-hours (GWh) by 2017 and represent a $113.5 billion incremental revenue opportunity for an industry that currently generates sales of $50 to $60 billion a year.

In the grid-scale sector alone, Lux predicts an average year-on-year demand growth of 231% from 2012 through 2015 when the growth rate moderates to 43% per year for 2016 and 2017. The forecast is tempered, however, by a cautionary note that demand of that magnitude can't be satisfied because "Believe it or not, the grid storage market will be supply-constrained in 2017."

Technologies and players

The eight energy storage technologies Lux evaluated for their new report are summarized in the following table, along with the price and performance metrics highlighted in beige. Comparable price and performance metrics from a recent SAND2011-2730 Sandia National Laboratories "Energy Storage Systems Cost Update" are also presented and highlighted in green. While there's room to quibble over the details and users of Lux's Smart Grid Storage Tracker and Demand Forecaster can fine tune the price and performance variables to suit their analytical needs, the parallels between the two sets of system cost estimates are close enough to lend substantial credence to Lux's basic assumptions.

4.4.12 Price-Performance.png

Based on a comprehensive evaluation of various local factors including "utility market structure, generation technology compositions, peak power demand, demand growth rate, infrastructure growth rate, penetration and growth rate of intermittent renewable energy sources, grid reliability, [time of use] electricity rates, commercial demand charges, and outage costs," Lux concluded that Japan, China, the United Kingdom, Germany, and the State of Arizona will be the top five regions for grid storage and collectively account for about 58% of global demand in 2017. Japan and China will each account for about 18%; United Kingdom and Germany, will each account for about 9%; and the US will account for about 23%, with Arizona alone accounting for 4% of global demand.

Some of the more surprising conclusions in the Lux report related to the relative importance of the various grid-scale applications by 2017. For me the biggest surprise was the conclusion that the current killer apps, ancillary services and renewable energy integration, will only account for 1.4% of global demand in 2017 while renewable energy time shifting will account for an impressive 54% of demand, or $61 billion in annual revenue potential. I was also surprised by the conclusion that high spreads between peak and off-peak electricity prices would create a major market opportunity in the residential and commercial sectors, which account for 28% and 17%, respectively, of the 2017 demand forecast.

Based on their in depth evaluation of application requirements and the price and performance of the eight energy storage technologies they evaluated, Lux reported that:

Li-ion takes the early lead, but fades to cheaper alternatives. Li-ion batteries for [power] applications capture nearly 80% of the market in 2012, but quickly fade as cheaper molten-salt and flow batteries become available in the ensuing years. By 2017, Li-ion batteries capture only 13% of the market, yielding 33% to vanadium redox batteries and a nearly even split of the rest of the market between sodium sulfur, sodium nickel chloride, and zinc bromine flow batteries at 19%, 15%, and 19%, respectively. This indicates the short timeframe Li-ion battery developers have to reduce their costs. In the long run, systems with discharge durations between two hours and four hours are the “sweet spot” size for most grid applications. Currently, Li-ion batteries are sought-after due to their availability and proven performance. Flow batteries and molten salt batteries, both of which perform well for longer discharge applications, have shown comparable performance to Li-ion batteries at a fraction of the cost and are currently limited by their availability and proven reliability. Flywheels retain 2% of the market in 2017 and find their niche in relatively small frequency regulation market and other niche applications that require rapid discharge capabilities, short durations, and an extremely long cycle life.

Many participants in the lithium-ion battery sector are developing and demonstrating grid-scale energy storage products. To date, the highest profile player has been A123 Systems (AONE), which has shipped over 90 MW of storage systems for ancillary services and renewables integration. While Johnson Controls (JCI) has been quiet about its plans to package and sell lithium-ion batteries for stationary applications, I have to believe the global footprint and sterling reputation of its building efficiency unit will make it a formidable competitor in the commercial markets.

Sodium Nickel Chloride, or Zebra, batteries have been a relatively low profile chemistry for years. They were originally developed by Daimler for use in electric vehicles but failed to gain much traction in that market despite a decade of solid performance in a 3,000 vehicle fleet that's logged over 150 million kilometers. In 2009 General Electric (GE) announced plans to build a NaNiCl factory in New York. In 2010, Italy's Fiamm bought a controlling interest in Swizerland's MES-DEA, the sole European manufacturer of NaNiCl batteries, and is now doing business as FZ Sonick. Both firms are rapidly ramping their marketing efforts on grid-scale systems.

The largest manufacturer of sodium sulfur batteries is Japan's NGK Insulators (NGKIF.PK), which was the global leader in grid-scale storage for the over a decade with an installed base of over 300 MW. NGK had a spotless safety record until late last year when they suspended NaS battery sales and asked customers to refrain from using installed systems pending completion of an investigation into the cause of a battery fire in Japan. Last year, NGK accounted for roughly 54% of the grid-scale energy storage market. While NGK's market share will fall as other technologies gain traction in the grid-scale markets, its revenues should continue to ramp because of rapid overall growth rates in the sector.

There have been no publicly held companies in the vanadium redox battery space since China's Prudent Energy bought VRB Power Systems in January 2009. At present, ZBB Energy (ZBB) is the only publicly held company that's active in the zinc bromine battery space. ZBB is actively exploring markets for a both zinc bromine flow battery that was originally developed by Johnson Controls and novel technology agnostic control systems that can integrate and manage a variety of conventional and renewable power sources and energy storage technologies.

I was a bit surprised that lead-carbon wasn't included in Lux's list of 2017 market leaders. When I asked the analyst why, he explained that the two leading developers of lead-carbon batteries, Axion Power International (AXPW.OB) and East Penn Manufacturing, were currently launching new products and conducting demonstrations, but didn't yet have enough price and performance history to warrant inclusion at anything beyond placeholder values. He also agreed that if Sandia's price and performance estimates prove accurate, lead-carbon could be a formidable competitor and garner a substantial market share.

Supply constraints

While Lux's bottom-up demand analysis contemplates an enormous ramp in new demand over the next five years, they acknowledged that the global battery industry can't satisfy that demand with existing and planned infrastructure. They didn't drill down into the details for the current report, but I think it's critical for investors to understand the magnitude of likely shortages and the market dynamics that are likely to flow from crushing supply constraints.

In its new report Lux predicted that lithium-ion batteries could account for up to 13% of $113.5 in demand by 2017, or roughly 20 GWh of batteries. To put that number in perspective, last year Lux reported that total global manufacturing capacity for large lithium-ion batteries would grow to about 30 GWh by 2017, which means demand from stationary applications alone could absorb almost two-thirds of global manufacturing capacity. This is good news for lithium-ion battery manufacturers in the short-term because it will help absorb an expected glut of manufacturing capacity. Over the long-term Lux believes lithium-ion batteries are not economically sustainable for grid-scale applications because:

"Li-ion batteries developed for transportation applications are energy dense storage devices. Stationary storage projects rarely value this metric, resulting in wasted value for grid-tied Li-ion battery systems. Rapidly evolving technologies with equivalent or superior performance metrics and substantially lower costs and higher resource availability will take over the majority of the grid storage market in the coming years."

For decades the battery industry has striven to standardize battery chemistries, formats and manufacturing methods. As a result, batteries are usually viewed as fungible commodities with little product differentiation or brand loyalty. In the final analysis, purchase decisions for grid-scale storage systems will be driven by the customer's specific power and energy needs and the ability of a particular battery chemistry to serve those needs at the lowest total cost of ownership. Absent a clearly demonstrable performance advantage, comparable products within a technology class will invariably be forced to compete on the basis of price, which will ultimately compress margins.

Any time there are several competing uses for a supply constrained commodity, the buyer that's willing to pay the highest price will get the first call on available production. If electric vehicle manufacturers are willing to pay up and outbid grid-scale storage users, they'll undoubtedly get enough batteries to satisfy their needs. If automakers are not willing to pay a higher price, battery manufacturers will undoubtedly serve their own economic interests first. On balance, I believe rapid growth in grid-scale energy storage will create substantial secondary problems for electric vehicle manufacturers who are already grappling with fundamentally uneconomic products.

As former director of Axion Power International, I'm intimately familiar with the work that's being done in the field of lead-carbon battery technology. Based on everything I know, I believe that Sandia's cost estimates are reasonable and that lead-carbon batteries will be a good choice for a large number of grid-scale storage applications that don't require extreme performance. It doesn't take much market share in a $113.5 billion niche to make for a very successful company.

Disclosure. Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long interest in its common stock.

March 30, 2012

Lux Research Dissects Lithium-ion Battery Mythology

John Petersen

We all know that you can't have a cost-effective electric car without a cost-effective battery. We also know that a small but vocal hodgepodge of ideologues, activists, politicians and dreamers wants everyone to believe that rapid and stunning advances in lithium-ion batteries will finally make the dream a reality after a century of one abject failure after another.

I frequently caution readers that it won't be anywhere near as easy as the proponents claim.

In a new report titled "Searching for Innovations to Cut Li-ion Battery Costs" Lux Research did a yeoman's job dissecting lithium-ion battery mythology and putting the often inconsistent and invariably confusing world of battery cost claims into an understandable and comprehensive framework that:
  • Explains the technical differences between various types of lithium-ion cells;
  • Explains how future technological improvements will impact cell costs;
  • Explains the differences between cell and battery pack costs;
  • Explains the differences between nominal and useable pack capacity; and
  • Reinforces the inconvenient but undeniable truths that:
    • it's lithium-ion batteries or bust for plug-in vehicles;
    • battery costs will ultimately dictate the future of EVs;
    • there isn't much hope for stunning cost reductions through the end of this decade, and
    • over the next eight years incremental solutions like micro-hybrids will be preferred by automakers and consumers alike because they provide reasonable fuel savings at a reasonable price.
Lux has created a formidable piece of work that's directed at industry professionals and institutional investors. While I can't do the report justice in a blog, I can at least touch on a few high points. For readers who'd like to learn more directly from the source, Lux will be presenting a free webinar on Tuesday April 3rd at 11 a.m. EDT.

All lithium-ion batteries are not created equal. A critical but frequently misunderstood battery performance metric is the relationship between power and energy.
  • Hybrid electric vehicles, or HEVs, are power applications that typically use a small (±1.4 kWh) battery pack to absorb braking energy for immediate re-use in the next acceleration cycle.
  • Plug-in hybrid electric vehicles, or PHEVs, occupy the middle ground and use a mid-sized (5.2 to 16 kWh) battery pack to offer both hybrid and  electric drive functions, which means they require both power and energy.
  • Battery electric vehicles, or BEVs, are energy applications that use a massive (24 to 85 kWh) battery pack to propel vehicles for long distances at high speeds.
In general, HEV batteries cost more per kWh than PHEV batteries, which in turn cost more per kWh than BEV batteries. Likewise, smaller battery packs for short-range BEVs from Nissan (NSANY.PK) cost more per kWh than larger battery packs for long-range BEVs from Tesla Motors (TSLA).

Nominal cost per kWh is far lower than effective cost per kWh of useable energy. Most battery packs are designed with safety margins that reduce battery strain from operating a vehicle at a very high or a very low state of charge. Since nominal capacity is always higher than useful capacity, battery pack cost per kWh of useful energy is always higher than than nominal battery pack cost.

Nominal pack cost for PHEVs is currently about $800 per kWh, but the effective pack cost is closer to $1,500 per kWh of useable energy. By 2020, Lux expects nominal pack cost for PHEVs to decline to about $500 per kWh, but it believes effective pack cost will be closer to $800 per kWh of useable energy.

Nominal pack cost for BEVs is currently about $750 per kWh, but effective pack cost is closer to $1,400 per kWh of useable energy. By 2020, Lux expects nominal pack cost for BEVs to decline to about $400 per kWh, but it believes effective pack cost will be closer to $700 per kWh of useable energy.

The following graph from the Lux report shows how they expect nominal and useable costs of automotive cells and EV battery packs based on nickel, manganese, cobalt chemistry to evolve through the end of the decade. It can be particularly instructive for investors who've had a hard time visualizing the disparities between nominal cell and battery pack costs and effective useful energy storage capacity costs.

3.30.12 Lux Graph.png

While the latest Lux forecasts for battery pack costs are significantly higher than most imagine based on press releases and news reports, they tie closely to comparable 2020 cost estimates from an AutomotiveWorld webinar last Thursday on "Reducing the cost of EV batteries." While neither organization focused on the fact that the price a battery manufacturer charges an automaker doesn't include the automaker's integration costs or markup, the fact remains that the effective 2020 cost to the consumer will be on the order of $1,000 per kWh of useful battery capacity.

HEVs are fuel efficiency technologies that squeeze as much mileage as possible from a gallon of gasoline. In contrast, PHEVs and BEVs are fuel substitution technologies that swap a battery pack for a fuel tank so that owners can swap electricity from coal and natural gas for gasoline. Advocates wax poetic on using alternative energy to charge EVs, but the truth is the virtue of green electrons lies in their creation, rather than their use, and most drivers want to use their cars during daylight hours, which is the only time solar panels work. While electric drive can be highly efficient in runabouts like the cute Renault Twizy, it can be preposterously wasteful in rubenesque halo cars like the Fisker Karma.

3.30.12 Twizy.jpg 3.30.12 Karma.jpg

It's a mystery to me how EV advocates can steadfastly cling to their mythology in the face of caution from leaders like Energy Secretary Steven Chu who told participants in the November 2010 United Nations Climate Change Conference:

"And what would it take to be competitive? It will take a battery, first that can last for 15 years of deep discharges; you need about five as a minimum, but really six- or seven-times higher storage capacity and you need to bring the price down by about a factor of three."

The Secretary's goals seem pretty straightforward:
  • A 15 year life;
  • Five to seven times higher storage capacity; and
  • A two-thirds cost reduction.
Achieving those lofty goals is proving to be far more daunting than describing them.

Lux is currently forecasting a fifty percent reduction in battery costs over the next eight years in the most likely scenario, which works out to an aggressive but attainable improvement of five to six percent per year. A123 Systems (AONE) has not made significant visible progress in efforts to reduce manufacturing costs over the last three years. While Altair Nanotechnologies (ALTI) and Valence Technologies (VLNC) are a good deal more opaque than A123 Systems when it comes to providing reliable cost data to the SEC or the markets, they also seem to be having problems reducing their costs.

Investors who expect cost reduction curves like we've seen in electronics will be sorely disappointed. Investors who pay 17.5 times book value for a money losing startup like Tesla when they could pay 6.3 times book value for an established and extraordinarily profitable innovator like Apple will pay dearly to learn an important lesson:

– that markets may act like a voting machine in the short term, but they always act like a weighing machine in the long term.

Disclosure: None.

March 24, 2012

Lead-Carbon Batteries: Cheap Classic Chemistry With 21st Century Performance

John Petersen

Overview

Mark Twain quipped, "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so." Truer words were never spoken, particularly when it comes to the batteries that most of us use and curse on a daily basis. If you have a car, you have a lead-acid starter battery that needs to be replaced every couple years. Cellphones and laptops offer similar trials and tribulations unless you upgrade your electronics regularly. When our cars don't start or our electronics don't work, we invariably blame the batteries first. While most of us haven't noticed any major change in starter battery performance over the last couple decades, the utility of electronics has skyrocketed and many believe the gains come from improved battery performance. They're dead wrong.

Today's car batteries aren't terribly different from the ones we bought in the '80s and '90s and they don't perform any better or worse. We just demand more from them as we add increasingly sophisticated entertainment, passenger comfort, information and fuel economy systems to passenger cars. The same is true for the batteries we use in portable electronics. NiMH batteries performed better than NiCd batteries that were plagued by memory effects. Lithium-ion performed even better than NiMH. Within each chemistry class however, today's batteries aren't terribly different from from the ones we bought years ago. The only truly major improvements have been longer cycle-lives – the number of times a battery can be charged and discharged before it needs to be replaced. When you cut through the fog of errant assumptions and get down to facts, the reason electronic devices work better is that clever manufacturers have found ways to slash energy use by 80 to 90 percent while increasing functionality. It has absolutely nothing to do with improving the performance of a particular chemistry.

A popular French phrase aptly describes technical progress in the battery industry – "plus ça change, plus c'est la même chose," or the more it changes, the more it’s the same thing. The following table summarizes the development history and typical specific energy of today's leading battery chemistries.

Battery chemistry
Invented Commercialized
Wh/kg
Lead-acid
1859 1880s
35
NiCd
1899
1950s
45
NaS
1960
1980s
80
NiMh
1967
1990s
90
Lithium-ion
1979
1990s
150

Two key takeaways are (1) the long periods between the invention and the commercialization of new battery chemistries, and (2) the slow incremental nature of progress in the battery industry. Despite a never-ending stream of optimistic press releases, no major new battery chemistry has entered the market since the launch of lithium iron phosphate in 1996.

For those who've gotten used to Moore's Law, cumulative gains of 1% a year over 153 years are not impressive. I read the same stories as everyone else and know all about the researchers who boldly promise to double or triple energy density by the end of the decade. I also understand the difference between hope and accomplishment. My inner geek will wildly cheer new developments if, as and when they prove their technical and economic merit in a free market. But my inner investor will never forget that hope is not an investment strategy and results are the only things that count.

Brief history lesson

Like all mature technologies, batteries have progressed through several evolutionary cycles over the last century as users' needs changed. Until the '60s, the two dominant classes of batteries were rechargeable lead-acid batteries and disposable dry cells. Lead-acid batteries did the heavy work like starting cars, powering equipment and providing emergency backup power while dry cells powered flashlights, toys and consumer goods, including the first wave of portable electronics.

In the early '70s a variety of low-maintenance flooded lead-acid batteries and high-performance AGM batteries were introduced. They rapidly became industry standards. They worked so well that R&D in the lead-acid battery sector plummeted because there was no need for better lead-acid batteries and the perceived value of additional refinements didn't justify the added cost. About the same time, Japanese manufacturers launched a wave of portable electronic devices that desperately needed better batteries. So R&D spending on lightweight rechargeable chemistries soared. That trend continued through the turn of the millennium because lead-acid batteries were good enough for the work they performed while batteries for portable electronics were grossly inadequate.

Since the turn of the millennium, a new market dynamic has emerged that's driving unprecedented levels of R&D in the fields of electrochemical and physical energy storage. The primary requirements of this new dynamic are cost-effective systems that store massive amounts of energy, need little or no maintenance and deliver peak performance for a decade or longer. It's a tall order when you understand that most of the batteries we used in the past were designed for devices that needed tiny amounts of stored energy and had short replacement and upgrade cycles.

For lithium-ion battery developers, the principal technical challenges included:
  • Making cells that were designed for short useful lives more durable;
  • Making cells that were designed for indoor use temperature tolerant;
  • Making larger cells with stable mechanical, thermal, electrical and electrochemical behavior;
  • Making watt-hour sized cells suitable for use in kilowatt- and megawatt-hour arrays;
  • Developing battery management systems for kilowatt- and megawatt-hour arrays;
  • Increasing specific energy to a point where electric drive can be economically feasible;
  • Improving safety, vibration and impact resistance, and overall abuse tolerance;
  • Building new manufacturing infrastructure and materials supply chains;
  • Slashing costs by 75% or more in an industry where raw materials represent 65% of cell costs; and
  • Developing cost-effective recycling technologies and infrastructure for massive battery packs.
Over the last decade, lithium-ion battery developers have made significant progress on a number of fronts, although cost reductions, specific energy gains and cost-effective recycling remain as elusive as unicorns. Some bright researcher may one day crack the code and solve all the technical challenges of lithium-ion batteries, but I'm not holding my breath.

For lead-acid battery developers, the principal technical challenges were far less daunting and included:
  • Making batteries that were designed for short useful lives more durable;
  • Making kilowatt-hour sized batteries suitable for use in megawatt-hour arrays;
  • Developing battery management systems for megawatt-hour arrays; and
  • Reducing charging times to permit more frequent and deeper cycling.
In a nutshell, the lead-acid sector had a simpler and shorter path. The industry had been making heavy-duty industrial batteries for decades. More importantly, researchers had a wider variety of technology and materials options because of the 30-year hiatus in lead-acid R&D. It was almost like the researchers returned from a 30-year vacation to find a different toolbox. As they started using advanced materials and manufacturing processes to improve the performance, cycle life and charging times of lead-acid batteries, the results were astonishing.

Application requirements

The thorniest conceptual problem in energy storage is the variable value of a kilowatt-hour of stored electricity. The two primary determinants of value are time and place. Each of these characteristics, in turn, has a value hierarchy that ranges from very high to merely desirable.

In the simple case of a stationary application where the only variable is time, it's easy to create a value hierarchy. The three principal types of high value applications are:
  • Off-grid batteries that make renewable power available when the sun isn't shining or the wind isn't blowing;
  • Grid-connected batteries that insure system-wide grid integrity by smoothing minute-to-minute variation in user demand and power from variable resources; and
  • Commercial and industrial batteries that provide uninterruptible power for mission critical operations.
While system reliability is the primary requirement for every high value application, total cost of ownership is a crucial secondary consideration and users are reluctant to pay a premium price for attributes they don't need. As you move down the food chain from critical reliability systems to desirable time-shifting applications, the economics get more complex and the users get more particular as they weigh the costs and benefits of energy storage against available alternatives. The complexities of the calculations are enormous, but the basic rules are clear.
  • Storage systems that cycle dozens of times per day are more valuable than systems that cycle once or twice;
  • Performance features that increase system cost without increasing end-user value are non-starters; and
  • The law of economic gravity is inviolate – the cheapest system that can do the work will win.
There are only a few cases where size and weight are mission critical for stationary systems. Examples include installations in existing buildings that have limited floor space or weight tolerances. As soon as you start evaluating shipping containers on a concrete pad, size and weight are irrelevant and the only features that matter are price and performance.

Portable power is usually more valuable than stationary power because it offers flexibility in both time and place. The most valuable batteries I own are in my cellphone and laptop where a few dozen watt-hours are priceless. Next in line is my starter battery. Once we move away from priceless applications, every energy storage decision involves trade-offs. The following simple examples highlight the economic issues that plague electric drive by assuming free electricity, a $5 gas price and an average fuel consumption of 400 gallons per year.
  • In a Prius-class HEV that cuts fuel use by 25%, a 1.3 kWh battery will save $500 a year or $385 per kWh;
  • In a Volt-class PHEV that cuts fuel use by 75%, a 16 kWh battery will save $1,500 a year or $94 per kWh;
  • In a short range Leaf-class EV that cuts fuel use by 100% but requires a second car for longer trips, a 24 kWh battery will save $2,000 a year or $83 per kWh;
  • In a short-range Tesla Model S that cuts fuel use by 100% but doesn't necessarily require a second car, a 45 kWh battery will save $2,000 a year or $44 per kWh; and
  • In a long-range Tesla Model S that cuts fuel use by 100% and won't require a second car, an 85 kWh battery will save $2,000 a year or $24 per kWh.
The examples deliberately ignore the question of battery cost because that fact is irrelevant to the fundamental truth that the economic value per kWh plummets as battery pack size increases. When it comes to portable power, small is beautiful but big is grossly inefficient.

Bill Reinert, Toyota's Advanced Technology group manager, recently described the problem as follows, "I used to be a big 100-miles-per-gallon guy. But I realized that we’re above the level of diminishing returns at 50 miles per gallon. So why not make a whole bunch of 50-miles-per-gallon cars and put people who are driving 20-miles-per-gallon cars into them?" It's a classic conflict where the technically possible is diametrically opposed to the economically sensible.

Lead-carbon batteries

The last decade has been an exciting time in the lead-acid battery industry as manufacturers respond to changing market dynamics. The first major technology transition was increased reliance on maintenance-free AGM batteries that are more robust and abuse tolerant than first-generation flooded batteries. The second major technology transition is the integration of varying amounts of carbon to reduce charging times and increase cycle-life. In a presentation at last September's Asian Battery Conference, the Advanced Lead Acid Battery Consortium offered an exhaustive technical analysis on the use of carbon in lead-acid batteries and the approaches the principal manufacturers are taking.

The simplest, cheapest and most direct approach is adding fine carbon powders to the sponge lead pastes used in the negative electrodes of first- and second-generation lead-acid batteries. Extensive testing over the last decade has shown that changing the paste formulation to include up to 6% carbon by weight (±30% by volume) offers excellent cycleability and power while significantly reducing charging times. Johnson Controls (JCI), Exide Technologies (XIDE) and several other companies are already using carbon paste additives in enhanced versions of their flooded and AGM batteries with notable success. Others will follow. While carbon enhanced batteries have slightly lower specific energy than their predecessors, their 100 to 200 percent increase in cycle-life reduces the cost of energy storage by 30 to 50 percent.

A more complex approach is the Ultrabattery from CSIRO, Furukawa Battery and East Penn Manufacturing. It divides each negative electrode into two parts, a lead half and a carbon half. The end result is superior cyclability and power with even shorter charging times. The Ultrabattery is being tested in a variety of stationary and micro-hybrid applications and shows significant promise, including the potential to reduce the cost of energy storage by 50 to 70 percent.

The third and most sophisticated approach is the PbC battery from Axion Power International (AXPW.OB) that replaces the lead-based negative electrodes used in conventional batteries with a carbon electrode assembly. The resulting device is an "asymmetric lead-carbon capacitor" that offers the energy storage of a battery and the power and cycleability of a capacitor in a single hybrid device. The PbC has the lowest specific energy of all the emerging lead-carbon technologies, but it offers the cycleability and charge acceptance of the best lithium-ion batteries at a fraction of the cost. The PbC has been extensively tested for stationary, railroad, micro-hybrid and military applications and shows great promise, including the potential to slash the cost of energy storage by 80 percent or more.

The road forward

Lead-acid battery chemistry is one of the oldest, safest, most widely used and most environmentally benign technologies known to man. While lead-acid batteries can cause grave health problems if they're not manufactured, used and recycled in compliance with applicable regulations, the lead-acid battery industry has a stellar track record in the US and Europe where over 98% of used batteries are recycled to make new ones. According to USGS reports, over 95% of the lead used by US battery manufacturers in 2011 came from recycled batteries. No other closed-loop recycling ecosystem even comes close. When it comes to other types of batteries, similar closed-loop recycling ecosystems don't even exist.

The lead-acid battery sector has a massive global footprint with robust supply chains, distribution systems and recycling infrastructure. The new lead-carbon technologies have been developed to integrate seamlessly into the existing infrastructure and leverage the manufacturing base instead of displacing it. The commercial lead-carbon batteries that are rolling off the assembly lines today already offer 200 to 1,000 percent better performance than the batteries you think you know.

Lead-carbon batteries are heavy and bulky. They'll never be small or light enough for portable electronics or electric cars that need to travel long distances at highway speeds. As soon as you move away from these niche applications where size and weight are mission critical and money is no object, the advantages of lead-carbon batteries become overwhelming. Shakespeare said, "Nothing is so commonplace as to wish to be remarkable ." When it comes to energy storage, however, most of our needs are fairly mundane and there's no sense paying for extreme performance when adequate performance can do the necessary work for a fraction of the cost.

The first commercial products based on R&D conducted since the turn of the millennium are being launched today. The new products use cheap classic chemistry, but offer 21st century performance that many thought was the exclusive province of lithium-ion batteries. Over the next few years, these innovations will re-energize the lead acid battery sector with products that are vastly superior to their predecessors and competitors for applications where size and weight are not mission critical constraints.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

March 15, 2012

Geneva Motor Show Highlights – The Revenge of the Internal Combustion Engine

John Petersen

March is Motor Show time in Geneva and it was fascinating to witness the shift in emphasis away from plug-in vehicles as European automakers highlighted their accomplishments in fuel efficiency technologies like HEVs, micro-hybrids and dual fuel drivetrains that can switch back and forth between gasoline and compressed natural gas. While there were modest displays for Tesla (TSLA), Fisker and other emerging brick-makers, and space was set aside for the obligatory plug-ins that most real manufacturers are toying with, the substantial majority of front-line vehicles at display entrances and halo cars on turntables were HEVs and micro-hybrids. As far as I could tell, this year's theme was The Revenge of the Internal Combustion Engine.

One of the most intriguing concept cars at the show was the "LC Super-Hybrid" from Controlled Power Technologies, which is really a super micro-hybrid. Instead of fooling with the expense and complexity of electric drive, CPT added longer gear ratios, a 2 kw belt driven starter generator, an electric supercharger and beefier electronics to a VW Passat with a 1.4 liter turbocharged gas engine. The changes cost less than $2,000, but the end result was a 50.5 mpg Passat with driving performance that rivals the 1.8 liter version while offering 23.4% better fuel economy. An associated presentation from the Advanced Lead Acid Battery Consortium summarized the value proposition in this table.

3.15.12 Table.png

The logic is compelling because it cooperates with the law of economic gravity. Micro-hybrids and the LC Super-hybrid offer attractive fuel savings at a very modest cost. While it's technically possible to do more with increasingly expensive and complex mild hybrids, HEVs and plug-ins, the incremental cost for a percentage point of incremental benefit starts getting absurd as soon as you add electric power to the wheels. After several years of unrelenting hype from ideologues, advocates, reporters and politicians who can't see the forest for the ferns the message is finally sinking in – The green in a consumer's wallet will always outweigh the green in his cocktail conversation.

On Monday of this week Automotive News published a brief but highly informative interview with Alex Molinaroli, the president of Johnson Controls Power Solutions (JCI), the world's most successful battery manufacturer and the only global manufacturer with major commitments to both lead-acid and lithium-ion batteries. While EVangelicals may be distressed by Mr. Molinaroli's frank assessment that electric cars won't generate big sales for at least a decade, I view it as just one more confirmation of my long-held belief that cheap will beat the pants off cool in the transportation market.

To understand the relative importance of JCI's diverse battery manufacturing activities, you need to dig into the segment information in its Annual Report on Form 10-K. At September 30th, the power solutions segment accounted for 22.4% of JCI's assets, 14.4% of its sales and a whopping 35.4% of its income before interest and taxes. In the last three years, JCI invested $937 million in its power solutions segment, plus an additional $300 million that was provided by a 2009 ARRA Battery Manufacturing Grant to the JCI-SAFT joint venture. Planned spending of several hundred million over the next three years will increase JCI's AGM battery manufacturing capacity from a couple million units in 2009 to:
  • 11.8 million units a year in Europe;
  •  6.8 million units a year in North America; and
  •  2.8 million units a year in China.
The reason is simple, AGM batteries generate twice the per unit revenue and three times the per unit margin of JCI's conventional flooded batteries. As its new AGM capacity comes online, JCI can expect its power solutions revenue to jump by $1.3 billion annually while adding about $500 million a year to operating income. AGM battery manufacturing is a key developing business segment for JCI and it's all being driven by automaker demand for better batteries that will be used primarily in micro-hybrids. A similar albeit less aggressive AGM battery manufacturing expansion is currently underway at Exide Technologies (XIDE) which is expanding its capacity to roughly 8.5 million units a year.

Of the two major battery manufacturers that are rapidly ramping AGM manufacturing capacity, I believe Exide presents the more exciting opportunity because its historic earnings were brutalized by restructuring costs and its stock has been beaten down to a point where it trades at 54% of book value and 8% of sales. If Exide's AGM manufacturing activities generate marginal profits that anywhere close to those expected from JCI, a $150 million boost to operating earnings could send the stock soaring.

Over the last year there's been an increasing amount of market noise as battery and supercapacitor developers hawk new systems for the micro-hybrid market ranging from enhanced lead-acid batteries to supercapacitors and even lithium-ion batteries, which proves once again that the whole world looks like a nail to a hammer manufacturer. Last month, SAE International published an important article on the micro-hybrid space titled "AGM battery takes primary role for idle stop-start in microhybrids" that explained the challenges of micro-hybrid applications with striking simplicity and clarity. I think it's a must read for any investor who wants to understand the space and the opportunities.

While I believe the SAE International article is too important to summarize, I do want to draw reader's attention to one key sentence.

"The fuel-economy improvements vary according to car maker, but a BMW study estimates up to 4% overall for current systems, with the potential for 10% if a higher charge-acceptance-rate battery (over 100 A) were available."

The sentence is important for two reasons.

First, BMW has spent almost three years and an immense amount of money testing the PbC battery from Axion Power International (AXPW.OB), an asymmetric lead-carbon capacitor that offers the charge acceptance of a capacitor and the power and energy of an AGM battery in an integrated hybrid device. A joint presentation from the two companies at the 2010 European Lead Battery Conference in Istanbul showed that alpha prototypes of the PbC offered sustained dynamic charge acceptance of 100 Amps through the equivalent of five years of simulated use under a testing protocol that was jointly developed by BMW and Ford.

Second, at this year's Geneva Motor Show BMW's front and center display space highlighted the new Series I; 116d EfficientDynamics Edition that launches this month and boasts CO2 emissions of 99 grams per kilometer, or fuel economy of roughly 62 mpg. Its turntable star was the BMW 6 Series Gran Coupé which will launch in June. Both cars are advanced micro-hybrids that share a novel BMW driver awareness system called ECO PRO Mode that helps drivers reduce fuel consumption by up to 20%. According to BMW's website:

"As soon as you select the ECO PRO Mode using Driving Experience Control including ECO PRO, everything is geared towards maximum efficiency. Pedal recognition, gear recognition and the best point at which to change gear are optimised and the heating and air conditioning strategy is adapted intelligently. The control display indicates which BMW EfficientDynamics functions are currently operating in order to actively reduce the amount of energy being used, such as Brake Energy Regeneration or optimised temperature control. The driver also receives situation-specific ECO PRO info on fuel efficient driving, such as the optimal gear to drive in. The Bonus Range Display in the on-board computer shows how much further it is possible to drive thanks to the ECO PRO Mode."

When I start connecting the dots an intriguing picture begins to emerge. The ALABC presentation for the LC Super Hybrid shows that automakers are spending €35 to €100 for each 1% of fuel economy in their mico-hybrids. The SAE is reporting that the best the automakers can do with AGM batteries is a 4% improvement in fuel economy, but that a battery with higher dynamic charge acceptance like the PbC could boost efficiency into the 10% range. When I factor in BMW's decision to showcase two advanced micro-hybrids with ECO PRO Mode, I have to think that BMW's found a solution to the dynamic charge acceptance issues they explained at the ELBC. These cars are promising fuel economy gains of up to 20% while providing real-time system performance information to the drivers. There's no indication that they've selected the PbC, but I have a hard time believing that a first tier automaker would introduce a new system that called drivers' attention to the dynamic charge acceptance degradation that all plagues all AGM batteries over time.

Now that the problems and challenges of electric drive are becoming increasingly obvious to the mainstream media and to politicians who need to think about elections later this year, I expect an increasingly difficult time for the developers of electric vehicles and their components. As Mr. Molinaroli said "A mass market for EVs is still a long way off. That's why we don't spend a lot of time talking about all this."

Investors with low risk tolerance who want meaningful portfolio exposure to an automotive mega-trend that's evolved quietly in the background while hucksters hype $100,000 toys for the 1% should take a serious look at JCI, a diversified dividend paying industry leader that's likely to be a dominant force in the micro-hybrid market for years to come. Those with a higher risk tolerance may want to take a good long look at Exide and consider what the market price might be with $150 million of incremental gross profit from AGM battery sales. The lottery ticket in the bunch is Axion, which currently trades at an R&D market capitalization in the $32 million range. Since Axion just tucked $8.5 million away in the bank from an offering at $0.35 per share, the price isn't likely to fall over the next six to nine months. If one or more of its first tier testing relationships matures into a customer relationship, the possibilities are endless.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

February 03, 2012

Lux Boosts Their Micro-Hybrid Vehicle Forecast to 39,000,000 Cars a Year By 2017

John Petersen

A couple days ago Lux Research published a new report titled “Every Last Drop: Micro‐ And Mild Hybrids Drive a Huge Market for Fuel‐Efficient Vehicles” that focuses on rapidly growing markets for micro-hybrid vehicles and their battery systems.

During 2011, automakers sold an estimated 5,000,000 micro-hybrids worldwide, mainly in Europe. By 2017, Lux forecasts global micro-hybrid sales of 39,000,000 cars a year and a $6.3 billion annual market for their battery systems, which represents an across the board average of $161 per vehicle compared to an auto industry average of less than $60 per vehicle in 2009. While most US investors aren't even aware that micro-hybrid technology exists, it's already crossed the chasm and become a mainstream automotive technology.

To put the micro-hybrid phenomenon into perspective, most auto industry observers believe combined global sales of HEVs, PHEVs and EVs will be lucky to reach the 2,000,000-vehicle a year mark by 2017. Electric drive technologies may become mainstream architectures for 2025 and beyond, but for the next six years there's no doubt that cheap and easily implemented micro-hybrid technologies for mass-market vehicles will be at the epicenter of battery industry growth and profitability.

The term micro-hybrid is used to describe idle elimination systems that reduce fuel consumption by turning the engine off when it's not being used to power the wheels. They typically replace both the starter motor and the alternator with a belt-driven starter-generator, or BSG, upgrade to a better battery and add required control electronics. No other changes are necessary. While a BSG will offer a couple horsepower of cranking and generate a couple kilowatts of electricity, BSG's are not robust enough to drive a vehicle's wheels. Nevertheless, they're simple to combine with existing engine architecture and very cheap to implement. Because of their mechanical simplicity, micro-hybrids only cost $400 to $1,000 more than a conventional vehicle, but promise fuel savings of 5 to 15 percent. Micro-hybrids are a baby step, but 39,000,000 baby steps a year can cover a lot of ground and save about 15 millions of barrels of oil per year.

In their latest report, Lux divides micro-hybrids into three distinct classes that require different types of batteries.

Light Micro-Hybrids are typically sub-compact and compact cars that offer limited stop-start functionality and don't have regenerative braking. The current batteries of choice for light micro-hybrids are enhanced flooded lead acid batteries. The global market for light micro-hybrids is expected to grow to 8.5 million vehicles per year by 2017.

Medium Micro-Hybrids range from sub-compact through full-size cars that offer greater stop-start functionality and may offer limited regenerative braking. The current batteries of choice for medium micro-hybrids are enhanced flooded lead acid batteries and advanced AGM batteries. The global market for medium micro-hybrids is expected to grow to 22.2 million vehicles per year by 2017.

Heavy Micro-Hybrids are typically mid-size and full-size cars that offer the highest level of stop-start functionality, take full advantage of regenerative braking and implement other fuel economy innovations. Because of their extreme power demands, heavy micro-hybrids need better performance than the best AGM batteries can offer. The global market for heavy micro-hybrids is expected to grow to 8 million vehicles per year by 2017.

The following graph from the latest Lux report shows how the market is expected to evolve over the next six years.

2.3.12 Lux.jpg

On a regional basis, Lux is forecasting that:
  • The European micro-hybrid market will grow from over 4 million units in 2011 to 12.6 million units by 2017.
  • The North American micro-hybrid market will grow from a standstill in 2011 to over 8 million units by 2017.
  • The Japanese micro-hybrid market will grow from about 400,000 units in 2011 to over 6 million units by 2017.
  • The Chinese micro-hybrid market will grow from under 300,000 units in 2011 to 8.9 million units by 2017.
Last November I used the following table to highlight the differences between the daily battery load in a normal car and the daily battery load in a micro-hybrid for a typical city driving commute with 15 engine-off opportunities per leg.

Power Event
Conventional Stop-Start
Initial engine start 500 Amp Seconds 500 Amp Seconds
Engine-off accessory loads
45,000 Amp Seconds
Engine restart loads
4,500 Amp Seconds
One-way battery load 500 Amp Seconds 50,000 Amp Seconds
Round-trip battery load 1,000 Amp Seconds 100,000 Amp Seconds

We're all familiar with the flooded lead-acid batteries that have been standard automotive equipment for decades and I don't think anybody would suggest that they can do 100 times the work without quickly failing. The automakers know that better batteries are needed, but they all want to get by with the cheapest better battery they can find because every dollar of cost matters in mass-market products.

Some automakers are using enhanced flooded batteries for their light and medium micro-hybrids solely because of cost considerations. They reason that enhanced flooded batteries offer twice the lifetime energy throughput of their simpler siblings and twice the throughput is always a good thing. The problem, of course, is that the numbers don't balance if you double the throughput of the battery and expect it to do 100 times the work.

A similar, albeit less dramatic, dynamic exists for the automakers who are upgrading medium micro-hybrids to AGM batteries that cost twice as much as their more primitive cousins but offer ten times the lifetime energy throughput. After all, improving performance by an order of magnitude is huge – until you understand that they're increasing the required work by two orders of magnitude. The bottom line is that AGM batteries will be the best available technology for micro-hybrids until a significantly better solution emerges, proves its merit and becomes available at relevant scale. Once a better solution is widely available, the market must gravitate to better performance unless the incremental cost exceeds the value of the incremental fuel savings.

I follow two companies that will be the first big beneficiaries of the rapid global adoption of micro-hybrid technologies. Johnson Controls (JCI) and Exide Technologies (XIDE) both manufacture enhanced flooded batteries for micro-hybrids and are rapidly expanding their AGM battery manufacturing capacity in North America and Europe. They will clearly be preferred suppliers for light and medium micro-hybrids from American and European automakers for the foreseeable future. While enhanced flooded batteries won't have a huge impact on either revenues or profits, their rapidly expanding AGM battery sales will double their per vehicle revenue and triple their per vehicle margins. It truly is a manufacturer's dream scenario. As micro-hybrid production numbers ramp rapidly over the next few years I expect both companies to outperform the market's expectations by a wide margin.

From my perspective the most interesting segment is heavy micro-hybrids that demand more performance than AGM batteries can hope to deliver. These next generation systems will push the frontiers of micro-hybrid technology by maximizing regenerative braking and adding other nuanced features like passive boost, which disables the BSG during acceleration, opportunity charging, which increases power to the BSG when the vehicle is decelerating, and engine-off sailing, which turns the engine off while the vehicle is rolling to a stop. The heavy micro-hybrid market is the prime target for two advanced technology systems that are working their way through the development and commercialization process, and stand a good chance of becoming industry leaders over the next few years.

In the fall of 2010, Maxwell Technologies (MXWL) and Continental AG introduced a dual device system that matches a supercapacitor module from Maxwell with an AGM battery and control electronics from Continental. The first design win for the Maxwell-Continental system is diesel powered micro-hybrids from Peugeot-Citroën. A comparable system will be used by Mazda in it's iELOOP heavy micro-hybrid. Other automakers will almost certainly follow their lead in adopting dual device systems for heavy micro-hybrids.

A second advanced energy storage system for heavy micro-hybrids is the PbC battery from Axion Power International (AXPW.OB). The PbC is an integrated battery-supercapacitor hybrid that combines lead-based positive electrodes from a battery with carbon based negative electrodes from a supercapacitor in a single cell. While the PbC is not yet available as a commercial product for heavy micro-hybrids, it is two and a half years into evaluation by BMW and other leading automakers, and offers a performance profile that simply can't be matched by anything short of a lithium-ion battery pack. If Axion can clear the last testing and manufacturing hurdles, the PbC has the potential to be a game changer in the heavy micro-hybrid space because it offers 5X the capacitance of dual device systems and 5X to 20X times the dynamic charge acceptance after a few months in service.

Last week I spent some time with a former Enersys engineer who noted that there are only two components in a car that automakers refuse to put their brand on. The first is the tires and the second is the battery. If a consumer has problems with either of those components, the automakers say, "Take it up with the manufacturer" who frequently says, "You abused our product by pushing it beyond design limits."

While the traditional blame game has a long and storied history, it can't continue indefinitely because micro-hybrids are being sold by the automakers as fuel efficiency and emissions control systems. Over the short term, the automakers will continue to play the game of using cheap batteries that can't stand up to the duty cycle. Over the longer term, applicable regulations will change to require that the OEM battery installed in a micro-hybrid be designed to satisfy the requirements of the vehicle's electric load profile.

For investors who want to benefit from the micro-hybrid vehicle trend but don’t have the time or inclination to study the various energy storage technologies in depth, a balanced portfolio weighted in favor of the large established battery manufacturers makes the most sense. While I have a personal favorite, I expect all four companies to outperform over the next three to five years.

Disclosure. Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

January 23, 2012

Understanding Manufacturing Economics for Grid-Scale Energy Storage

John Petersen

I have a new favorite word — AGGREGATION!

At the risk of sounding like a reporter, I’m going to summarize a pre-holiday news story you might have missed but need to know about.

In late November the PJM Interconnect, the largest of nine regional grid system operators in the US, announced that it had begun buying frequency regulation services from small-scale, behind the meter, demand response assets in Pennsylvania.

The first resources brought on-line by PJM were variable speed pumps at a water treatment plant and a 500 kW industrial battery array at a factory. Each of these resources has been configured to respond to PJM’s signals within four seconds and provide 100 kW of frequency regulation capacity.

In the water treatment plant, the operator will change pump speeds as necessary while keeping average throughput at 80% of nameplate capacity. For the industrial battery array, the operator will shift loads to the battery when the grid needs power and charge the battery when the grid has excess power.

The contract operators for both installations envision portfolios of flexible industrial loads that can be aggregated and operated as a distributed virtual utility that responds instantaneously to supply and demand conditions on the grid side of the meter. They’re literally turning grid loads into grid assets.

How cool is that?

I learned about the development because my old team at Axion Power International (AXPW.OB) built the battery array and is using its New Castle plant in Pennsylvania as the test-facility. But this was more than just an Axion event because it opens a world of opportunity for all manufacturers of industrial power quality and reliability systems.

Traditionally, the battery industry’s pitch on industrial energy storage systems focused on ensuring the highest possible level of power quality and reliability for industrial customers. More recently manufacturers have refined their pitch to include other behind the meter benefits like time of use and demand charge management.

This latest twist creates a whole new set of opportunities to reduce the net cost of a customer’s power quality assets by aggregating incremental revenue from grid-side ancillary services. The battery industry is at a tipping point because energy prices have finally reached a level where waste isn’t always cheaper than storage.

It’s still a tough cost-benefit equation because customers hate anything that eats into margins, but as energy storage system (ESS) developers find new ways to aggregate benefits and use their facilities more efficiently, the potential market grows exponentially.

Now it’s time to shuck the reporter’s fedora and give my horns a little room to breathe. Let’s drill deeper into the inherently confusing metrics ESS developers use to describe grid-scale storage systems.

In a recent report on grid-scale ESS costs, the DOE’s Sandia National Laboratories took a bifurcated approach to pricing that separated the costs of the power control subsystem from the costs of the energy storage subsystem. Their summary table of generic ESS costs using the principal battery chemistries breaks down like this.

1.23.12 Sandia.png

The problem arises when battery manufacturers focus on a power metric in their public statements, instead of an energy metric, and fail to give readers any clues about who contributes what share of system value.

To highlight the problem I’ll use Sandia’s numbers to estimate the prices of Axion’s PowerCube and A123 Systems’ (AONE) Laurel Mountain wind farm project.

1.23.12 Projects.png

ESS buyers aren’t stupid. They won’t let battery manufacturers earn the same margin on the power control subsystem that they earn on the energy storage subsystem.

That leads to the inescapable conclusion that a $2 million ESS sale that’s 70% power control systems and 30% batteries is not the same as a $2 million battery sale. At some point the failure to clearly distinguish between purchased components and proprietary components will give rise to stakeholder confusion that could have been avoided. If market participants can’t find a way to effectively communicate the difference between power control subsystem sales and energy storage subsystem sales, they run an enormous risk that investors, analysts, bankers and other stakeholders will over-estimate the relative impact of ESS sales on the bottom line and then be disappointed when their inflated expectations aren’t met. Losing credibility with stakeholders is a luxury that no company can afford.

Life was simpler when UPS systems integrators built their products and bought batteries as necessary components. It gets far more difficult when battery manufacturers sell ESS products where the bulk of the added value comes from upstream component suppliers.

While my cup usually overflows with sage advice for anybody who’ll listen, I don’t see any easy answers to this conundrum. I suppose the industry could take the easy way out and claim that the batteries just keep the turbines turning when the wind dies down, but that’s really not an acceptable answer either.

1.23.12 Toon.png

NOTE: This article was first published in the Winter 2012 issue of Batteries International Magazine and I want to thank editor Michael Halls and cartoonist Jan Darasz for their contributions.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

January 21, 2012

A123's Elegant Financing Transaction

John Petersen

On Friday A123 Systems (AONE) announced a direct registered offering that's an elegant example of a well-structured financing transaction in a difficult market. A123 had a solid financial base before the offering and the stock was starting to turn a critical corner into an upward trend. The new financing should add momentum to that trend.

The first stage deal terms are pretty straightforward. The investors will buy units consisting of one share of common stock and one common stock purchase warrant for $2.034 per unit, a 10% discount from the closing price of A123's common stock on Thursday. The warrants will be exercisable at $2.71 per share, a 20% premium to Thursday's close, during the 24-month period beginning six months after the closing date. The net proceeds will be approximately $23.5 million after costs and expenses.

An elegant second stage gives A123 the right to require the investors to buy up to 12.5 million additional shares next summer at a 10% discount to the 10-day average market price if A123 calls on the standby commitment and exercises what's effectively a put option. The only substantive limitation on A123's right to require the investors to buy additional shares is that they can't be required to invest more than $100 million, or $8 per share, in the second stage.

The thing I find most fascinating about the transaction is the tension between A123's current sacrifice and the investors' longer-term commitment. 

Last April I wrote that the market over-reacted to an attractive financing transaction and A123's stock was undervalued in the $6 range. The market disagreed with my conclusion and over the next eight months A123's stock price crumbled to an all time low of $1.51 in mid-December before turning to the upside. At Thursday's close, A123 was trading at a 19% discount to its September 30th book value of $2.80 per share. That makes a sale of additional shares at a 10% discount to market painful because the new investors will enjoy a modest accretion to book value while the existing stockholders will suffer a slight dilution, as summarized in the following table.

Book value per share at September 30th $2.80
Estimated fourth quarter loss
($0.46)
Estimated book value per share before offering
$2.34
Estimated book value per share after offering $2.30
Accretion to new investors
$0.27
Dilution to existing stockholders
($0.04)

When you factor in 100% warrant coverage at a 20% premium to Thursday's close, the first stage terms are attractive for the new investors. The second stage terms, however, are very attractive for A123 because they give the company six months to execute on its business plan and require the investors to standby with up to $100 million of additional financing if A123 decides it wants the money. The standby commitment may not be needed, in which case A123 will have no duty to sell the additional shares, but it sure is nice to have a second stage transaction locked, loaded and ready to go if more money is needed.

Earlier this month I picked A123 as a break out stock for 2012. As the following graph shows, A123's 10- and 20-day moving averages have turned up nicely and a simple reversion to the 200-day moving average would suggest a value in the $4.25 range as the stock reverts to a mean.

1.21.12 AONE.png

Since stocks that are significantly undervalued tend to over-correct as they revert to the mean, I would not view a six- to twelve-month target in the $6 range as unreasonable.

Like all battery technology developers, A123 faces a myriad of execution, market acceptance and business risks that each investor will have to assess assess in light of his own expectations and risk tolerance. It is, however, the clear sector leader in the lithium-ion battery space and likely to significantly outperform the market this year.

Disclosure: None.

January 12, 2012

An Elephant Hunter's Theory About Axion Power's Price Surge

An Elephant Hunter's Theory About Axion Power's Price Surge

John Petersen

Over the last few days I've been inundated with questions from readers who want to know why Axion Power International (AXPW.OB) has smoothly surged from a low of $0.25 on December 30th to a closing price of $0.58 yesterday. The short answer is the stock is finally emerging from the mother of all supply and demand imbalances and the persistent sellers that punished the price over the last 20 months are almost out of the picture. Since I believe we're witnessing the beginning of an entirely new market dynamic, a detailed explanation seems appropriate.

In December 2009, Axion closed a private placement transaction where four large buyers and 47 small investors bought 45.8 million shares of common stock at a price of $0.57 per share. I was thrilled. At the time I wrote:

"To my way of thinking, the most impressive aspect of Axion's financing is sheer size. Axion had roughly 37 million common share equivalents outstanding before the placement and sold 46 million additional shares. Selling 55% of a company without surrendering control is extremely rare. The more telling fact is that the cumulative reported trading volume in Axion's stock for 2009 has only been 6.6 million shares. In other words, these private placement investors bought roughly seven times the annual trading volume in a single transaction. Nobody in his right mind buys that kind of weight with the expectation that he'll be able to resell at a profit in an illiquid market. That tells me this group of investors is taking a long-term view and swinging for the fences with Axion's other large holders. I'm delighted to have the company, even if they did get a better price."

Based on 30 years in the trenches as a small company corporate finance lawyer I believed the 2009 private placement would put a solid floor of $1.20 under the stock price. The market behaved about the way I expected it would for three and a half months and then all hell broke loose when:
  • A busted hedge fund that owned 2.7 million shares began liquidating;
  • A bankruptcy estate that owned 544,000 shares began liquidating; and
  • Resale registration statements for 2008 and 2009 private placement shares went effective.
All of the sudden there were far more shares in the hands of willing sellers than the market could absorb. As the sellers started pushing their offer prices down in an effort to clear their books or turn a quick profit, the price fell from a 10-day moving average of $1.18 on March 30th to $0.80 on May 30th. By the end of July the 10-day average had fallen to $0.55. There were no problems with Axion's business, but there were a number of large shareholders who forgot the fable of the goose that laid the golden eggs.

A few days ago one of my followers on Seeking Alpha drew my attention to the daily short reports OTCBB market makers file with FINRA. The FINRA data is unusual because the market makers report all sales of shares that aren't under their control as short sales. Therefore, two types of transactions show up in the FINRA reports:
  • True short sales; and
  • Transactions where a selling stockholder has a physical stock certificate that must be converted into electronic form prior to delivery.
Other transaction types are reported from time to time, but they're rare. Since true short selling has never been an issue for Axion, it occurred to me that the FINRA daily short sale reports might provide an accurate and reliable way to track resales by private placement purchasers. On Tuesday my data-mining friend H. T. Love sent me FINRA short data going back to April 1, 2010, just before the resale registration statements for the private placement shares went effective. The accuracy of the FINRA data as a tracking tool for resales of private placement shares is astounding.

Since April 1, 2010, the total of short sales reflected in daily FINRA reports from market makers is 35,888,306 shares. During that period, my best estimate of the shares that have moved from physical certificates to electronic form follows:

Busted hedge fund 2,746,869
Bankruptcy estate 543,600
Deceased stockholder 8,245,614
The Quercus Trust 5,724,978
Special Situations Funds 7,433,411
Weak 2009 small investors
10,800,000
   Total 35,708,594

My best estimate of the shares remaining in the hands of 2008 and 2009 private placement purchasers follows:

Blackrock 7,150,000
Manatuck Hill Partners 7,200,000
The Quercus Trust 2,846,451
Strong 2009 small investors 3,600,000
   Total 20,796,451

The only numbers in the tables that are an outright guess are the shares held by weak vs. strong 2009 small investors, and that guess simply assumes that 3/4 the small 2009 investors were spooked by the market decline and decided to take their cash out of the game at a break-even price. While the data for Blackrock and Manatuck Hill is based on old SEC filings, both should file updated reports by mid-February.

If you look at the Axion chart for the last 20 months there is nothing that would attract a short-term trader, except for a brief run-up in January through March of 2010. In fact, the chart would terrify every trader I know. That means the only people who might have been attracted the stock were investors who attended an Axion presentation and decided to buy, or who've followed my blog for a long time, climbed a personal wall of worry and decided to swing for the fences in hopes of an elephant hunter's return.

I believe my long-term readers have bought the substantial bulk of Axion’s float. Unless Manatuck Hill, Blackrock or the remaining 2009 small investors start selling in meaningful volume, it looks like the only reliable source of supply is the Quercus Trust which will probably sell the rest of its shares over the next few months. From this point forward, I believe the market price is in the collective hands of the investors who bought over the last 20 months.

The last 20 months have been a very trying time for Axion's stockholders because of a highly unusual supply and demand dynamic. In a  normal market I would have expected the floor of $1.20 to hold till the summer of 2010 when Axion announced an important development contract with Norfolk Southern that would normally have boosted the price into the $1.80 range. Last fall I would have expected Axion's disclosure of superior testing results with BMW to boost the price into the $2.70 to $3.60 range. At this point I don't know what an objective fair value for Axion's stock is, but I expect to find out over the next few weeks.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

December 08, 2011

Hype Busters From Lux Research Explain Grid Based Energy Storage

John Petersen

In 1883 Thomas Edison said, "The storage battery is one of those peculiar things which appeals to the imagination, and no more perfect thing could be desired by stock swindlers than that very selfsame thing. ... Just as soon as a man gets working on the secondary battery it brings out his latent capacity for lying."

The problem isn't so much the batteries, which haven't improved all that much over the last century. Instead, the problem lies in the fertile imaginations of scientists, engineers, politicians, ideologues, analysts and investors who focus on new energy storage applications, overestimate the potential, underestimate the challenges and make a quantum leap from the reasonable to the absurd. There is no issue in the energy storage sector that's more wildly over-estimated than the short- to medium-term potential for using manufactured energy storage devices in the electric grid.

This week, the Smart Grid Intelligence Team at Lux Research, aka the hype busters, presented a 46 minute webinar on the current state of the grid-based energy storage market and its likely development over the next few years. After listening to the live webinar I asked Lux if they're be willing to share their work with my readers and they graciously agreed. Readers who want to listen to the entire webinar can do so by clicking on this link to "Grid Storage: Connecting dots in a fragmented market." For readers who don't have the time for the webinar, I'll try to summarize some of the highlights.

While respected institutions like Sandia National Laboratories have estimated that grid based energy storage represents a $200 billion opportunity, the global installed base of manufactured energy storage devices cost about $1.1 billion, roughly half of that capacity was built in 2011, and a similar amount of new capacity will be added next year. The following table offers a more granular analysis that allocates the installed base and planned additions, expressed in millions of dollars, among the five storage technologies Lux evaluated.

12.8.11 Storage Base.png

By 2015, Lux forecasts an annual market for grid-based storage in the $1.5 billion range. Other firms like Pike research expect faster growth rates. While the prospect of rapid and sustained growth is enough to awaken the animal spirits in all of us, Lux took pains to emphasize several key points:
  • There is no silver bullet solution for the grid and several technology classes will be important;
  • There is no unified mass market for grid-based energy storage technologies;
  • The market for grid-based energy storage is highly fragmented and extremely price sensitive;
  • The two largest market segments for grid-based storage are behind the meter installations for commercial and industrial facilities and in front of the meter facilities for renewable power generators;
  • Most buyers of grid-based energy storage will require several years of reliability data before making a major capital commitment to any energy storage technology; and
  • End-users of energy storage systems will try to aggregate as many value streams as possible to maximize the total economic benefit of their energy storage investments.
For energy storage investors, the most important question is always "Cui Bono?," who will benefit. While there are a lot more questions than answers at this point and Lux did not focus on the principal players in the emerging grid-based storage sector during the webinar, there is a fairly short list of public companies that are actively involved in developing large scale energy storage systems for the grid connected market including:
  • Japan's NGK Insulators (NGKIF.PK), which has built and installed the overwhelming bulk of the high-temperature sodium-sulfur battery systems in the world and is currently trading at about 40% discount from recent highs because it has suspended battery sales pending investigation of a recent fire.
  • General Electric (GE), which has built a new manufacturing facility for a high-temperature molten salt device known as the Zebra battery and is preparing to launch a series of products for large commercial and industrial users.
  • A123 Systems (AONE), which has a strong working relationship with AES Corporation (AES) and is making rapid progress in the renewable power generation market with its high-power lithium-ion battery systems that are used for output smoothing and renewable to grid integration.
  • Altair Nanotechnologies (ALTI), which has demonstrated a high-power lithium-ion battery system for frequency regulation and negotiated a significant sale in El Salvador that's bogged down in regulatory approval issues.
  • Enersys (ENS), which manufactures advanced lead-acid batteries for commercial and industrial power quality, load leveling and uninterruptable power supply systems.
  • Axion Power International (AXPW.OB), which has joined with Viridity Energy to demonstrate a behind the meter energy storage system for commercial and industrial facilities that integrates utility revenue and demand response savings with conventional power quality, load leveling and uninterruptable power benefits to users.
  • Active Power (ACPW), which is a world-leader in flywheel based power quality and reliability systems for data centers and other critical infrastructure facilities that require absolute reliability.
  • ZBB Energy (ZBB), which recently completed a three-year validation test of its flow-battery system in cooperation with Australia's Commonwealth Industrial and Scientific Research Organization, is awaiting UL approval for its power control systems and is rapidly expanding its sales and marketing team.
My clearest takeaway from the Lux webinar is that regulated utilities will probably be among the last to invest heavily in grid-based storage because of their risk aversion and their need to justify capital spending to regulatory agencies that are charged with protecting the ratepayers.

On the power producer's end of the grid there are significant opportunities for storage systems to smooth and stabilize power output from wind and solar while optimizing revenue streams to the owners of the facilities. At the power user's end of the grid, the most readily quantifiable values will be derived by commercial and industrial customers who can aggregate the internal benefits of power quality and reliability with external monetary benefits from demand response programs and providing ancillary services to the utility side of the meter. Over time, the most successful technologies will build a long enough track record of reliability to take a direct run at utilities and transmission system operators, but it's not reasonable to expect the utility and transmission markets to develop rapidly over the next five years.

It's far too early in the game for me to try handicapping likely winners and losers, but most of the companies in the list are currently trading at lottery-ticket prices that will not be available once their competitive positions in this rapidly expanding niche are better understood.

Disclosure. Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

December 02, 2011

Culling My Energy Storage Tracking Group

John Petersen

In my second quarter update I deleted China Ritar Power (CRTP.PK) from my energy storage tracking list because of its decision to terminate its SEC registration during a period when China-based companies with US listings were bogged down in a dense fog of suspicion. Since then the carnage in the energy storage sector has been far worse than I expected and it's time to permanently remove the companies highlighted in pink from my energy storage and vehicle electrification tracking list for the reasons described below.

12.2.11 Cull List.png

Current Culls

In March of this year when its stock was trading in the low $3 range, I predicted that Ener1 (HEVV.PK) would be forced to come to grips with an improvident investment in Th!nk Motors and a pair of mushy balance sheet accounts including $11.7 million of intangible assets and $51.7 million of goodwill. Since then the collapse of Ener1's stock price has been catastrophic as it wrote off the Th!nk investment and said that it would impair the bulk of its goodwill and intangible assets. When I adjust Ener1's last reported balance sheet amounts for known write-offs and likely intervening operating losses, it's clear to me that stockholders equity has been completely wiped out and while Ener1's creditors may recover some portion of their investment, the holders of 197 million outstanding common shares own an empty bag.

Earlier this year I was hopeful that Beacon Power (BCONQ.PK) would gain enough momentum from the commissioning of their Stephentown frequency regulation facility and a favorable FERC ruling to keep the company afloat long enough to prove the technical and economic merit of their high-speed flywheel technology. Unfortunately, management concluded that bankruptcy reorganization was the only option and filed on October 31st. Beacon subsequently agreed to sell the Stephentown facility for the benefit of its principal creditor, the US Department of Energy. The impairments included in their Form 10-Q for the period ended September 30, 2011 were savage and like Ener1, Beacon's stockholders equity has been completely wiped out, leaving the holders of 32.2 million outstanding common shares with an empty bag.

C&D Technologies (CHHP.PK) has been a problem stock since the fall of 2010 when it unexpectedly took a $46 million impairment charge that resulted in a forced restructuring of the company's debt. While it appeared that the reorganized C&D would continue to operate as a public company, it announced in October that its principal stockholder would buy all remaining shares for cash at a price of $9.75 per share during the fourth quarter. Accordingly, the company is no longer of interest to me.

In March of this year several articles on Seeking Alpha challenged the accuracy of SEC reports filed by Advanced Battery Technologies (ABAT.PK) and while much of the criticisms seemed to be based on innuendo and conjecture, there were some questions that concerned me enough to back away from my prior support of the company. I wasn't troubled much by ABAT's aloof response to the accusations but I became concerned when a wholly-owned subsidiary needed a $6.3 million line of credit while the parent reportedly had cash balances in $75 million range. The subsequent abrupt departure of their CFO set off alarm bells. On Monday the company's chairman told shareholders that ABAT was unwilling to comply with the Nasdaq Stock Market's request for formal confirmations prepared by its banks in the presence of its auditors because the procedure was degrading. I understand the importance of "face" in Asian culture, but I can't condone, understand or abide by an abject refusal to provide bank confirmations to a stock exchange when the price of refusal is delisting. It may all be a grand xenophobic conspiracy as ABAT's chairman claims, but I'm not willing to assume that risk.

The final cull is the result of a surprise announcement this week that New Energy Systems (NEWN) had agreed to sell its two battery manufacturing subsidiaries to employees. It will apparently retain a consumer battery design and marketing operation as well as a solar panel business, but it will no longer manufacture batteries or components. Accordingly, the company is no longer of interest to me.

Overvalued Stock Watch List

I remain very concerned with the viability of Valence Technology (VLNC) which has been surviving from hand to mouth on open market sales of securities and loans from a principal stockholder for years. In its last Form 10-Q Valence reported a negative stockholders equity of $56.8 million, which means its current market capitalization of $146.1 million represents a whopping $203 million premium to book value. As a native English speaker who lives in a French speaking country, I know all about relying on the kindness of strangers. It may work as a lifestyle, but I've never seen it work as an investment philosophy. Unless and until Valence eliminates the Sword of Damocles threat of $66.7 million in related party debt, I think the stock is too risky to own.

While Tesla Motors (TSLA) is not facing an imminent threat, its working capital adequacy is troubling if you're willing to consider possibility idea that it might encounter an unanticipated delay or two with the launch of its Model S or maybe even fall short of ambitious sales targets for 2013. At yesterday's close Tesla's market capitalization was a stunning $3.4 billion, an amount that's 11.6 times its September 30th book value of $294 million. When world class companies like Bernstein Research and Ricardo agree that electric vehicles will not be a credible market force until 2025 but almost all analysts and talking heads are gushing over Tesla's prospects, it's a sure sign that a stock has reached the Peak of Inflated Expectations which is inevitably followed by an eye watering descent into the Trough of Disillusionment. I will be first to congratulate Tesla if they pull off an Exodus-class miracle and meet current expectations, but I've seen far too many cases where the herd went careening over Wall Street's buffalo jump to believe a happy ending is likely. After all, how many other vehicles can proudly bear the following truth in advertising sticker?

12.2.11 Bumper Sticker.png
Disclosure: None.

November 28, 2011

Stop-start Idle Elimination Crossed The Chasm While Everyone Was Distracted

John Petersen

John Lennon once quipped, "Life is what happens to you while you're busy making other plans." A classic example of the phenomenon is the quiet emergence of stop-start idle elimination as standard equipment on new vehicles while politicians, pundits, the media and mechanical monkeys beat the drum and played the kazoo for the amazing EV sideshow.

Stop-start is more than a vague promise of hope and change. It's a reality that's sweeping through the auto industry today and will conserve more gasoline in 2013 than all of the worlds HEVs and plug-in vehicles combined. It's proof positive that a huge number of baby steps cover more ground than a couple of giant leaps.

Stop-start is one of the most sensible ideas you can imagine. Turn off the engine while a car is stopped at a light and then restart the engine when the light changes. In heavy traffic, this simple economy feature can improve gas mileage by 5% to 15% while eliminating emissions from idling vehicles. It's a win for the driver, a win for the environment and a win for the people on the sidewalk who don't have to choke on exhaust fumes. There are no losers and no hidden costs.

While early versions of stop-start technology date back to the '70s, the first modern stop-start systems were introduced by Peugeot-Citroën in 2006 and BMW in 2008. What began as a modest baby step with little or no fanfare is taking the auto industry by storm. In its 2011 Power Solutions Analyst Day presentation, Johnson Controls (JCI) used the following graph to show how automakers plan to implement stop-start as standard equipment over the next five years. The subtext of their presentation was "we sure didn't see this one coming."

9.27.11 Global SS.png

Regardless of how you judge the merit of an automotive efficiency technology, a production ramp from zero vehicles in 2005 to planned production of 15 to 22 million vehicles a year by 2015 is extraordinary. While most investors don't even know that stop-start exists, the technology has already crossed the chasm and is certain to have a significant impact on the future earnings of a handful of public companies that are currently trading at huge discounts from their 52 week highs.

Technology-Adoption-Lifecycle.png

Stop-start is a classic disruptive technology; a simple baby step that opens the door to improvements in fuel economy that nobody even considered a few years ago. The only fly in the ointment is the reality that yesterday's automotive batteries are simply not durable or robust enough for the immense electrical loads stop-start systems require them to carry.

The battery problem is easy to understand. In a conventional car the battery starts the engine when you leave for work and it has to recover enough charge during your commute to restart the engine when you head home at night. With a stop-start system, the battery has to start the engine when you leave for work, carry the accessory loads during engine-off intervals, restart the engine on demand, and recover its state of charge as quickly as possible in preparation for the next engine off opportunity. The pattern repeats on the trip home. The following table highlights the differences in battery duty cycles for a 15-mile commute with an average of one engine-off event per mile.


Conventional
Stop-Start
Initial engine start
500 Amp Seconds
500 Amp Seconds
Engine-off accessory loads

45,000 Amp Seconds
Engine restart loads

4,500 Amp Seconds
One-way battery load
500 Amp Seconds 50,000 Amp Seconds
Round-trip battery load
1,000 Amp Seconds
100,000 Amp Seconds

Think about the table for a minute. An optimized stop-start system requires 100 times the work from its battery; two full orders of magnitude. This is not a simple problem with an easy fix.

Recent studies from BMW and Ford show that flooded lead-acid batteries start to degrade in a matter of weeks and more expensive AGM batteries start to degrade within a couple months, but the batteries don't simply die. Instead, their charge recovery time increases from 30 seconds with a new battery to four minutes or more after a few thousand miles. Since stop-start systems disable themselves until the battery regains an appropriate state of charge, longer charge recovery times make the mechanical systems less efficient and eat into potential fuel savings. In many cases, stop-start systems lose most of their functionality within six months. It's sure to become a huge problem when pollution control inspectors start testing for stop-start functionality. Finding a solution now is a major challenge for both automakers and the battery industry.

In an effort to compensate for the shortcomings of conventional lead-acid batteries, automakers are upgrading from flooded batteries to AGM batteries, or to dual battery systems that use flooded batteries for starter loads and AGM batteries for accessory loads. The first big beneficiaries of these battery upgrades will be Johnson Controls and Exide Technologies (XIDE). Both companies are building new AGM battery manufacturing capacity at a blistering pace and it's easy to see why. Historically the automakers spent about $60 per car on a flooded starter battery. AGM batteries in comparison cost about $120 and dual battery systems cost about $180. Anytime a manufacturer can double or triple its per vehicle revenue and widen its margins by selling premium products wonderful things happen to the income statement. So far the income statement impact has been small because production volumes have been small. Over the next couple years the impact will become dramatic and it's already baked in.

While AGM batteries and dual battery upgrades are the best the automakers can do with current technology, they're a still a compromise and there's a growing recognition that the automakers need a more durable solution for the basic stop-start systems they're selling today and a more powerful solution for the advanced stop start systems they want to sell tomorrow. That dynamic has created a compelling business opportunity for two technology developers whose products can integrate easily with existing battery manufacturing infrastructure and are better suited to the demands of stop-start systems.

The first advanced energy storage system for stop-start was introduced last year by Maxwell Technologies (MXWL) and Continental AG. It combines a supercapacitor module from Maxwell with an AGM battery from Continental to provide the extra cranking power required by stop-start diesels from Peugeot-Citroën. The dual device architecture complements current automotive battery technologies instead of competing with them. Shifting the starter loads to the supercapacitor slows the rate of battery degradation and extends AGM battery life by up to 30%. It's not a perfect solution because it can't address the accessory loads that are over 90% of the problem, but it's clearly a step in the right direction with a product that's available today in relevant scale.

A second advanced energy storage system for stop-start is the PbC® battery from Axion Power International (AXPW.OB). The PbC is an asymmetric lead-carbon capacitor that replaces the lead-based negative electrodes in a conventional AGM battery with carbon electrode assemblies. The end result is a hybrid device that offers extraordinary charge recovery times while eliminating negative electrode sulfation, the principal failure mechanism of conventional lead acid batteries. Like the Maxwell supercapacitor module, the PbC complements current battery technologies instead of competing with them because the PbC electrode assemblies have been designed to work as plug-and-play replacements in any AGM battery plant. The PbC hasn't scored a design win yet, but extensive data generated in over two years of bench and vehicle testing by first tier automakers shows that the PbC is a very promising solution for basic and advanced stop-start systems.

A dark horse energy storage system for stop-start vehicles was introduced this year by A123 Systems (AONE). This one kilowatt-hour lithium-ion battery pack offers the cold cranking power of a quality lead-acid battery, the exceptional charge acceptance of lithium-ion and a weight reduction of about 20 pounds. While A123 has not released pricing information on its Nanophosphate® Engine Start Battery, its average unburdened cost of goods sold for the quarter ended September 30th was $1,015 per kWh. Even with significant future economies of scale, I believe it will be difficult for lithium-ion batteries to compete effectively in the low-end stop-start market because automakers must carefully weigh the trade-off between battery cost and fuel savings. As you move to the high-end market with very heavy accessory loads, the A123 solution could be compelling.

Stop-start creates an unusual business dynamic in the battery industry because the additional revenue from doubling or tripling the battery capacity of every new car leaves plenty of room for the old line competitors and the new technology entrants to thrive. The following table provides summary market capitalization and stock price data on the five companies that are likely to compete in the stop-start market.

11.27.11 Data Table.png

There isn't a stock in the table that I wouldn't feel good about buying at current prices.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

November 24, 2011

Bernstein and Ricardo Report: Cheap Will Beat Cool in Vehicle Electrification

John Petersen

On September 26, 2011, Bernstein Research and Ricardo plc published a 450 page analytical report titled, "Global Autos: Don't Believe the Hype – Analyzing the Costs & Potential of Fuel-Efficient Technology," which combines best in class securities research from Bernstein with the deep automotive expertise of Ricardo, a global leader in engineering, product innovation and strategic consulting. The result is the most comprehensive, detailed and eminently reasonable forecast of short-, medium- and long-term trends in advanced automotive powertrain technology that I've had the pleasure to read.

It's devoid of axe grinding or cheer-leading and simply describes how the auto industry is likely to evolve over the next couple decades. The key takeaway is two themes I regularly stress – Cheap Beats Cool and Baby Steps Rule.

Since the "Black Book" is far too detailed and comprehensive to adequately explore in a blog like mine, I think the best approach will be to summarize the key conclusions and explain how the expected evolution of powertrain technology will impact the companies I write about.

Overview. Bernstein and Ricardo are bullish on gasoline and advanced diesel technology, but cautious on the near term or medium term prospects for electric vehicles. They believe advanced automotive technologies must be affordable before logical consumers will buy new-generation vehicles in significant quantities. They have concluded that improvements to conventional engines will be key over the next 10 to 15 years and HEVs will become viable on a large scale by 2020. They believe near-term mass market adoption of electric vehicles is unlikely given the tough financial comparison with ever improving combustion engine vehicles. While premium-priced plug-ins may become viable earlier, by definition they will be niche products.

Conventional engines can meet 2020 regulatory targets at low cost. While widespread adoption of several emerging technologies including downsized engines, turbocharging, advanced fuel injection, stop-start idle elimination, advanced transmissions and other technologies that reduce rolling losses will be needed to meet regulatory targets, a shift to more expensive hybrid and electric drive technologies is unnecessary and unlikely. Except for Nissan-Renault, automakers' electric drive ambitions point to high-profile concept cars coupled with vaguely modest production plans.

Current HEVs and Plug-in Vehicles have much higher TCOs than conventional powertrains. Bernstein and Ricardo estimate the total cost of ownership, or TCO, of a conventional C-segment car at €21,300 ($28,400) over a typical four-year ownership period for the first purchaser. Without exception electric powertrains fail to offer any cost savings with HEVs costing approximately €1,650 ($2,200) more over four years, PHEVs costing approximately €4,500 ($6,000) more over four years and EVs costing approximately €10,800 ($14,400) more over four years.

Aggressive downsizing and modest electrification will be needed after 2020. To move from niche to volume production, PHEVs and EVs require a breakthrough in battery performance (energy and power density) and cost to overcome range anxiety and TCO concerns. While aggressive downsizing and modest electrification will be required from 2020 on, Bernstein and Ricardo believe the auto industry can meet regulatory targets with a 10% market share for HEVs, a 4.5% market share for PHEVs with small battery packs and a 4% market share for full BEVs. They estimate that the current cost differential between manufacturing a conventional car and manufacturing the same car with an electric powertrain is on the order of €16,000 ($21,500) before incentives.

At current vehicle costs and tax rates, oil would need to cost $300/bbl in Europe, $500/bbl in China and $800/bbl in the US before plug-ins would break even with conventional vehicles. Bernstein and Ricardo believe market forces alone are unlikely to provide enough incentive for a demand pull in electrified powertrains. While electric vehicles are likely to benefit from sizable cost reduction opportunities, combustion engines will require more expensive technology upgrades. The combination of the two will lower the break-even point for fossil fuels by ±20% over the next five years and another 35-40% by 2020. By 2025, Ricardo and Bernstein expect EVs to be competitive with conventional vehicles.

Battery cost reductions will be a key driver of future vehicle electrification. Bernstein and Ricardo estimate that currrent battery pack costs range from €4,500 ($6,000) for PHEVs to €13,500 ($18,000) for full electric vehicles, or $750-$800 per kWh of pack capacity. Battery costs will need to halve if EVs are to break even with internal combustion. Historical trends indicate that battery costs will decline by roughly 5% per year, which should bring costs down into the $310-$350 per kWh range by 2025. Until then, governments will need to bridge the gap with subsidies of several thousand dollars per vehicle for electric powertrains to be competitive.

Hybrids, PHEVs and EVs require significant amounts of additional raw materials. Conventional cars are material intensive but batteries and traction motors for HEVs, PHEVs and EVs will require significant additional amounts of raw materials that are far less plentiful and recyclable than the principal metals used in conventional cars.

While lithium supplies are adequate, competing demands for rare earth metals and copper will be challenging. Global lithium supplies are adequate for the foreseeable future, but rare earth metal production is dominated by Chinese producers and prices have skyrocketed. As new mines become productive and recycling technologies are developed, the constraints will become less burdensome, but costs will remain significant. The biggest metal constraint will likely be copper because a conventional car needs 24 kg of copper while an HEV needs 34 kg, a PHEV needs 54 kg and an EV needs 94 kg. As a result the value of the copper in an EV will probably exceed the total value of the steel and aluminum combined.

Stop-start systems offer some of the best value for money CO2 reduction potential. Bernstein and Ricardo expect that virtually every conventional internal combustion powertrain in the mature markets will feature either simple or advanced stop-start systems by 2020.

Almost all widely hyped improvements to powertrain are based on old concepts. The fundamental chemistry and physics of powertrains have not changed significantly over the past 100 years, but design and combustion efficiency gains have provided continuous advances in power density while noise, emission and fuel consumption levels have decreased. The next 15 years will be characterized by an evolution of existing technologies and the co-existence of various powertrain options, rather than the emergence of a disruptive dominant new technology such as electric or fuel cell vehicles. Over the next 15 to 20 years electrification is expected to become commonplace, but Bernstein and Ricardo expect that three out of four vehicles will still have an on-board internal combustion engine.

While I am a frequent and relentless critic of lithium-ion and electric vehicle investments because I believe the investing public has unrealistic expectations about the amount of time that will elapse between introduction and commercial success Bernstein and Ricardo didn't reach any conclusions that I'd disagree with. They expect battery development timelines to be lengthy and improvements to be limited to ±5% per year. They expect manufacturers of electric vehicles and components to lose money for several more years as they try to overcome immense TCO disadvantages and establish a toehold in the mass market. These conclusions are entirely consistent with the industry's experience with HEVs which took almost a decade to achieve a 3% market penetration in the US. The process will be evolutionary rather than revolutionary and investors who pay premium prices for the stock of companies that won't hit their stride for another decade will suffer.

In the energy storage sector, the first big beneficiaries of powertrain improvements will be Johnson Controls (JCI) and Exide Technologies (XIDE) who make starter batteries. Since stop-start technology puts tremendous strain on the battery from starting the engine several times during a commute and carrying accessory loads during engine off intervals, the auto industry is rapidly increasing the per vehicle amount they spend on batteries. Historically a new car used a simple flooded lead acid battery that cost the automakers about $60. Because of the heavier battery demands of stop-start, automakers are rapidly shifting to AGM batteries that cost about $120 and dual battery systems that cost $120 to $180. On a per vehicle basis, JCI expects cars equipped with stop-start systems to generate twice the revenue and three times the profit margin.

While current battery technology may be good enough for basic stop-start systems, it is clearly inadequate for the advanced stop-start systems automakers want to implement to minimize emissions and maximize fuel economy. Those advanced systems will need far more robust energy storage devices like the battery-supercapacitor combination that Maxwell Technologies (MXWL) has introduced on diesel powered cars from Peugeot and the revolutionary PbC battery from Axion Power International (AXPW.OB) which is in advanced stages of vehicle testing by BMW and other automakers.

I continue to believe lithium-ion cell manufacturers including A123 Systems (AONE), Valence Technologies (VLNC) and Altair Nanotechnologies (ALTI) will be poor investments over the next seven to ten years because these companies are under immense pressure to reduce costs in an industry where materials represent 60% of pack level costs and heavily automated manufacturing methods keep labor and overhead in the 22% range combined. While there are some potential economies of scale to be realized in battery management systems and perhaps a more efficient use of raw materials, the gains are expected to be slow and painful during a period when profit margins are compressed to help heavily electrified vehicles overcome crushing TCO handicaps.

While I'm cautiously negative about battery manufacturers, I don't see any possibility that niche manufacturers like Tesla Motors (TSLA) can possibly live up to outlandishly inflated expectations and maintain clearly unreasonable stock market valuations by manufacturing niche products that can only appeal to a minute fraction of the car buying public. It took three years before Tesla sold its 2,000th Roadster. While there are a respectable number of reservations for the Model S that will debut next year, there is no reason beyond unbridled optimism to believe demand for a $60,000 electric passenger car is a well-spring rather than a puddle. Even NPR, a bastion of conservative thinking, has taken to pessimistic reporting on the near-term potential of the electric vehicle sector now that unlimited government spending on ideology seems to be going the way of the dodo bird. There will be some demand and Tesla may survive as a going concern, but I can't imagine how it will retain a market capitalization that's an eye-watering 11.2 times book value and 16.4 times sales. The law of economic gravity simply cannot be denied and it will not be mocked.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

November 17, 2011

Electric Vehicles; Ineptitude, apathy ... and piles of taxpayer money

John Petersen

The last few weeks have been a media and political circus in the US as a pair of high-profile Department of Energy loan guarantees wound up in bankruptcy court. In the first case, solar power innovator Solyndra filed two years after closing a $535 million loan for a factory that never quite made it into production. In the second case, flywheel storage innovator Beacon Power (BCONQ.PK) filed about a year after scoring a $43 million loan for a 20 MW frequency regulation plant that was commissioned in June. Both are black eyes for the Obama administration’s green energy policies.

Commentators are quick to note that loan guarantees to undercapitalized companies are indistinguishable from sub-prime mortgages for busboys — the ultimate “heads I win, tails you lose” opportunity for the chosen few. While they’re right, of course, I think a superficial analysis of individual outcomes obscures deeper and more disturbing policy choices that are having a disastrous impact on American innovation, particularly in energy storage.

The ancients taught that necessity is the mother of invention, which is why we have such a wide variety of energy storage technologies. They each serve different needs and they’re each important in their own right because we live in a world where there are no silver bullets and the best we can hope for is silver buckshot. Unfortunately, preferential governmental support for a specific technology or family of technologies is the equivalent of an intellectual abortion clinic. The mere act of choosing one technology group for favorable treatment stifles inquiry and innovation on other ideas that deviate from the government sanctioned path of righteousness.

It’s official, OTHERS NEED NOT APPLY!

Lithium-ion has been chosen as the golden child of energy storage and heaven help the innovator who has an idea for a second-generation nickel metal chloride battery, a new flow battery, an advanced lead-acid battery or any other energy storage device or system that doesn’t pay grovelling homage to the official orthodoxy. In the end, society suffers when government chases the pipe dreams and promises of politically connected demagogues, ideologues and snake oil salesmen. The only possible outcome is catastrophic malinvestment that subverts the stated policy goals. While the taxpayers usually get fleeced, investors invariably get gutted.

In August 2009, the US gave a stunning $1.2 billion of ARRA Battery Manufacturing Grants to a handful of battery companies on the theory that good intentions would trump economics and usher in a golden age of electric cars to free America from the tyranny of imported oil. The 95% allocation to emerging lithium-ion technology compared to the 5% allocation to all other battery technologies combined said it all. Pharaoh has spoken – So let it be written, so let it be done!

Nobody bothered to ask whether the world’s mines could produce enough raw materials to make the batteries at relevant scale. In most cases they’re still not asking, even though metal prices are climbing faster than energy prices. Power-drunk political appointees simply assumed there would be no critical supply chain or technology issues and staggered down the primrose path. Similar ill-conceived plans were adopted with reckless abandon by governments worldwide.

We live on a resource challenged planet where six billion people want a small slice of the lifestyle that one billion of us have and take for granted. Our world produces almost two tons of energy resources a year for every man, woman and child on the planet, but it only produces 8.5 kg of non-ferrous industrial metals. Given the stubborn and inflexible nature of metal production constraints, it doesn’t take much math skill to see the problem.

The stark reality is humanity can’t make enough machines to have a significant impact on global energy consumption and CO2 emissions because the world's miners can’t provide the necessary raw materials. It's not just a question of lithium. The physical constraints on global production of aluminum, copper, lead, nickel, cobalt and a host of scarcer metals are staggering and the six billion people who simply want electric lights, a washing machine and maybe a refrigerator will not sacrifice their basic needs so that Tesla Motors (TSLA) can sell electric cars in California financed by a $465 million ATVM loan that it can’t possibly repay without an Exodus-class intervention from the Almighty.

The first fruits are evident. Existing and planned lithium-ion battery plants will be able to manufacture cells for 2.4 million EVs a year by 2015, however, they can only expect 820,000 units of demand in a high penetration rate scenario. While the looming global glut of cell manufacturing capacity is widely recognized, a more pervasive and perverse dynamic exists in the supply chains for several critical components those factories will need if they hope to manufacture cells.

The following graph comes from an August 2011 presentation from Roland Berger Strategy Consultants. It shows that the global supply chain for anodes will be exhausted if cell production reaches 430,000 units per year while the supply chain for separators will be exhausted if cell production reaches 450,000 units per year. It also shows that the supply chain for cathodes and electrolytes will hit ceilings at 660,000 and 770,000 units respectively.

11.17.11 Berger Graph.png

Since it’s impossible to manufacture cells without anodes, cathodes, separators and electrolytes, I have to wonder about the management teams that are building cell manufacturing facilities without first ensuring the integrity of their supply chains. The apparent lack of concern over supply chain issues is staggering. I can’t decide whether it’s reckless apathy or simply a childlike faith that the taxpayers, like doting first-time grandparents, are breathlessly waiting for any opportunity to provide whatever the golden child needs or wants.

How do you justify building cell-manufacturing capacity that’s three times greater than your best-case demand?

How do you justify building cell-manufacturing capacity that’s six times greater than your supply chain can support?

Is government somehow exempt from the duty to conduct reasonable due diligence before investing?

Seriously, where are the adults in this process?

While the media can’t begin to comprehend the magnitude of the impending catastrophe, the dominoes have started to fall.

Ener1 (HEVV.PK) spent about half of its $120 million ARRA Battery Manufacturing grant before an obscenely optimistic investment in Th!nk Motors brought the company to its knees. In the process its stock tumbled from a post-grant high of $7.53 to a current price of $0.11. Now Ener1’s third management team in eight months plans to change the business focus from automotive to heavy-duty transport and grid-based applications. Thanks to $80 million of improvident borrowing and $51.8 million of additional planned goodwill impairments that are buried in an attachment to its recent Notification of Late Filing, Ener1’s fate will probably be decided in a bankruptcy case controlled by its largest creditor Goldman Sachs, which put a $3.75 price target on the stock last March while I was warning readers to run for cover.

How the hell do you default on a grant?

A less dramatic but equally ominous surprise was the Johnson Controls (JCI) - SAFT divorce. Their ambitious plans to make automotive batteries together till death do us part couldn’t even survive the commissioning of a new factory that’s being built with $300 million of DOE grants. In the face of feeble automotive demand, JCI wanted to expand the joint venture's focus to encompass stationary and ancillary markets. SAFT wanted no part of that proposal because it didn’t want yet another competitor for its factory in Florida that was; you guessed it, built with $95.5 million in DOE grants.

While they’re keeping a stiff upper lip in public, I can’t help but feel a little sorry for A123 Systems (AONE), which is building a factory with $249 million in DOE Grants and wants to borrow hundreds of millions more under the DOE's ATVM loan program. Their IPO prospectus spoke of strong relationships with global automotive manufacturers and tier 1 suppliers, but their automotive design wins to date are limited to a $15,000 electric upgrade to the $15,000 GM Spark and the gorgeous but corpulent Fisker Karma, which is being financed with yet another $530 million from the public trough.

While it’s a decidedly pessimistic view I can identify over $3 billion in battery and electric vehicle projects funded by Federal money that have poor to dismal business prospects, including:

$299.2 ARRA Battery Manufacturing Grant to JCI-Saft
$249.2 ARRA Battery Manufacturing Grant to A123 Systems
$118.5 ARRA Battery Manufacturing Grant to EnerDel
$95.5 ARRA Battery Manufacturing Grant to Saft America
$528.7 ATVM Loan to Fisker Automotive
$465.0 ATVM Loan to Tesla Motors
$1,400.0 ATVM Loan to Nissan Motors

I’m a frequent critic of the headlong rush to build electric vehicle manufacturing capacity and infrastructure without any real proof that the planned wonder vehicles will satisfy customer needs, or that the facilities will be used for something other than homeless shelters for displaced green workers.

My fundamental problem arises from the fact that every industrial revolution in history started with a technology that proved its economic merit in a free market and then went on to change the world. Companies and indeed industries that cannot survive without government subsidies can’t thrive with them. Supporting the moribund with the lifeblood of the vibrant may be compassionate, but it can’t produce a good economic outcome.

Over a decade of experience in the HEV market shows that consumer demand ramped sharply for several early years, hit a market penetration rate of about 3% and then flatlined. Over the last three years, clean diesels and plug-ins have begun to cannibalize the HEV market, but they've done nothing to bring new buyers to the fold.

Once again, governments are pushing on a string and trying to force the market to embrace electric drive, the only vehicle class with an unbroken 100-year history of failure. Once again governments will fail, just like they did with other panacea energy solutions including fast breeder reactors, synthetic fuels, hydrogen fuel cells, clean coal and the ever popular corn ethanol and biodiesel that turn food into fuel and make both more expensive.

In late 2008 the world fell into the mother of all recessions as it reached the peak of a decades long debt supercycle. Now the piper is demanding his due and individuals, businesses and governments around the world are being forced to reduce their crushing debt burdens. In the midst of a global deleveraging, I don’t see how insolvent governments can continue to use public funds to subsidize the ideology-based personal consumption of eco-royalty. How many bottomless pits can one nation's taxpayers be expected to fill?

11.17.11 Money Pit.png
Even if our governments are willing to continue this foolishness, I don’t see how a vibrant market for EVs can possibly develop among real world consumers who can buy gasoline versions of a Lotus Elise, Ford Focus or GM Spark for half the price of their electric counterparts.

The transformer Optimus Prime is a big hit with little boys. Spending billions so big boys can pay twice the price for their very own Suboptimus Prime strikes me as a triumph of hope over experience.

This article was first published in the Fall 2011 issue of Batteries International and I want to thank editor Michael Halls and cartoonist Jan Darasz for their contributions.

Disclosure: None.

November 15, 2011

High Conviction Paired Trade – Short Tesla Motors And Buy Exide Technologies, The Sequel

John Petersen

Last November I broke with tradition for the first time in over 30 years and suggested a paired trade that bought Exide Technologies (XIDE) and shorted Tesla Motors (TSLA). Over the following three months, investors who made the trade and bought four Exide shares while shorting one Tesla share pocketed the following gains.


16-Nov-2010
16-Feb 2011
Net

Entry
Exit
Gain
Buy Four Exide
-$29.76
$49.68
$19.92
Short One Tesla
$30.80
-$24.73
$6.07
Pair Trade Total
$1.04
$24.95
$25.99

While the paired trade hit its peak value in mid-February of this year, it didn't turn south until early June.

11.15.11 2010 Pair.png

Since June, Exide has fallen to unsustainably low levels and Tesla has climbed to unsustainably high levels, which means it's once again time to recommend a paired trade that buys Exide while shorting Tesla. At yesterday's close the ratio works out to an 11.5 share Exide buy for each shorted share of Tesla. The results this time around should be even better than last year because the valuation disparities summarized in the following table are so immense.


Exide
Tesla
Price Per Share
$2.87
$33.22
Market Capitalization
$244.2
$3,464.2
Working Capital
$512.1
$257.9
Book Value
$415.8
$294.1
TTM Sales
$3,092.9
$201.1
TTM Earnings
$8.8
-$224.3

A couple days ago I suggested that Exide's Recent Price Collapse Was Unjustified and explained how forced liquidations by a large Exide shareholder have crushed its stock price on two occasions during the last two years. Today I'll summarize a few of the headwinds that Tesla must face and overcome if it hopes to avoid a major price decline.

Battery Safety Questions. Over the last week there have been numerous news stories about an NHTSA inquiry into the safety of automotive lithium-ion battery packs after a GM Volt that had been used for crash testing spontaneously caught fire at an NHTSA facility. While the stories remain optimistic about the outcome, they overlook the inconvenient truth that safety testing of lithium-ion battery packs is not comparable to the procedures automakers used for other batteries.

In the late 90s Ford built a test fleet of electric delivery vans called the EcoStar that used sodium sulfur batteries. As part of their normal testing, Ford took a "Vlad the Impaler" approach to safety and used a hydraulic ram to drive a ten-inch long four-vaned arrowhead wedge into a fully charged 35 kWh battery pack. The sodium sulfur battery passed the test. As far as I know, safety testing for lithium-ion batteries is limited to driving an eight penny nail into a single cell. I have not been able to find any published reports of destructive pack level testing to determine how the failure of one cell might cascade through a battery pack that contains up to 6,800 cells.

To put the safety question into sharper perspective, Japan's NGK Insulators suspended its sodium sulfur battery production and asked its customers to stop using its products until an investigation uncovered the cause of an unexplained battery fire. Before the incident NGK had a flawless 10-year safety record, but it still asked its customers to suspend operations on an installed base of 305 Megawatts of power and over a gigawatt hour of energy storage at 174 locations worldwide because of a single incident where nobody was hurt.

If the NHTSA reaches an entirely reasonable conclusion that pack-level testing of lithium-ion batteries has been given short shrift in the headlong rush to bring electric vehicles to market, the delays and risks of thorough pack level testing and the associated news coverage could be catastrophic for specialty EV manufacturers.

Charging Infrastructure Issues. For several years China has been perceived as a global leader in vehicle electrification. Over the last several months, public statements from Chinese leaders have grown increasingly wishy-washy, suggesting that fuel efficiency and HEV technologies would be easier and less expensive to implement at relevant scale. Just this week Forbes reported that China’s power-grid giants – China Southern Grid and State Grid – may throw another monkey wrench into the works by insisting on battery exchange schemes instead of distributed charging infrastructure. While actions in Mainland China will probably not have much direct impact on Tesla, the risk of similar restrictive decisions by utilities in more important markets cannot be dismissed out of hand.

Resale Value Questions. One of the biggest unanswered questions in the electric vehicle space is resale value. Advocates assure us that EVs will retain their value better than conventional cars despite the fact that the battery packs that represent up to half of the vehicle cost are consumable and wear out over time. Yesterday's Wall Street Journal reported that vehicle leasing firms in Israel were having second thoughts about Project Better Place because of uncertainty over residual value. While leasing and residual value issues may not be critical to buyers of the Tesla Roaster, they're likely to be important to buyers of the upcoming Model S which is targeted to an upscale consumer market where vehicle leasing is commonplace.

The Valley of Death. There are no greater, crueler or more universal truths in the stock market than the hype cycle and the valley of death. While there are exceedingly rare exceptions like Google, substantially all new companies and new industries go through a cycle of inflated expectations followed by profound disillusionment. Substantially all cases where companies have avoided the hype cycle have involved a high level of business maturity and close to flawless execution. The following graph from the Gartner Group illustrates the typical stages.

11.15.11 2010 Pair.png

Tesla's execution to date has been pretty good and as far as I can tell it hasn't encountered any significant delays or setbacks. Unfortunately its stock is priced to perfection and anything less than flawless execution going forward can be a catalyst that pushes the stock off the peak of inflated expectations and into the trough of disillusionment. Given the substantial external risks I've discussed above and the inherent risks discussed in Tesla's SEC filings, I think the downside risk in Tesla's stock outweighs the upside potential by an order of magnitude.

Disclosure: None.

November 13, 2011

Exide's Recent Price Collapse Was Unjustified

John Petersen

After the market closed on Monday, Exide Technologies (XIDE) released surprisingly poor second quarter results, a $3.6 million loss that included a $5.7 million charge for several years of reporting irregularities at a small Portuguese recycling subsidiary. The market's reaction was absolutely savage as the stock collapsed from Monday's close of $4.48 to Friday's close of $3.01. In my view, the reaction was unjustified and has set up a tremendous buying opportunity for investors who are willing to look beyond the headlines and focus on core business fundamentals.

To put things in perspective, Exide's stock has closed at or below Friday's price on 24 days since October 2007, and 22 of those days were during the depths of the March 2009 market melt-down. The stock is currently trading at a 59% discount to its 200-day moving average of $7.32, a mere 7.6% of annual sales and about 57% of book value. Despite some obvious challenges Exide faces over the next year, this is a blood in the streets buying opportunity.

Since I started blogging in the summer of 2008 Exide's stock has seen more ups and downs than a high-tech roller coaster. The following chart overlays the 10-, 20-, 50- and 200-day weighted moving average price on the 200-day moving average volume since July 2008.

11.13.11 Exide Price.png

To a casual observer the chart looks absolutely chaotic, but most of the blame for bizarre price swings can be attributed to factors that have nothing to do with Exide's business. On December 31, 2009, a family of funds managed by Jeffrey Gendell owned 23,705,133 shares, or about 30% of Exide's outstanding stock. The following is table derived from holding reports and other SEC filings and summarizes the quarterly Gendell stock sales in 2010 and 2011. The timeframes marked with red bars in the chart coincide exactly with the periods of heaviest Gendell selling.

Date Balance Sales
31-Dec-09 23,705,133 -
31-Mar-10 20,738,399 (2,966,734)
30-Jun-10 15,089,230 (5,649,169)
30-Sep-10 12,312,410 (2,776,820)
31-Dec-10 10,295,260 (2,017,150)
31-Mar-11 9,489,476 (805,784)
30-Jun-11 9,489,476 -
26-Sep-11 7,799,476 (1,690,000)

Since the beginning of 2010 a single holder has pushed almost 16 million shares into the market with catastrophic results for the stock price. When the selling abated for a while in the first two quarters of 2011 the stock price tripled, only to crash yet again when the selling began anew. The bottom line reality is that no market can hold up under sustained selling pressure from large stockholders and it doesn't matter whether the sustained selling pressure occurs in an industry leader like Exide or a newcomer like Axion Power International (AXPW.OB). The result is always the same.

I'll not minimize the challenges Exide must face as it idles its flooded lead-acid battery plant in Bristol, Tennessee and restructures its domestic manufacturing and distribution network, but total restructuring costs over the next 12 months should amount to less than half of the average annual restructuring costs Exide incurred over the last three years and the positive impact on short- to medium-term earnings should be substantial. It's also important to note that Exide is just now entering its two strongest fiscal quarters and expects to report significant earnings for the current year.

As Exide gets its house in order over the next two years, its price to book ratio should climb into the 1.75 range and its price to sales ratio should climb into the 55% range, which implies an upside potential of 300% to 500%. The challenges Exide faces are serious, but they're ordinary course of business challenges, rather than existential challenges.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

November 02, 2011

Is Stop-start Idle Elimination Crushing Vehicle Electrification?

John Petersen

Since June of 2009 I've been a voice in the wilderness proclaiming that stop-start idle elimination will become a dominant automotive fuel efficiency technology by mid-decade and represent a tremendous business opportunity for established lead-acid battery manufacturers like Johnson Controls (JCI) and Exide Technologies (XIDE) and emerging energy storage technology developers like Maxwell Technologies (MXWL), Axion Power International (AXPW.OB) and A123 Systems (AONE). In the process I've suffered more than a little abuse, scorn, derision and ridicule from EVangelicals who think it makes sense to propel up to 5,300 pounds of metal at highway speeds with quarter-ton battery packs. With each passing day, however, it becomes increasingly clear that my cautious assessment of electric drive and my optimistic outlook for cheap and simple fuel efficiency is spot-on accurate because, in the words of Vinod Khosla, "Economics matter and nothing that defies the law of economic gravity can scale."

The most recent confirmation that stop-start will leave all other vehicle electrification technologies in the dust over the next decade comes from a Pike Research report titled "Stop-Start Vehicles, Micro Hybrid Technologies, Batteries and Ultracapacitors; Market Analysis and Forecasts," which reports that while stop-start technology is not well known or understood in North America, stop-start vehicles, or SSVs, are already outselling hybrids by a factor of 3.5 to 1 and the stop-start advantage is expected to widen to 16 to 1 over the next few years because of low cost and easy integration.

11.1.11 Pike Graph.png

In its discussion of the business opportunity Pike said, "Global revenue from the sales of stop-start batteries will grow from $827 million in 2011 to $8.9 billion in 2020, at a compound annual growth rate of 30%." The Pike report mirrors similar conclusions from Lux Research in their October 2010, report "Micro-hybrids: On the Road to Hybrid Vehicle Dominance." Both reports are a good deal more conservative than EPA forecasts that stop-start will be implemented in 42% of US light duty vehicles by 2016. In a weirdly ironic Halloween twist, Wunderlich Securities analyst Theodore O’Neill blamed the rapid adoption of stop-start for limiting demand for lithium-ion batteries and plug-in vehicles. “Where it went off the rails," said O'Neill, "is all the major car companies figured out in 2009 that they could use a different technology to meet the emissions standards in the U.S. and in Europe ... That technology is start-stop."

I've always argued lead-acid batteries would remain competitive for decades as the battery of choice for cars with internal combustion engines, but I never expected to read that stop-start technology and lead-acid batteries were crushing vehicle electrification. Score one for the home team!

Even though stop-start has had a hard time catching the mainstream media's attention, it's the most sensible and cost-effective fuel efficiency and pollution reduction technology imaginable. It automatically turns off the engine when your car isn't moving and instantly restarts the engine when you take your foot off the brake. The biggest problem with stop-start is that it's a battery killer because instead of starting the engine once when you begin a trip, it has to start the engine several times during the trip, carry accessory loads during engine off intervals and recover its charge very quickly to prepare for the next engine off opportunity.

The conventional flooded lead-acid batteries that we've all come to know and hate are simply not robust enough for stop-start. So the auto industry needs a better energy storage solution to accomplish the worthy goal of eliminating wasted fuel and useless pollution from idling vehicles.

The auto industry's widespread and rapid adoption of stop-start has come as a big surprise to most battery manufacturers and industry analysts. Historically almost all cars used flooded lead-acid batteries for starting, lighting and ignition. While AGM batteries have existed since the 70s, global production capacity was limited to a few million batteries a year and most AGM batteries were used in aviation, marine and other high-end applications where their sealed design avoided problems with electrolyte leakage, gas generation and maintenance. Simply put, the world's battery manufacturers were not ready for a surge in AGM battery demand from the auto industry which needs about 55 million batteries a year.

Since the world's battery manufacturers didn't have enough factory capacity to make AGM batteries for the auto industry, their first response was to introduce enhanced flooded batteries that don't perform as well as AGM, but can be made in existing plants. Their next response was to go on a huge capital-spending spree to build new AGM battery manufacturing facilities. Between 2002 and 2009, JCI averaged about a million AGM batteries per year. By 2015 it plans to make about 18 million AGM batteries a year. Exide is also expanding its AGM capacity from 500,000 batteries a year in 2010 to 5.5 million batteries a year by 2015. Other battery manufacturers are quickly following suit.

When Citroën and BMW introduced the first stop-start systems in 2006 and 2008, the technology was viewed as a modest advance with an uncertain future. The initial reviews were less than flattering because the systems performed fabulously in new cars but suffered sharp performance declines as the batteries aged. That gave rise to a concerted industry-wide effort to learn why lead-acid batteries failed in stop-start vehicles and find solutions to the problem.

At the 2010 European Lead Battery Conference, BMW and Ford explained the problem of dynamic charge acceptance to the world's lead-acid battery manufacturers and used the following graphs to show how AGM batteries used in stop-start systems begin to lose their dynamic charge acceptance almost immediately and become effectively worthless after a few months. They also explained that unlike traditional vehicle designs, engine starting was only a minor issue in stop-start because over 90% of the energy used during an engine off interval was attributable to accessories, rather than the starter.

11.1.11 BMW Ford Graph.png

While the graphs provide a lot of data the most important line has a burgundy highlight and shows how charge recovery time increases from 30 seconds with a new battery to several minutes with a battery that's been used for a few months. Since stop-start systems disable themselves until the battery has recovered, a battery that can recover in 30 seconds will invariably save more fuel than a battery that needs several minutes to recover.

Today the auto industry and the battery industry find themselves at an impasse over battery performance in stop-start. The automakers have made it clear that traditional AGM technology is not good enough for today's stop-start systems and can't possibly support future stop-start systems that will offer better fuel economy and put even greater strain on their batteries. The battery industry has responded by producing enhanced AGM batteries that are an improvement over traditional AGM technology, but remain inadequate for the demands of future stop-start systems. To solve the problems and accomplish their fuel economy and emissions reduction goals, most automakers are actively evaluating other technology alternatives.

Continental AG and Maxwell Technologies developed the first new approach to energy storage for stop-start. Their system combines a supercapacitor module with an AGM battery to ensure that stop-start diesels from Peugeot Citroën have enough cranking power to reliably restart the engine. In their second quarter conference call, Maxwell's CEO noted that the system would also increase AGM battery life by roughly 30%. While the Continental-Maxwell system can't do much to overcome the dynamic charge acceptance limitations of AGM batteries, Pike believes supercapacitors will be used to complement batteries in stop-start systems for diesel engines.

Axion Power International is presently completing the development of a second novel approach to energy storage for stop-start and preparing to launch their first product. Axion's PbC battery is a hybrid device that replaces the lead-based negative electrodes in an AGM battery with carbon electrode assemblies that eliminate sulfation, the chemical process that causes conventional AGM batteries to lose their charge dynamic acceptance capacity over time. Since the PbC is a third-generation lead-acid device, it can be assembled on any conventional AGM battery line. In over two years of exhaustive testing by BMW and others the PbC has demonstrated remarkably stable dynamic charge acceptance through several years of simulated use in a stop-start vehicle. While the PbC is not currently available for use in stop-start vehicles, the Pike report suggests that the PbC will be available for use in 2013 model year vehicles.

A123 Systems has recently announced the launch of a lithium-ion battery for stop-start vehicles. Their engine start battery combines sixteen of their 20 Amp hour cells with associated control electronics to deliver a kilowatt-hour of energy and the cold cranking amperage necessary for an automotive starter battery. Because of the high cost of lithium-ion batteries, Pike believes their market penetration will be "very limited" and restricted to expensive performance vehicles.

Stop-start presents a rare dynamic for the lead-acid battery industry because the new technology solutions from Maxwell and Axion will complement rather than compete with existing battery products. Supercapacitors from Maxwell will function as add-on component that improves the efficiency of today's AGM batteries. Similarly, carbon electrode assemblies from Axion have been designed for easy integration into existing AGM plants as a plug-and-play component that can make today's AGM batteries better. Both technologies can help established battery manufacturers better serve their customers needs without eating into their revenue from product sales. For both companies, the ability to leverage existing manufacturing facilities, distribution networks and customer relationships should facilitate a much faster ramp rate than one could expect from a new product that needs to overcome entrenched competitors, build manufacturing, distribution and customer service capabilities and divert staff from other lucrative markets.

JCI and Exide will be the first big beneficiaries of the global shift to stop start. Both companies are trading well off their historic highs and have attractive upside potential. As products from Maxwell and Axion prove their merit in stop-start vehicles and increase production capacity, their shares should perform well. Since Axion has a market capitalization of $40 million while Maxwell is valued $550 million, Axion has greater upside potential for risk tolerant investors.

Currently, the media hype is all about lithium-ion batteries and plug-in electric drive, but auto industry's production plans are all about stop-start and other fuel efficiency technologies. Given a choice between chasing sunshine, lollipops and rainbows or investing in an established automotive trend, I'll take the established trend any day.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

October 29, 2011

Electric Vehicle and Lithium-ion Battery Investing For Imbeciles

John Petersen

In their 1969 bestseller "The Peter Principle" Laurence Peter and Raymond Hull quoted a Latin-American student named Caesare Innocente who lamented, "Professor Peter, I'm afraid that what I want to know is not answered by all my studying. I don't know whether the world is run by smart men who are, how you Americans say, putting us on, or by imbeciles who really mean it." After watching the events of the last few weeks, I think most of my regular readers would agree that the imbeciles are clearly steering the ship.

Last March I went to the Geneva Motor Show on press day, which gave me a chance to see the cars up close and personal without fighting the crowds. While I'm generally skeptical when it comes to electric drive, I left Geneva convinced that the Fisker Karma was the most beautiful passenger car I'd ever seen. I even promised my inner geek that I'd secretly take one for a test-drive once production started. The last remaining hurdle was cleared in mid-October when the EPA issued its official fuel economy rating of 52 MPGe for the electric range of 32 miles and 20 MPG for gas powered trips using the 2.0 liter onboard generator.

I was crestfallen. How could something so gorgeous and green get such a horrible fuel economy rating?

The answer, it seems, is that when you put the Karma on a scale it weighs a few hundred pounds more than a Hummer H3 and a few hundred pounds less than a Cadillac Escalade. That's right folks: it's a 5,300 pound behemoth that was engineered in California with $169 million of ATVM loan guarantees from the Department of Energy. While most of the long-term economic benefits from manufacturing these shocking green monstrosities will be outsourced to Finland, at least the batteries will be made in the US by A123 Systems (AONE) which made a $23 million venture capital investment in Fisker to establish a strategic relationship and ensure the battery supply contract.

When journalists and political pundits questioned the reasonableness of the Fisker loan guarantee, the DOE explained:

"Fisker’s loan has two parts. In the first part, Fisker used $169 million to support the engineers who developed the tools, equipment and manufacturing processes for Fisker’s first vehicle, the Fisker Karma. That work was done Fisker’s U.S. facilities, including its headquarters in Irvine, California, which has 700 employees and plans to continue hiring. While the vehicles themselves are being assembled in Fisker’s existing overseas facility, the Department’s funding was only used for the U.S. operations. The money could not be, and was not, spent on overseas operations. The Karma also relies on an extensive network of hundreds of suppliers in more than a dozen U.S. states."

The sophistry of using taxpayer money to finance special project jobs in California while creating long-term manufacturing jobs in Finland is self-evident. The more troublesome questions in my mind are:
  1. How many $100,000 Karmas will Fisker need to sell to earn enough profit to repay $169 million in DOE loans?
  2. How many battery packs will A123 need to sell to Fisker if it wants to recover its $23 million investment?
  3. Is either outcome even remotely possible given the lackluster sales and margins that Tesla Motors (TSLA) has realized from its equally sexy and expensive Roadster?
This was clearly a series of deals negotiated by imbeciles who really mean it. The most outrageous part of the DOE's defense was the penultimate paragraph which says:

"Remember that plasma TVs, cell phones, personal computers and many other common products were once fabulously expensive luxury items, but quickly became a staple for middle class Americans. These price declines wouldn’t have been possible without the first, commercial scale marketing as premium products."

BALDERDASH! I expect that kind of bafflegab from EVangelicals but not from government officials.

There is no possibility that electric vehicles will ever deliver the kinds of cost reductions we witnessed during the information and communications technology revolution because the fundamental science is totally different. There is no Moore's law for the physics of moving a 2.65-ton vehicle down the road. There is no Moore's law for electrochemistry. There is no fairy godmother to increase global production of non-ferrous metals or control commodity prices. But instead of rationally discussing science, supply chains and energy economics, we have the DOE deflecting reasonable questions with the time-honored wisdom that "facts don't matter because the essence of political debate is the plausible boldly asserted."

A little over three years ago I started cautioning readers that Ener1 (HEVV.PK) was a disaster in the making. My cautions got more strident when Ener1 made a substantial venture capital investment in Th!nk Motors to strengthen their strategic relationship and retain a battery supply contract that was jeopardized by Th!nk's insolvency. While some readers took my words of caution to heart, many did not. This week they learned that analyzing battery and electric vehicle companies through rose colored glasses is a great way to end up with a stock that's listed on the Pink Sheets. While I generally like to be right, I hate being this right.

I wonder how the DOE feels about that $118.5 million ARRA Battery Manufacturing Grant they gave Ener1 in August of 2009.

My graph for this week is courtesy of Lux Research and appeared in their recent report "Using Partnerships to Stay Afloat in the Electric Vehicle Storm." The graph is particularly instructive because it overlays their forecasts for the electric vehicle and lithium-ion battery markets in a single graph.

10.29.11 Lux Graph.png

The yellow lines represent total demand for lithium-ion batteries in automotive applications through 2020 using three different oil price scenarios. The blue shaded area represents the total planned production capacity of the global lithium-ion battery industry for the same period. The inescapable conclusions are that (1) without $200 oil, growth in electric vehicle sales will be tepid at best and certainly not robust enough to justify nosebleed market capitalizations for companies like Tesla, and (2) the glut of lithium-ion battery manufacturing capacity will be a crushing burden for all but the most efficient and financially sound battery manufacturers.

While Pike Research recently reported that demonstration projects have deployed 538 MW of lithium-ion based storage on the grid, all of the facilities I've read about report power based on a 15 minute discharge. That means the demonstration projects have used about 135 MWh of batteries to date, or less than 1% of the expected annual capacity glut. While grid-based storage may have significant long-term potential, it's not a big enough short-term opportunity to make a difference.

The takeaway for investors who are willing to remove their rose colored glasses is that the industry leaders in the electric vehicle and lithium-ion battery sectors are run by imbeciles who really mean it and their companies are doomed to underperform the market for years. Molly Ringwald was Pretty in Pink, but it's an ugly color for stock listings.

Disclosure: None.

October 20, 2011

Another Reality Check for EV Investors

John Petersen

Earlier this month Deloitte Touche Tohmatsu Limited’s Global Manufacturing Industry group rained all over the plug-in vehicle parade when they published the results of a survey of over 13,000 individuals in 17 countries that concluded:

"The reality is that when consumers actual expectations for range, charge time, and purchase price (in every country around the world included in this study) are compared to the actual market offerings available today, no more than 2 to 4 percent of the population in any country would have their expectations met today based on a data analysis of all 13,000 individual responses to the survey."

While Deloitte's conclusions didn't surprise me, they did clarify my thinking about the market for ultra-high efficiency vehicles and the changes I've been following for the last three years. While I'm usually pretty opinionated, this article will focus more on uncertain market dynamics that aren't clear today but will become self-evident over the next couple years.

The niche market for ultra-high efficiency vehicles has only existed since 2000 when Toyota (TM) introduced the Prius. For the first nine years, the only real contenders were hybrid electric vehicles. Beginning in 2008, we saw demand emerge for new classes of ultra-high efficiency vehicles including "clean diesels" and plug-in vehicles like the Tesla Roadster (TSLA), which was recently joined by the Nissan Leaf (NSANY.PK) and the GM Volt (GM). The common characteristic of all ultra-high efficiency vehicles is a price premium that ranges from $4,000 in the case of a clean diesel to $15,000 or more in the case of a plug-in.

The following stacked graph shows total US sales of ultra-high efficiency vehicles since 2000 and estimates 2011 sales based on sales through September 30th.

11.20.11 UHE Vehicles.png

Over the last three years, the niche market for ultra-high efficiency vehicles has basically stagnated, averaging about 3% of new car sales. While that number ties nicely to Deloitte's conclusion that plug-in vehicles would satisfy the expectations of 2 to 4 percent of the population, the more fascinating thing about the graph is that while the trendline for the ultra-high efficiency vehicle class isn't all that bad given the financial turmoil we've experienced since 2008, it's crystal clear that clean diesels and plug-ins are eating into the HEV market instead of attracting new converts to the ultra-high efficiency vehicle fold.

Logically it makes sense to me that only a small percentage of US car buyers would be willing to pay a $4,000 to $15,000 premium for an ultra-high efficiency vehicle, but we'll need to see at least a couple more years of data before drawing any definitive conclusions. Until we see a major upswing in the overall market penetration rate for the ultra-high efficiency vehicle class, however, I have to assume that plug-ins, clean diesels and HEVs will compete hammer and tong with each other for the 3% of the new car market that doesn't care about cost premiums and be politely ignored by the 97% of the market that thinks the green in their wallets is more important than the green in their cocktail party conversations.

Usually when I get to this point in an analysis, the EVangelicals start trotting out their subsidy arguments to justify the exorbitant costs. While a wide variety of subsidies and incentives have been adopted over the last couple years, I don't believe they have any long-term viability because the world has reached a tipping point where governments can no longer afford to throw public money at an ideology embraced by the 1% at substantial cost to the 99% who are finally taking to the streets in sheer unfocused frustration. While today's protestors lack the coherent goals that we had during the civil rights and anti-war movements of the 60s and 70s, public fury over government policies that benefit the new royalty at the cost of the masses is mounting and it's only a matter of time before people come to grips with the inherent immorality of taxing Peter to buy Paul a new car, particularly when Paul is part of the 1%. When you add in recent developments like a car dealer Congressman who fired an employee over the unauthorized purchase of a GM Volt for his dealership, I have to conclude that today's immense but wholly unjustifiable eco-bling subsidies will quickly become little more than footnotes in automotive history.

My favorite reader comments are the ones that breathlessly compare Tesla and other EV developers with Apple (AAPL). The comparisons are actually quite apt, but not in the way commenters intend. For the first 15 years that I used Apple's computer products they focused on the 3% to 5% of the market that was willing to pay a stiff premium for something different and clearly superior. The stock was one of the worst investments in the tech sector and those of us who loved Apple's computers spent a lot of time worrying that the company would fail. The dynamic didn't change until Apple rolled out its iPod line for the masses in late 2001. Since then serial successes with mass market products including the iPhone and iPad have Apple them the success story of the new millenium. The possiblilty that Tesla or any other EV developer will be able to make a comparable splash with four wheels, a massive battery and a 25 foot power cord is laughably remote.

The graph clearly shows that the ultra-high efficiency vehicle market has temporarily if not permanently flat-lined at a 3% market penetration. While it may be a fun place for technology geeks to marvel over the latest gee-whiz press release, it's not a market for serious investors because there's no upside unless the market penetration rates change significantly. For the next five years, the solid potential for market beating performance will be in un-loved battery industry stalwarts like Johnson Controls (JCI), Exide Technologies (XIDE) and Enersys (ENS) and emerging technology developers like Axion Power International (AXPW.OB) that are working on less dramatic fuel efficiency technologies for the 97% of the market that doesn't care about premium priced eco-bling and believes baby steps matter.

Since September 30th, the broad market indexes have gained an average of 6.7%. During that period JCI has gained 20.6%, Exide has gained 12.5%, Enersys has declined 0.4% and Axion has declined 1.9%. All four companies have rebounded convincingly from recent bottoms and appear likely to outperform the market on a go-forward basis.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

October 08, 2011

Lithium-ion Battery Stocks: Investment Opportunities or Subsidized Laggards?

John Petersen

I'm often critical of public lithium-ion battery manufacturers based on objective investment metrics including their financial condition, their results of operations, their potential markets and the fundamental soundness of their business plans, but I don't usually drill down into thornier issues like technical merit and business execution because those questions are out of my depth and in the words of Harry Callahan, "A man's got to know his limitations."

Every once in a while, however, organizations that are competent to evaluate those issues publish analytical reports that can help investors cut through the hype and make better investment decisions. The following “Innovation Grid” graphic from Lux Research that first appeared in a June 2011 report titled, "Using Partnerships to Stay Afloat in the Electric Vehicle Storm," is a fine example.

10.8.11 Lux Lithium.png

In the underlying report, Lux explained that they:
  • Evaluated the value of core technologies, the addressable market size, the competitive landscape, and IP position to rank companies along a vertical axis ranging from 1 (Low) to 5 (High);
  • Evaluated management strength, profitability, partnership value, overall momentum, and the surrounding environment to rank companies along a horizontal axis ranging from 1 (Low) to 5 (High);
  • Evaluated maturity by considering size, stage of development, and annual revenues to rank companies by dot size; and
  • Provided a subjective overall ranking ranging from strong caution to strong positive.
Lux developed the Innovation Grid hierarchy of lithium-ion battery producers because its market analysis indicates that global lithium-ion battery manufacturing capacity will exceed demand by a wide margin for the better part of the next decade. Accordingly, it believes the looming capacity glut will force an inevitable consolidation where a handful of dominant manufacturers survive while weaker market participants fail.

Since I didn't create the Innovation Grid hierarchy, I'm not going to argue about the relative technical and business merits of the various companies. My primary goal today is to observe that some winners of headline grabbing ARRA battery manufacturing grants in August 2009 seem to be technical and/or business laggards, including:
  • JCI-Saft, which was awarded $299.2 million dollars in ARRA battery manufacturing grants, recently became a wholly owned subsidiary of Johnson Controls (JCI), and is safely ensconced in the heart of mediocrity;
  • A123 Systems (AONE), which was awarded $249.1 million dollars in ARRA battery manufacturing grants but received mediocre grades for technical merit and sub-par grades for business execution; and
  • Ener1 (HEV), which was awarded $118.5 million dollars in ARRA battery manufacturing grants but received laggard grades for both technical merit and business execution.
All of them are apparently less attractive business opportunities than Advanced Battery Technologies (ABAT) which was savaged in a trio of articles from Variant View Research in March and April of this year, but is well positioned in the Lux hierarchy.

At Friday's close ABAT was trading at 30% of book value, 70% of annual sales and 1.9 times trailing-twelve-month earnings. If you want to own stock in a lithium-ion battery company ABAT seems like a far better choice than the subsidized laggards.

Disclosure: None.

October 04, 2011

Micro-Hybrids – The Fuel Efficiency Innovation of the Decade

John Petersen

I've been writing about micro-hybrid vehicles and stop-start idle elimination since May 2009. It's a cheap and simple fuel efficiency innovation that turns the engine off while a car is stopped at a light and automatically restarts the engine when you take your foot off the brake. It's not gee-whiz sexy, but it can boost fuel economy by 5% to 15% in city driving and dramatically improve urban air quality by reducing idling. What could be more sensible?

When I first wrote about stop-start in "Why Advanced Lead-acid Batteries Will Dominate the HEV Markets," the only market forecast I could find came from Frost & Sullivan, which predicted that global micro-hybrid sales would ramp from 800,000 units in 2008 to about 10 million units in 2015, a superb growth rate by almost anyone's standard.

10.4.11 F&S Stop-start.png

By April 2010, expectations about the ramp rate for stop-start technology had increased significantly and the final rule release for new CAFE standards predicted that stop-start would be used in 42% of new US passenger cars by 2016. In its recent Power Solutions Analyst Day presentation, Johnson Controls (JCI) summarized automakers current plans and forecast a global penetration rate of 25 million stop-start vehicles per year by 2016, over 2-1/2 times the rate forecast by Frost & Sullivan in 2009.

9.27.11 Global SS.png

By 2020, JCI expects global stop-start vehicle sales on the order of 50 million vehicles per year.

Regardless of what you believe automakers and consumers should do when it comes to fuel efficiency, it's clear that the automakers are implementing stop-start at a fevered pace and the technology will become standard equipment over the next five years. In response to surging demand from automakers, JCI is ramping its manufacturing capacity for absorbed glass mat, or AGM batteries, from four million units this year to an estimated 18 million units by 2015. Other manufacturers like Exide Technologies (XIDE) are following suit and it won't be long before cars equipped with stop-start systems are saving more fuel per year than all HEVs, PHEVs and BEVs combined.

Baby steps and low hanging fruit are important!

Despite their fuel economy advantages, stop-start systems are very hard on the batteries that need to restart an engine ten or even twenty times in a typical commute and carry accessory loads during engine-off intervals. In the real world, stop-start systems work great when the batteries are new but quickly lose their functionality as the batteries age. The following graph from the Department of Energy's Idaho National Laboratory illustrates the problem with shocking clarity.

10.4.11 INL SS Economy.png

With brand new batteries the test vehicles had great fuel economy. As the batteries deteriorated over a few months of use, the bulk of the fuel economy benefits vanished.  At last September's European Lead Battery Conference, BMW and Ford explained the problem in a joint presentation that focused on dynamic charge acceptance, the ability of a starter battery to recover the energy used during an engine-off cycle and get ready for the next engine-off cycle. The key take-away from the BMW-Ford presentation was that today's leading battery technologies, including flooded and AGM batteries, are not well-suited to the extreme power and charge acceptance demands of stop-start systems.

For stop-start to reach its full potential, the auto industry desperately needs a better energy storage solution.

Maxwell Technologies (MXWL) and Continental AG developed the world’s first enhanced energy storage system for stop-start vehicles with diesel engines manufactured by Peugeot-Citroën. The system uses a supercapacitor module from Maxwell and an AGM battery from Continental to ensure that there will be enough power to restart the engine at the end of a stop-start cycle. While the Maxwell-Continental system is a significant advance over AGM batteries, it does not address the core issue identified by BMW and Ford, which is the ability of the battery to recover the energy used by a vehicle's accessories during an engine-off interval. It does a great job of carrying a 300 amp-second starter load, but does very little to help the battery recover from a 3,000 amp-second accessory load.

A123 Systems (AONE) developed a second enhanced energy storage system for stop-start based on its lithium iron phosphate technology. The one kilowatt-hour battery pack offers the cold cranking amps of a high quality lead-acid battery, the high charge acceptance of lithium-ion batteries and a weight reduction of about 20 pounds.

Axion Power International (AXPW.OB) is currently completing the development of a third enhanced energy storage system for stop-start vehicles based on its PbC technology, a lead-carbon hybrid that does not suffer from negative plate sulfation, the primary failure mechanism for both flooded and AGM batteries in stop-start applications. At last September's European Lead Battery Conference, BMW and Axion presented test data confirming that the PbC retained its dynamic charge acceptance through the equivalent of four years of use in stop-start simulation. In a recently published white paper, Axion released more detailed information on the performance of a dual-battery PbC system.

Currently, the market for stop-start energy storage systems is wide open and there is very little clarity about the types of systems automakers will ultimately choose for their vehicles. The following table summarizes the alternative approaches automakers are actively testing and evaluating, and provides a rough estimate of the cost of each energy storage alternative.

Enhanced flooded batteries
(single battery system)
JCI
Exide
$75
Enhanced flooded batteries
(dual battery system)
JCI
Exide
$150
AGM batteries
(single battery system)
JCI
Exide
$150
Dual battery - flooded starter battery with
AGM accessory battery
JCI
Exide
$225
Dual device - supercapacitor starter with
AGM accessory battery
Maxwell
Continental
$250
Dual device - flooded starter battery with
PbC accessory battery
Axion Power
$325
Lithium-ion battery
A123 Systems
$750

The emergence of stop-start as standard equipment presents a tremendous opportunity and a tremendous challenge for energy storage developers and manufacturers. Automakers are accustomed to paying $75 for a starter battery and there is intense pushback against dual battery systems and AGM batteries that will double the cost. Despite the automakers' resistance to cost increases, many have accepted the reality that they'll have to upgrade to single battery AGM systems or even dual battery systems that use an AGM battery for accessories and a flooded battery for the starter. To date only one automaker has made the decision to upgrade to a dual device supercapacitor and AGM battery system, however A123 systems has said that an undisclosed automaker has signed a production contract for its lithium-ion starter battery. The Axion system is currently being tested by BMW and several other automakers, but has not yet captured a design win.

I see the market for stop-start batteries as a knockdown drag-out brawl for the next couple of years. Consumers will not be happy with stop-start systems that offer great performance for a month or two and then deteriorate. While the automakers will resist upgrading to premium energy storage systems, customer demands coupled with constantly increasing regulatory pressure to improve fuel economy will force them to implement more sophisticated and expensive systems from Maxwell, A123 and Axion.

In the third quarter Maxwell gained 13% while the broader markets lost 13%. At yesterday's close, Maxwell had a market capitalization of $495 million and was trading at 4.7x book value and 3.5x trailing twelve month sales. Those metrics strike me as expensive compared to A123 Systems, which has a market capitalization of $381 million and trades at a discount to book value and 3.6x sales. Since it's still in the last stages of product development, Axion carries a very modest market capitalization of $42 million, or about 1.5x book value (after adjusting for bargain asset purchases) and trades at 4x to 5x anticipated 2011 sales.

While established lead-acid battery manufacturers like JCI and Exide will be the first beneficiaries of the stop-start market as their revenue per vehicle doubles and their margins triple, the energy storage system that offers the best combination of price and performance will ultimately win the lion's share of the market. While it’s impossible to pick a winner at this point, second, third or even fourth place in a $7 to $10 billion dollar market niche with no solidly entrenched competitors could be a company maker for any of the emerging technology developers.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

October 01, 2011

Energy Storage: A Bloody Q3 is Creating a Great Buying Opportunity

John Petersen

Tom Lehrer is frequently credited with a quip that perfectly summarizes my feeling about the financial markets in the third quarter, "Apart from that Mrs. Lincoln, how did you enjoy the play?" During the quarter we were given box seats to classic political opera in two acts. Act One was set in Washington DC while Act Two moved to Europe so we could hear the same tortured songs of woe in a different language. We all know the opera has to end with the immensely popular "Kick the Can Chorus," but we suspended disbelief, bought into the fear and held a massive liquidation sale. As a curtain call it looks like we've let our elected demagogues scare us into a new recession. Do you ever wonder if the system might work better if ballots included "None of the above" as an alternative and required the offices to remain vacant if nobody won a majority?

For the third quarter the Dow, S&P 500 and Nasdaq indexes were down an average of 13.1% and it was even uglier in energy storage where the best names in the business were beaten down by 35% to 50%. The following table summarizes the price performance of my tracking list for the year and the quarter ended September 30, 2011.

9.30.11 Price Table.png

It was a bloody time that's creating a great buying opportunity. While it's still a little early to buy the biggest companies in the sector, it's a wonderful time to do some homework, map out a strategy and prepare for the inevitable bottom.

For reasons I can't explain, several energy storage companies move in the same direction as the S&P 500, but react more violently to changing market sentiments. To illustrate the phenomena I've created a graph that compares percentage price movements for Johnson Controls (JCI), Enersys (ENS), Exide Technologies (XIDE) and Active Power (ACPW) against the S&P 500 using 10-day volume weighted moving averages instead of daily prices.

9.30.11 ST Comparison.png

While the pattern is less obvious over longer periods, the following graph that tracks the percentage price movements since April 1, 2009 shows that the pattern holds in both up and down markets, which suggests that buying storage at the next bottom should have a significantly greater upside potential than buying the broader market at the bottom.

9.30.11 LT Comparison.png

The next bottom may well be the buying opportunity of a lifetime as energy storage emerges as an investment mega-trend and the market realizes that cool has no place in an industrial sector where cost matters and the law of economic gravity reigns supreme. Core positions in Johnson Controls, Enersys and Exide Technologies are a must have for all serious storage investors. Depending on your risk appetite, more speculative companies like Active Power, Axion Power (AXPW.OB), Maxwell Technologies (MXWL) ZBB Energy (ZBB) and perhaps Beacon Power (BCON) also merit serious consideration.

For the last three years I've cautioned investors that the media circus around plug-in vehicles and exotic batteries was a transitory phenomenon driven by ill-conceived ideology instead of common sense. The upcoming recession will force the government and the markets to recognize that plug-in vehicles are unconscionable waste masquerading as conservation and a luxury no nation can afford, much less subsidize at relevant scale.

My last chart for the day compares the market capitalizations of my tracking list companies on September 30, 2009 and September 30, 2011. While Axion Power and Exide are far stronger today than they were in the fall of 2009, most of the companies that lost a lot of market value have also lost a lot of ground.

9.30.11 Two Year.png

The simple but undeniable reality is everybody wants better batteries but nobody wants to pay a premium price for them. The green in an ordinary consumer's wallet will always take priority over the green in his cocktail conversation. Manufacturers of objectively cheap products that can do the required work are certain to thrive over the next five years. Developers of exotic batteries for plug-in vehicles and other uneconomic applications are likely to follow the same tragic path as Ener1 (HEV).

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

September 27, 2011

Plug-in Vehicles Have Been Weighed in the Balance and Found Wanting

John Petersen

A comment from maxkilmachina recently drew my attention to an article in the Proceedings of the National Academy of Sciences titled Valuation of plug-in vehicle life-cycle air emissions and oil displacement benefits. While it costs $10 to download the article and supporting documentation, I believe it's worthwhile for all serious energy storage and electric vehicle investors because the underlying study is the first comprehensive total cost of ownership analysis I've seen that includes both direct end-user costs and identifiable externalities like emissions, military and other indirect costs arising from oil consumption in the US. While all studies leave room to quibble, the bottom line conclusion is clear:

"[T]oday’s HEVs and PHEVs with small battery packs offer more emissions reduction and petroleum displacement per dollar spent with less of a need for new infrastructure and with lower uncertainty about future costs ..."

The detail is a bit dense for an investment blog, but two summary graphs from the article go a long way toward reducing glittering generalities to hard economics. They summarize the direct and indirect costs for five types of vehicles under three possible scenarios. The term CV refers to conventional vehicles with internal combustion engines. The term HEV refers to conventional hybrid electric vehicles. The terms PHEV20 and PHEV60 refer to plug-in hybrids with electric drive ranges of 20 km and 60 km, respectively (12.5 and 37.5 miles). The term BEV240 refers to a battery electric vehicle with a 240 km range (150 miles).

The first graph deals exclusively with unpriced externalities including emissions, military and global supply and demand impacts of US oil consumption. While bigger battery packs offer modest advantages in the wildly optimistic case of a zero emission grid, they're not as cost effective as HEVs and PHEV20s in either real world scenario.

9.27.11 Externalities.png

The second graph ties it all together in a unified total cost of ownership analysis that accounts for all direct and indirect costs including purchase price, fueling, maintenance and unpriced externalities. Once again, bigger battery packs offer modest advantages in the Pollyanna case but are 50% to 100% more expensive in both real world scenarios.

9.27.11 TCO.png

The message for investors is clear. When you cut through the hand waving and glittering generalities plug-in vehicles with big batteries have been weighed in the balance and found wanting. They promise the worst possible combination of facile emotional appeal and dismal economics. They can only be attractive to the philosophically committed or the mathematically challenged. As the ugly truth becomes apparent to congressmen, businessmen and consumers that are staggering under crushing debt burdens and facing an immediate need to balance revenues and expenses, the hype induced euphoria over companies like Tesla Motors (TSLA) that make plug-in vehicles and battery companies like A123 Systems (AONE) and Valence Technologies (VLNC) that make big battery packs for toys must fade because immutable laws of economic gravity won't permit any other outcome.

As a child of the 1950s I once believed Superman could leap tall buildings in a single bound. As a mature adult of the 2010s I know the only way to reach a mountaintop is by climbing a slippery slope one step at a time. When I consider the magnitude of the economic sophistry underlying current government policy, I'm not sure that I'd want to be a Congressman or Senator standing for election next year and explaining how subsidized toys for the politically favored eco-elite benefit the voting public. Green jobs that cost consumers money instead of saving it simply aren't worth having.

I'm a securities lawyer, accountant and investment writer, not a futurist. My only concern is whether a particular company will prosper over the next five years or struggle. Anything beyond that is unknown and to my way of thinking largely unknowable. While investors are constantly bombarded with shimmering mirage-like visions of what might happen in a decade or two, they're largely ignorant about the concrete steps automakers are taking today to improve fuel economy and reduce emissions now. The following graph is a great example because it shows how the auto industry is responding. It begins with 2010 plans for the rollout of stop-start technology, layers on new plans that were announced this year and offers a conservative estimate for likely future additions. Stop-start is only a baby step toward a more fuel-efficient future, but it's an immediate step that will save more fuel over the next decade than all HEVs and plug-ins combined.

9.27.11 Global SS.png

The first beneficiaries of the rapidly evolving implementation of stop-start as standard equipment will be established battery manufacturers like Johnson Controls (JCI) and Exide Technologies (XIDE) that will see their revenue per vehicle double and their margin per vehicle triple as automakers upgrade their starter batteries from flooded lead-acid to valve regulated AGM batteries. Second tier beneficiaries include Maxwell Technologies (MXWL) which has partnered with Continental AG to offer a system that pairs a supercapacitor module with an AGM battery to improve performance; A123 Systems which is offering a 1,100 watt hour lithium-ion battery for stop-start applications; and Axion Power International (AXPW.OB) which is completing the development of a third generation lead-carbon battery that promises lithium-ion class performance for stop-start applications at an advanced lead-acid price point.

It will be a horse race, or a knock-down drag-out brawl, as established manufacturers and emerging technology developers compete for their share of a $5 to $10 billion market that didn't exist three years ago. We probably won't be able to identify the ultimate winners with any degree of confidence for another three to five years. In the interim the stock prices of all the credible competitors are certain to climb because they're in the race for a major business prize. While it's hard to find much good in current market conditions, the stock prices for most of the credible competitors have recently been beaten down to very attractive levels. In a period of transition it's only natural for the more timid element to run for cover, but these are the days elephant hunters dream of when the broader market is distressed but the universe of likely players is small.

Talking about what the vehicle fleet might look like in a decade or two is fun for futurists but it's very dangerous ground for investors because of intervening business and technical risks, overwhelming and unavoidable natural resource constraints, the time value of money and the inherent unreliability of forecasts that extend for more than a few years. For my money, today's sure thing is far more attractive than a wildly uneconomic technological long shot.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and owns a substantial long position in its common stock.

UPDATE: I just received an e-mail message advising that the lead author of the PNAS report has posted a free copy on his faculty web page at Carnegie Mellon University.

September 02, 2011

Axion Power is Poised to Dominate Energy Storage for Stop-start Idle Elimination

John Petersen

After eight years of rarely speaking above a whisper, Axion Power International (AXPW.OB) has found its voice, taken the scientific wraps off its PbC® battery technology and shown potential customers, competitors and investors that it's carrying a big stick and is poised to dominate energy storage for stop-start idle elimination – a cheap and sensible fuel efficiency and emissions reduction technology that's expected to grow at spectacular rates for the rest of the decade as shown in the following forecast of battery demand in vehicles equipped with stop-start systems.

6.27.11 10-year.png

In a new white paper on dynamic charge acceptance that's available in the Investor section of its website, Axion has thrown down the technology gauntlet and shown why flooded and valve regulated lead-acid batteries from Johnson Controls (JCI), Exide Technologies (XIDE) and others aren't good enough for today's stop-start systems and won't be good enough for even more demanding second generation systems. In the process it's also shown why a dual device system from Maxwell Technologies (MXWL) and Continental AG (CTTAY.PK) that combines a supercapacitor module with a valve regulated AGM battery can't be an optimal solution either.

The basic problem is that stop-start systems require their batteries to operate at a partial state of charge and conventional lead-acid batteries rapidly deteriorate if they're not kept fully charged. There's a fundamental mismatch between the needs of the application and the capabilities of the battery. With flooded lead-acid batteries the deterioration is obvious within weeks. With valve regulated AGM batteries it takes a few months. As the battery deteriorates, the mechanical systems just stop working. Stop-start systems that lose their functionality over a few weeks or a few months because of feeble batteries aren't efficiency technologies at all - they're greenwash. Automakers desperately need a better solution, but it has to be easy to manufacture, easy to scale and cheap enough for a price sensitive mass market.

In simple terms, the PbC is a battery-capacitor hybrid that loves operating at a partial state of charge and doesn't deteriorate rapidly with age. While the basic chemistry is pure lead acid, Axion replaces the lead-based negative electrodes found in conventional batteries with carbon electrode assemblies that eliminate battery deterioration and pave the way for second-generation systems that will offer even better performance. Since the white paper does a fine job of explaining the science, I'll focus on the business dynamics that favor rapid launch and widespread implementation of the PbC technology.

The PbC offers 10x the dynamic charge acceptance and 20x the cycle-life of conventional lead acid batteries for one reason – it's a third-generation device that takes valve regulated AGM battery technology to a whole new level. While the science underlying the PbC technology was patented in 2002, the challenge was developing production methods and equipment that could leverage existing manufacturing and distribution infrastructure instead of replacing it. Axion spent eight years developing PbC electrode assemblies that can be used as plug-and-play replacements for the lead-based electrodes used by battery manufacturers worldwide. The last step is earning OEM certification for its automated electrode manufacturing processes. Once the OEM's have certified Axion's electrode manufacturing processes, it will be easy for an AGM battery manufacturer to substitute PbC electrode assemblies for their conventional lead electrodes and offer a better battery to customers without having to requalify their factories or their products.

Unlike other battery manufacturers that want to build new factories and develop new customers, or wrestle business away from entrenched competitors, Axion plans to pursue a platform technology strategy where it will focus on manufacturing a high value component for sale to existing manufacturers that want to offer a better product to current customers. Axion's strategy was lifted from the Intel playbook. They don't care who manufactures the battery for a particular customer as long as it uses Axion's electrodes. With a strong intellectual property estate that will keep new entrants away from its sandbox, Axion is well positioned to forge a variety of cooperative relationships with battery manufacturers worldwide.

The only battery technology on the market that can offer comparable performance in stop-start applications is lithium-ion. While lithium-ion developers like A123 Systems (AONE) are actively developing products for the stop-start market, their batteries are more expensive than the PbC and harder to scale because they can't leverage existing infrastructure. They also suffer from significant cold weather performance issues and have limited potential for future cost reductions while the PbC is at the upper left-hand corner of the learning curve. There's a reason that first tier battery buyers like BMW and Norfolk Southern publicly aligned themselves with the PbC technology before there was a PbC product.

In his seminal book The Innovator's Dilemma, Dr. Clayton Christensen uses the term disruptive technologies to describe low-cost innovations that satisfy new customer needs, improve over time and eventually displace established technologies. The following graph illustrates the phenomenon.

9.2.11 Disruption.png

If you believe Dr. Christensen's theory it's impossible to believe that lithium-ion batteries that were developed for the most demanding uses will be the ultimate winner in energy storage for stop-start idle elimination. Technologies simply do not transition downstream from high quality uses to low quality uses. Disruptive technologies always start at the bottom and work their way to the top. Given a choice between embracing the PbC technology and working with Axion or losing critical market share to more expensive lithium-ion products, the lead-acid battery industry will do the only sensible thing.

At yesterday's close Axion had a $48 million market capitalization and a serially patented technology that holds the price and performance keys to a multi-billion dollar market. The math seems obvious to me. In less than two weeks Axion will present at the Rodman & Renshaw conference in New York. It's stock had a strong run in February and March of this year after similar presentations at lower tier cleantech conferences sponsored by Piper Jaffray, Jefferies and Kaufman Bros. While the first run was crushed by selling pressure from a couple of large stockholders, cumulative trading data leads me to believe that the willing sellers are effectively out of stock and can't cause a comparable reversal of the next run.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

August 25, 2011

It's Time to Kill the Electric Car, Drive a Stake Through its Heart and Burn the Corpse

John Petersen

I was recently invited to prepare a memorandum on the battery industry for the electric mobility working group of the World Energy Council, a global thought leadership forum established in 1923 that includes 93 national committees representing over 3,000 member organizations including governments, businesses and research institutions. Since my memorandum integrated several themes from this blog and tied them all together, I've decided to publish a lightly edited version for readers. To set the stage for the substantive discussion that follows, I’ll start with an 1883 quote from Thomas Edison:

“The storage battery is one of those peculiar things which appeals to the imagination, and no more perfect thing could be desired by stock swindlers than that very selfsame thing. Just as soon as a man gets working on the secondary battery it brings out his latent capacity for lying.”

At the time, Edison was a customer who wanted to buy batteries to improve the reliability of the Pearl Street Station, the first coal-fired utility in North America. An essential truth even Edison failed to recognize is that battery developers don't lie, but potential customers consistently lie to themselves. They hear about gee-whiz inventions, overestimate the practical importance of the innovations and then make quantum leaps of imagination from the reasonable to the absurd. Therefore, the most important task for investors is to critically and objectively examine their own assumptions and avoid hopium induced hallucinations.

Cleantech, the Sixth Industrial Revolution

I believe we are in the early stages of a new industrial revolution, the Age of Cleantech. The cleantech revolution will be different from all prior industrial revolutions because the IT revolution forever changed a dynamic that has existed since the dawn of civilization. It gave the poor and the ignorant access to the global information network, proved that there was more to life than deprivation and sparked a burning desire for something better in billions of people who were once content with mere subsistence. It's long-term significance will be more profound than the discovery and settlement of North America.

The inescapable new megatrend is that six billion people have been awakened to opportunity and are striving to earn a small slice of the lifestyle that 600 million of us enjoy and typically take for granted. If the six billion are even marginally successful and attain a paltry 10% purchasing power parity, global demand for everything must double. Therefore, the most important challenge of our age will be finding new ways to satisfy insatiable demand for water, food, construction materials, energy and every commodity you can imagine.

The first and easiest step will be to eliminate waste in all its pernicious forms to make more room at the economic table. After that, the challenges become far more daunting.

The Everything Shortage

There is a widely held but grossly inaccurate belief that energy prices and CO2 emissions are the most pressing problems facing humanity. The reason is simple – in advanced economies everybody buys energy commodities in minimally processed form several times a month. Each of those purchases reinforces a belief that energy prices are an intolerable burden. While few of us purchase other minimally processed commodities beyond energy and food, the following graph compares the prices of non-ferrous industrial metals with the price of crude oil and highlights an inescapable and highly inconvenient truth that almost nobody understands –

METAL PRICES ARE MORE VOLATILE AND INCREASING MORE RAPIDLY THAN ENERGY PRICES.

6.23.11 Metals vs Oil.png

To compound the problem, global production of energy resources is several orders of magnitude greater than global production of critical metals, as the following table based on data from the U.S. Geological Survey clearly shows.

7.10.11 Energy vs Metals.png

Metric tons per person vs. kilograms per person is an insurmountable disparity.

Most alternative energy and electric drive technologies can’t be implemented without large quantities of scarce metals. All of the metals in the table have critical competitive uses in other essential products and significantly increasing global production of any of them is problematic if not impossible. While improved recycling practices have the potential to help alleviate shortages of critical metals, a recent UN study of global recycling rates for 60 industrial and technology metals found that only 18 had end of life recycling rates over 50% while 34 had end of life recycling rates under 1%. The metals that are most important to alternative energy and electric drive are very difficult and expensive to recycle. So with the exception of lithium, which is a plentiful resource that only represents 5% or 6% of the metal content in Li-ion batteries, the world cannot produce enough technology metals to permit a widespread transition to alternative energy or electric drive.

Any alternative that can't be deployed at relevant scale isn’t an alternative at all. It’s merely an expensive distraction for the masses, a bit like the circus in ancient Rome.

The Diminishing Marginal Utility of Batteries

Once you understand that metal supplies are far more constrained than energy supplies, every evaluation of electric drive becomes a simple exercise in optimizing the fuel savings from each unit of metal used. The five generic levels of electrification and the typical fuel savings at each level are summarized below.

Vehicle configuration Battery Savings
Stop-start systems use lead-acid batteries to eliminate idling while a vehicle is stopped but do not provide any electric boost. 1.0 kWh 10%
Mild hybrids like the Honda Insight use NiMH batteries to recapture braking energy and provide up to 20 or 30 horsepower of acceleration boost. 1.5 kWh 25%
Full hybrids like the Toyota Prius use NiMH batteries to recapture braking energy, offer electric launch and provide up to 80 horsepower of acceleration boost. 1.5˚kWh 40%
Plug-in hybrids like the GM Volt use Li-ion batteries to offer 40 miles of electric range before a range extender engine kicks in to power the electric drive. 16 kWh 75%
Battery electric vehicles like the Nissan Leaf use Li-ion batteries to offer up to 100 miles of electric range under optimal conditions. 24 kWh 100%

While NiMH has been the preferred battery chemistry for mild and full hybrids since they were introduced in the late 90s, it is a terribly resource constrained chemistry because the “M” most commonly used in NiMH batteries is the rare earth metal lanthanum. With per capita global lanthanum production running at a rate of 5 grams per year, significant expansion of NiMH battery production is effectively impossible, which is the main reason that Li-ion is gaining traction for use in electric vehicles. While not free from doubt, many industry observers believe NiMH and Li-ion will be the preferred batteries for full hybrids while mild hybrids will use NiMH, Li-ion and advanced lead-acid batteries.

There are important technical differences between the high-power batteries required for hybrid drive and the high-energy batteries required for electric drive. The differences, however, are relatively insignificant when it comes to raw materials requirements. Therefore, it’s not unreasonable to use battery capacity as a rough proxy for metal consumption in a fuel economy optimization analysis. The following comparisons assume that a new car with an internal combustion engine will use 400 gallons of fuel for 12,000 miles of annual driving. For the sake of simplicity, they assume a total of 96 kWh of batteries are available to reduce societal fuel consumption. The numbers are easily scalable.
  • 96 kWh of batteries would be enough for a fleet of 64 Prius-class hybrids that will each save 160 gallons of fuel per year and generate a societal fuel savings of 10,240 gallons per year;
  • 96 kWh of batteries would be enough for a fleet of six Volt-class plug-in hybrids that will each save 300 gallons of fuel per year and generate a societal fuel savings of 1,800 gallons per year; and
  • 96 kWh of batteries would be enough for a fleet of four Leaf class electric vehicles that will each save 400 gallons of fuel per year and generate a societal fuel savings of 1,600 gallons per year.
This example highlights the fundamental flaw in all vehicle electrification schemes. When batteries are used to recover and reuse braking energy that would otherwise be wasted, a single kWh of capacity can save up to 107 gallons of fuel per year. When batteries are used as fuel tank replacements, a single kWh of capacity can only save 19 gallons of fuel per year and most of the fuel savings at the vehicle level will be offset by increased fuel consumption in power plants.

Using batteries to enable energy efficiency technologies like recuperative braking is sensible conservation.

Using batteries as fuel tank replacements is a zero-sum game that consumes huge quantities of metals for the sole purpose of substituting electricity for oil. Since roughly 45% of domestic electric power from coal fired plants and that percentage will decline very slowly, the only rational conclusion is that electric drive is unconscionable waste and pollution masquerading as conservation.

The Green Power Sophistry

EV advocates invariably paint an appealing picture of EVs being charged by wind or solar power and claim that the combination of the two is wondrous beyond reckoning. Beyond the impossibility of charging an EV from home solar panels and driving it to work at the same time, the reality is that the presumptive virtue of wind and solar power arises from generating green electrons, not using them. Once green electrons exist, it makes no difference whether they’re used to power an EV or a toaster oven. Since green electrons that are consumed in an EV can't be used to clean up a toaster oven, there can be no double counting of virtue. In fact, since wind and solar power impose their own burdens on materials supply chains there's a solid argument that the pretty picture is doubly wasteful.

The Fixed Cost Conundrum

In a conventional vehicle, the fixed vehicle cost is relatively low and the variable fuel cost per mile is relatively high. In electric drive the dynamic is reversed and the fixed vehicle cost is relatively high while the variable fuel cost per mile is relatively low. While few financial metrics are more shrouded in secrecy, intrigue and speculation than Li-ion battery manufacturing costs, A123 Systems (AONE) includes enough hard data in its quarterly and annual reports to the SEC to permit a reasonable estimate. The following graph compares A123’s reported quarterly revenue, their adjusted cost of goods sold (after backing out unabsorbed manufacturing costs) and their gross margin per kWh of batteries shipped.

8.8.11 A123 Graph.png

A123’s direct battery production costs have averaged over $1,000 per kWh for the last two years. By the time A123 adds a reasonable profit margin for its effort and an automaker adds another layer of markup, the only possible outcome is an end-user cost of $1,500 per kWh or more.

Since most advocates insist that battery costs will decline rapidly, I’ll assume end-user battery pack costs of $1,000 and $500 per kWh to keep the peace. I'll also use several other charitable assumptions including stable electricity costs of $0.12 per kWh, no loss of battery capacity over time, no cycle-life limitations and a 15% second-life value. The following graph presents alternative gas price scenarios of $3, $6 and $9 per gallon, and then overlays depreciation and charging cost curves for an EV with a 25 kWh battery pack priced at $1,000 and $500 per kWh. The solid red and green lines show current gas and battery prices. The dashed lines show possible futures that are uncertain as to both timing and magnitude.

6.19.10 Fuel Costs.png

The most striking feature of this graph is the shape of the curves. Where prevailing mythology holds that EVs will be wonderful for urbanites with short commutes that don't need much range flexibility, the curves show that high-mileage drivers who presumably need more flexibility will derive the most value. The reason is simple – spreading battery pack depreciation over 5,000 or even 10,000 miles a year results in a higher cost per mile than spreading that depreciation over 20,000 or 25,000 miles a year. Since the GM Volt has an effective electric range of 40 miles per charge and the Nissan Leaf has an effective range closer to 80 miles, it's clear that high mileage users will need to charge more than once a day to get the maximum benefit. Since nobody has claimed a useful life of more than about 100,000 miles for a battery pack, it seems likely that sustained and frequent recharging will impair the economics for high-mileage users who will need to replace their battery packs more frequently.

Moore’s Curse

The IT revolution set the stage for fatally flawed assumptions in cleantech because we all got accustomed to the phenomenon known as Moore’s Law, which describes exponential improvements in the speed and processing power of electronics. In the Moore’s Law world, electronic devices doubled their capacity every 18 to 24 months while requiring the same or smaller natural resource inputs. As a result, we’ve seen decades of falling prices for exponentially better products.

Unfortunately, Moore’s Law has no relevance to electric drive because the energy needed to move a given mass a given distance at a given speed is constrained by the laws of physics. Likewise, the number of electrons in a given mass of chemically active material is constrained by the laws of chemistry. These laws cannot be violated and in practice the theoretical limits can never be achieved. The best we can possibly hope for is highly efficient systems that take us most of the way there.

In the IT world of Moore’s Law the generational progression was 2, 4, 8, 16 etc.

In the cleantech world of Moore’s Curse the generational progression will be 50%, 75%, 87.5% etc.

The following graph is a bit dated, but it shows that current expectations respecting future advances in battery technology are completely out of touch with historical reality.

8.19.11 Batteries.png

When Edison was bitching about batteries specific energies of 25 wh/kg were common. A hundred and thirty years later specific energies of 150 wh/kg are pushing the envelope. A six-fold improvement over 130 years does not provide a rational basis for prevailing expectations.

Investment Conclusions

It's an Iron Law of Nature – things that can't happen won't happen. The world does not and cannot produce enough metals to permit the deployment of electric drive at a rate that approaches relevant scale. Chinese wind turbine producers are reeling from skyrocketing rare earth metal prices that are scuttling wind power deployment plans. Beijing is backing away from its aggressive vehicle electrification policies. If China can't make the numbers work in a command economy that produces over 95% of the world's rare earth metals, nobody can. The inescapable conclusion for investors is that resource dependent alternative energy and vehicle electrification schemes must fail.

Let's face it folks, it's time to kill the electric car, drive a stake through its heart and burn the corpse.

Companies like Tesla Motors (TSLA) are doomed because their vanity products can't possibly make a difference and have all the environmental and economic relevance of pet rocks. The only companies that stand a chance of long term survival are manufacturers of efficiency technologies that reduce aggregate resource consumption. If lithium-ion battery manufacturers like A123 Systems, Altair Nanotechnologies (ALTI) and Valence Technologies (VLNC) can stop chasing rainbows and focus on sensible applications like electric two-wheeled vehicles that reduce natural resource waste, they may have long and prosperous futures. Manufacturers of fundamentally cheap energy efficiency technologies like Johnson Controls (JCI) and Exide Technologies (XIDE) are certain to thrive in any event. The surprise winners in a resource constrained world will most likely be disruptive innovations like the PbC® battery from Axion Power International (AXPW.OB) which uses a third less metal while promising a ten-fold improvement in battery cycle life to optimize the performance of efficiency technologies like stop-start systems, stationary applications and hybrid drive for everything from passenger cars to freight trains.

This article provides a summary overview of several topics I’ve examined in detail over the last three years. A complete archive of my work is available on Seeking Alpha. Most of the resource materials I’ve relied on are available through the numerous hyperlinks I’ve embedded in my articles.

Given the nature of the investing process I don't expect anyone to accept my logic without independently verifying the facts. I sincerely hope that this article will give at least a few investors reason to question their own assumptions in a hopium free environment. Most of us grew up in a rare period of privilege, prosperity and plenty that has seriously distorted our worldview. If we don't accept the reality that our supply chain assumptions are fatally flawed, we can’t possibly identify realistic solutions that can be implemented at relevant scale.

My perspective is very different from the views held by many alternative energy and vehicle electrification analysts. Some readers will no doubt find my thinking reactionary if not heretical. But even the Catholic Church requires a Devil's Advocate to argue against the canonization of proposed saints and gives that advocate fair and equal consideration before making a decision.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

August 21, 2011

Four Bargain-Priced Stocks in the Energy Storage Sector

John Petersen

The last couple weeks remind me of the adage that history never repeats itself, but it frequently rhymes. As I watched the awesome market volatility my mind drifted back to October 1987 when I cleared SEC comments on a client’s registration statement a week before Black Monday. As a result of the market break, the planned IPO didn’t happen, the client and its underwriter both went broke and I didn’t get paid. It was an expensive education that’s paid for itself many times over.

The market is always fickle, often brutal and sometimes downright vindictive. But it’s times of maximum ugliness, volatility and fear that give rise to the greatest opportunities. Barron Rothschild is credited with saying, "buy when there's blood in the streets, even if the blood is your own." A similar line of reasoning from Warren Buffet says investors "should try to be fearful when others are greedy and greedy when others are fearful."

While I usually avoid specific stock picks and focus on groups of companies that are likely to outperform or underperform the broader market, sometimes prices get far enough out of line with reality that I have to prepare a short list of specific companies that I think energy storage investors should seriously consider.

Exide Technologies (XIDE) is an easy double if not a triple over the next 12 months. The stock trades at 11.7 times trailing twelve-month earnings of $30.3 million. What the market fails to recognize is that Exide has finished a major restructuring that savaged its historic earnings and is not expected to impact future earnings. If you adjust Exide's historical net income to eliminate restructuring costs, you'll find it earned $69,098 in FY 2011 and $68,782 in FY 2010. On a go-forward basis, Exide is trading at 5 times earnings and 12% of revenue. With $3 billion in annual revenue and a heavy focus on the replacement battery market, Exide is well positioned to thrive even if the economy slows.

Enersys (ENS) is not as undervalued as Exide, but its current price represents 8.1 times earnings and 48% of revenue. The stock is down 42% from its June 30th close in spite of a strong quarter and favorable outlook. The stock is 50% down from its 52-week high while the broader markets are down about 15%. It all adds up to opportunity for investors who want to position themselves in an established company with solid fundamentals, a good chance for short-term appreciation and a likely double over the next year.

A123 Systems (AONE) doesn't have the immediate upside potential of Exide and Enersys, but the stock is trading at a 33% discount to the $6 per share A123 received in a public offering earlier this year. I was a critic when A123's stock was trading in the $20s, but now that the stock is trading at $4 it's a different story. My opinion on electric cars hasn't changed because the application is a foolish waste batteries and can never be economic. I have a different outlook, however, when it comes to electric two-wheeled vehicles, electric drive for buses and commercial vehicles and grid-based storage to smooth minute-to-minute variations in the power output of wind turbines and solar panels. A123 makes a fine battery and there are several substantial markets for products from its new plant. Given its solid financial foundation, fine products and modest premium over book value, I think A123 is the best bet by far in the lithium-ion battery space.

Axion Power International (AXPW.OB) is the most speculative stock on the list, but it also has the most potential. Axion has a very ugly price chart, but the last 18 months of trading have been dominated by huge supply and demand imbalances.

For calendar 2009, Axion's reported trading volume was 7 million shares and in December of that year it sold 45 million new shares (over 6 years of trading at historic volumes) in a private placement and agreed to promptly register the shares for resale. When the resale registration went effective in April 2010, the price plunged as investors who bought with short time horizons started selling. During calendar year 2010, reported volume ramped to 22 million shares and the price languished. The price started to recover in February and March of this year, which kicked off another round of selling from the 2009 investors. Total volume for 2012 now stands at 53 million shares.

After adjusting for the OTCBB double-count, the total number of shares that have moved from willing sellers to new buyers since April 2010 is just a hair over 36 million. Since Axion's stock is not volatile enough to attract day-traders, the only rational conclusion is that most of the shares sold in the 2009 private placement have been resold into the market. The one nice thing about investors who buy with short time horizons is that they eventually become small stockholders and then they become irrelevant when they run out of stock to sell.

I've been to this rodeo before and I've learned that the only stockholders that really matter are the buyers because they'll be around until their investment goals are met or they get tired of waiting. Based on trading patterns over the last 18 months I believe the 36 million shares of buying came from thousands of retail investors who have been educated by my blog, view Axion as a speculative investment and are willing to give the company time to mature and flower. Based on the available information, I think Axion is within weeks or even days of an inflection point where the price will begin a transition from undervalued to overvalued. I don't think many of the retail investors who bought over the last 18 months are likely to sell for 25%, 50% or even 100% gains. Instead I think most will wait for multi-bag returns on their investment. Then the question becomes "How far and how fast is up?" I can't even venture a guess.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

August 19, 2011

EVs, Lithium-ion Batteries and Liars Poker

John Petersen

Last week I stumbled across a link that led to a 2010 report from the National Research Council titled "Hidden Costs of Energy, Unpriced Consequences of Energy Production and Use." This free 506-page book takes a life-cycle approach – from fuel extraction to energy production, distribution, and use to disposal of waste products – and attempts to quantify the health, climate and other unpriced damages that arise from the use of various energy sources for electricity, transportation and heat. After studying the NRC's discussion of the unpriced health effects, other nonclimate damages and greenhouse gas emissions of various transportation alternatives, and thinking about what the numbers really mean, I've come to the conclusion that the electric vehicle advocates are playing liars poker with their cost and benefit numbers – emphasizing a couple areas where electric drive is superior and de-emphasizing or completely ignoring a far larger number of areas where electric drive is clearly inferior. The result, of course, is unfounded and wildly optimistic claims of superiority based on four sevens in a ten digit serial number that don't mean a thing if your goal is to evaluate the entire serial number.

The first graph from the introduction summarizes the unpriced health and other nonclimate damages arising from the use of thirteen different vehicle fueling technologies over the entire cycle life of an automobile and quantifies the unpriced mine to junkyard cost per vehicle mile traveled, including well or mine to wheels costs of manufacturing the vehicle and fueling it over its operational life.

8.19.11 Health Damages.png

The thing I found most surprising was the relative consistency of the numbers across all thirteen classes, both for today and for the future, and the fact that many advanced drive train technologies score lower than their conventional cousins because the unpriced costs of manufacturing the vehicle or processing the fuel exceed the claimed operating benefits. When you look at the realities from a cradle to grave perspective there are no clearly superior choices and the values are all clustered within ±15% of a $1.25 average. While I derive some personal satisfaction from the idea that the low cost winners are a Prius-class HEV or an internal combustion engine with a CNG fuel system, and that electric drive is just a smidgen cleaner than a diesel engine burning fuel produced from Fischer Tropsch coal liquifaction, the reality is that none of the advanced technologies are inherently better. They're just more expensive.

The game is simply not worth the candle. It’s certainly not worth the enormous expenditures of public funds that governments worldwide don't have. There’s nothing electric drive can accomplish that CNG and fuel efficiency can’t accomplish cleaner, faster and cheaper.

The second graph from the introduction summarizes the unpriced greenhouse gas damages arising from the use of the thirteen different vehicle fueling technologies over the cycle life of an automobile. While the range of variation around a current average of about 450 grams of CO2 per vehicle mile traveled is a little wider at ±25%, once again it's just not worth getting worked up over inconsequential differences that entail substantial incremental costs.

8.19.11 GHG Damages.png

One of the most intriguing take aways from these two graphs is the inescapable conclusion that the differences today are modest and as technologies mature and improve the differences will become less important, not more. By 2030, plug-ins will have no advantage over internal combustion when it comes to greenhouse gasses and be significantly worse than internal combustion when it comes to health and other nonclimate costs.

Over the years I've suffered endless abuse from commenters who decry my appalling lack of vision when it comes to lithium-ion superstars like Ener1 (HEV), A123 Systems (AONE), Altair Nanotechnologies (ALTI) and Valence Technologies (VLNC) that are certain to drive battery performance to new highs while driving manufacturing costs to new lows and enabling a paradigm shift to electric cars from Tesla Motors (TSLA), Nissan (NSANY.PK), General Motors (GM) and a veritable host of newcomers that are positioning for future IPOs and certain to change the world. While the following graph is a little dated, it shows why the electric pipe dream can’t happen unless some genius in a garage comes up with an entirely new way to store electricity.

8.19.11 Batteries.png

Liars poker can be a fun way to fritter away the hours in Wall Street watering holes like Fraunces Tavern, but it creates enormous risk for investors who hear about four sevens but never hear about the other six characters in the serial number. I've seen this melodrama before. For the period from 2000 through 2003 fuel cell developers like Ballard Power (BLPD) and FuelCell Energy (FCEL) carried nosebleed market capitalizations based solely on dreams. From 2005 through 2007, it was the age of corn ethanol kings like Pacific Ethanol (PEIX). Lithium-ion battery developers have already taken it on the chin and there's no question in my mind that Tesla will be the next domino to fall. Its demise is every bit as predictable and certain as Ener1's was.

It's frequently said that those who do not learn from history are condemned to repeat it. There isn't much I can add.

Disclosure: None. | | Comments (12)

August 07, 2011

Lithium-ion Batteries and 8-Track Tapes

John Petersen

In three years of writing about investing in energy storage, I’ve learned that most public relations nightmares encountered by battery companies are self-inflicted wounds. They do an appalling job of managing the expectations of investors and potential customers. Then, when the inevitable delays, disappointments and cost overruns arise, everybody suffers. It may not be their fault, but it is most certainly their problem.

Most of my long term readers have seen this timeless and blistering 1883 Thomas Edison quote:

“The storage battery is one of those peculiar things which appeals to the imagination, and no more perfect thing could be desired by stock swindlers than that very selfsame thing. Just as soon as a man gets working on the secondary battery it brings out his latent capacity for lying.”

Edison understood innovation problems well, but he didn’t understand innovation problems in the battery industry until he tried to develop a better battery for use in electric cars and failed to win the hearts and minds of a grateful nation.

The essential truth most battery developers fail to recognize is that the problem isn’t their products or even their development plans; it’s the fertile imaginations of investors and potential users who read about gee-whiz discoveries in research laboratories, overestimate the importance of the developments and make wildly optimistic leaps from the possible to the absurd. Battery developers don’t lie to investors and potential users; but the investors and potential users lie to themselves and then blame the industry for failing to meet their patently unreasonable expectations.

My first job after law school was in the Houston office of a Big-8 public accounting firm that had a substantial oil and gas tax practice. On my first day at work, the partner in charge of our group hauled me into his office and explained that every oil project in history could be explained with a simple Venn diagram.

8.8.11 Target.png

Over the last 30 years I’ve learned to my chagrin that this Venn diagram is not just an overview of the oil industry, it’s a fundamental truth that applies to every form of human interaction and endeavor from sex to science to business to politics, especially politics. Over the years I’ve worked with some of the finest minds on the planet, but I’ve never been involved in a project that didn’t take twice as long, cost twice as much and deliver half the expected result – and that’s when everything went right.

A truly bizarre twist that I’ve only encountered in the energy storage industry is that developers report modest results, but a hyper-imaginative public adds a couple layers of expectations, eliminates all time and materials constraints, assumes a roll-out speed that would make Steve Jobs jealous and fabricates outlandish promises developers didn't make and can’t possibly keep.

I think it all boils down to the fact the world desperately wants better batteries but doesn’t understand the magnitude of the challenge and isn't really willing to pay the price. At last year’s ELBC I spoke with an executive from India, who described batteries as “a grudge purchase.” The sad part is he’s right. We don't buy batteries because we want them. We buy them because we need them. In most cases, we don't even think about batteries unless they need to be recharged or replaced. Is it any wonder that the adjective most commonly associated with batteries is “damned?”

The finest examples of horrible expectations management are found in the advanced battery space where Secretary Chu of the US Department of Energy frequently says things like this:

"And what would it take to be competitive? It will take a battery, first that can last for fifteen years of deep discharges. You need about five as a minimum, but really six- or seven-times higher storage capacity and you need to bring the price down by about a factor of three. …

Now, how soon will that be? Well, we don't know, but the Department of Energy is supporting a number of very innovative approaches to batteries and it’s not like it’s ten years off in the future, in my opinion, it might be five years off in the future. It's soon.”

This is a fair statement of the DOE’s goals. They’re pushing very hard to develop new technologies that will leapfrog the state of the art in the battery business. What the DOE never explains, however, is that any major advance will make all of today’s spiral-wound batteries obsolete before their developers have a chance to become profitable.

The data in the following graph was taken from quarterly and annual reports that A123 Systems (AONE) has filed with the SEC over the last 30 months. It compares their quarterly revenue per kWh of batteries shipped with their adjusted cost of goods sold (after backing out unabsorbed manufacturing costs) and their gross margin per kWh.

8.8.11 A123 Graph.png

The purchase prices paid by A123's customers have been gradually declining, but their manufacturing costs have climbed and their gross margins have turned sharply negative. Without gross income, net income isn't even a pipe dream. I expect the dynamic to change when A123's new factory is brought on line, debugged, optimized and ramped to reasonable capacity utilization rates. But that transition is not going to happen quickly and until it occurs A123's stock price will continue to languish.

My next graph comes from the current issue of Science and shows why the spiral-wound lithium-ion battery can never be a viable long-term solution.

7.17.11 Science Graph.png

It doesn’t take a rocket scientist or electrochemist to see that lithium-ion batteries can’t ever meet Secretary Chu’s goals of six or seven times more energy at a third of the cost. That will require a different kind of battery and a different kind of battery manufacturing infrastructure. No matter what you believe the next big thing will be, it’s clear that today's lithium-ion batteries are a dead end – the 8-Track tapes of the battery world and little more than a transition technology from what we have to what we need. This Jan Darasz cartoon from the current issue of Batteries International Magazine is too true to be funny.

8.8.11 Darasz.png

Readers frequently assume I’m a Luddite who can’t or won’t see the future. The fact is I see the future all too clearly and know to a certainty that lithium-ion batteries are the barest of beginnings, not the Holy Grail. The true Luddites are the EVangelicals who are so enthralled with the EV dream that they refuse to see that our very best batteries are not good enough for the short term and can never be good enough for the long term.

The global fleet of 800 million cars and light trucks all depend on lead-acid batteries for starting, lighting and ignition functions. Within a few years, all new cars will come with stop-start idle elimination systems as standard equipment. No matter what happens in the sexy battery space over the next five to ten years, that fleet will need replacement batteries for decades to come. Established lead-acid battery manufacturers like Johnson Controls (JCI), Enersys (ENS) and Exide Technologies (XIDE), together with advanced lead-acid battery innovators like Axion Power International (AXPW.OB), will have a long and profitable run regardless of what happens in the sexy space.

While I can’t make any predictions about timing, it is only a matter of time before one of the scientists in one of the labs that are working on better batteries has a Eureka! moment. When that moment arrives, the new technology will become the darling of EVangelicals, automakers and maybe even utilities, and the market potential of lithium-ion batteries will be capped forever at the number of vehicles that are made between now and then using a bridge technology.

As a broker friend of mine once observed, a bridge that only connects with land at one end is more properly called a pier.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

July 31, 2011

Aggressive New CAFE Standards; The IC Empire Strikes Back

John Petersen

Last Friday President Obama and executives from thirteen leading automakers gathered in Washington DC to announce an historic agreement to increase fleet-wide fuel economy standards for new cars and light trucks from 27.5 mpg for the 2011 model year to 54.5 mpg for the 2025 model year. While politicians frequently spin superlatives to describe mediocre results, I believe the President's claim that the accord "represents the single most important step we've ever taken as a nation to reduce our dependence on foreign oil" is a refreshing example of political understatement. After three decades of demagoguery, debate, dithering and delay, meaningful policy change has finally arrived, and not a moment too soon.

The economic impact will be immense – a staggering $1.7 trillion in fuel cost savings that will flow directly to consumers. As those savings begin to work their way through the economy and kick-start secondary fiscal multiplier effects, the boost to GDP will be closer to $7 trillion. I believe Friday's agreement will ultimately be seen as the biggest economic stimulus event in human history.

The following graph from a new White House report titled, "Driving Efficiency: Cutting Costs for Families at the Pump and Slashing Dependence on Oil" says it all.

7.31.11 Cafe Sandards.png

The most surprising aspect of this agreement isn't the aggressive goals; it's the fact that the auto industry has helped forge the goals and plans to achieve them by implementing "affordable technologies that are on the road today." The new goals are not based on the electric dreams of a Tesla Motors (TSLA). They're based on the automaker's hard-nosed evaluation of the cumulative gains that can realistically be achieved with existing ICE technologies like engine downsizing, stop-start idle elimination, turbocharging, optimized cooling, low friction, direct fuel injection and variable valve timing.

Individually the fuel economy gains from advanced ICE technologies will only be baby steps toward energy independence. Collectively they'll give American consumers passenger cars with lower well-to-wheels CO2 emissions than a 2012 Nissan (NSANY.PK) Leaf plugged into the typical wall socket. They'll change the world without a budget busting paradigm shift.

In early July The Boston Consulting Group released a new report titled "Powering Autos to 2020; The Era of the Electric Car?" that evaluated the combined potential of baby-step fuel efficiency technologies and considered their likely impact on wildly expensive and impractical proposals to convert the world's transportation infrastructure from liquid fuels to electricity. In the report BCG concluded that:
  • Conventional technologies have significant emissions-reduction potential, but OEMs will need to pull multiple levers simultaneously to meet emissions targets.
  • Advanced ICE technologies can reduce gasoline consumption by 40% at a cost to the consumer of $50 to $60 per percentage point of reduction – roughly half what BCG predicted three years ago.
  • Advanced ICE technologies are likely to become standard equipment worldwide during the next decade.
  • Electric cars will face stiff competition from ICE and will not be the preferred option for most consumers.
  • Battery costs will probably fall to about $9,600 per vehicle, but become increasingly uneconomic as the potential fuel savings per kWh of battery capacity plummets.
  • In addition to dismal economics, plug-ins will face substantial go-to-market challenges including battery durability concerns and the absence of adequate charging infrastructure.
In my view the BCG report is a must read for investors who want to profit from this fuel efficiency mega-trend and avoid heavy losses in vehicle electrification schemes that will become increasingly uneconomic over time. The fundamental flaw is simple. Today an EV with a fully charged 24 kWh battery pack can save a consumer the equivalent of 3 gallons of gas. By 2025, the savings will be closer to 1.5 gallons of gas. Even with falling battery prices the value proposition can only get more challenging with each passing year.

For the last couple years I've been cautioning investors that gee-whiz vehicle electrification technologies are transitory, a flash in the pan, and the biggest business opportunities in energy storage involve cheap, simple and effective baby-step technologies like stop-start idle elimination that will slash fuel consumption by 5% to 15% for a few hundred dollars. The BCG report and the newly announced fuel economy goals are yet another proof of that principle.

The future is all about getting more from less and has absolutely nothing to do with increasing consumption of one class of scarce natural resources in the name of conserving another.

While I can't identify the component manufacturers that will thrive from the widespread implementation of advanced ICE technologies like turbocharging, direct fuel injection and variable valve timing, picking the winners in energy storage is easy. Johnson Controls (JCI) and Exide Technologies (XIDE) will be the first beneficiaries as automakers upgrade their electrical systems to withstand the strains of stop-start idle elimination. As stop-start systems become standard equipment worldwide and the inherent limits of current AGM battery technology become obvious, more powerful energy storage solutions from emerging technology developers like Maxwell Technologies (MXWL) and Axion Power International (AXPW.OB) will ascend to prominence if not dominance.

The new fuel efficiency standards are not an omen of doom for lithium-ion battery solutions from A123 Systems (AONE), Ener1 (HEV) and Valence Technologies (VLNC) which will no doubt gain a toehold among the 6% to 13% of consumers who say they'd purchase an environment-friendly car even if they had to pay a premium over the life of the vehicle. I'm just not certain how significant that toehold will be in light of the incontrovertible reality that less than 2% of consumers actually buy environment-friendly cars.

On balance I believe that survey-based uptake forecasts will be just another example of a painful lesson I learned in the biodiesel business – that individual buying decisions speak louder than surveys and the green in a consumer's wallet always takes priority over the green in his cocktail party conversation.

For several years the mainstream media, financial press and sell-side analysts have been publishing irrationally optimistic stories and reports about the end of the ICE age and the dawn of a golden electric era. On Friday the Obama Administration and the automakers put the world on notice that IC Empire is striking back and plans to bury the now generation of electric wannabes like it has all of their predecessors.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

July 17, 2011

Three Years of Seeking Alpha in Energy Storage

John Petersen

Today is the third anniversary of my blog on investing in energy storage. While the last three years have been profoundly troubled by a market crash, a slow recovery and more ups and downs than a roller coaster, energy storage has been surging to prominence as investors realize that batteries, products we all love to hate, are a critical enabling technology for wind and solar power, efficient transportation, the smart grid and hundreds of other applications that make life more pleasant. With each passing day it's increasingly clear that energy storage is an investment mega-trend that will endure for decades. Most of the smart money is still on the sidelines looking in, which explains the popularity of my blog. As the smart money transitions from analyzing opportunities to making investments, the sector should encounter rising tides that lift all boats.

Thomas Edison was the first to identify the biggest risk of energy storage investing a century ago when he complained:

The storage battery is one of those peculiar things which appeals to the imagination, and no more perfect thing could be desired by stock swindlers than that very selfsame thing.

The problem isn't really the batteries, which haven't improved all that much over the last century. Instead, the problem lies in the fertile imaginations of investors, ideologues and demagogues who read about scientific discoveries in research laboratories, overestimate the value of those discoveries and then make a wildly optimistic leap from the reasonable to the absurd.

The two most common forms of batteries are carry-over relics of the 19th century. Lead-acid batteries have been around for 150 years and spiral wound batteries have been popular for almost as long. While battery chemistry has changed over the years and manufacturing methods have been modernized, the energy storage capacity of today's best batteries is only four or five times greater than the energy storage capacity of the batteries Edison complained about. Regardless of what you read in the paper or hear on the news, making a better battery is very hard work and the vast majority of exciting new discoveries never make it from the laboratory bench to the factory floor because they're just too expensive.

It's fun to daydream about the technical possibilities of portable power, but the market will only pay for cheap, reliable and safe portable power. The chasm between technical possibility and economic viability is both wide and deep.

Today's most common myth in energy storage is that exponential performance gains will be accompanied by rapidly falling prices. The current issue of Science includes an article titled "Getting There" that offers a classic example of how the mythology grows and spreads. The article's centerpiece is the following graph that compares the theoretical potential of battery materials and the best results obtained in working cells.

7.17.11 Science Graph.png

A quick read through the article and a glance at the graph would be enough to convince any reasonably imaginative person that a golden age of battery powered everything is just around the corner. The undeniable facts the article and the gee-whiz graph don't explain with any force are:
  • All lithium-ion batteries in commercial production are in the first category;
  • The performance differences between today's lithium-ion chemistries are minor;
  • Current technologies offer little room for improvement because the theoretical limits are absolute;
  • The first category are the only batteries we know how to manufacture in bulk;
  • All advanced battery technologies will require the development of completely new manufacturing methods and equipment;
  • All advanced technologies will require the construction of different infrastructure from the ground up;
  • All advanced technologies are five to ten years from production if everything goes right; and
  • The companies that own the best current technologies do not own their advanced counterparts.
In other words each step forward will make all the science and all the manufacturing infrastructure required for the prior generation of lithium-ion batteries obsolete. It's the epitome of creative destruction where the future poses an existential threat to the past, but the future can't leverage, build upon or even use the massive infrastructure investments of the past. Progress in IT was immense and rapid because every step along the path built upon and leveraged the past. Progress in energy storage is agonizingly slow because innovation that builds upon and leverages the past is rare.

In my first Seeking Alpha article, I wrote that the market prices for Ener1 (HEV) and Altair Nanotechnologies (ALTI) resulted in "nosebleed market capitalizations based on little more than dreams." In September 2008, I added Valence Technologies (VLNC) to my list of dangerously overvalued lithium-ion battery developers because like Jacques Cousteau it was under water to the tune of $68.4 million at mid-year. In October 2009, I added BYD Co. Ltd. (BYDDF.PK) to my list and wrote that it was "a classic example of why it's never a good idea to make investment decisions based on simple questions like "What did Warren do?" In November 2009, I added A123 Systems (AONE) to the list observing that it was "well up the hype cycle curve and approaching the Peak of Inflated Expectations." Last November, I added the magical gravity defying Tesla Motors (TSLA) to my list and suggested a paired trade that would short Tesla and buy Exide Technologies (XIDE). In every case the reader outrage over my criticisms was palpable. You'd have thought I was torturing kittens. Subsequent price performance tells a very different story. The following table summarizes the market price of each of these companies when I first openly criticized them, their closing price last Friday, and the percentage decline in the interim.

Company
Symbol
Initial Price
Friday's Price
Change
Ener1
HEV
$5.91
$0.79
-87.6%
Altair Nanotechnologies
ALTI
$7.92
$0.96 -87.9%
Valence Technologies
VLNC
$3.59
$1.03
-71.3%
BYD Co. Ltd.
BYDDF.PK
$11.12
$2.86
-74.3%
A123 Systems
AONE
$15.88
$5.68
-64.2%
Tesla Motors
TSLA
$30.80
$27.58
-10.5%

My record at picking winners isn't perfect, but I'm batting a thousand when it comes to identifying over-hyped stocks near the peak of inflated expectations.

Since I first criticized them, A123 and BYD have fallen to levels where they're beginning to look attractive for long-term investors who believe in the future of electric transportation and are not concerned about a looming glut of lithium-ion battery manufacturing capacity that will increase losses and force marginal manufacturers out of business without reducing material, manufacturing or finished battery costs. In spite of the happy talk from Silicon Valley and buy-side cheerleaders, Tesla hasn't even started to bleed. Ener1, Altair and Valence may survive, but only if they can negotiate massive capital infusions on terms acceptable to new money.

I've been bullish about the lead-acid battery sector for years because the major battery manufacturers including Johnson Controls (JCI), Exide and Enersys (ENS) have global manufacturing footprints, established product lines, strong customer relationships, billion dollar revenue streams and rust-belt market capitalizations. My favorite in the group is Exide because it trades at a significant discount to its peers and is well-positioned to out-perform market expectations on a go-forward basis.

In light of recent forecasts that stop-start idle elimination will be deployed in almost a hundred million cars over the next five years, I think JCI and Exide are facing a dream scenario where unit volumes remain stable but per unit revenues double and margins ramp sharply as customers gravitate to their premium AGM products.

My old company Axion Power (AXPW.OB) has not been a stellar stock market performer over the last couple years, but the delays have arisen from the stringent manufacturing and quality control requirements of it's principal potential customers. Since I can't remember another instance where huge companies like BMW and Norfolk Southern have publicly aligned themselves with a nano-cap technology developer that hasn't even launched its first product, I can live with delays that disappoint the market but please them.

The last three years have been a lot of fun and intelligent comments from knowledgeable readers have provided a balance and breadth that I could never have achieved on my own. New readers in particular may find it helpful to peruse my article archive, but be sure to spend enough time reading the comments to understand where the views of others differ from mine. I always try to explain the factual basis for my opinions and provide links to relevant source documents, but in the end I'm only human and I can only speak from the shoes I stand in. I want to thank everyone for their respective contributions, even those who haven't learned how to disagree without being disagreeable.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

July 14, 2011

The Lithium-ion Battery Glut Will Be Massive

John Petersen

I hate being wrong, but Mother always taught us, "if you have to eat crow don't nibble."

In February 2010 I wrote an article titled "Why I Don't Expect A Lithium-Ion Battery Glut" that's shaping up as one of the worst predictions in the history of my blog. This week Lux Research published a report titled "Using Partnerships to Stay Afloat in the Electric Vehicle Storm" that has me convinced that the capacity glut in lithium-ion batteries will be massive for at least a decade.

I humbly and sincerely apologize to any readers who bought shares in lithium-ion battery developers based on my starry-eyed optimism for the EV battery market.

The basic premise of my February 2010 article was that while plug-in electric vehicles would almost certainly die a slow and agonizing death from the congenital birth defects that have doomed every generation of EVs to the scrap heap of history, booming sales of electric two-wheeled vehicles, or E2Ws, and Prius-class hybrid electric vehicles, or HEVs, would be enough to absorb the slack. With eighteen months of history to look back on, it's just not working out the way I thought it would.

As I expected, plug-in vehicles are drawing breathless reviews from the press and EVangelicals, and indifference or outright scorn from the car buying public. Automakers are toying with plug-in vehicle concepts that may go into production over the next few years if the plans aren't scrapped due to customer apathy, but they're all rushing to make new fuel efficiency technologies like stop-start idle elimination standard equipment. With the exception of Advanced Battery Technologies (ABAT) which makes both ebikes and the batteries that power them, E2W manufacturers are letting their customers decide and the overwhelming majority of E2W buyers are voting with their wallets and deciding that cheap and reliable lead acid batteries are better suited to their needs despite a little extra weight.

Can you believe it? Cheap is beating cool. Who could have predicted such an outcome in the depths of the worst financial crisis since the 1930s?

In all seriousness, Lux forecasts a catastrophic supply and demand imbalance in the lithium-ion battery sector over the next decade. On the supply side it predicts that global manufacturing capacity will ramp to about 21,000 MWh by next year (875,000 Leaf-class BEVs) and climb to almost 30,000 MWh (1.25 million Leaf-class BEVs) by 2015. On the demand side, Lux's optimistic case based on $200 oil predicts annual battery sales of about 6,000 MWh in 2015 (250,000 Leaf-class BEVs) ramping to 22,500 MWh (937,500 Leaf-class BEVs) by 2020. Under their more conservative $140 oil price scenario, demand won't hit 6,000 MWh until 2020. The low oil price scenario is aggressively ugly. Is it any wonder that France has recently withdrawn €100 million of subsidized loans for a planned Renault battery plant?

The Lux forecast is bad news for diversified first tier manufacturers like LG Chem, GS Yuasa, SB LiMotive, AESC, and Sanyo; terrible news for financially sound second tier manufacturers like Toshiba, Hitachi, and JCI-Saft; and an "existential threat" for emerging third tier battery developers like A123 Systems (AONE), Ener1 (HEV), Valence Technologies (VLNC) and Dow Kokam that were counting on transportation markets that are unlikely to develop.

Now you know why so many lithium-ion battery developers are suddenly talking trash about using their batteries for grid-scale storage. In the near future, that myth will be buried along-side its brother the electric car because the world's utilities can't possibly soak up 20,000 to 25,000 MWh per year of excess lithium-ion battery manufacturing capacity.

Last February, the Department of Energy released a comprehensive study on the economic potential of grid-based storage titled "Energy Storage for the Electricity Grid: Benefits and Market Potential Assessment Guide." It was commissioned by the Energy Storage Systems Program and written by Jim Eyer and Garth Corey. Based on the conclusions of that study, which I discussed in "Grid-Based Energy Storage; A $200 Billion Opportunity," I cobbled together a table that identifies the principal grid-based energy storage applications, quantifies the potential national demand and quantifies the 10-year economic value for a kilowatt-hour of grid-based storage dedicated to an application. The table is mine, but the baseline numbers are Sandia's.

7.14.11 Grid Demand.png

The color coding in the table represents my attempt to segregate system value per kWh into cool technologies like flywheels, supercapacitors and lithium ion batteries, which are highlighted in blue, and cheap technologies like flow batteries, lead-acid batteries, compressed air and pumped hydro, which are highlighted in yellow. If you total up the potential demand for all of the blue highlighted applications and throw in the orange for good measure, you get to a likely US demand of 11,500 MWh spread over a period of several years. It won't make a dent in 20,000 to 25,000 MWh per year of excess lithium-ion battery manufacturing capacity.

Like bloggers, outfits like Lux want every dark cloud to have a silver lining and their new report is no exception. In addition to forecasting doom, gloom and bust for the lithium-ion battery space, it focuses on the expected development of a $300 million annual market for supercapacitors in the transportation markets. In that market, Lux identified Maxwell Technologies (MXWL) as the dominant competitor and took pains to observe that "For the numerous supercapacitor technology developers to gain market share in transportation, they will need to validate products with a clear edge over Maxwell's incumbent technology, and not rely on growing demand to create ripe opportunities for new entrants."

While I'm a fan of Maxwell's products and business potential, I'd be remiss if I didn't point out that its stock trades at 4.3 times book value and 3.3 times trailing twelve-month sales of $131 million. Even if you assume that Maxwell will walk away with the lion's share of the $300 million transportation supercapacitor market that Lux is forecasting for 2016, its upside potential will be limited as it negotiates the transition out of the valley of death and begins trading on the basis of sales, growth and profitability.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

July 11, 2011

Saviors and Saboteurs in Alternative Energy

John Petersen

Last week Societe Generale published a thematic research report titled "A new world order, when demand overtakes supply" which examines the macro-economic and demographic trends that will transform the global economy over the next 20 years. It mirrored the theme of Jeremy Grantham's April 2011 quarterly letter titled "Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever" and did a great job of summarizing an issue I touched on in "How PHEVs and EVs Will Sabotage America's Drive For Energy Independence."

In the words of Societe Generale:

"So, while up until now less than one billion people have accounted for three-quarters of global consumption, over the course of the next two decades, the new Chinese, Indian, Indonesian, Latin American and African middle classes will bring an additional two billion consumers with similar needs and aspirations as today's North American, European and Japanese consumers." (Page 12)

"Beyond growth in demand for finished products, the most spectacular effect likely to be brought about by the stronger development of the emerging economies will be the enormous rise in demand for raw materials." (Page 14)

"A structural increase in raw materials prices is in fact an inevitable consequence of chronic resource insufficiencies, whether we're talking about industrial, energy or agricultural resources." (Page 19)

The following table from Mr. Grantham's quarterly letter summarizes China's current consumption of key energy, industrial and agricultural commodities as a percentage of total global consumption and drives the point home with the subtle clarity of a sledge-hammer.

7.10.11 China.png

If we've seen this kind of demand dislocation as a result of a few decades of growth in China, what's going to happen when the surging middle class populations of India, Indonesia, Latin America and Africa decide to show up for the dinner party? The answer, of course, is that we'll be thoroughly screwed unless we stop wasting time, money and materials on pipe dreams, toys and panacea solutions, and focus instead on finding relevant scale solutions to persistent global shortages of water, energy, food and every commodity you can imagine. We all face a clear, present and persistent danger that can’t even be addressed until we accept the entire ugly reality with all its vulgar implications!

One of the most disturbing conclusions in the Societe Generale report is that while per capita energy demand in advanced economies will remain stable at 5,463 kg of oil equivalent, or maybe even decline to 5,000 kg per person by 2030, global average demand will increase from current levels of 1,818 kg per person to 3,312 kg per person in the low case and 4,228 kg per person in the high case. All of the increased demand will come from emerging and developing economies.

Our fundamental problem is that per capita global production of energy resources is 100 to 200 times greater than per capita global production of the technology metals that underlie all alternative energy schemes. To make things worse, all of those metal resources have critical competing uses that cannot be set aside or ignored in the name of advocacy. At a recent grid-based energy storage conference in Brussels I used the following table to emphasize the point. The orange highlight quantifies available energy resources while the green highlight quantifies technology metal resources.

7.10.11 Energy vs Metals.png

The mathematically challenged optimists in our midst earnestly believe we can solve our energy problems with cool toys like wind turbines, solar panels, electric cars and other materials intensive energy schemes that fire the imagination but can never be sustainable. These aren’t solutions! They’re the energy and transportation equivalent of graphic novels and just a half-step removed from warp drive. In the final analysis, the dreamers who want to waste metals and other natural resources in the name of conserving coal, oil and natural gas are not saviors. They're unwitting saboteurs who can only make the problems worse!

Whether we like it or not, the only technology that has a prayer of generating enough new energy to satisfy even a small fraction of anticipated global demand is nuclear, a point that was forcibly driven home by Bill Gates in a recent interview at the WIRED Business Conference 2011. The naive idea that we can cut hydrocarbon consumption for the laudable goal of saving the planet is sophistry. Given a choice between freezing in the dark and burning hydrocarbons human beings will always choose the later because immediate personal need will always trump long term societal goals, especially fuzzy green goals.

I'm an unrelenting critic of obscene raw materials users like Tesla Motors (TSLA), A123 Systems (AONE), Ener1 (HEV) and Valence Technologies (VLNC) that want to build a future out of making toys for our emerging eco-royalty because I've read about the French Revolution and remember how 'Madame Le Guillotine' put a uniquely sharp edge on popular discontent over conspicuous consumption. These business models are doomed to fail because they're diametrically opposed the needs of society.

The only alternative energy investments that stand a chance of survival, much less profitability, are basic efficiency technologies that slash waste and deliver real savings for every ounce of natural resource inputs. Nuclear power, idle elimination, fuel efficiency, demand response, building efficiency, ebikes, recycling and a host of other technologies that do more with less are the only possible future. Wind turbines, solar panels, electric cars and all of the other feel-good graphic novel schemes are merely pleasant distractions, a bit like Nero's fiddle.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock because Axion's disruptive third generation lead-acid-carbon battery technology uses 30% less lead to deliver impressive gains in power, cycle-life, charge acceptance and overall real world utility.

June 28, 2011

Johnson Controls Forecasts Enormous Stop-Start Growth

John Petersen

On June 27th Johnson Controls (JCI) hosted their 2011 Power Solutions Analyst Day and unveiled their expectations for the future of stop-start idle elimination systems. After noting that all automakers are developing a range of powertrains, JCI used this graph to emphasize their view that the overwhelming bulk of alternative powertrain vehicles over the next five years will have simple, cost effective and fuel efficient stop-start systems.

6.27.11 5-year.png

You don't see much about stop-start systems in the mainstream media because politicians and reporters are too enchanted with plug-in vehicles and other exotica to deal with mundane issues like purchase prices and payback periods, but JCI has made it crystal clear that its meat and potatos business over the next five years will be cheap, not cool.

JCI's estimates for market growth over the next ten years were equally impressive, particularly when you realize that the advanced energy storage systems required for stop-start generate twice the per unit revenue and three times the per unit margins of flooded lead-acid batteries. It's a manufacturer's dream come true, stable unit volumes with rapidly increasing revenues and margins.

6.27.11 10-year.pngIn their presentation JCI explained that the three key attributes of energy storage systems for stop-start are:
  • Cycling – reliable system charge/recharge cycles over time;
  • Useable energy – range of stored energy that can be used to optimize the system; and
  • Charge acceptance – rate of recharge to maximize opportunity capture.
It ties perfectly to a joint presentation from BMW and Ford at last fall's European Lead Battery Conference where the two automakers explained why the stop-start duty cycle is so hard on conventional batteries. In a normal vehicle, you start the engine at the beginning of the trip and turn it off at the end. In a car equipped with stop-start, the engine turns itself off automatically every time the car is stopped and restarts automatically when the driver takes his foot off the brake. While the difference between one start per trip and one start per mile is enormous, a more critical problem arises from the fact that stop-start systems require the battery to carry all accessory loads during frequent engine off intervals.

In the segment of the BMW-Ford presentation that quantified a typical stop-start duty cycle, the accessory load was 50 amps for 60 seconds, or about 3,000 amp seconds while the starter load was 300 amps for one second. In other words, the accessories accounted for a whopping 91% of total load. Their graph of AGM battery performance over time shows that charge acceptance (the downward curving blue line) plummets as the battery ages while the time required to recover from an engine off event (the upward curving red line) soars from 30 seconds to three minutes or more.

6.27.11 AGM Performance.png
Since all systems are designed to disable the stop-start functionality until the battery has recovered an acceptable state of charge, system efficiency falls off rapidly as the battery ages. The automakers want and need something better than AGM batteries, the principal solution that old line auto battery manufacturers like JCI want to provide.

The first advanced technology introduced for stop-start systems was developed by Continental AG in cooperation with Maxwell Technologies (MXWL) for use in diesel stop-start systems from Peugeot. In this dual device configuration an AGM battery carries the accessory load and a supercapacitor module carries most of the starter load. It insures a reliable engine restart, but can't do much about the bigger problem of accessory loads. Contiental and Maxwell expect that their system will be installed in up to a million Peugeot vehicles in the next three years. If the system works well for Peugeot and stop-start vehicle sales ramp as rapidly as JCI expects them to, implementation rates will probably be higher.

A second advanced technology solution for stop-start systems is a third generation lead-acid-carbon hybrid that's being developed by Axion Power International (AXPW.OB), which hopes to begin a commercial roll-out of its PbC battery later this year. In a joint presentation by BMW and Axion at last fall's ELBC, the performance differences were obvious. The graph that tracked PbC's performance over time using the BMW-Ford test protocol showed that charge acceptance (the flat blue line) stayed stable at 100 amps, or twice the charge acceptance of a new AGM battery, while recovery times (the flat black line) remained stable at 30 seconds.

6.27.11 PbC Performance.png

The BMW-Ford graph shows that AGM batteries fade very rapidly over the first 5,000 miles of use in a stop-start equipped vehicle. The BMW-Axion graph shows that the PbC offers optimal performance through 40,000 miles. In a recent presentation at the 2011 Advanced Automotive Battery Conference in Mainz, Germany, Axion unveiled an updated graph of follow-on testing through 80,000 cycles, or approximately eight years of use, with only modest degradation.

6.27.11 PbC AABC.png

I've been bullish about the future of stop-start idle elimination technology for a couple years. If the JCI forecasts are even close to accurate, I've been seriously understating the potential. Since JCI is the largest lead-acid battery manufacturer in the world and has a 36% share of the global automotive OEM and battery replacement markets, it will undoubtedly be the biggest beneficiary of the rapid worldwide implementation of stop-start idle elimination systems. The second biggest beneficiary will probably be Exide Technologies (XIDE), which is emerging from several years of tough restructuring and trades at a significant discount to JCI on a forward looking earnings basis. Emerging technology developers like Maxwell and Axion also have significant opportunities to grab a sizeable share of what's shaping up as $6 to $12 billion market niche. Their respective market capitalizations are summarized below:

Johnson Controls
JCI
$26.8 billion
Exide Technologies
XIDE
$569 million
Maxwell Technologies
MXWL
$442 million
Axion Power
AXPW.OB
$54 million

As former Axion director, I'm all too aware that it's a very little fish in a very big pond. I also understand why the PbC's extreme cycling performance and charge acceptance can be crucial to the future development of stop-start, a world-class fuel efficiency technology that's already being produced at scale and will become dominant in this decade. It's easy to dismiss my ramblings because I have a large stake in Axion. It's harder to dismiss BMW, a first tier automaker that joined Axion as a co-presenter at last year's ELBC. It will be darned near impossible to dismiss a big three US automaker that's apparently signed on as an Axion subcontractor in a pending DOE grant application.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

June 24, 2011

The Alternative Energy Fallacy

John Petersen

In 2009, the world produced some 13.2 billion metric tons of hydrocarbons, or about 4,200 pounds for every man, woman and child on the planet. Burning those hydrocarbons poured roughly 31.3 billion metric tons of CO2 into our atmosphere. The basic premise of alternative energy is that widespread deployments of wind turbines, solar panels and electric vehicles will slash hydrocarbon consumption, reduce CO2 emissions and give us a cleaner, greener and healthier planet. That premise, however, is fatally flawed because our planet cannot produce enough non-ferrous industrial metals to make a meaningful difference and the prices of those metals are even more volatile than the prices of the hydrocarbons that alternative energy hopes to supplant.

The ugly but undeniable reality is that aggregate global production of non-ferrous industrial metals including aluminum, chromium, copper, zinc, manganese, nickel, lead and a host of lesser metals is about 35 pounds for every man, woman and child on the planet. All of those metals are already being used to provide the basic necessities and minor luxuries of modern life. There are no significant unused supplies of industrial metals that can be used for large-scale energy substitution. Even if there were, the following graph that compares the Dow Jones UBS Industrial Metals Index (^DJUBSIN) with the Amex Oil Index (^XOI) shows that industrial metal prices are more volatile and climbing faster than hydrocarbon prices, which means that most alternative energy schemes are like jumping out of the frying pan and into the fire.

6.23.11 Metals vs Oil.png

For all their alleged virtues and perceived benefits, most alternative energy technologies are prodigious consumers of industrial metals. The suggestion that humanity can find enough slop in 35 pounds of per capita industrial metals production to make a meaningful dent in 4,200 pounds of per capita hydrocarbon production is absurd beyond reckoning. It just can't happen at a relevant scale.

I'm a relentless critic of vehicle electrification schemes like Tesla Motors (TSLA) because they're the most egregious offenders and doomed to fail when EV hype goes careening off the industrial metals cliff at 120 mph. Let's get real here. Tesla carries a market capitalization of $2.8 billion and has a net worth of less than $400 million, so its stock price is 86% air – a bubble in search of a pin. Tesla plans to become a global leader in the development of new electric drive technologies that will use immense amounts of industrial metals to conserve irrelevant amounts of hydrocarbons. Even if Tesla achieves its lofty technological goals it must fail as a business. Investors who chase the EV dream without considering the natural resource realities are doomed to suffer immense losses. Tesla can't possibly succeed. Its fair market value is zero. The stock is a perfect short.

I won't even get into the sophistry of wind turbines and solar panels.

Next on my list of investment catastrophes in the making are the lithium-ion battery developers like A123 Systems (AONE), Ener1 (HEV), Valence Technologies (VLNC) and Altair Nanotechnologies (ALTI) that plan to use prodigious quantities of industrial metals as fuel tank substitutes, or worse yet for grid-connected systems that will smooth the power output from inherently variable wind and solar power facilities that also use prodigious quantities of industrial metals as hydrocarbon substitutes. Talk about compounding the foolishness.

I can only identify one emerging battery technology that has a significant potential to reduce hydrocarbon consumption and industrial metal consumption at the same time while offering better performance. That technology is the PbC® Battery from Axion Power International (AXPW.OB), a third generation lead-acid-carbon battery that uses 30% less industrial metals to deliver all of the performance and five to ten times the cycle life. There may be other examples, but I'll have to rely on my readers to identify them.

Humanity cannot reduce its consumption of hydrocarbons by increasing its consumption of industrial metals. The only way to reduce hydrocarbon consumption is to use less and waste less.  There are a world of sensible and economic fuel efficiency technologies that can help us achieve the frequently conflicting long-term goals of reduced hydrocarbon consumption and increased industrial metals sustainability. They include but are not limited to:
  • Better buiding design and insulation;
  • Smarter power management systems;
  • Telecommuting;
  • Denser cities with shorter commutes;
  • Smart transportation management to reduce congestion;
  • Buses and carpooling;
  • Bicycles and ebikes;
  • Shifting freight to rail from trucks;
  • Smaller vehicles that use lightweight composites to replace industrial metals;
  • Deploying solar and wind with battery backup for remote power and in developing countries;
  • Shipping efficiency technologies, such as better hull coatings, slow steaming, etc.; and
  • Recycling, recycling and recycling
My colleague Tom Konrad wrote a 28 part series on "The Best Peak Oil Investments." While I'm skeptical about the future of biofuels after suffering major losses in the biodiesel business, Tom's work provides an exhaustive overview of the energy efficiency space and a wide variety of investment ideas that have the potential to make a real difference. Since we can't simply take a couple of giant leaps into the future, we'll just have to get out of our current mess the same way we got into it – one step at a time.

We live in a cruel world. There is no fairy godmother that can miraculously accommodate the substitution of scarce industrial metals for hydrocarbons that are a hundred times more plentiful. We can and we must do better, but we can't solve humanity's problems until we accept the harsh realities of global resource constraints without the filters of political ideology and wishful thinking.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and owns a substantial long position in its common stock.

June 01, 2011

Plug-in and Hybrid Locomotives; Another Sweet Spot for Axion Power

John Petersen

I'm a cynic and a heretic when it comes to plug-in vehicle schemes because most defy the laws of economic gravity and violate a cardinal rule that Ford engineers developed for the EcoStar light delivery vehicle program in the early '90s:

– The unloaded weight of a plug-in vehicle should never exceed 70% of its loaded weight.

Investors who pay attention to this simple rule can easily distinguish between pipe-dream vehicle electrification schemes that are nothing more than feel-good eco-bling and realistic vehicle electrification projects that make economic sense.

For the last few weeks I've been studying a technology partnership between Norfolk Southern (NSC) and Axion Power International (AXPW.OB) that is developing cost effective battery and hybrid electric drive retrofit systems for railroad locomotives. After extensive research I've decided that battery and hybrid electric locomotives are applications that even a heretic can love because:
  • Vehicle weight to cargo weight ratios range from good to extraordinary;
  • Expected payback periods are in the three to four year range;
  • Electric retrofits can avoid emissions abatement costs mandated by EPA regulations; and
  • Axion's PbC technology appears likely to overcome the battery problems that plagued earlier efforts.
Like e-bikes, stop-start idle elimination and hybrid electric vehicles, battery and hybrid electric locomotives are clean fuel efficiency technologies that just make sense.

The Green Goat


The first hybrid electric switching locomotive was introduced in 2004 by Railpower Technology and called the "Green Goat." It replaced the 1,750 hp diesel engine in a General Motors EMD GP9 locomotive with a 290 hp diesel generator and 60,000 pounds of lead-acid batteries that offered a combined power output of 2,000 horsepower. The Green Goat's core strengths were a $750,000 price tag that compared favorably with the $1.5 million price of a new switching unit and a battery dominant hybrid electric drive promised fuel savings of 40% to 60%. Subsequently, Railpower launched a smaller version called the "Green Kid" that offered a combined power output of 1,000 horsepower.

6.1.11 Green Kid.png

In a year long field trial by IDC Distribution Services, the operator of an inter-modal port facility in British Columbia, the Green Kid logged 3.6 million feet of switching operations over 2,347 hours, saved 10,450 gallons of diesel fuel, and reduced CO2, CH4 and N2O emissions by 53% compared to a conventional switching locomotive.

Initially, the Green Goat was well received and railroads including BNSF, Union Pacific (UNP) and Canadian Pacific (CP) ordered a combined total of 175 units. Despite the initial marketing successes, the Green Goat had significant battery problems and only 55 units were delivered before Canadian Pacific returned four units and canceled the balance of a 35-unit order citing unsatisfactory performance. The company went bankrupt in 2009 and emerged as a subsidiary of the RJ Coleman Co. that no longer builds the Green Goat.

The NS 999

In 2009, Norfolk Southern unveiled an experimental electric switching locomotive that it built in cooperation with the Department of Energy, the Federal Railroad Administration and Penn State University with the aid of a $1.3 million Federal grant. Unlike the Green Goat, the NS 999 draws all its power from an array of 1,080 lead-acid batteries that provide a power output of 1,500 horsepower. The project's goal was to demonstrate the feasibility of a plug-in battery powered locomotive that would eliminate direct rail yard emissions and save up to 50,000 gallons of diesel fuel per year.

6.1.11 NS 999.jpg

During initial trials with 80% of its batteries connected, the NS 999 "operated a full switcher shift, at one point pulling 2,200 tons of rail cars on an uphill track – without using a sanding system, which helps locomotives gain traction. After the shift, the four-axle locomotive had enough juice in its 12-volt batteries to run two more eight-hour shifts." Like the Green Goat, however, the NS 999 ran into battery performance issues that had Norfolk Southern evaluating lithium-ion batteries, nickel-based batteries and advanced lead-acid batteries in a matter of weeks. In June of 2010 Norfolk made its battery technology selection and recruited Axion Power to develop a new battery management system and integrate its disruptive PbC battery technology into the NS 999. The project is scheduled for completion later this year.

In addition to the NS 999 project, Norfolk Southern is working with Axion to develop a retrofit hybrid drive system for multi-purpose locomotives that will use 1,600 to 1,700 PbC batteries to improve fuel economy in long distance freight transportation. A prototype is expected by next spring.

The Battery Problem

The fundamental battery problem encountered by both the Green Goat and the NS 999 is a chemical process known as negative electrode sulfation. During discharge, a lead-acid battery's electrodes are partially dissolved and lead sulfate is created. During charging, the bulk of the lead sulfate gets dissociated and redeposited on the electrodes. In practice complete dissociation of lead sulfate never happens. Instead, a portion of the lead sulfate is deposited on the negative electrode in the form of hard crystals. As the number of cycles increases so does the level of crystallization. When the crystal build up is extreme, the battery fails. The following electron micrographs show how sulfation increases over time in a shallow-cycle partial state of charge environment.

6.1.11 Sulfation.png

The PbC Solution

Axion's patented PbC battery is a hybrid device that uses conventional lead plates for the positive electrodes and carbon electrode assemblies for the negative electrodes. The PbC is technically classified as an asymmetric ultracapacitor. Due to its unique architecture, the PbC does not experience negative electrode sulfation. It also offers significantly higher charge and discharge currents than a conventional lead-acid battery. In a shallow cycling environment like the Green Goat, prototype PbC batteries have demonstrated the ability to withstand tens of thousands of cycles without degradation. In a deep cycling environment like the NS 999, prototype PbC batteries have demonstrated the ability to withstand up to 2,000 cycles at a 100% depth of discharge without battery damage.

After several years of working with alpha and beta prototypes of its PbC electrodes and electrode fabrication processes, Axion is just now completing the installation, optimization and certification of its first commercial electrode fabrication line. While it has not launched a commercial product yet, that launch is expected later this year.

The Business Opportunity

North America's Class I Railroads operate a combined fleet of approximately 1,500 switcher units that each burn about 50,000 gallons of diesel fuel per year. The average switching locomotive is 30 to 40 years old and was manufactured during an era when emissions control regulations were far less stringent than they are today. As a result of new EPA regulations and a variety of state air quality initiatives, the railroads are under intense pressure to reduce N2O and particulate emissions in their switching yards, which are often located in heavily populated urban areas.

Based on a recent report to the California Air Resources Board, it appears that the cost of bringing an old locomotive up to current standards is roughly equivalent to the cost of converting an old locomotive from diesel-electric to battery powered electric. While an emissions abatement upgrade will improve fuel economy through the application of newer technology, a battery retrofit can eliminate all direct emissions and fuel consumption. Based on a current off-road diesel price of $3 per gallon and an estimated fuel consumption of 50,000 gallons per year, a battery retrofit should offer a payback period in the three to four year range. In comparison, the payback period for an emissions abatement upgrade will be closer to ten years. The long-term revenue potential of retrofitting a portion of the switcher fleet to run on batteries isn't a company maker, but it's a darned good start.

The Voting Machine

Over the last year Axion's stock price has stagnated in the $0.50 to $0.75 range as shares that were sold in December 2009 moved from relatively weak hands to stronger hands. While I've responded to countless comments and questions from readers, many have missed the crucial fact that Axion is focused on completing the development of its technology, rather than marketing a fully developed product. It's never had a marketing team and except for the odd technical presentation at industry events, its selling efforts have been non-existent.

Despite a lack of marketing for a development-stage product that wasn't ready for commercial use, Norfolk Southern found the path to New Castle because it was looking for a cost-effective solution to a critical performance problem that could not be solved with conventional lead-acid batteries. Based on its own technical evaluation of the prototype PbC batteries Axion was able to make in 2009, Norfolk Southern hired Axion to design and build a new battery management system that would facilitate the integration of PbC batteries into the NS 999. After about eighteen months of working with the technology, the refurbishing project for the NS 999 continues apace. If there was any substantial reason to believe the PbC would not stand up to the rigors of the NS 999, Norfolk Southern would have terminated its relationship with Axion long ago. The same can be said for BMW which also found the path to New Castle because it was looking for a cost-effective solution to a crucial performance problem that could not be solved with conventional lead-acid batteries.

In its last quarterly report, Axion disclosed that it had received notification from the Department of Energy that a grant application under the Vehicles Technology Program had passed the first round of criteria testing and advanced to the final round of review. In its last conference call, management told participants that the grant application identified Axion as the prime contractor, and included a top-three US automaker, a research university and a national laboratory as subcontractors. While details of the application will remain confidential until a funding decision is made, it appears that this time around a first tier US automaker has found the path to New Castle because it was looking for a cost-effective solution to a critical performance problem that could not be solved with conventional lead-acid or lithium-ion batteries.

Given the mainstream media's infatuation with lithium-ion batteries, the voting machine that is the market does not want to believe the PbC will be a disruptive energy storage technology. When I consider the growing parade of world-class companies that found the path to New Castle before Axion even had a product to sell, I have to believe there is more substance to the PbC than even I understand.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

May 16, 2011

Why Advanced Lithium Ion Batteries Won't Be Recycled

John Petersen

One of the most pervasive and enduring myths in the energy storage sector is that a robust recycling infrastructure for used lithium-ion batteries will be built before the wonder-batteries that are being manufactured today for the first generation of plug-in vehicles reach the end of their useful lives. In the worst case scenario, advocates suggest used lithium-ion batteries will be stockpiled until there are enough used batteries to justify the build-out of recycling infrastructure.

The numbers tell a very different story.

For several years the single minded obsession of all lithium-ion battery developers has been reducing costs to a point where using batteries as a substitute for a fuel tank makes economic sense. Most of the progress has come from substituting cheap raw materials like iron, manganese and titanium for the more costly cobalt and nickel that were used in first generation lithium-ion batteries. Unfortunately, when you slash the cost of the materials that go into a battery you also slash the value of the materials that can be recovered from that battery at the end of its useful life.

Using Material Data Safety Sheets from Powerizer and current LME Prices from MetalPrices.com, I've calculated the value of the metals that can be recovered from recycling a ton of used batteries and summarized them in the following table.

Battery Chemistry
Metal Value
Per Ton
Lithium cobalt oxide
$25,000
Lead acid
$1,400
Lithium iron phosphate
$400
Lithium manganese
$300

Given the extremely high metal value of used cobalt-based lithium batteries it seems strange that only one company in the world, Unicore of Belgium, has bothered to develop a recycling process. When you take the time to read and digest Umicore's process description, however, the reason becomes obvious. Recycling lithium-ion batteries is an incredibly complex and expensive undertaking that includes:
  • Collection and reception of batteries;
  • Burning of flammable electrolytes;
  • Neutralization of hazardous internal chemistry;
  • Smelting of metallic components;
  • Refining & purification of recovered high value metals; and
  • Disposal of non-recoverable waste metals like lithium and aluminum.
The process is economic when a ton of batteries contains up to 600 pounds of recoverable cobalt that's worth $40 a pound. The instant you take the cobalt out of the equation, the process becomes hopelessly uneconomic. Products that cannot be economically recycled can only end up in one place, your friendly neighborhood landfill.

Lead-acid batteries are the most widely recycled product in the world because they're 70% lead by weight, the recycling process is simple and a robust global recycling infrastructure already exists. Many leading lead-acid battery manufacturers including Johnson Controls (JCI) and Exide Technologies (XIDE) view their recycling operations as major profit centers that also insure continuity of raw materials supply.

Despite their extremely high metal value, cobalt-based lithium batteries are rarely recycled because process is so difficult and expensive.

In light of their appallingly low metal values, lithium iron phosphate batteries from A123 Systems (AONE) and Valence Technologies (VLNC), lithium manganese batteries from Ener1 (HEV) and lithium titanate batteries from Altair Nanotechnologies (ALTI) will never be reasonable candidates for recycling, which effectively guarantees that buyers will ultimately be required to pay huge up-front disposal fees – think tires with a few more zeros.

In the final analysis, the recycling mythology is just another glaring example of unconscionable waste and pollution masquerading as conservation.

Disclosure: None

May 08, 2011

Are Advanced Battery Technologies' Financial Statements Accurate?

Eiad Asbahi, CFA

In this article, I’m going to analyze Advanced Battery Technologies, Inc. (ABAT) and provide evidence that the company is inflating its financial statements.

This article summarizes key points that we have put together in a longer report available here (.pdf). An alternative copy for backup purposes is available here.

A video summary of the findings, along with discussions with certain customers, are available at the following links:

Our customer interviews feature recorded conversations with ABAT customers. After visiting one of ABAT’s plants, one customer called the facility “absolutely the biggest joke I’d ever seen”.

Some of our arguments have been discussed in prior Seeking Alpha articles by other authors, including here, here, here, and here. For instance, in our report, we discuss how ABAT’s SAIC filings show that the company’s actual revenue and profit are a fraction of what is reported in SEC filings. We also show that ABAT’s $20 million acquisition of a Shenzhen battery company appears to be a sham, and that ABAT paid $20 million in 2010 for an entity that they had previously bought in 2008 for $1 million, but had not disclosed to public investors.

In this article, we’re going to highlight new information that ABAT is inflating its financial statements, including:

  • A comparison of the profit margins of ABAT to 106 global battery makers as provided by Bloomberg and a list Chinese battery makers as provided by Research and Markets in its “Global and China Rechargeable Lithium Battery Industry Report: 2009-2010” industry report. ABAT shows the highest profit margins out of any global and Chinese battery maker, despite having no technological advantage, limited operating experience, an unrecognized brand name, and production facilities too small to claim economies of scale.
  • Site visits show underutilized facilities lacking in quality control. We hired investigators to visit both the Harbin and Wuxi facilities, and provide photos as well as commentary from our investigators in our report. Our investigators concluded that both facilities produce commodity, low-margin products that are highly unlikely to be generating industry-leading margins or return on capital.
  • Extensive discussions with customers and partners that confirm our beliefs that ABAT is fabricating its financial statements.

Impossible Economics

Selling a commodity product into a competitive market with no technological advantage is difficult. It's especially difficult for a small business without economies of scale, limited customer relationships, and no distinguished brand name. But ABAT purports to be not just surviving, but thriving with industry-leading margins and an ROIC that warrants explanation.

A company with an EBITDA margin of 45% in 2010 must have some uniquely special competitive advantage. Yet ABAT itself recognizes that it has no special technology for its main products. The following is taken from its 2010 10-k (.pdf):

The technology utilized in producing polymer lithium-ion batteries is widely available throughout the world, and is utilized by many competitors, both great and small. ZQ Power-Tech’s patents give it some competitive advantage with respect to certain products. However, the key to competitive success will be ZQ Power Tech’s ability to deliver high quality products in a cost-efficient manner. This, in turn, will depend on the quality and efficiency of the assembly lines that we have been developing at our plant in Harbin.

In choosing a set of comparable companies for ABAT, we’ll use companies listed by Bloomberg in its “Batteries/Battery Systems” industry classification.

The results are startling. In terms of EBIT margin, ABAT ranked #1 out of 106 global companies, with an EBIT margin of 39%, compared to 23% for the next closest competitor Exide Industries Ltd of India, a $40 billion revenue business.

click to enlarge

ABAT comps_Bloomberg

Out of the 106 companies provided by Bloomberg in the “Batteries/Battery Systems” classification, Bloomberg records the EBIT margins for 79 of them (the remaining companies’ margins are shown as “N.A.”). ABAT reports a 39% EBIT margin. Only three other companies report EBIT margins above 20%, one of which is NEWN, another suspect Chinese reverse merger company. Only 10 companies report EBIT margins above 15%. ABAT, a company with less than $100m of sales and a relatively tiny player in a commodity industry, is an extreme outlier in our analysis. ABAT also comes up top in other profit margin metrics, with the #1 ranking in EBITDA margin and #2 ranking in net income margin.

Out of the 106 companies provided by Bloomberg in the “Batteries/Battery Systems” classification, Bloomberg records the EBIT margins for 79 of them (the remaining companies’ margins are shown as “N.A.”). ABAT reports a 39% EBIT margin. Only three other companies report EBIT margins above 20%, one of which is NEWN, another suspect Chinese reverse merger company. Only 10 companies report EBIT margins above 15%. ABAT, a company with less than $100m of sales and a relatively tiny player in a commodity industry, is an extreme outlier in our analysis. ABAT also comes up top in other profit margin metrics, with the #1 ranking in EBITDA margin and #2 ranking in net income margin.

Is it possible that a company with only about 5 years of operating experience is generating higher margins than a company such as Energizer (ENR) with its 15% EBIT margins, based on the “quality and efficiency of the assembly lines”?

Perhaps it's ABAT's position in China and access to cheap labor that gives it such an amazing edge in the global arena. We can test this hypothesis by comparing ABAT to a handful of other Chinese battery manufacturers. The independent third party research organization Research in China publishes an annual report titled “Global and China Rechargeable Lithium Battery Industry Report”. In the 184 pages of the 2009-2010 edition, no mention is made of ABAT or its subsidiaries. The report does, however, make mention of China BAK Battery Inc. (BAK), BYD Company (BYDDY.PK), SCUD Group Ltd, and Tianjin Lishen, which generate respective revenue of $222m, $5,805m, $185m, and $295m.

Other Chinese battery manufacturers which are not active in the lithium polymer market can also be compared to ABAT. Examples include the Coslight Technology International Group Limited and Tianneng Power International Limited, with $352m and $330m of revenue respectively in 2009. Gross margins and operating profit margins for all six of these companies, as well as ABAT, have been summarized in the table below for the most recent available fiscal year:

Company Gross Margins Operating Profit Margins
China BAK Battery, Inc. 10.6% -9.7%
BYD Company 17.7% 7.3%
SCUD Group Ltd 18.1% 5.8%
Tianjin Lishen*
5.4%
Coslight Technology 26.6% 9.1%
Tianneng Power 28.5% 14.3%
ABAT 47.3% 39.0%

*This is a subsidiary of CNOOC (CEO) and financial statements were not readily ascertainable, although it is evident that the Research In China report is using numbers specific to Tianjin Lishen.

ABAT’s operating margin is nearly triple that of its closest competitor and six times that of the median operating margin of our Chinese battery makers.

Obviously, strong operating performance alone would not normally be cause for concern. But when a company is doing as well as ABAT, investors need to understand why or how. ABAT clearly states in its annual report that it has limited (if any) technological advantage, and is competing in what is predominantly a commodity market. We have spoken to a customer who has visited ABAT’s Harbin battery manufacturing plant, and he has stated that there was nothing uniquely special about the Harbin facility. We also hired investigators to visit the Harbin facility and their findings are discussed later in this article.

The founder of ABAT, Zhiguo Fu, established it in 2002 despite having experience in construction and real estate, as opposed to battery manufacturing (see here (.pdf)). Furthermore, this company didn't begin manufacturing until 2004 (see here (.pdf)).

ABAT has limited operating experience, an unrecognized brand name, and production facilities too small to claim economies of scale.

Yet it seems like no matter how we compare ABAT to its competitors, ABAT’s financial figures come out ahead despite the numerous causes for concern discussed elsewhere in our report.

Wuxi ZQ and Heilongjiang ZQPT Site Visit

As part of our investment research process, we sent an experienced factory inspector to both the Wuxi electric vehicle facility and the Harbin battery facility. What we found was not encouraging.

Summary points from the Wuxi visit included:

  • Out of four assembly lines, only three were operational.
  • Staff included 200+ workers, but only 20 are office workers, indicating likely weaknesses in R&D, engineering, QC, and sales.
  • Factory management indicated 20,000 unit sales for 2010, with prices ranging from $450-$920 USD. This compares to 90,000 units reported to us by ABAT VP of Finance Dan Cheng on a conference call, a number which can also be backed into using data provided in ABAT’s 10-k.
  • The facility does not have a motorcycle manufacturer’s permit issued by the Chinese government.
    • Management claims to use the VIN of a partner, which is illegal.
  • Our investigators’ greatest concern was the lack of quality control (QC).
    • No line inspector or inspection of finished products.
    • No inspection list attached to each bike.
    • No testing center inside the factory.
    • The facility lacked basic equipment to test different parts for new product development.
    • Motor speed and efficiency testing machines were present, but no noise, temperature, or salt-fog testing machines.
    • No incoming parts inspection.

Photographs of the Wuxi facility are available in our report.

As lacking as the facilities were in the Wuxi facility, the Harbin site visit was even more disturbing in light of the world-class margins and the company’s reliance on this facility to support the bottom line.

Our investigators concluded the following:

It appears that the Harbin plant is in operation, does produce cells, and has sales. The semi-automated processes… are more advanced than some of the battery companies of China, and far less advanced than battery companies of international standing such as ATL, Lishen, Samsung, LG Chem. It appears that they do some things well, and have some potential great strength, but appear to have limited ability and concepts in the marketing and sales of their product. Selling cells to packagers is a common business model for Asian battery factories, but not one that realizes as much profit. And I note that the CTO acknowledged that the packagers and trading companies were making the entire margin and he was not. Again, normal for Asian cell makers – but not a way to gain success.

A proprietary BMS (Battery Management System) is essential for a successful battery company in the Light Electric Vehicle space. And the lack of such is a major handicap for Harbin. It appears to me that this company has a tiny business selling Li Ma or LFP (Lithium Iron Phosphate) cells to packagers for use in low priced battery packages sold to the domestic China market. This is the least profitable business they could have. The LI-Polymer cells are apparently not really in production (the normal issue with Li poly) due to high cost of materials and resulting high cost of the cells making them uninteresting to most applications. The LFP cells cannot be exported due to patent issues… So the only apparent product for any significant sales would be Lithium Manganese cells, and for that to make money for Harbin they would, probably, need to develop their own BMS, become their own packager, and compete with Phylion, Zhenlong, AEE, MGL, LG Chem, Lishen, HYB, and others.

Conversations with ABAT Customers

Since Advanced Battery's inception, management has made numerous claims regarding relationships with suppliers, distributors, research partners, and other related parties. As part of our due diligence process, we attempted to contact most of the relevant parties that ABAT has mentioned having a relationship with. In many cases, the parties we have contacted have been nonexistent, non-locatable, unwilling to speak, or had something strongly negative to say about ABAT.

In multiple cases, we found customers who either came away from their visits to the company’s factories unimpressed or confident that the company was inflating its financial figures. In this section, we provide a recording with one such customer, but have concealed and modified his voice.

This customer had signed a contract to receive scooters from ABAT’s Wuxi facility in 2009. After receiving a defective product, the customer demanded to visit the Wuxi facility that had supposedly been manufacturing the scooters. During our conversation, the customer indicated that he had visited numerous other Chinese manufacturing facilities to which Wuxi could be compared, and he described the Wuxi facility as a “joke” multiple times. The facility was described as “four empty walls”, the inadequacy of which made him suspect Wuxi was some sort of distributor operation rather than a manufacturing facility. Furthermore, the customer stated that he thought about contacting the SEC to report ABAT for fraudulent claims made in press releases. He said that “none of the stuff they put out was accurate”.

Other customers we’ve been in touch with have voiced similar opinions of ABAT. For example, in 2010, ABAT touted an agreement to re-enter the US market, expecting to deliver 200,000 electric scooter units to All-Power America for $1.1 million. Only half the delivery was taken before serious issues surfaced regarding quality control and licensing. The following comprises one excerpt from the long conversation we had regarding these issues and more with an All-Power executive:

All-Power:

Every step of the way we had some serious QC issues… The licensing is the official word that we gave out to everybody because that was a very tangible problem that the retailer used to return the products. But licensing was a major part of it, they should have checked for licensing compliance before they sent it.

Prescience:

So Wuxi, which is the company that you got the cycles from, they sent you sh**** product, am I reading you right? I’m not sure if I follow you?

All-Power:

Yeah, and that caused a major loss of confidence with our customer. Plus, we missed a lot of deadlines, and the customer said “you missed a lot of deadlines plus you have licensing issues, we’re going to send you all of them back”. So they put them on trucks and sent them back. Now we’re stuck with the inventory that I don’t know how the hell to move.

Wuxi ZQ mentions additional customers in its February 3, 2010 press release and in this excerpt (.pdf) from ABAT's 2010 10K. We reviewed our diligence with many of these customers in our report.

Conversations with ABAT Partners

Alongside numerous ruined or strained customer relationships, we have also uncovered a number of failed partner relationships. In our report, we discuss our conversations with ZAP (ZAAP.OB) and Altair Nanotechnologies (ALTI), as well as our attempts to contact numerous other ABAT partners. Our conversations, as well as our inability to locate many of ABAT’s obscure or hard-to-locate partners, reinforced our belief that ABAT’s business is much smaller than its SEC financial statements indicate.

Conclusion

Our longer report elaborates on the evidence discussed in this article. Our evidence that ABAT is inflating its financial statements includes:

  • SAIC filings show that ABAT is reporting significantly lower revenue and operating losses to the authorities in China. For 2009, SAIC filings showed less than $2 million of revenue, compared to $64 million in SEC filings.
  • ABAT has unreasonably high margins in an established industry with strong competitors. The Company’s SEC-reported margins and return on capital are virtually impossible. Out of 106 global battery manufacturers as classified by Bloomberg, ABAT has the highest operating profit margin by a wide margin. When compared to six leading Chinese battery makers, ABAT’s operating margin is triple that of its closest competitor and six times that of the median operating margin of the comparable companies.
  • Site visits show underutilized facilities lacking in quality control. We hired investigators to visit both the Harbin and Wuxi facilities, and provide photos as well as commentary from our investigators. Our investigators concluded that both facilities produce commodity, low-margin products that are highly unlikely to be generating industry-leading margins or return on capital.
  • In December 2010, ABAT announced that it was acquiring a Shenzhen battery maker for $20 million. We believe this acquisition is a sham, and that ABAT paid $20 million in 2010 for an entity that they had previously bought in 2008 for $1 million, but had not disclosed to public investors.
  • Confirmation from former customers and partners that the company is likely a fraud. After visiting one of ABAT’s plants, one customer called the facility “absolutely the biggest joke I’d ever seen”.
  • Low quality auditors and high turnover. The company has had 4 auditors in the past 7 years, with no auditor being ranked in the top global 100 auditors at the time of hire.
  • Unqualified CFOs and high turnover. A CFO or auditor has resigned at least once a year. The company’s past three CFOs have included: (i) a company insider who has been general manager of the company’s main operating subsidiary since 2004, and is therefore not remotely independent, (ii) a 29-year-old who was formerly VP Finance at China Natural Gas, another fraud, and (iii) a candidate whose primary experience comprised of being a financial adviser at Smith Barney.
  • Continuous share dilution through secondary offerings, despite having more than adequate cash reserves. Through repeated share issuances, the company has grown its outstanding shares from 10.0 million following the 2004 reverse merger to 76.4 million today.

Disclosure: I am short ABAT.

Additional disclosure: Please read the full disclaimer at the end of our report.

Eiad Asbahi, CFA, is the founder and Managing Partner of Prescience Investment Group. Prescience is a research-driven, performance-oriented investment and advisory firm specializing in extensive, independent research on companies in order to develop unique insights and identify singular investment opportunities. Prescience manages a private investment partnership as well as separately managed accounts.  This article is reprinted with permission from the author.

April 28, 2011

Dilution for Dummies – Why A123 Systems is Undervalued

John Petersen

Bartenders are smarter than most investors because they know what dilution is and they never get it wrong. Unfortunately, the markets have made such a bogeyman out of the word 'dilution' that public companies often suffer extreme backlash from financing transactions that should have existing stockholders on their feet and dancing in the aisles.

Today I'll try to clear up some of the profound confusion that runs rampant in the minds of retail investors.

Every bartender knows you can't dilute a beer by adding a shot of whiskey. The boilermaker is always stronger. The same is usually true when a public company sells new stock for cash. The company is stronger and better funded after the transaction than it was beforehand. Frequently, however, the existing stockholders recoil in terror from a vague threat of  dilution and bail out instead of celebrating.

For astute investors, these are great buying opportunities.

Most readers know I'm rarely bullish about A123 Systems (AONE), or for that matter any pure-play lithium-ion battery developer. Since I believe that it's critically important for my readers to understand what dilution is, I've decided to break away from tradition, jump to A123's defense, and explain why A123 is a far better risk today than it's ever been.

Every IPO prospectus is filled with dire warnings of dilution because IPO investors always pay a price per share that's higher than the book value of the stock owned by the pre-IPO stockholders. In A123's IPO, its pre-offering book value was $2.34 per share, the IPO investors paid $13.50, and its post-IPO book value was $5.13 per share. Investors who bought stock in the IPO were the whiskey and they suffered dilution of $8.27 per share. The pre-offering stockholders, on the other hand, were the beer and the book value of their shares increased by $2.79 each through the magic of corporate finance.

During its first 15 months of operations A123 suffered a series of expected operating losses and by December 31, 2010, the summary year-end balance sheet in its Form 10-K looked like this:


(thousands)
Cash and equivalents
$ 216,841
Working capital
191,892
Total assets
576,158
Long-term debt
9,982
Capital lease obligations
20,226
Stockholders' equity
398,198

On March 28, 2011, after its stock closed at $7.82 for the day, A123 announced concurrent underwritten public offerings for $125 million in convertible debentures and 18 million shares of common stock. The stock price fell to $6.35 per share within three days because somebody somewhere whispered the word dilution and the stockholders went into a panic.

On the morning of April 1st, A123 announced that the stock offering would be priced at $6 per share and the debentures would be convertible at $7.20. Both offerings were well received and A123 ultimately sold 20,184,067 shares of common stock and $143.75 million in debentures. The net cash proceeds of the offerings were $253.9 million. After giving effect to the offering proceeds, a pro forma summary year-end balance sheet would have looked like this:


(thousands)
Cash and equivalents
$ 515,741
Working capital
445,792
Total assets
830,058
Long-term debt
9,982
Capital lease obligations
20,226
Convertible subordinated debentures
143,750
Stockholders' equity
508,348

At December 31, 2010, each of A123's common shares had a book value of $3.77. After giving pro forma effect to the offering each of A123's common shares had a book value of $4.04. Just like we saw in the IPO, the new investors were the whiskey and they suffered dilution of $1.96 per share while the pre-offering shareholders were the beer and the book value of their shares increased by $0.27 through the magic of corporate finance. If you take the analysis a step further and assume the debentures will ultimately be converted, the value accretion to the old shareholders will be closer to $0.70 per share. More importantly A123 is now in a position where it has plenty of cash to complete the build out of its facilities and pursue the development of its business. I thought it was a masterful piece of corporate finance work.

The stock market, however, interpreted the facts differently. As soon as retail investors began reacting to the dilution bogeyman the stock price tanked. Over the next two weeks the market price of A123's stock plunged to a post-offering low of $5.29. It finally broke back up through the $6 threshold on Tuesday.

The easiest way to prove the silliness of the over-reaction is to note that A123's market capitalization was $826.4 million at the close of business on March 28th. The offering added $253.9 million in cash and $110.2 million in stockholders' equity to its balance sheet. Because of the market's over-reaction, its current market capitalization is $766.5 million.

At the end of last year A123 had some serious financial weaknesses that jeopardized its ability to finance ongoing losses and continue its planned expansion. The offering obliterated those weaknesses and left A123 in a very strong position. If its stock was fairly priced prior to the offering, the post offering market capitalization should be at least $936.7 million ($826.4 million in pre-offering market capitalization plus $110.2 in additional stockholders equity), or $7.44 per share.

A123 has a first quarter conference call scheduled for May 9th and I won't be surprised if its revenues and earnings fall short of expectations, but if you liked A123 Systems at $7.82 you should love it in the $6.00 range.

It's a far better investment today than it was a month ago.

Disclosure: None.

April 19, 2011

Why Energy Storage Investors Must Understand Economies of Scale

John Petersen

One of the most seductive and dangerous stock market myths is the immensely popular but demonstrably false notion that the rapid cost reductions and performance gains we enjoyed during the information and communications technology revolution will be repeated in the age of cleantech. The persistence of the mythology is astonishing when you consider that the entire history of alternative energy proves that cost reductions and performance gains are extraordinary events, rather than common occurrences. Investors who buy into economies of scale mythology without carefully considering the fundamental differences are in for a world of disillusionment and pain as they watch their portfolio values erode.

Everybody above the age of twelve has heard about economies of scale – they're the reason products tend to get better and cheaper over time. Most of us, however, don't take the time to consider the forces that give rise to economies of scale. As a result, we blithely assume that experience in one sector will carry over to another. Unfortunately, it's not that simple.

Wikipedia identifies the following basic economies of scale:
  • Purchasing economies – bulk buying of materials through long-term contracts;
  • Managerial economies – increasing the specialization of managers;
  • Financial economies – obtaining lower-interest rates and having access to a wider range of financial instruments;
  • Marketing economies – spreading the cost of advertising over a greater range of output in media markets;
  • Manufacturing economies – taking advantage of larger scale in the manufacturing function; and
  • Experience economies – learning by doing.
Each of these factors reduces long run average costs (LRAC) and shifts the cost of production down and to the right.
4.12.11 Economies_of_scale.png
The ugly truth most investors fail to recognize is that economies of scale occur in specific companies and diminish as a company or product matures. While specific companies can benefit from economies of scale that drive their production costs down, industries frequently suffer from diseconomies of growth and competition that drive production costs up while product prices are falling – a combination that invariably compresses profit margins. The principal diseconomies include:
  • Constraints on raw material and component availability;
  • Cannibalization of market opportunities by competing firms;
  • Duplication of efforts on "secret sauce" differentiation within product classes;
  • Ownership of critical technological advances by emerging market participants;
  • Economic gravity, which favors cheaper products over more costly alternatives; and
  • Human inertia, which favors established products and practices.
When I was young, the best performing battery technology was lead-acid, which had specific energy in the 30-50 watt-hours per kilogram range. The next step was nickel cadmium (NiCd) batteries with specific energy in the 45-80 wh/kg range. Then came nickel metal hydride (NiMH) batteries with specific energy in the 60-120 wh/kg range. Today's pinnacle of performance is lithium-ion batteries with specific energy in the 90-190 wh/kg range.

My inner optimist considers a four-fold improvement in battery technology and calls it progress. My inner pragmatist compares a four-fold improvement in battery technology to a billion-fold improvement in information technology and knows that something is very different. Our need for better batteries was no less urgent than our need for better electronics. In fact, many of the companies that drove gains in electronics were also active in the battery industry. Where progress in IT was immense, the battery industry was basically stagnant. Even the cast of Sesame Street can look at these facts and say with confidence “One of these things is not like the other.”

The reasons for the disparity are really quite simple. Where electronics are governed by the laws of physics, energy storage is governed by the laws of chemistry. When you make an electronic device smaller you reduce its material content and improve its performance at the same time. When you make an energy storage device smaller, you get fewer chemical reactions and less storage potential. More importantly, battery manufacturing is a mature industry and we use the same basic processes, equipment and product architecture today that we used 35 years ago. Albert Einstein taught that “doing the same thing over and over again and expecting different results” was insanity. There’s a lesson there for investors.

While it would be an oversimplification to suggest that the only major differences between battery types are changes in the chemistry manufacturers put into their can or pouch, it wouldn't be gross oversimplification. In many cases energy and power are declining as manufacturers try to optimize safety and cycle life. The major performance gains the world so desperately needs are not going to arise from minor modifications to chemistry in a can. If they arise, they'll come from entirely new approaches based on fundamentally different chemistries, manufacturing processes and product architectures.

In the lithium-ion space there is precious little substantive differentiation between the various chemistries and form factors. There are differences, but they're usually fine tuning to optimize energy, power, safety or cycle life. In general, the chemistries with the highest energy and power have the lowest safety and cycle life. Conversely, manufacturers who are willing to dial energy and power down a notch have been able to realize impressive safety and cycle life gains. When it comes to manufacturing costs, however, nobody has a significant advantage over the old line lithium-ion battery producers like Sony, Panasonic-Sanyo and LG Chem who've been in business for decades and have already optimized their economies of scale. Any way you look at it, new market entrants like A123 Systems (AONE), Ener1 (HEV), Valence Technologies (VLNC) and Altair Nanotechnologies (ALTI) will be playing catch-up ball for years.

The lead-acid space is a lot like the lithium-ion space when it comes to product differentiation. Leading lead-acid battery manufacturers like Johnson Controls (JCI), Enersys (ENS) and Exide Technologies (XIDE) produce high quality products that are basically fungible commodities. While there are modest differences, there's nothing that's truly unique about any of their products.

To the best of my knowledge, Axion Power International (AXPW.OB) is the only publicly held battery technology developer that's doing something completely different. Where its competitors are fooling around with additives that offer modest improvements in cycle-life and charge acceptance, Axion is replacing traditional lead-based negative electrodes with patented carbon electrode assemblies that boost cycle-life and dynamic charge acceptance by 1000% or more. The chemistry stays the same, but the electrode fabrication methods are completely different and so is the final device – a hybrid that's half battery and half supercapacitor and can be assembled on any conventional AGM battery production line.

Axion's carbon electrode assemblies have never been manufactured on a commercial scale. Its first generation electrode fabrication line produced enough electrode assemblies to support its testing, demonstration and validation projects with automakers, railroads and other potential customers, but the production capacity and quality control were not high enough to meet customer needs. Last month, Axion completed the installation of a second-generation automated electrode fabrication line that promises to significantly improve both. Axion is currently engaged in manufacturing process, quality control and product performance validation with its potential customers. Until that work is completed, a design win or production contract would be premature. Once Axion introduces its first commercial product, it will be at the top left-hand corner of the total cost curve. As near as I can tell, Axion is the only battery manufacturer in the world that has a reasonable opportunity to realize true and significant economies of scale in its future operations.

Disclosure: Author is a former director of Axion Power Internatinal (AXPW.OB) and owns a significant long position in its common stock.

April 15, 2011

Lux Research Confirms that Cheap Will Beat Cool in Vehicle Electrification

John Petersen

On March 30th, Lux Research released an update on the vehicle electrification market titled "Small Batteries, Big Sales: The Unlikely Winners in the Electric Vehicle Market" that predicts:
  • E-bikes and micro-hybrids carry minimal storage, but compensate with high volume. E-bikes show strong unit sales, as they sustain a 157 GWh storage market totaling $24.3 billion in revenues in 2016. Micro-hybrids benefit from increasingly stringent emissions limits, supporting 41 GWh and $3.1 billion in storage sales.
  • Hybrid electric vehicles (HEVs) like Toyota's Prius grow steadily while PHEVs and EVs are at the mercy of external factors. Both PHEVs and EV sales are sensitive to oil prices, but catalyze growth for Li-ion batteries, along with HEVs powering a $2.3 billion market in our base case scenario.
  • Advanced lead-acid batteries will dominate the storage market now and in the future, resulting in a 165 GWh and $16.1 billion market in 2016.  Lithium-ion follows, showing strong growth from 4.1 GWh and $2.7 billion in 2011 to 32.2 GWh and $11 billion in 2016.
Since the report echoes several themes I frequently discuss in this blog, it seems like an opportune time to back away from the minutiae and revisit the broad opportunities for growth in the vehicle electrification sector.

The basic drivers of all vehicle electrification initiatives are the desire to break the economic stranglehold of increasingly expensive petroleum, reduce CO2 emissions and improve air quality in big cities. The major countervailing force is the economic reality that consumers will not sacrifice the flexibility and reliability of internal combustion engines for a more expensive alternative that doesn't offer a compelling value proposition. Governments and EVangelicals are pushing hard for flashy EV solutions with miserable economics, but Lux believes cheap will beat cool over the next five years.

Electric Two-wheeled Vehicles

In Lux's view, the runaway winner over the next five years will be e-bikes – the most energy efficient transportation in the world. It expects battery sales for e-bikes to double from $12 billion in 2011 to $24.3 billion in 2016. While roughly 85% of today's e-bikes use lead-acid batteries because they cost less, Lux expects lithium-ion batteries to garner an 18% market share in China by 2016, which implies a global market share of closer to 30%. As an avid cyclist who understands the impact of extra weight on a bicycle, I think Lux's market penetration forecast for lithium-ion is low. Lead-acid may retain its dominance in China, the world's biggest e-bike market, but I'm convinced that lithium-ion will be the battery of choice in North America and Europe where e-bikes are rapidly gaining ground.

Lux expects a limited market for e-bikes outside of China, but I think it's a market that could surprise people who haven't really considered the mobility needs and transportation budgets of young adults and cost-conscious commuters. E-bikes are not an all weather solution, but on a pleasant day a $1,000 e-bike is far more attractive than alternatives that cost thirty to fifty times more and can't come close in the fun per mile category.

I've been following Advanced Battery Technologies (ABAT) for a couple years and have been impressed by its cost control and business strategy. It began as a low cost manufacturer of commodity lithium-ion batteries and then expanded into e-bike manufacturing. It's growth rates and profit margins are impressive enough that I've often said ABAT is too cheap to be cool. ABAT's stock price recently tumbled by over 40% when Variant View Research, an acknowledged short seller, published three "hatchet-job" articles that were highly critical of its operations, financial reports and corporate governance. Since I don't want to jump into the middle of a dogfight, I'll simply note that ABAT is the only publicly held pure play in the e-bike space and seems to have a bright future as a vertically integrated manufacturer of e-bikes, the most popular electric vehicles in the world.

Micro-hybrids

The second biggest market over the next five years will be micro-hybrids, conventional internal combustion vehicles that simply turn the engine off when the car is stopped and restart the engine when the driver takes his foot off the brake. In an earlier report titled "Micro-hybrids: On the Road to Hybrid Vehicle Dominance," Lux forecast that the micro-hybrid market would grow from three million units this year to 34 million units a year by mid-decade. The primary drivers of growth will be strict new European CO2 emissions rules and ambitious new CAFE standards that will be phased in over the next few years. According to Lux "micro-hybrids sit in an enviable position as a cost effective approach to improve fuel efficiency, since their start-stop and regenerative braking capabilities can be implemented in the OEMs' current stable of vehicles, without the more drastic redesigns needed to create a full EV, PHEV, or HEV." Overall, Lux believes the market for advanced batteries in micro-hybrid vehicles will grow from $495 million this year to $3.1 billion by 2016.

Competition in the micro-hybrid battery space is intense and diversified. Johnson Controls (JCI) and Exide Technologies (XIDE) are both offering a variety of advanced lead-acid batteries for micro-hybrids that range from enhanced flooded batteries to valve regulated absorbed glass mat batteries. With their global manufacturing footprints, established OEM relationships and proven manufacturing competence both companies should benefit from impressive growth in OEM battery sales over the next five years.

While advanced lead-acid batteries currently dominate the micro-hybrid battery market, there is a growing body of proof that advanced lead-acid batteries are ill suited to the demands of micro-hybrids. In a 2007 Journal of Power Sources article, a team of battery researchers from Ford described the problem as follows:

"Charge acceptance, particularly at low temperatures, is a battery requirement that determines the charge balance of the power supply system. The more the battery has to contribute to supplying electrical loads, the more essential it becomes that it can be recharged quickly. ... [A]dvanced HEV applications will require good charge acceptance in a dynamic discharge/charge micro-cycling operation. We call this feature dynamic charge acceptance (DCA). In the particular case of lead/acid batteries, DCA capability is extremely sensitive to the short-term previous charge/discharge exposure of the battery."

At last September's European Lead Battery Conference in Istanbul (the ELBC) Ford and BMW jointly proposed a new battery testing protocol for micro-hybrids. Under the protocol a 60-second engine off cycle will require 39,600 watt-seconds of energy. Of that total, 36,000 watt-seconds will be used to support accessory loads during engine off interval and the remaining 3,600 watt-seconds will be used to re-start the engine. Until the 39,600 watt-second discharge is recovered, the stop-start system will be disabled. Since a disabled stop-start system can't save fuel by turning off the engine at a stoplight, dynamic charge acceptance is rapidly emerging as one of the important battery performance requirements for micro-hybrids, if not the most important one.

The big drawback of using enhanced flooded batteries and AGM batteries in micro-hybrids is that their dynamic charge acceptance degrades over time. While a new battery needs about 30 seconds to recover from an engine-off event, it can take three minutes or more when a battery's been in service for a year. Since city driving typically offers one or two engine-off opportunities per mile, pushing the battery recovery time from 30 seconds to three minutes or more has a very negative impact on fuel economy.

The following graphs come from the BMW-Ford presentation at the ELBC and show how the dynamic charge acceptance of an AGM battery degrades over time. The graph on the left shows what happens if the generator is disabled for seven seconds after restart to maximize the engine power available for acceleration. The graph on the right shows what happens if the generator kicks in immediately. The downward curving blue lines show the amount of current the battery can accept as the number of stop-start cycles increases. The upward curving black scatters with red overlays show the time required for the battery to regain an acceptable state of charge. The simple summary is that both batteries performed poorly and lost most of their dynamic charge acceptance capacity in a matter of months.

4.13.11 VRLA.png

While advanced lead-acid batteries are currently the best available choice for micro-hybrids, their market dominance is vulnerable because dynamic charge acceptance is so critical. As the market matures, I believe automakers will choose batteries for micro-hybrids on the basis of detailed cost benefit analysis that includes lifecycle fuel economy. When all costs are accounted for, I believe emerging energy storage technologies will gain the upper hand.

Three advanced battery developers have disclosed alternative approaches to the micro-hybrid market.

The first design win from Peugeot-Citroën went to a three-component system from Continental AG and Maxwell Technologies (MXWL) that combines an AGM battery and control electronics from Continental with a small supercapacitor module from Maxwell. In this system, the AGM battery carries the 36,000 watt-second accessory load and the supercapacitor picks up the 3,600 watt-second starter load. While this three-component approach will reduce battery strain by shifting the starter load to the supercapacitor, it can't eliminate the gradual loss of dynamic charge acceptance in the AGM battery that does the yeoman's share of the work.

A second design win from an undisclosed OEM has reportedly gone to A123 Systems (AONE), which has been testing a lithium-ion micro-hybrid battery solution for the last few years. Given the charge acceptance characteristics of A123's lithium-ion chemistry, I believe its stop-start solution will perform well and avoid the dynamic charge acceptance issues that plague advanced lead-acid batteries. The big questions will be cost and cold weather performance. Until A123 releases more details on its micro-hybrid solution, it will be hard to assess its competitive position.

The third contender for a share of the micro-hybrid market is Axion Power International (AXPW.OB), which is working with several automakers and has progressed far enough in its relationship with BMW that the two companies made a joint technical presentation at last year's ELBC. While it's not unusual for an automaker to enter into a development contract or supplier relationship with a micro-cap, I'm not aware of another case where an automaker shared the podium with a battery developer at an industry conference. A more surprising development was a brief conference call reference to a grant application under the DOE's Vehicle Technologies Program that Axion filed as a co-applicant with a major automaker. To the best of my knowledge, this is the first time an automaker has joined in a DOE grant application with a component developer. While the details remain sketchy, the DOE plans to make its award decisions by late June and fund in the third quarter.

Axion is not currently producing PbC batteries for commercial sale to customers. It has recently installed a second-generation automated production line for its patented carbon electrode assemblies and is engaged in manufacturing process, quality control and product performance validation activities with potential customers. Until that work is completed, a design win or production contract will remain out of reach.

EVs, PHEVs and HEVs

While Lux forecasts that EVs, PHEVs, and HEVs will command a solid chunk of storage revenue because of their high per vehicle battery costs, Lux doesn't "expect EVs or PHEVs to take the world by storm, and sees steady but not explosive growth from HEVs." Lux said that consumer acceptance of the GM Volt and Nissan Leaf is "anything but a certainty" and noted that early results indicate only 40% of the non-binding pre-orders for the Nissan Leaf are turning into purchases. It cited high battery costs as a major obstacle to making electric vehicles cost effective. Overall Lux believes that light and heavy PHEVs will depend on high oil prices and "EVs will disappoint in all scenarios." As a product class, Lux predicts that battery sales for EVs, PHEVs, and HEVs will grow from $710 million this year to $2.1 billion in 2016. Since there are so many competitors in the EV, PHEV and HEV markets, it's hard to pick likely winners and I'd rather watch from the sidelines.

Heavy Vehicles

The last class of vehicles considered by Lux was delivery trucks, city buses and railroad locomotives. It forecast that sales in the heavy vehicle segment would grow from $110 million in 2010 to $642 million in 2016. A number of energy storage technology developers are active in the heavy vehicle segment including:
  • Maxwell, A123, Ener1 (HEV), Altair Nanotechnologies (ALTI) and Valence Technologies (VLNC), which are actively marketing energy storage systems for hybrid and electric buses and delivery trucks; and
  • General Electric (GE) and Axion Power, which are developing battery systems for hybrid locomotives and retrofit solutions for the existing locomotive fleet.
While there are too many competitors to pick likely winners in the highway vehicle markets, I'll continue watching the railroad market with interest because the existing locomotive fleet includes 24,000 units nationwide and implementing hybrid drive in a train is relatively simple because of the ability to mix and match conventional diesel locomotives and retrofitted electric locomotives to meet the power and recuperative braking needs of a specific load and route.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

March 28, 2011

Four Green Money Managers' Top Stock Picks

Green money managers' stock picks after the Japanese nuclear crisis.

Even as the nuclear disaster in Japan unfolds, it's clear that the world's energy industry will be forever changed. Russian reactors were never considered safe, but a Japanese to have a nuclear meltdown is an entirely different story.

Market Reaction

Since Monday, nuclear stocks and ETFs have been plummeting. As of Wednesday night, The Market Vectors Uranium + Nuclear Energy ETF (NYSE:NLR), the iShares S&P Global Nuclear Energy Index (NASD:NUCL), PowerShares Global Nuclear Energy Portfolio ETF (NYSE:PKN), and the Global X Uranium ETF (NYSE:URA) are down 17%, 14%, 16%, and 29% respectively.

Yet we still need energy, and when the dangers of traditional energy once again rise in our awareness, the safety of renewable energy gains appeal. Over the same three days, the most liquid of the Clean Energy ETFs, the Powershares Wilderhill Clean Energy ETF (NYSE:PBW), the First Trust ISE Global Wind Energy ETF (NYSE:FAN), and the Guggenheim Solar ETF (NYSE:TAN) gained 1%, 2%, and 11%, respectively, even as the S&P 500 fell 3%.

The market thinks that the outlook for clean energy in general and solar in particular, has improved greatly. This makes sense, because as the Japanese rebuild their energy infrastructure, they will stay away from nuclear, and focus on electricity that's safe, and quick to deploy. Green energy fits the bill.

Stock Picks

If green energy will do well in general, which stocks will do the best? I emailed my contacts among green investment fund managers, and asked them each to pick one stock they thought was particularly well positioned. Here are their picks.

Garvin Jabusch: LDK Solar

Jabusch manages the Sierra Club Green Alpha Portfolio. He thinks that, in the long run, solar will be the big winner, followed by wind. His top pick is LDK Solar (NYSE:LDK), which his fund holds. He also blogs about green investing, and has just finished an article on Japan, Nukes, and Solar.

John Segrich CFA: Capstone Turbine

Segrich manages the top-performing Gabelli SRI Green Growth Fund (SRIGX). Like many contrarian investors, he's not great at following instructions (I asked for no more than three sentences), but he has interesting things to say:

The big beneficiary in the aftermath of the Japan nuclear crisis will be natural gas related companies. In particular Japan is likely to rebuild generation infrastructure with natural gas and in particular liquid natural gas (LNG). The pushback against nuclear will not necessarily be the boon to renewable that many are suggesting. Renewables are not failsafe in a disaster scenario (look at how many solar panels were shattered in the quake) and they cannot replace baseload power. Gas is the logical and cleanest and safest solution and we would expect Japan, Italy, and Germany to build more gas vs increase emphasis on renewable. … one interesting way would be to look at companies whose business model is gas based and can handle local based generation with rapid deployment:

Capstone Turbine (NASD:CPST) makes gas powered microturbines that can be locally installed and can provide immediate efficient and clean power generation for stand alone facilities (hospitals, schools, hotels, critical infrastructure) – we are already seeing deployment on infrastructure in the US to provide constant, reliable, failsafe power. I would expect to see adoption of these solutions for rapid deployment in disaster areas such as Japan at the moment to provide critical power on a local level as needed. Longer term, integrating these turbines as a backup/distributed power solution also makes sense for future emergency planning.

Sam Healey: MEMC Electronic Materials

Sam Healey manages a Cleantech stock portfolio at Lamassu Capital. He thinks MEMC Electronic Materials (NYSE:WFR) has two chances to benefit from the disaster. First, the nuclear renaissance stalls, it will boost to the Solar industry, and MEMC will benefit. By year end WFR will be vertically integrated from Poly [silicon] production through installation via Sun Edison and will be able to capitalize on any global expansion of solar power. Second, and more important in the near term, Japan accounted for 10-20% of the global Poly manufacturing of Semi[conductor] Wafers. Therefore, MEMC, will be able to gain share in the near term as it absorbs some of the demand for Semi Wafers, and perhaps will also have better pricing. MEMC does have one plant in Japan that is currently off line as a result of the earthquake.  The plant does not produce raw poly but was one of MEMC's 8 plants that manufacture 300 MM wafers and 1 of 3 MEMC plants that engage in wafer polishing and slicing.  The risk is that they will not be able to replace this production at their non Japan plants.

Tom Konrad CFA: NGK Insulators

My own pick is NGK Insulators (Tokyo:5333, Pink:NGKIF). NGK has fallen along with the Japanese market, but stands to benefit from the rebuilding of the northern Japanese grid. NGK's manufacturing is located in the central and southern part of the country, so the company should not have been too badly hurt by the earthquake and tsunami. NGK also sells the most mature, high capacity grid-based electricity storage technologies: the Sodium-Sulfur (NaS) battery. Especially on a small island like Japan, electricity storage is very helpful for integrating the variable power from solar and wind, and the Japanese are likely to favor this home-grown technology over foreign rivals.

Solar, distributed Natural gas, Electric grid & storage: they could all be winners. What do you think? The comments are open. I've also started a poll.

This article was published on Tom Konrad's Green Stocks blog on March 18th.

DISCLOSURE: No Positions. I did not ask the money managers interviewed if they own their picks, but we can assume they do.

Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

March 27, 2011

An Elephant Hunter's Thesis for Axion Power

John Petersen

Last Friday I breathed a sigh of relief as my core position in Axion Power International (AXPW.OB) regained the price level it established in the first quarter of 2010. The last 12 months have been a stockholder's worst nightmare as supply and demand dynamics pushed Axion's stock price down into the $0.50 range and kept it there. Since it looks like new buyers have finally eaten their way through the excess supply, now seems like an opportune time to unwrap my crystal ball and lay out an elephant hunter's thesis for Axion's stock price outlook over the next few months.

Axion went public through a reverse merger in December 2003. Like many reverse merger companies, its market was illiquid in the early years and the stock traded by appointment. The following table summarizes the reported annual trading volume during Axion's first seven years as a public company. It shows the total reported volume for each year and the percentage derived by dividing the reported volume by the fully diluted common shares outstanding at year-end.

Year
Shares Traded
Percentage
2004
243,255 1.8%
2005
325,882 1.9%
2006
1,092,755 4.6%
2007
835,030 3.3%
2008
1,888,865 5.4%
2009
7,176,200 8.5%
2010
22,015,900
25.8%

So far this year, Axion's cumulative trading volume is 18.4 million shares. That means 2011 is likely to be the first time in its history that annual trading volume will exceed 50% of the issued and outstanding shares, a level of activity that most investment professionals believe is required for a healthy liquid market.

In December 2009 Axion closed a $26 million private placement that is properly classified as a venture capital investment in public equity, or VIPE, transaction. Four purchasers including Blackrock, the Special Situations Funds, Manatuck Hill Partners and one individual, bought 31.4 million shares in blocks of 7.2 to 8.8 million shares each. In addition, 47 small funds and individuals bought 14.4 million shares in smaller blocks. The offering was priced at $0.57 per share and the 45.7 million shares that were sold in the offering represented about 55% of the company.

In a September 2010 study of 1,655 VIPE transactions between 1995 and 2008, the authors reported that VIPE investors typically buy at a 47% discount to market, which meshes well with my experience that large private placements are typically priced at a 50% discount to market. The reasons for the deep discount are obvious. In a market transaction, an investor will buy a few hundred to a few thousand shares with the expectation that he can change his mind, liquidate and move on whenever he feels like it. In a VIPE transaction, an investor cannot have any reasonable liquidity expectations for months or even years. In cases where several large investors participate in a VIPE transaction, the liquidity assessment is performed at the transaction level, rather than the investor level. In cases where there's a big gap between historical trading volumes and the size of the VIPE transaction, the discount will usually be more than 50% to offset the liquidity deficiencies.

If one assumes that 50% was a proper discount for Axion's VIPE transaction where the investors bought shares that represented six and one-half years of historical trading volume, the transaction should have put a $1.15 baseline trading value on Axion's stock. If one assumes that a 60% discount would be more appropriate in light of the liquidity deficiencies, a baseline trading value of $1.50 per share would have been more reasonable. Those two numbers bracket the range – $1.15 on the low end and $1.50 on the high end – that I believed Axion's stock would trade in when I wrote a December 2009 article titled "Why I'm Thrilled by Axion's Financing Transaction."

While I believed in December 2009 that Axion's stock price would stabilize in the $1.15 to $1.50 range, and it did exactly that during the first quarter of 2010, liquidations that were unrelated to business fundamentals began in the second quarter and continued into the summer. As a result, the price was beaten down to an all time low of $0.46 before stabilizing in the $0.60 range by year-end. Since then, the stock price has doubled.

3.27.11 AXPW Chart.png

I've always believed the plateau from February through April 2010 represented fair value and the slump that began in late April was based on supply and demand dynamics instead of business fundamentals. While Axion's stock price was swooning, the following key corporate and regulatory events were unfolding.

March 30, 2010 Annual Earnings Release
April 1, 2010 The EPA and NHTSA adopt new CAFE standards for cars and light trucks
May 5, 2010 Announced upgrade to first generation electrode line and plans for second generation line
May 18, 2010 Announced presentation at 2010 Advanced Automotive Battery Conference & Symposia
June 9, 2010 Announced development program with Norfolk Southern Railroad
September 20, 2010 Announced joint technical presentation with BMW at the European Lead Battery Conference
February 14, 2011 Announced foundation patent on PbC electrode assembly
March 8, 2011 Announced order for $3.5 to $8 million of flooded batteries
March 8, 2011 Confirmed first quarter commissioning of second generation electrode line

A couple of these events were nothing short of extraordinary.

Many small companies in the battery and power electronics space decide to develop their own battery management system expertise, but I'm not aware of another situation where a transportation giant like Norfolk Southern hired a micro-cap company like Axion to develop a battery management system as the first step in a project geared toward the potential retrofit of a portion of its diesel electric locomotive fleet to hybrid diesel electrics.

Many small companies in the battery space are engaged in development projects with automakers, but the identities of the automakers are closely guarded secrets until the automakers announce a production decision. Several recent reports that other battery manufacturers have won production contracts from automakers but declined to publicly identify their customers are prime examples of the normal course of business. I've spent several months searching for a comparable example of a joint technical presentation by an automaker and a battery developer at a major industry conference. So far my effort has been unsuccessful.

Axion was not dealing with a normal market in 2010 and is just now getting back to the baseline trading value it established in the first quarter of 2010. While it's hard to say what the 2010 developments would have been worth in the in the context of a more normal trading market, I think most people who invest in small company stocks would have expected at least a double from the Norfolk Southern and BMW relationships and perhaps a good deal more.

I don't know what the fair value of Axion's stock is or where the price will go from here. However my experience with small companies in the valley of death has taught me that over the long-term market prices tend to oscillate around a fair value line, but only touch fair value as they transition from one extreme to the other. In cases where the market price has been undervalued for an extended period of time, the next stage is a roughly equivalent overvaluation for a similar period of time. If you want to assume that $2.40 would have been a reasonable fair value in December 2010, you can pretty well count on an eventual peak in the $4.20 range. If you believe $2.40 would have been low in a normal market then your outlook for the next peak should probably be higher.

Over the last year I've been frank in expressing my opinion that Axion was undervalued. As long as the market price was within spitting distance of the price paid in the 2009 VIPE transaction, it was easy to take that position. Now that Axion's market price has returned to a level that represents reasonable parity with the 2009 VIPE pricing, we should begin to see how the market values the events that have transpired over the last year. Axion's year-end earning call is scheduled for Thursday of this week and I'm hoping management will add color to their recent disclosures and better explain their outlook for the coming year.

I wrote this article because several readers have asked me what my expectations are for Axion's future stock price. While I don't usually make price predictions, I thought a detailed explanation of my opinions and outlook would be more valuable than stony silence. I will probably be more restrained in my future discussions of Axion's market price, but the elephant hunter in me thinks the fun is just beginning.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a subtantial long position in its common stock.

March 22, 2011

Grid-based Energy Storage: Widely Misunderstood Challenges and Opportunities

John Petersen

The most widely misunderstood subject in the field of energy storage is the potential for grid-based applications. They fire the imagination because the grid is so pervasive and the need is so great. They also present immense challenges to storage technology developers because the fundamental economic value per unit of grid-based energy storage is very low. While the subject of grid-based storage provides rich fodder for media reports and political posturing, the reality bears little relation to the perception. On March 9th, Lux Research published a sorely needed reality check in a new report titled "Grid Storage – Islands of Opportunity in a Sea of Failure," which concluded that "Amongst the sea of possible scenarios, there are few combinations that offer an acceptable payback, while endless potential pitfalls exist."

Lux analyzed the business scenario for 14 emerging energy storage technologies across 23 applications to identify the best investments for utilities, transmission operators, independent power producers and building operators in California, Germany, and China. The report was based in large part on data from a December 2010 study published by the Electric Power Research Institute, "Electricity Energy Storage Technology Options – A White Paper Primer on Applications, Costs and Benefits." While the Lux report and the EPRI study both offer detailed insight for institutional investors that are contemplating investments in energy storage, they're too detailed for individual investors who are mainly concerned with managing their personal portfolios.

The first thing individual investors need to understand is that while global electric power generating capacity is roughly 4,000 GW, total installed energy storage capacity is less than 128 GW, or 3.2% of generating capacity. The second thing they need to understand is that substantially all of the existing storage facilities are pumped hydro. The following graph from the EPRI report provides additional color on how much installed capacity really exists for the exciting new energy storage technologies the press is gushing over.

3.22.11 Global Storage.png

While EPRI's installed capacity graph should be enough to make cautious investors pause to check their assumptions, another graph from the EPRI report is far more useful. It shows the estimated size of the potential market for 15 key energy storage applications on the horizontal axis and then shows the maximum price per kWh of storage capacity an end-user would be willing to pay on the vertical axis. The red annotations are mine.

3.22.11 Grid Markets.png

Wholesale frequency regulation, the application that's getting the bulk of the media attention, is shown on the left-hand side of the graph. It's the primary target for cool storage technologies like flywheel-based systems from Beacon Power (BCOND) and lithium-ion battery based systems from Altair Nanotechnologies (ALTI), A123 Systems (AONE), Ener1 (HEV) and others. Despite the media's excitement, the reality is wholesale frequency regulation represents less than 1% of potential demand for grid-based storage. The other 99% can only be served by cheap energy storage technologies. Less than a half of the potential market will ever be addressable by manufactured energy storage devices. The rest will remain out of reach without widespread deployment of pumped hydro, compressed air and other large-scale electro-mechanical systems.

There's little question that the potential markets for manufactured energy storage devices in grid-based applications are big enough to support several successful companies. They're just not as easy as the media reports would have us believe. Wholesale frequency regulation in the US is probably limited to something on the order of 400 MW, which works out to about $1.6 billion in domestic revenue potential. The bigger prize is the $16 billion of potential demand for manufactured systems that can be installed at a price point of $500 to $1,700 per kWh. Globally, those target markets are closer to $5 billion and $50 billion, respectively.

Of the electro-chemical energy storage technologies discussed in the EPRI report, conventional and advanced lead-acid batteries and flow batteries usually offered the best cost profiles for the work of transmission and distribution upgrade deferral in both fixed and transportable formats. The economics remain challenging when you include the costs of containerization, interconnect equipment and control electronics, but they are within the realm of reason. Once you get beyond short-duration frequency regulation, however, cool technologies don't stand a chance of being competitive.

The universe of publicly traded US companies that can respond to the need for cheap grid-based energy storage is small. It includes Enersys (ENS), Exide Technologies (XIDE), and C&D Technologies (CHHPD.PK)  in the established manufacturer ranks with Axion Power International (AXPW.OB) and ZBB Energy (ZBB) in the emerging company ranks. Cool technologies will probably continue to claim the lion's share of the headlines, but cheap technologies will almost certainly claim the lion's share of the revenues and profits. From an investor's perspective, those are the only metrics that really matter.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

March 08, 2011

Two Stocks For Grid Storage - ZBB Energy and Axion Power

John Petersen

On March 4, 2011 the Pacific Northwest National Laboratory published a comprehensive review of "Electrochemical Energy Storage Technologies for Green Grid" that is a must-read for serious investors who want to understand the technical and economic intricacies of the energy storage sector. It explains why storage is a key enabling technology for wind and solar power, the smart grid, efficient transportation and a legion of high-technology manufacturing and service enterprises that can't survive without reliable power. It also explains why energy storage is an investment mega-trend that will endure for decades. While I normally try to provide links to materials that are available for free, this particular review is only available from the American Chemical Society website and their charge for non-members is $35. If you own stock in a battery company or are thinking about investing in one, it's the best $35 you'll ever spend.

Conceptually, a battery is nothing more than a bottle that stores electricity. The term "energy" describes the total amount of electricity you can put into the bottle. The term "power" describes how quickly you can empty or fill the bottle. The basic problem with energy storage is that batteries are thousands of times more expensive than the electricity they store. You may be able to buy a kilowatt-hour (kWh) of electricity for a dime, but a battery to store that much electricity will set you back $150 to $1,000. Once you include battery depreciation in the equation, the cost of electricity from a battery is always higher than the cost of electricity from a wall-socket. If you only need to store a few watt-hours of energy for a cell phone or laptop computer, convenience will usually outweigh battery cost. If you need five, ten or twenty thousand watt-hours of battery capacity so that you can use electricity from solar panels at night or drive a plug-in vehicle 40 to 80 miles, battery cost quickly becomes a major issue, if not an insurmountable obstacle.

In its report, the PNNL explains that capital cost and life-cycle cost are the most important and fundamental issues in the energy storage sector. Capital costs are usually expressed in terms of dollars per kilowatt ($/kW) for power applications and dollars per kilowatt-hour ($/kWh) for energy applications. Cycle-life cost is calculated by dividing the sum of the capital cost and expected maintenance costs by the number of cycles a battery can deliver over its useful life. In general, the authors of the PNNL report believe the following attributes are essential for grid storage applications:
  • Capital cost of $250 per kWh or less;
  • Long calendar life (e.g. > 15 years);
  • Long cycle-life (e.g. > 4,000 deep cycles);
  • High safety standards; and
  • Low maintenance costs.
It's a tall order and most energy storage technologies fall short of the mark. The following graph from the PNNL report shows the estimated capital cost per cycle of various storage technologies before project financing costs, operation and maintenance costs, and replacement costs.

3.8.11 Storage Costs.jpg

After studying the PNNL report in detail, I believe flow battery and lead-carbon battery technologies have the best shot at meeting these high standards in the short term. Others will no doubt disagree. The only way for a serious investor to make an informed decision is to download the report, study the PNNL observations and draw his own conclusions.

There is one publicly-held pure-play energy storage company in the flow battery space. ZBB Energy (ZBB) is the owner of a zinc-bromine technology that was invented by Exxon, developed by Johnson Controls and ultimately sold to ZBB. Over the last few years, ZBB has developed a modular system architecture for its technology and successfully completed a three-year validation test by Australia's Commonwealth Scientific and Industrial Research Organisation (CSIRO). ZBB has also devoted considerable resources to an open-platform power management system that facilitates the integration of diverse power sources and diverse energy storage device types to meet the needs of a particular customer. ZBB has been a poor market performer since its IPO in 2007 and currently trades at one-fifth of the IPO price. Its market capitalization of $33 million is the lowest of the 18 pure-play energy storage companies I follow. ZBB hasn't had a particularly strong balance sheet for several years and it will need to raise additional capital. Given the proven status of its technology and its low market capitalization, I believe ZBB has limited downside risk and attractive upside potential.

The section of the PNNL report that I found most illuminating was their discussion of lead-acid batteries in general and lead-carbon batteries in particular. While I've been writing about lead-carbon battery technologies for a couple of years, the PNNL review is the first major report from a national laboratory that does not require A to B to C analysis to integrate information from several sources. The following schematic from Furukawa Battery shows the three primary lead-acid battery electrode configurations that are presently being developed.

3.8.11 LAB Configurations.jpg

In its discussion of conventional lead-acid batteries the PNNL report noted that lead-acid has historically suffered from limited cycle life (e.g. 1,000 cycles), limited depth of discharge (e.g. less than 30%), low round-trip energy efficiency (e.g. 50% to 75%) and low charge acceptance capacity (e.g. 7% of the one hour discharge rate). In combination, these technical factors have made large-scale applications problematic from an economic perspective.

The first innovation PNNL discussed in the field of advanced lead-acid batteries involves the use of carbon additives to improve cyclability while inhibiting the formation of hard lead sulfate crystals on the negative electrodes. In the graphic, a carbon additive design will replicate the conventional lead-acid battery configuration shown on the upper left. Johnson Controls (JCI) and Exide Technologies (XIDE) are both actively developing carbon enhanced lead-acid batteries in both flooded and absorbed glass mat, or AGM, form factors. Both companies claim performance improvements of 100% or more, which can reduce the capital cost per cycle by 50% or more.

The second innovation PNNL discussed is an asymmetric lead-carbon capacitor that uses a carbon electrode assembly to replace conventional lead-based negative electrodes. In the graphic, an asymmetric lead-carbon capacitor is shown on the upper right. The key advantages noted by PNNL include a higher operating voltage for the cell as a whole, greater utilization of negative electrode capacitance, the elimination of negative electrode sulfation and reduced swings in acid concentration. The asymmetric lead-carbon capacitor was patented in 2001 and is owned by Axion Power International (AXPW.OB) which has trademarked the name PbC® and filed a suite of protective patents around the core technology. In exhaustive performance tests over the last three years, Axion has demonstated that the PbC battery:
  • Offers a depth of discharge of up to 70%, as compared to 30% for conventional lead-acid;
  • Offers stable round-trip energy efficiency of 85%, as compared to 50% to 75% for conventional lead-acid;
  • Offers cycle life improvements of 400% or more;  and
  • Offers dynamic charge acceptance rates that are a 10x improvement over conventional lead-acid.
In combination, these unique features of the PbC battery can reduce capital cost per cycle by an order of magnitude and make the PbC the most cost-effective electrochemical storage system in the industry. Axion's PbC battery is almost ready for commercial roll-out. The company has taken delivery of its second generation electrode fabrication line and expects to commission the line by the end of this month. Once the line is commissioned, potential customers who have been testing first generation products for over a year will need to conduct extensive process and equipment validation evaluations before placing orders. Barring unforeseen difficulties, that process should be completed this year. Axion has enough capital to finance its activities over the next year, but will need additional capital to build new electrode production capacity if demand for its product develops. Given the unique attributes of the PbC technology and Axion's relatively low market capitalization of $70 million, I believe Axion has limited downside risk and attractive upside potential.

The last innovation PNNL discussed in the field of advanced lead-acid batteries was the Ultrabattery, a half-measure developed by CSIRO that represents an improvement over conventional lead-acid batteries but does not offer all the performance advantages of the PbC. In the graphic, Ultrabattery is shown on the bottom. The PNNL report was the first detailed discussion I've seen of the Ultrabattery technology and it highlights a couple of issues that strike me as potentially problematic. During a discharge cycle the Ultrabattery does not begin to access the capacitance of its carbon electrode until the lead electrode has been depleted. Likewise during a charge cycle, the carbon electrode charges first which results in significant hydrogen production at the lead electrode.

Several lithium ion battery companies including A123 Systems (AONE), Ener1 (HEV) and Altair Nanotechnologies (ALTI) have sold high profile demonstrations of their technologies in grid- connected applications. After reading the PNNL report I'm more convinced than ever that these demonstrations will not turn into sustainable businesses until those manufacturers are able to overcome a variety of hurdles relating to system cost, safety, durability and cycle life. They may be successful, but when I compare their market capitalizations with the market capitalizations of ZBB and Axion, I have to believe that the greater upside potential lies in the companies with the lower current market capitalizations.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and owns a substantial long position in its common stock.

March 06, 2011

Alice in EVLand – Cracks in the Looking Glass

John Petersen

In his 2006 State of the Union Address, President George W. Bush said:

"Keeping America competitive requires affordable energy. And here we have a serious problem: America is addicted to oil, which is often imported from unstable parts of the world. The best way to break this addiction is through technology."

What a crock of balderdash! If you compare US fuel prices with those in other industrialized countries, gasoline is a screaming bargain and the same can be said for electricity. It's not the energy we use that's a problem. The problem is the immense amount of energy we waste, and that problem will keep getting worse until higher prices force us to change.

The world can't stop using oil without immeasurable suffering. Since we can't simply quit, the best we can do is accept the ugly truth that we're all wasteful petroleum gluttons who need to cut our consumption to more sensible levels. You don't cure drug addiction with better and cheaper drugs, and we can't cure our oil addiction with magic technologies mandated by Congress. We must accept personal responsibility and change our wasteful habits instead of blaming others or looking for a painless solution. In the final analysis, the solution to our problems is visible in every looking glass we pass.

Three weeks ago I wrote "Alternative Energy Technologies and the Origin of Specious," an article that examined the serial failures of panacea energy policies that promised independence without pain. Since then I've seen a number of reports that strike me as cracks in the EVLand looking glass, including:
  • A February 28th earnings release from A123 Systems that reported 69.2 million watt-hours of battery shipments, $73.8 million of battery sales, and $94.3 million of production costs for the year ended December 31, 2010; which pencils out to an average customer price of $1,067 per kWh and an average production cost of $1,363 per kWh.
  • A March 2nd report from hybridcars.com that cumulative sales of the GM Volt and Nissan Leaf for the first two months of this year were a whopping 756 units, as compared to cumulative HEV sales of 42,726 units.
  • A March 3rd Bill Ford Jr. interview at the ECO:nomics Conference where he characterized the Volt and Leaf as "talismanic vehicles" and expressed grave reservations about meaningless sales projections, the lack of charging infrastructure and the grid's ability to support electric vehicles if they ever became mass market products.
Many readers assume that I have an irrational hatred of electric vehicles and the companies that make them when in truth my only concern is whether those companies are good investments at current prices. During his recent presentation at the United Nations Climate Change Conference in Cancun, Dr. Steven Chu, the Secretary of Energy, said:

"And what would it take to be competitive? It will take a battery, first that can last for 15 years of deep discharges. You need about five as a minimum, but really six- or seven-times higher storage capacity and you need to bring the price down by about a factor of three. And then all of a sudden you have a comparably performing car; let's say a mid-sized car which has a comparable acceleration and a comparable range."

***

Now, how soon will that be? Well, we don't know, but the Department of Energy is supporting a number of very innovative approaches to batteries and its not like its 10 years off in the future, in my opinion. It might be five years off in the future. It's soon. Meanwhile the batteries, the ones we have now, will drop by a factor of two within a couple of years and they're gonna get better. But if you get to this point, then it just becomes something that's automatic and I think the public will really go for that."

When Dr. Chu tells the world that battery manufacturers won't have a competitive product unless their prices fall into the $300 per kWh range and A123's annual earnings release reports that their production costs overshot that goal by a whopping $1,000 per kWh last year, I don't see a lot of upside potential. When a poorly capitalized company like Tesla Motors trades at 11.5 times book value and 20.4 times last year's sales I wonder what the markets are smoking. When more than half of Ener1's equity is in mushy balance sheet categories like intangible assets, goodwill and investments in money losing subsidiaries, I can't help but think back to the asset impairment charges that crushed C&D Technologies last year. I'm completely baffled by the valuation disconnect at Valence Technologies which is upside down to the tune of $67 million but sports a $243 million market capitalization.

I hate to be the bearer of bad news, but these companies are just starting their journey into the valley of death. They may survive the trek, but their bloated stock prices can't. The EV dream may be beautiful, but for the next decade EV investments will be ugly as sin.

Each of us knows that we need to go on a petroleum diet, but none of us is willing to starve in the process. For the next decade, at least, the only real solution will be aggressive steps toward increasing fuel efficiency. Observant investors saw the writing on the wall when the EU and the US adopted stringent new CO2 emissions and fuel economy regulations that will start taking effect this year. I saw the impact last week in Geneva where the press headlines gushed over grand plans for plug-in cars but the vehicles on display proved that manufacturers are turning to diesel and natural gas fuel systems, direct fuel injection, dual clutch transmissions and stop-start systems as their mass market solutions. We all know that actions speak louder than words. I'm here to tell you the automakers' actions don't have plugs.

Two weeks ago I identified a list of five fuel efficiency stocks that should outperform the market by a wide margin over the next couple years because the die is cast and the solutions are being implemented today. To keep things interesting, I'll use last Friday's closing prices to formalize that list in a hypothetical $25,000 long portfolio structured as follows:

Company Symbol Shares Investment
Johnson Controls JCI 121 $4,998.51
Enersys ENS 139 $4,984.54
Maxwell Technologies MXWL 281 $4,993.37
Exide Technologies XIDE 431 $4,995.29
Axion Power AXPW.OB 6,172 $4,999.32
Cash

$28.97
Total


$25,000.00

I'll also use last Friday's closing prices to formalize my long-standing and oft-repeated position on vehicle electrification with a hypothetical $25,000 short portfolio structured as follows:

Company Symbol Shares Investment
Tesla Motors TSLA -200 -$4,990.00
A123 Systems AONE -599 -$4,995.66
Ener1 Inc HEV -1,428 -$4,998.00
Altair Nanotechnologies ALTI -1,953 -$4,999.68
Valence Technology VLNC -3,144 -$4,998.96
Cash

$49.982.30
Total


$25,000.00

In coming months I’ll revisit both hypothetical portfolios on a regular basis and either gloat or eat crow as the circumstances dictate. It will be fascinating to see whether the cracks in the looking glass spread or heal themselves.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and has a substantial long position in its common stock.

February 23, 2011

Just One Sector – Fuel Efficiency Pure Plays

John Petersen

In 1789 Benjamin Franklin wrote "in this world nothing is certain but death and taxes." Today he probably would have written "in this world nothing is certain but death, taxes and rising oil prices." There's no escaping the misery, but astute investors who take the time to understand the fundamental trends can profit as the misery unfolds. For the short term, I'm convinced the biggest opportunities will be in fuel efficiency technologies for cars and light trucks.

After 20 years of complacent stagnation, the US started to get serious about light-duty vehicle fuel efficiency in 2005 and has made solid progress with improvements in the 14% to 18% range. The rate of change will ramp rapidly over the next five years as aggressive new CAFE standards that were adopted in April 2010 take effect. The following graph provides an at a glance summary of new light-duty vehicle fuel efficiency over the last 30 years and new fuel efficiency standards for the next five years.

2.23.11 Fuel Efficiency.png

In their 2010 adopting release for the new CAFE rules, the NHTSA and EPA identified three fuel efficiency technologies that would play crucial roles in automakers' efforts to meet the new standards (page 484):

Efficiency Technology Fuel Savings
Penetration
Gasoline direct fuel injection
4%
60%
Dual clutch transmissions
7%
55%
Stop-start idle elimination
8%
42%

The usual diversified group of first tier manufacturers of automobiles and component systems will control two of the three technologies. Only one, stop-start idle elimination, offers a pure-play opportunity with a certain outcome.

Stop-start is the most sensible fuel efficiency technology you can imagine – turn off the engine while the car is stopped in traffic. While the concept is simple, implementation is a beast because drivers typically want their sound systems, climate control, lights and other accessories to keep working when the engine is off. Therefore, the key enabling technology for start-stop systems is a better starter battery.

Traditionally, a battery had to start a car once during a normal trip. With a stop-start system, however, the battery has to start the engine an average of once per mile and carry critical accessory loads while the engine is off. For a one-minute engine-off cycle, the accessories will demand ten times as much energy as the starter. For a 15-mile commute with one engine-off cycle per mile, the battery will have to deliver 165 times the energy that it would in a car without stop-start. The battery load is immense, but an optimized stop-start system can slash fuel consumption in city driving by up to 15% and do it for an incremental capital investment in the $400 to $800 range.

The normal flooded lead-acid batteries we've used for decades simply can't stand up to the demands of stop-start systems. That reality has forced automakers to rely on cut-out systems that disable the stop-start function when the battery's state of charge falls below a minimum level, and won't re-enable the stop-start function until the battery recovers an acceptable state of charge. The result is stop-start systems that don't function anywhere near peak efficiency. To minimize problems, automakers are currently using dual battery systems and upgrading to absorbed glass mat, or AGM, batteries.

In recognition of the shortcomings of flooded batteries, the leading battery manufacturers are building new AGM battery production capacity at a blistering pace. In 2007, Johnson Controls (JCI), the world's biggest battery manufacturer, had global production capacity for 400,000 AGM batteries per year. Their announced expansion projects will boost that capacity to 11.2 million AGM batteries per year by 2014 and further expansions in the US are being discussed. Exide Technologies (XIDE) is also on an expansion spree that will boost its AGM battery capacity from 500,000 units in 2009 to 3.5 million units in 2013. On a worldwide basis, Lux Research forecasts that AGM battery demand will soar by 800% over the next five years, from three million units in 2010 to 27 million units in 2015. As they substitute higher margin AGM batteries for lower margin flooded batteries, the revenues and margins of leading battery manufacturers including JCI, Exide and to a lesser extent Enersys (ENS) will soar. Their stock prices will follow suit.

While AGM batteries are currently the best available technology for stop-start systems, they are far from ideal because their ability to recover an optimal state of charge deteriorates rapidly as the battery ages. Using simulation protocols from BMW and Ford, researchers have learned that the time required for an AGM battery to recover from an engine-off event increases from 50 to 60 seconds with a new battery to 4 or 5 minutes with a battery that's been in service for six months. The bottom line is automakers need a better solution than AGM batteries. Until a better solution comes along, however, the AGM battery will reign supreme as the battery of choice for the stop-start market.

The two principal contenders for "better solution" honors are:
  • A multi-component system from Continental AG and Maxwell Technologies (MXWL) that combines an AGM battery, a small supercapacitor module and associated control electronics in a system that eliminates the voltage drops and black screens that commonly occur when the starter engages at the end of an engine-off cycle; and
  • The third generation lead-carbon battery from Axion Power International (AXPW.OB) that replaces the lead-based negative electrode in a conventional AGM battery with a carbon electrode assembly that boosts cycle life by 400% and provides consistent charge recovery times of about 35 seconds through four years of simulated use.
The Maxwell - Continental system is available now and was recently selected by PSA Peugeot Citroën for use in Citroën C4 and C5 diesels featuring PSA's e-HDi second generation micro hybrid system. With an estimated three-year value in the $50 million range, this design win should provide a significant boost for Maxwell's top-line revenue. Despite its advantages, however, the Maxwell - Continental system is not an ideal solution because the supercapacitor can slow but it can't stop the deterioration of the AGM battery it's paired with. So over time, vehicles equipped with the Maxwell-Continental system will suffer the same kind of performance degradation that all other stop-start systems exhibit.

The most promising solution to the challenges of stop-start, the PbC® battery from Axion, is in the final development stages and won't be ready for a large-scale commercial rollout until 2012. Axion is currently installing a second-generation fabrication line for their serially patented carbon electrode assemblies and potential customers should begin validation testing on the new fabrication processes and equipment soon. Once its potential customers validate the fabrication process, the last major step will be to build additional electrode fabrication capacity so that Axion can manufacture PbC batteries on its own AGM battery line and sell electrode assemblies to other AGM manufacturers. Since the PbC electrodes are designed to work as plug-and-play replacements for traditional lead-based electrodes, Axion should be uniquely positioned to leverage existing AGM battery manufacturing capacity while giving other battery manufacturers the opportunity to sell a premium product to their existing customers.

While the PbC battery is still a development stage technology and Axion is just barely out of the nano-cap range with a $60 million market capitalization, its roster of disclosed industry relationships is extraordinary. Axion has longstanding relationships with both East Penn Manufacturing and Exide, the second and third largest AGM battery manufacturers in North America; it has a service contract to develop a battery management system for Norfolk Southern (NS) which wants to retrofit a portion of its 3,500 unit locomotive fleet with hybrid drive; and the PbC battery has demonstrated exceptional performance during 18 months of testing by BMW, the industry leader in stop-start with over a million EfficientDynamics vehicles on the road today. In over 30 years as a small company securities lawyer, I've never seen another company that was able to generate a comparable level of interest and involvement from the giants in its industry.

The energy storage sector offers a wide range of fuel efficiency pure plays. The following table provides summary data on key financial (in millions) and market metrics that I consider important. While JCI is not technically an energy storage pure play because of its diversified operations in auto parts and building efficiency, I've included it in this list because 14.6% of its revenues and 52.5% its earnings are derived from battery manufacturing operations.

2.23.11 Market Metrics.png

While I closely follow the energy storage and vehicle electrification sectors and am convinced that every manufacturer who can bring a cost-effective product to market will have more demand than it can handle, these five companies have the clearest paths to market beating growth over the next five years and are my favorites for that reason. JCI, Enersys, Exide and Maxwell have been stellar performers since December 31, 2008 with market crushing gains of 126% to 264%. Axion has been the laggard of the group, losing 39% of its market value it raised new capital in a brutal market and worked to complete the development of its promising PbC technology and start climbing out of the valley of death. For the next few years, I expect the entire group to outperform the market by a wide margin because the die is already cast.

Fuel efficiency has been a hot topic in the automotive world for the last five years and new regulations in the US and EU will provide a massive impetus for immediate change. Increasing political turmoil in oil producing regions can only add to the sense of urgency. There is a wide variety of potential long-term solutions, but short-term solutions to immediate problems are very limited. For the next five years, stop-start will be at or near the top of the list.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

February 16, 2011

Alternative Energy Technologies and the Origin of Specious

John Petersen

Thanks to a recent comment from JLBR, I've found a new hero in Dr. Peter Z. Grossman, an economics professor from Butler University who cogently argues that government attempts to force alternative energy technologies into an R&D model that was created for the Manhattan Project and refined for the Space Program will always result in commercial disaster because "the goal of the Apollo Program was the demonstration of engineering prowess while any alternative energy technology must succeed in the marketplace." In a recent article titled "The Apollo Fallacy and its Effect on U.S. Energy Policy" Dr. Grossman summarized the problem as follows:

"The Apollo fallacy has been detrimental to the development of effective energy policies in the US [and] instead of asking what kinds of programs might be useful, the government holds out the promise of a technological panacea to be delivered simply by an act of Congress. The prospect of an energy panacea actually has some political benefits. It allows politicians to claim that they can provide simultaneously the two outcomes most Americans seek from energy policy: low energy prices and energy independence. In fact, with conventional resources these goals are mutually exclusive. To get low prices, the government should provide incentives to drill for oil and gas not just in the US but also in places where they might be exploited more cheaply – of course making the nation more dependent on outside sources. To lessen dependence (true energy autarky is not a feasible goal) on foreign resources, the only method government can use with conventional resources is to raise prices through taxes. But a new technology presumably can to both at once: provide cheap, US-made energy. Unfortunately, the history of energy programs argues that the pursuit of a technological-commercial panacea will fail."

In a 2008 white paper titled "The History of U.S. Alternative Energy Development Programs: A Study of Government Failure," Dr. Grossman started with the Eisenhower Administration's wildly optimistic plans to commercialize nuclear fission reactors for civilian electricity and offered a brief history of serial energy policy failures including:
  • The Nixon and Ford Administrations' support for synthetic fuels from coal and oil shale;
  • The Carter Administration's support for synthetic fuels, nuclear fusion and ethanol; and
  • The Clinton Administration's "Partnership for a New Generation of Vehicles" that failed miserably while privately funded initiatives from Toyota and Honda were remarkably successful.
My additions to Dr. Grossman's list would include Bush the Younger's support for fuel cells, the hydrogen economy and corn ethanol, and the Obama Administration's support for vehicle electrification and alternative energy in general.

These ambitious energy policies all shared three fatal flaws:
  • An inability to distinguish between the technologically possible and the economically desirable;
  • A belief that intervention can force innovation and overcome technical challenges on time and within budget; and
  • A failure to recognize that generous subsidies invariably lead to increased demand for more generous subsidies.
The end result has always been grandiose, unrealistic and extravagant mandates that resulted in catastrophic losses for naive and credulous investors who bought the hopium.

For over sixty years, the government has consistently and predictably failed to understand that industrial revolutions arise from technologies that are perfected by entrepreneurs and prove their value in a free market. The government can accelerate advances in basic science and engineering when cost is not an object, but it can't make technologies cost-effective or ignore the realities of a resource-constrained world. The following cartoon from Jan Darasz appears in the most recent issue of Batteries International Magazine and may overstate the problem a bit, but only a tiny bit.

2.16.11 Daraz Cartoon.png

During the "Sputnik moment" discourse in his recent State of the Union Address, President Obama promised to spend billions of taxpayer dollars to put a million plug-in vehicles on the road by 2015. Back in the business world, Johnson Controls (JCI) and Exide Technologies (XIDE) are spending their own money, together with a $34 million ARRA battery manufacturing grant, to build factories that will make AGM batteries for 14.7 million micro-hybrids a year by 2014. The President's plan will save up to 400 million gallons of gas per year by 2015. The 56 million micro-hybrids that will be built during the same time frame using AGM batteries from JCI and Exide will save 1.6 billion gallons of gas per year. Last time I checked, spending millions to save billions of gallons of gasoline was more sensible than the inverse.

I've frequently argued "Alternative Energy Storage Needs to Take Baby Steps Before it Can Run." A favorite quote from William Martin's novel "The Lost Constitution" says it all – "In America we get up in the morning, we go to work and we solve our problems." Unfortunately government programs never use the tools that are readily available to do the work. Instead they impede sensible actions like using compressed natural gas instead of gasoline and let urgent problems fester while new, exotic and politically popular technologies are invented and refined, but never commercialized. A cynic might suggest that it's a great way for a politician to kick the can down the road while deferring blowback from policy failures and unintended consequences until his successor takes the oath of office.

We have 60 years of experience that proves well intentioned but ill-conceived government alternative energy technology initiatives aren't doing the job. Investing $46 of capital to save a gallon of gasoline with a plug-in vehicle is foolish when you can save that same gallon of gasoline with a $24 capital investment in an HEV. Taxing Peter to underwrite the cost of Paul's new car will impoverish the masses instead of empowering them. Using imported metals to make non-recyclable batteries for the purpose of conserving more plentiful petroleum has all the intellectual integrity and economic appeal of using cocaine as a weight loss supplement.

There are solid growth opportunities in the domestic energy storage sector. JCI and Enersys (ENS) both trade at about eighteen times earnings while Exide trades at about twelve times earnings. In the more speculative small company space, Axion Power International (AXPW.OB), ZBB Energy (ZBB) and Beacon Power (BCON) all present intriguing value propositions as they emerge from the trough of disillusionment and begin to build industry relationships and revenue by proving the value of their products one baby step at a time.

I'm convinced that every manufacturer of energy storage devices that brings a cost-effective product to market will have more business than it can handle as dwindling global energy supplies make storage more cost-effective than waste. That conviction, however, does not extend to market darlings like Tesla Motors (TSLA), A123 Systems (AONE) and Ener1 (HEV) who owe their high profiles and huge swaths of their balance sheets to government largess and glittering promises of an all-electric future once they prove that their wonder products work in the hands of normal consumers and learn how to manufacture better than Toyota Motors (TM), Sony (SNE), Panasonic (PC) and a host of lesser industrial luminaries that have proven their capabilities with decades of successful execution.

Over the last several months I've become convinced that a transition from gasoline to compressed natural gas may be one of the great opportunities of our age. Natural gas is abundant and clean, and an easy domestic substitute for imported oil. While I don't know as much as I'd like to about fiscal multipliers, I have to believe a massive shift from imported oil to domestic natural gas would reduce energy costs to consumers, slash CO2 emissions, generate trillions in additional GDP and go a long way toward ameliorating the looming deficit spending crisis many observers predict.

Just yesterday, the 2011 Honda Civic GX, a conventional vehicle with a CNG fuel system, tied with the all-electric Nissan Leaf for top honors in the American Council for an Energy-Efficient Economy's list of the Greenest Vehicles of 2011, a position it's held for eight years in a row. The Toyota Prius came in fourth, well ahead of the GM Volt, which came in seventh. I can only imagine what the ACEEE ratings would look like if Honda added a hybrid drive to the Civic GX or Toyota added a CNG fuel system to the Prius.

Mark Twain observed that "history doesn't repeat itself but it does rhyme." When it comes to specious and ill-conceived alternative energy technology initiatives that originate on the banks of the Potomac and rapidly mutate into bad investments, I can't help but wonder whether we're just hearing another chorus from the same old song – 99 Bottles of Energy on the Wall.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

February 06, 2011

Electric Vehicles and the Natural Resource Cliff

John Petersen

We all love to whine and complain about oil prices because we buy gasoline regularly and that makes the price changes obvious. To solve this overwhelming problem, myopic visionaries with rose colored glasses propose a simple solution – convert personal transportation from vehicles powered by oil to vehicles powered by clean, free and renewable electricity from the wind and sun. Like most fairy tales, it can't happen in real life which means it won't. This is not a technology issue. It's a raw materials issue and electric vehicles cannot solve the problem.

In the first three quarters of 2010, the world produced an average of 86 million barrels of crude oil per day. That works out to 0.65 metric tons, or 200 gallons per year, for each of the planet's 6.6 billion inhabitants. There's no doubt about it, oil is a scarce resource – at least until you compare it with metals that are two to five orders of magnitude scarcer. To put oil in its proper perspective, the following table summarizes global production data for several critical natural resources.

Natural
Global Production
Per Capita
Resource
(Metric Tons)
Production
Crude Oil
4,282,736,000
648.9 kg
Iron & Steel
2,400,000,000
363.6 kg
Aluminum
41,400,000
6.3 kg
Copper
16,200,000
2.4 kg
Lead
4,100,000
0.7 kg
Nickel
1,550,000
0.2 kg
Rare Earths
130,000
20 g
Lithium
25,300
4 g

For every thousand pounds of global oil production, we produce ten pounds of aluminum, four pounds of copper, one pound of lead, six ounces of nickel, a half-ounce of rare earth metals and a tenth of an ounce of lithium. No thoughtful investor can compare per capita production of oil and essential metals and rationally conclude that we can increase metal consumption in the name of conserving oil. The resource sophistry can't work in anything beyond technical puppet shows for lazy, impressionable or childish minds.

To make matters worse, metal prices are anything but stable. We ignore changes in metal prices because they're usually buried in the cost of other products. That doesn't mean that metals are a bargain compared to oil or that their prices are any more stable. The following graph tracks market prices for oil and three of our most important metals over the last 20 years. The trend lines are remarkably similar.

2.6.11 Commodity Prices.png

If we even try to significantly increase metal consumption in an effort to conserve oil, the inevitable supply and demand imbalances will quickly eliminate any advantage and simply make the situation worse. In the final analysis, any energy policy or business model that increases metal consumption in an effort to conserve oil must fail. We've already seen the disastrous results of using food to make ethanol for fuel. There will be blood if we follow the same foolish path with metals.

I am a relentless and unrepentant critic of plug-in vehicle hype and propaganda because any plan to use hundreds of pounds of metal to replace a fuel tank must fail. There aren't enough metals in the world to make a dent in global oil consumption and using scarce metal resources to make non-recyclable components like batteries and motors for plug-in vehicles can only make the problem worse. It's sabotage masquerading as a solution.

The only transportation technologies that stand a chance of survival in a resource-constrained world are those that use tiny amounts of metals to conserve large amounts of oil. Electric two-wheeled vehicles work as long as the empty vehicle weight is less than twice the passenger weight. For automobiles, resource effective technologies range from simple stop-start idle elimination at the low end to Prius class HEVs at the high end, although even these technologies can be marginal if the primary components are not easily recycled. The instant you add a plug the resource balance goes to hell in a handbag along with the investment potential.

All the political will, good intentions and happy-talk forecasts in the world cannot change the ugly facts. We’re driving toward a natural resource cliff at 120 mph and fiddling with the dials on the navigation system.

With the exception of Advanced Battery Technologies (ABAT) and Kandi Technologies (KNDI), which have the common sense to focus on entry-level two- and four-wheeled electric vehicles with minimal natural resource inputs, the entire electric vehicle sector is a bug in search of a windshield. It doesn't matter how cool the products are if there will never be enough affordable raw materials to make them in meaningful volume.

Several companies that I follow have no chance of survival when their business models are analyzed from a resource sustainability perspective. The list includes Tesla Motors (TSLA), Ener1 (HEV), A123 Systems (AONE), Valence Technologies (VLNC) and Altair Nanotechnologies (ALTI). In each case their products have extreme natural resource requirements and little or no end-of-life recycling value. They will compound our problems, not solve them.

Several other companies that I follow have good resource sustainability profiles because their products can make major contributions to oil conservation without putting undue strain on global metal production. My list of sustainable companies includes Johnson Controls (JCI). Enersys (ENS), Exide Technologies (XIDE), Beacon Power (BCON), ZBB Energy (ZBB) and Maxwell Technologies (MXWL). In each case their products have moderate resource requirements and high end-of-life recycling value.

There is only one energy storage company that can offer better performance and lower resource requirements in the same product – Axion Power International (AXPW.OB). Its serially patented PbC battery technology uses 30% less lead than a conventional lead-acid battery, boosts cycle life and dynamic charge acceptance by an order of magnitude, and retains the recycling advantages of lead-acid batteries, the most recycled product in the world. The unique performance characteristics of the PbC technology are proven and the principal remaining risk is further refining fabrication equipment and processes for Axion's carbon electrode assemblies. When Axion's equipment, processes and products complete the final stages of validation testing by its principal potential customers, the technology can be easily ramped to a global footprint within a few years for a fraction of the cost of other emerging energy storage technologies.

Axion has never been a stock market darling because its management speaks in the past tense and focuses on challenges overcome, milestones passed and goals accomplished. As a result of its low key approach to the financial markets, Axion carries a $54 million market capitalization despite the fact that its disclosed industry and customer relationships include East Penn Manufacturing and Exide Technologies, the second and third largest lead-acid battery manufacturers in North America, Norfolk Southern (NSC), the fourth largest railroad in North America and BMW, one of the most highly regarded automakers in the world. Any time a tiny company with a transition stage technology can quietly build relationships with several world-class companies, astute investors should pay attention.

Seven years ago I believed Axion had an honest shot at the big leagues. Today I think I may have set my sights too low. The progress I expect won't happen overnight, but it will happen long before we see a million plug-in vehicles on the road in the United States.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and has a substantial long position in its common stock.

February 03, 2011

Battery Recycling Realities for Energy Storage Investors

John Petersen

One of the most fervently debated and poorly understood topics in energy storage is the subject of battery recycling. What percentage of the raw materials that go into a battery can be economically recovered from used batteries with existing recycling technology and infrastructure? While the details are quite complex, this article will offer a high-level overview of the economics of battery recycling for energy storage investors.

Lead-acid batteries are the most recycled products in the world. The process is both straightforward and cost-effective. When batteries arrive at the recycling plant, they're put through a shredder and then sent to a water bath. The shredded plastic floats to the top where it's cleaned and reprocessed like any other recycled plastic. The shredded metals sink to the bottom where they're transferred to a blast furnace for further processing. The output from the blast furnace is mostly molten lead with small amounts of copper and other metals that are skimmed from the surface for disposal or further processing. The lead is then poured into ingots and returned to manufacturers for use in making new batteries.

Because of the inherent efficiency of the recycling process, over 97% of all lead-acid batteries in the US and Europe are recycled and almost 80% of the lead used in the US comes from recycling rather than mining. Many major lead-acid battery manufacturers, including Johnson Controls (JCI), Enersys (ENS) and Exide Technologies (XIDE), operate company-owned recycling facilities for the dual purpose of protecting the environment and stabilizing their raw materials supply chains.

Nickel Metal Hydride [NiMH] batteries present a more complex recycling challenge than lead acid batteries. First the electrolyte is evaporated using a thermal process and the batteries are then shredded and put into a blast furnace. The output from the blast furnace is a simple alloy of nickel (~60%) and steel (~40%) that requires moderate post-recycling processing before the metals can be reused to make stainless steel. All rare earth metals in NiMH batteries end up in a slag that's either sent to a landfill or used for construction material.

Using material recovery estimates published by Umicore Battery Recycling and average annual metal prices from the US Geological Survey, I've calculated that roughly two-thirds of the raw materials that go into a NiMH battery are recoverable through recycling while one-third of those materials are lost forever.

Lithium-ion batteries are a couple steps beyond NiMH in terms of recycling complexity and cost. The closed loop Umicore recycling process that will be used to recycle batteries for Tesla Motors (TSLA) includes the following steps.
  • Step 0: collection and reception of batteries (worldwide, Hoboken (Belgium)
  • Step 1: smelting + energetic valorisation (in Hoboken, Belgium)
  • Step 2 & 3 : refining & purification of metals (in Olen, Belgium)
  • Step 4 : oxidation of Cobalt chloride into Cobalt oxide (in Olen, Belgium)
  • Step 5: production of Lithium metal oxide for new batteries (in South Korea)
The electrolytes, plastics and carbons used in lithium-ion batteries are burned off and destroyed in the recycling process. The output from the blast furnace is a complex alloy of cobalt (~37%), steel (~37%), Copper (~22%) and Nickel (~4%) that requires extensive post-recycling processing before the metals can be reused. The lithium and aluminum end up as slag that is either sent to a landfill or used as construction material.

Using material recovery estimates published by Umicore and average annual metal prices from the US Geological Survey, I've calculated that about half of the raw materials that go into a lithium-ion battery are recoverable through recycling while the other half the materials are lost forever.

In a press release last week Tesla announced a new battery-pack recycling program with Umicore. A related blog from Tesla's Director of Energy Storage Systems spoke in glowing terms of how the recycling would provide "a high margin of return." The claims may defensible in Tesla's case since (a) they use lithium cobalt oxide batteries and roughly 75% of the economic value recovered through the use of Umicore's process is attributable to the recovered cobalt, and (b) even $1 in recycling revenue would be a "high rate of return" when compared with the alternative of paying a landfill tipping charge. It's certain, however, that Tesla's potential recycling revenue won't be more than a low single digit percentage of the cost of a new battery pack. For chemistries like lithium-iron-phosphate from A123 Systems (AONE), lithium-magnesium-phosphate from Valence Technologies (VLNC), lithium-iron-sulfate and lithium-magnesium-oxide from Ener1 (HEV) and lithium-titanate from Altair Nanotechnologies (ALTI) that use cheaper electrode materials, recycling is likely to be a major cost burden instead of an insignificant revenue source.

Disclosure: None.

January 27, 2011

Electric Vehicles – The Opportunity of Which Decade?

John Petersen

Hardly a day passes without some talking head breathlessly describing electric vehicles as the opportunity of the decade. The fine point most investors miss, however, is that the decade they're describing won't begin until 2020 and for the next seven to ten years electric vehicle manufacturers like Tesla Motors (TSLA) and lithium-ion battery manufacturers like Ener1 (HEV) and A123 Systems (AONE) will hemorrhage cash as they try to traverse the trough of disillusionment that runs through the cruel black heart of the valley of death.

The following graph is a stylized view of the valley of death from Osawa and Miyazaki with a red overlay that highlights the trough of disillusionment. This is the most difficult period in the life of a product when its manufacturer must identify and eliminate any defects, optimize manufacturing processes, minimize production costs, establish a market presence and earn market share. For big-ticket items like cars, the failures and mediocre performers outnumber successes by a wide margin.

1.26.11 Valley of Death.png

Today we're witnessing the first product launches for the Tesla Roadster, the GM Volt and the Nissan Leaf. Despite their gee-whiz glamor and sex appeal, the crushing economic reality is that it takes $46 of incremental capital investment to save a gallon of gasoline per year with a plug-in while it only takes $24 of incremental capital investment to save the same gallon of gasoline per year with an HEV. Under those circumstances, the tyrannical laws of economic gravity dictate that the time between the "Product launch" and "Success as a new product" will be five to seven years under optimal conditions and a decade or longer under likely conditions. Let's be honest, an 8-year payback on an HEV premium is nothing to write home about but a 15-year payback on a plug-in vehicle premium is absolutely atrocious.

My optimistic self wants to believe that plug-in vehicles will eventually offer a sensible value proposition for the average consumer, but my rational self knows that it won't happen quickly because paradigm shifts never do.

In 2000 Toyota introduced a new fuel efficiency technology to the US market called a hybrid electric vehicle, or HEV. The idea was to improve fuel economy by capturing braking energy and immediately reusing it for electric launch and acceleration boost. While HEVs didn't require drivers to change their driving habits or their behavior, they were met with polite skepticism until they proved their value and performance over a period of several years in the hands of consumers. The following graph summarizes annual HEV sales by manufacturer from 2000 through 2010.

1.26.11 HEV Sales.png

In 2010, HEVs accounted for a miniscule 2.4% of light-duty vehicle sales in the US. It took eight years to sell the first million units because an eight-year payback was hard for consumers swallow and manufacturers were fighting a constant uphill battle with the laws of economic gravity. It took Toyota six years to top the 100,000 vehicle a year mark. Last year Toyota booked 69% of domestic HEV sales, Ford and Honda each booked 12%, GM and Nissan each booked 2.5% and the rest were insignificant. The only HEV model that can fairly be classified as a commercial success is the Toyota Prius.

President Obama may dream of a million plug-ins on the road by 2015, but a 15-year payback will be a non-starter for most buyers. Unless and until the technology premium falls to a point where the incremental capital investment per gallon of annual gasoline savings is competitive with an HEV, plug-ins will only appeal to a niche market of philosophically committed and mathematically challenged buyers.

The crucial fact that talking heads fail to grasp is that plug-in vehicles are not an incremental advance in automotive technology. They're a paradigm shift that will force consumers to change their driving habits and their behavior. Those realities bring human inertia into play along side the laws of economic gravity. It's not an easy market dynamic.

Since paradigm shifts are very rare, it's hard to find a current and directly comparable example. Instead we need to study historical paradigm shifts to see how they unfolded and how long the process took. One of the best examples I could find was the paradigm shift from draft animals to tractors on US farms. In that paradigm shift, the new technology was clearly superior to the legacy technology. The only real drawbacks were higher capital costs and less flexibility. Even so, this graph from Wessels Living History Farm shows that the paradigm shift occurred very slowly and it took 35 years for the new technology to earn a dominant market position.

1.26.11 Horse Tractor.jpg

The decade from 2020-30 may prove to be a golden age for plug-in electric drive if reliability, performance, consumer behavior and cost issues can be overcome during the next 10 years. Until then, the knock down drag out marketing battles will focus on direct competition between HEVs and plug-ins because it's extremely unlikely that electric drive will be cheap enough to compete head-to-head with internal combustion engines before 2020.

Under all reasonably foreseeable scenarios, the major business opportunity for the next decade will be improving efficiency for the 90% to 95% of new vehicles that won't have electric drive. In Europe, existing regulations require automakers to achieve an average fuel economy of 42 mpg for gasoline engines and 48 mpg for diesel engines by 2015. In the US, existing regulations require automakers to achieve an average fuel economy of 37.8 mpg for passenger cars and 28.8 mpg for light trucks in the same time frame. Stricter rules are already being discussed for 2020 and beyond. The specific fuel saving technologies automakers choose to meet these new fuel economy standards will not be offered to consumers as options. Instead they'll be standard equipment. Given a choice between relying on marketing and relying on government regulation, I'll bet on government regulation every time.

While emerging mechanical efficiency systems are a bit out of my depth, the leading electrical efficiency system for the next decade will be stop-start idle elimination. If you think about it for a second, it's the most sensible idea around - turn the engine off while your car's stopped in traffic. For simple systems that improve fuel efficiency by 5% the cost is only a couple hundred bucks. For more complex systems that improve fuel efficiency by 10%, the cost is still under $1,000. The one thing that both types of stop-start systems need is better starter batteries, which sets up a wonderful business dynamic for old line lead-acid battery manufacturers like Johnson Controls (JCI) and Exide Technologies (XIDE) and emerging lead-acid technology developers like Axion Power International (AXPW.OB). They may not sell any more batteries, but they'll sell better batteries that have higher prices and higher profit margins. Once you understand that an estimated 34 million new cars a year will need better batteries by 2015, the top line revenue impact and the bottom line profit impact will be stunning. It's a bird in the hand and nobody's paying attention because the application isn't sexy.

I've spent the last 30 years working as securities counsel for companies that were trying to traverse the valley of death. While it's always a miserable time for management teams, it's a disastrous time for investors and it's not unusual to see equities lose 90% of their value before the price begins to recover. Despite the media hype, investors in electric drive are in for a decade of unrelenting pain as plug-in vehicles experience slow uptake rates and have to compete with simpler and cheaper HEVs for market share. With slow plug-in vehicle uptake rates, it will be at least seven to ten years before widely heralded but vaguely defined economies of scale kick in.

If we learned anything from Microsoft and Apple, it's that the objectively cheap technology is the place to be for the first ten to fifteen years of a technological revolution and the objectively cool technology is only a reasonable investment when they figure out how to make cool cheap.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and hold a substantial long position in its common stock.

January 21, 2011

Nick Hodge's Night Time Solar Energy Tease

Tom Konrad, CFA

NiMH battery company that's going to "make coal and oil obsolete" sleuthed out.

I can't help but chuckle at the hyperbole of some promoters of alternative energy stocks.  We can wish that coal and oil will be obsolete tomorrow all we want, but it ain't gonna happen.  That's just what Nick Hodge was claiming in a recent teaser for Highpower Technology (HPJ)

How do I know it's Highpower that Hodge is hailing as the answer to all our hopes?  Because Travis Johnson, the Stock Gumshoe told me so.  Travis is the same guy who sleuthed out Magma Energy (MGMXF.PK) for us in a guest article a year ago, and that the "Sunless solar" stock Green Chip Stocks was using to stir up the interest of potential subscribers was New Energy Technologies (NENE.OB).

NiMH to save the day?

I'm actually a fan of looking at the stocks of companies using battery chemistries other than Li-ion, since they're less likely to be overpriced because they get less hype (at least until now.)  But I doubt a few improvements to Nickel-Metal Hydride (NiMH) technology are going to allow it to become an economical way to store solar power.  The Gumshoe may claim to not know much about battery technology, but I think he's spot on when he says, "It’s hard to believe that Sanyo or Panasonic or even China BAK or BYD is quaking in its boots."

If you want to know more about Highpower's advances in NiMH technology (or just want a chuckle), here's the full article on StockGumshoe.

You can also look in the comments here for AltEnergyStocks' battery expert John Petersen's answer to my question:
John, what's your opinion on Highpower's technology?  Will it make EVs affordable and oil obsolete?

DISCLOSURE: None.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

January 19, 2011

Alice in EVland Part III; Cost Benefit Analysis For Dummies

John Petersen

Sometimes I think bloggers like me are the real dummies. We spend so much time delving into the minutiae of a stock or sector that we manage to obscure the big picture with too much detail. I've certainly been guilty of that particular flaw over the last couple years and want to offer an apology to readers I've confused rather than enlightened.

Yesterday a reader sent me a copy of a presentation that Exide Technologies (XIDE) used in its December 2010 Investor Meetings. The slide on page 6 of the presentation did a great job of separating the wheat from the chaff on the subject of vehicle electrification and clarified my thinking on several points I've been trying to make for a long time. Using Exide's presentation data as a guide, I'm going to see if I can finally nail down the economics in terms everybody can understand. I'm sure we'll hear from those who don't want to understand in the comment section.

The following table summarizes the operating capabilities, incremental costs, expected fuel savings and expected CO2 emissions abatement of the leading vehicle electrification technologies. For the baseline case I used a new car with 30-mpg fuel economy and anticipated usage of 12,000 miles per year, which works out to a basline gasoline consumption of 400 gallons per year. The numbers aren't spot-on accurate, but they're certainly in the right range. Since subsidies distort comparisons by shifting the cost of consumption from the buyer of a plug-in vehicle to the taxpayers who pay for the subsidies, I'll ignore them for purposes of this article.

1.20.11 Electrification Table.png

My next graph uses the table data to show the comparative capital cost of leading vehicle electrification technologies per gallon of annual fuel saving and per kilogram of annual CO2 abatement. You can download an Excel file with the calculations here.

1.20.11 Cost Graph.png

It doesn't matter whether you use fuel savings or CO2 abatement as your preferred metric. Vehicles with plugs simply can't deliver anywhere near the bang for the buck that their simpler and cheaper hybrid cousins offer.
  • In the four hybrid categories, the average capital cost per gallon of annual fuel savings is $24 and the average capital cost per kg of annual CO2 abatement is $2.24.
  • In the two plug-in vehicle categories, the average capital cost per gallon of annual fuel savings is $46 and the average capital cost per kg of annual CO2 abatement is $7.25.
Cars with plugs may feel good, but until somebody repeals the laws of economic gravity they will never be an attractive fuel savings or emissions abatement solution.

Lead-acid batteries from Exide and Johnson Controls (JCI), supercapacitors from Maxwell Technologies (MXWL) and lead-carbon batteries from Axion Power International (AXPW.OB) are the only rational choices for stop-start systems and micro-hybrids. Lux research has recently forecast global production of up to 34 million vehicles per year by 2016. Since the growth of stop-start and micro-hybrids is being driven by pollution control and fuel economy regulations in Europe, the US and elsewhere, it's as close to a bird in the hand as most investors will ever find.

Mild and full hybrids have historically used NiMH batteries for their electric drive functions and lead-acid batteries for their starters. Unfortunately, the "M" in NiMH is the rare earth metal lanthanum and production restrictions in China will limit global ability to ramp NiMH battery production until alternate sources of lanthanum come on line. Due to the rare earth metal crisis, I'm convinced that mild and full hybrids will be a competitive market where lead-acid and lead-carbon batteries vie for a share of the down-market offerings while lithium-ion batteries and supercapacitors vie for a share of the up-market offerings. Since design and production decisions will ultimately be made by the automakers, I won't even try to forecast potential market penetration rates for the competing technologies.

Lithium-ion batteries from A123 Systems (AONE), Ener1 (HEV), Altair Nanotechnologies (ALTI), Valence Technology (VLNC) and a host of foreign manufacturers are the only technically feasible choice for plug-in vehicles. Since the basic economics of plug-in vehicles don't make sense to me, neither do the basic economics of their manufacturers and battery suppliers. I'm sure we'll hear from commenters who hold different views.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

January 18, 2011

Plug-in Vehicle Subsidies; Taxing Peter To Buy Paul's New Car

John Petersen

Industrial subsidies have been an important feature of the American economic landscape since the late 19th century for one simple reason – they work. After the steam locomotive proved its ability to quickly and cheaply move people and cargo long distances, the government launched a massive effort to span the country with steel rails and bring the benefits of a rapid, safe and reliable national transportation system to all its citizens. After electric lighting proved its merit, the rush was on to build a national infrastructure and bring the benefits to all. After the internal combustion engine proved its merit the rush was on to build better roads and highways, increase oil production and make automobiles a luxury all men could afford. After advances in communications and information technology proved their merit, we were off to the races again. In fact, it's hard to name an industry that hasn't been richly rewarded by our long tradition of subsidizing the rapid implementation of proven technologies through the creation of productive assets that make the nation richer.

Over the last decade, however, there's been a subtle erosion of subsidy theory that most observers have failed to notice. In addition to traditional subsidies that create productive assets and make the nation richer, we're seeing a proliferation of consumption subsidies that enrich individuals while providing no meaningful benefit to society. The poster child for this unconscionable rape of the treasury is the $7,500 tax credit for buying a plug-in electric vehicle. The government is quite literally taxing Peter to buy Paul's new car.

The credit will be available for the first 200,000 qualifying vehicles sold by a manufacturer at a direct cost of $1.5 billion per automaker. On the positive side of the ledger, Paul's new plug-in will reduce national oil consumption by about 100 barrels over its useful life at a cost of $75 per barrel. On the negative side, Paul's State, city, utility, employer and favored merchants will have to spend their own money adapting to Paul's increased demand for electricity and Paul's desire for a convenient charging infrastructure. I have to wonder if it wouldn't be cheaper to just give Paul a 10-year free gas coupon.

At this juncture I'm not sure which thought is most apropos, Everett Dirkson's quip, "a billion here, a billion there, and pretty soon you're talking real money;" Ayn Rand's bleak warning that "No private embezzlers or bank robbers in history have ever plundered people's savings on a scale comparable to the plunder perpetrated by the fiscal policies of statist governments;" or the bandit Calvera's self-absorbed arrogance in The Magnificent Seven, "If God didn't want them sheared, he would not have made them sheep!"

In December Vinod Khosla surprised cleantech investors when he called for an end to corn ethanol subsidies, which Al Gore characterized as a mistake motivated by presidential aspirations and the importance of the farm vote. While I agree wholeheartedly with their conclusions about corn ethanol subsidies, I have a very hard time buying into the argument that "subsidies should be a short-term, and not a permanent measure, used for five to seven years after a technology first starts scaling in order to allow it to transition down the cost curve until it can compete on its own merits."

No industrial revolution has ever flowered from a technology that did not first prove its merit to a skeptical, competitive and inertia bound market. Subsidies can accelerate the adoption of cost-effective innovations, but they can't make a silk purse out of a sow's ear. The harsh reality is that a business model that can't survive without subsidies can't thrive with subsidies.

While reasonable men can argue the pros and cons of every subsidy, the historical justification has always boiled down to the fact that subsidies encourage domestic economic activity, create domestic jobs and increase the national wealth. Even the much-maligned corn ethanol subsidies were paired with tariffs on imported ethanol to protect domestic producers. But when it comes to plug-in vehicles, domestic productive capacity and economic activity are irrelevant. The credit doesn't add a single brick to the nation's productive capacity and it doesn't even distinguish between foreign and domestic products. Regardless of where the vehicles are built the batteries that will account for 25% to 50% of their total cost will be manufactured overseas, or made in the US using imported equipment, components and supplies.

We've quite literally gone from sending jobs overseas to subsidizing job creation overseas.

In my adult lifetime, every government sponsored energy independence program has failed because the core technologies were not cost-effective. The schemes that were ultimately disastrous for investors include:

28 years ago Methanol
18 years ago Electric vehicles
13 years ago HEVs and Electric vehicles
8 years ago Hydrogen Fuel Cells
5 years ago Ethanol

Does anybody see a pattern besides me? Have investors who are paying ten times book value for Tesla Motors (TSLA) failed to learn anything from the experience of Ballard Power (BLDP) and Pacific Ethanol (PEIX)? What about battery manufacturers like A123 Systems (AONE), Ener1 (HEV), Altair Nanotechnologies (ALTI) and Valence Technologies (VLNC) who have no meaningful protection from foreign competition? Does anybody really believe a feel-good program that taxes Peter to buy Paul’s new car will, or for that matter should, survive looming Federal budget battles?

Albert Einstein defined insanity as "doing the same thing over and over again and expecting different results." Once again we've hared off on a tangent and tried to force uneconomic technologies on a skeptical, competitive and inertia bound market. In the process we've made a mockery of more than a century of sound industrial subsidy theory to enrich individuals while making the nation poorer.

Disclosure: None.

December 30, 2010

Why Energy Storage Investors Must Understand Newton's Laws

John Petersen

Vinod Khosla, the founder of Sun Microsystems and an icon of cleantech venture capital investing, is famous for bluntly telling audiences that "Economics matters, NOTHING that defies the law of economic gravity can scale." This principle is a simple yet self-evident adaptation of Newton's law gravitation to the human condition.

An equally self-evident characteristic of the human condition is explained by Newton's laws of motion, which state:
  • First, that a body at rest will remain at rest, and a body in motion will remain in motion with a constant velocity, unless acted upon by a force.
  • Second, that a force acting on a body is equal to the acceleration of that body times its mass.
  • Third, that for every action there is an equal and opposite reaction.
While human beings are far more complicated than physical objects, the reality is we all resist rapid, pronounced, or uncontrollable changes in our lives, our habits and our established rituals, even when the changes might be beneficial. In the final analysis we're all bound by inertia. We praise change, adaptation and progress as desirable goals for others but resist them mightily in our own lives.

By now you're probably wondering where I'm going with the physics discussion so I'll cut straight to the chase. I believe all of the widely publicized forecasts about the future rate of vehicle electrification are wildly optimistic because they ignore the laws of economic gravity and human inertia.

In November of this year JD Power & Associates released "Drive Green 2020: More Hope than Reality?" The JD Power report was widely criticized for being far too conservative in forecasting HEV, PHEV and BEV penetration rates that were less than a third of the rates forecast by the Boston Consulting Group in its January 2009 report, "The Comeback of the Electric Car? How Real, How Soon and What Must Happen Next." When it came out, the BCG report was similarly criticized for being far more conservative than forecasts published by other analysts.

To put things into perspective, the following graph from the Electrification Coalition summarizes the PHEV and BEV market penetration forecasts published by a variety of analytical organizations. The JD Power forecast would have fit nicely between the EIA forecast and the Deloitte forecast.

12.29.10 Forecast Range.png

I created the following graph using historical data on HEV sales from the DOE and forecasts of future HEV, PHEV and BEV penetration rates from the Energy Information Administration (the "EIA") and JD Power.

12.29.10 Past & Future.png

It's clear to me that the EIA has a good understanding of the laws of economic gravity and human inertia; JD Power has put more reliance on peoples' tendency to praise change, adaptation and progress as ideals for others while resisting them individually; and the analysts from Deloitte through Deutsche Bank have spent far too much time drinking lithium-laced Kool-Aid. I suppose anything could happen, but if I'm putting my money at risk to gamble on an uncertain future, I want to see far stronger forces than hype, public relations, advertising and government subsidies driving the change.

In the last decade HEVs had the benefit of gas prices that rocketed from $1.50 to $3.00 per gallon, they had the benefit of government subsidies, they had the benefit of slashing emissions and they had the benefit of a generally positive end-user experience. When those four market drivers ran into the laws of economic gravity and human inertia, the net result was a 2.35% market penetration rate after 10 years. Nobody believes for a minute that cars with plugs will be as trouble free as HEVs. How anyone can think they'll be adopted more quickly is beyond me.

I'm convinced that electric drive will be the crushing investment disappointment of the next decade. We're sure to see parlor tricks like Ener1's (HEV) planned sale of 5 MWh of storage to Russia's Federal Grid Company for an obscene price of $8,000 per kWh, but they won't be repeatable without an oligarch pulling the strings. These are not businesses, they're fairy tales.

The only vehicle segment where I can identify a force strong enough to overcome the laws of economic gravity and human inertia are micro-hybrids that use simple stop-start idle elimination systems to reduce fuel consumption and emissions. This market will not be driven by individual choice. Instead it will be driven by EU mandates that require automakers to reduce CO2 emissions to 130 grams per kilometer by 2015 and US mandates that require automakers to achieve average fuel efficiencies of 37.8 mpg for passenger cars and 28.8 mpg for light trucks by 2016. Car buyers will undoubtedly resist stop-start the same way they resisted seat belts in the 1960s and pollution control systems in the 1970s, but it won't make any difference because government mandates have the power to overcome both economic gravity and human inertia. If you want proof of the principle I can do it with two words – CORN ETHANOL.

Regardless of our individual opinions on the issue, micro-hybrids are coming and stop-start will be standard equipment on most new cars by 2020. Roland Berger Strategy Consultants expects 67% of new cars in Europe, 51% of new cars in the US, 60% of new cars in Japan and 30% of new cars in China to be equipped with stop-start systems. In October of this year, Lux Research estimated that 34 million new cars a year will be equipped with stop-start by 2015.

For the foreseeable future, substantially all stop-start systems will draw their power from lead-acid batteries made by Johnson Controls (JCI), Exide Technologies (XIDE), Enersys (ENS) and others. Since automakers are every bit as inertia-bound as the rest of us, their current plans include flooded batteries, enhanced flooded batteries, AGM batteries, enhanced AGM batteries and combination systems that include supercapacitors from Maxwell Technologies (MXWL) and others to meet the extreme demands of stop-start systems.

At September's European Lead Battery Conference, a presentation from BMW, Ford Research & Advanced Engineering and Moll Batterien reviewed the requirements of battery systems for micro-hybrids and discussed various alternatives the industry is considering, including possible upgrades to lithium-ion. It noted that lithium-ion promised better charge acceptance and a potentially longer service life, but concluded that lead-acid was cheaper, more sustainable and avoided several critical issues that can't be avoided with lithium-ion. It then proposed a technology agnostic testing regime for stop-start batteries and showed that anything less than an optimized AGM battery couldn't handle the strain of stop-start applications for more than a couple thousand cycles, which corresponds roughly to the same number of miles.

12.29.10 Ford BMW.png

A second presentation from BMW and Axion Power International (AXPW.OB) showed that even enhanced AGM batteries performed poorly under the proposed BMW-Ford-Moll test protocol and the only device that demonstrated acceptable performance for a typical automakers' battery warranty period was Axion's PbC® battery, a third-generation lead-acid battery that uses carbon electrode assemblies to replace the lead-based negative electrodes used in conventional AGM batteries and is currently in the final stages of validation testing and production process optimization.

12.29.10 AGM.png

12.29.10 AGM CC.png

12.29.10 AGM HSC.png

12.29.10 PbC.png

While there's little question that micro-hybrids with stop-start systems will be exempt from the laws of economic gravity and human inertia because of government mandates, I don't believe energy storage devices for stop-start systems will enjoy the same status because the buyers of those devices will be automakers. Every storage device that costs more than a flooded lead-acid battery will have to fight the laws of economic gravity. Every storage device that isn't based on lead-acid chemistry will have to fight a century of auto industry inertia. The only real counterbalance will be the desire to avoid warranty claims or recalls arising from stop-start systems that don't function properly because their energy storage systems are inadequate. It will certainly be street-fight for the next few years and while I don't mind cheering for my own team, the victor is far from certain and the only sensible approach for a cautious investor is diversification across the entire range of companies that developing energy storage solutions for this new class of vehicles.

Some of them are going to make a pile of money for their stockholders.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

December 27, 2010

Why Cheap Will Beat Cool During The Next Decade Of Vehicle Electrification

John Petersen

Last Friday I received my copy of the presentations from September's European Lead Battery Conference in Istanbul. Most of the presentations were written for a technically astute audience and don't offer much in the way of concrete guidance for investors, but an overview presentation from Ricardo PLC, a global leader in engineering solutions for low carbon, fuel-efficient transportation, included three slides that merit serious investor consideration and show why I'm convinced cheap will beat cool for the next decade of vehicle electrification. I've posted a copy of the Ricardo presentation here.

Technology Timeline

The first slide is a simple timeline that answers the eternal question "When are the technological wonders we read about on a daily basis likely to become profitable business reality?"

12.26.10 Timeline.png

Lead-acid batteries have been the dominant energy storage technology for the last century and the global manufacturing footprint is immense. As vehicle electrification becomes more commonplace and energy storage requirements increase, leading lead-acid battery manufacturers including Johnson Controls (JCI), Exide Technologies (XIDE) and Enersys (ENS) are seeing a pronounced shift in demand patterns. Users who once bought inexpensive first-generation flooded batteries are now buying premium second-generation AGM batteries. Concurrently, lead-acid technology innovators like Axion Power International (AXPW.OB) are finishing development and testing of third-generation devices that will bring the power and cycle-life of lead-acid batteries up to a level that's comparable with NiMH batteries at a reasonable cost. The bottom line for investors is that lead-acid battery technology is rapidly improving and barring a seismic technological shift, manufacturers can only get more profitable over the next decade as global demand for cost-effective mass-market energy storage products surges.

Nickel Metal Hydride, or NiMH, has been the battery chemistry of choice for HEVs since Toyota (TM) introduced the Prius in 1997. Over the last decade HEVs have earned an enviable reputation for efficiency and reliability. Unfortunately, the "M" in NiMH batteries is the rare earth metal lanthanum, which is only produced in small quantities and primarily mined in China. While material supply constraints have not limited NiMH battery production in the past, China has recently announced plans to limit rare earth metal exports in the future. Therefore looming supply constraints will limit the scalability of current HEV technology and most observers believe future HEVs will have to accommodate a lateral substitution of advanced lead-acid batteries and accept a slight weight penalty, or accommodate an upgrade substitution of lithium-ion batteries and suffer a substantial cost penalty.

For several years, dreamers, politicians and environmental activists have shamelessly portrayed lithium-ion batteries as a silver bullet solution to the planet's energy storage needs. From Ricardo's perspective, however, large-format lithium-ion batteries are just beginning to emerge from the prototype stage and enter the early commercialization and demonstration stage. Nissan (NSANY.PK) and General Motors (GM) have recently introduced the Leaf and the Volt and publicized ambitious plans to expand EV production. Those plans, however, will depend on mass-market acceptance of expensive products that haven't been adequately tested under real world conditions by people who just want reliable transportation. I've always believed the ramp rate for plug-in vehicles would be slower than the historical ramp rate for HEVs because users will inevitably have problems with dead batteries, range limitations and other performance issues. As the problem stories spread through the grapevine, the only possible outcome is reduced demand. Ricardo believes it will take at least six years before EVs begin to make the transition from the bleeding edge of early commercialization and demonstration to the leading edge of mass production. I think ten years is more likely.

Application Requirements

The second slide compares the energy and power requirements of various vehicle electrification technologies with the energy and power characteristics of today's leading battery technologies.

12.26.10 Requirements.png

There's no question that plug-in vehicles will need the energy and power of lithium ion batteries if they hope to penetrate the mass-market. Nevertheless, HEVs have built an enviable track record over the last decade using NiMH batteries that were only slightly more powerful than first- and second-generation lead-acid batteries. Since third-generation lead-acid battery technologies promise far higher power and tremendous cycling capacity, I tend to believe that lithium-ion will be viewed as overkill for all but the most demanding HEV applications.

Economic Comparisons

The most intriguing slide from the Ricardo presentation is a simple table that shows the economic performance of their HyTrans micro-hybrid in commercial door-to-door delivery cycles using a variety of energy storage solutions. The table excludes the mechanical elements and control electronics, so it doesn't reflect total system cost. It does, however, highlight the striking economic differences that arise from a decision to use an objectively cool technology to do the work when an objectively cheap technology can do the same work for less money.

12.26.10 Economics.png

For the average consumer the only reason to consider vehicle electrification alternatives is to save money. The Ricardo table leaves little room for doubt on the question of which energy storage technology wins the cost efficiency crown.

What It Means For Investors

Over the last few years a slick, carefully coordinated and beautifully executed PR program from the lithium-ion battery sector has convinced many wishful thinkers that the IT model will carry over to electro-chemistry; that economies of scale will conquer all despite the fact that material and component costs for lithium-ion batteries are four times greater than comparable costs for lead-acid batteries; and that modest size and weight differences will somehow dictate the design and performance of a 3,000 pound car.

As a result lithium-ion battery stocks sell at substantial premiums to their lead-acid peers.

If Ricardo is right, most lithium-ion battery developers can plan on another six to ten years of losses before they turn the corner to profitability. In my experience that's not a healthy business dynamic for investors who worry about details like capital preservation. On the other hand it's equally clear that the next decade will be very good for both lead-acid battery manufacturers and lead-acid technology innovators who are certain to be the first major beneficiaries of the trend toward increasing vehicle electrification.

In another decade, the business dynamic may be different if lithium-ion battery developers can meet their aggressive cost reduction goals and prove a compelling value proposition for plug-in vehicles. Until that happens, however, the safest energy storage investments for investors who want superior portfolio performance are in lead-acid batteries.

I frequently remind readers that I've been a Mac user since 1988 and always believed Apple had superior technology. My opinion didn't change the fact that compared to Microsoft; Apple was a poor market performer until 2000. It only goes to prove that in the gritty world of investments, being right too early is no better than being wrong.

Over the last year the four lithium-ion battery stocks I track have lost an average of 22.2% of their value while the three lead-acid battery stocks I track have gained an average of 15.1%. I don't expect that dynamic to change any time soon.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its stock.

December 19, 2010

Active Power – A Solid Investment Opportunity And A Valuable Object Lesson For Investors

John Petersen

In December 2008 I went hunting for opportunities in the energy storage sector and selected six pure-play stocks that seemed seriously undervalued. I bought Enersys (ENS) at $6.00, Exide Technologies (XIDE) at $2.00 and Active Power (ACPW) at $0.26. While Enersys and Exide have been fabulous performers with appreciation to date of 442% and 397%, respectively, Active Power has been the runaway champion with appreciation to date of 923%.

My other three picks have performed poorly. C&D Technologies (CHHP.PK) is down 96% and finalizing a restructuring that will give 95% of its equity to noteholders; so I don't expect stockholders to recover more than a fraction of their losses. ZBB Energy (ZBB) is down 49% and remains a question because of its weak financial condition. Axion Power International (AXPW.OB) is down 51%, but my confidence in its technology, business model and financial health has never been greater.

A diversified portfolio created in December 2008 with a $1,000 investment in each of my six picks would have been worth $19,218 at Friday's close, for a two-year portfolio appreciation of 220%. In comparison, a diversified portfolio created in December 2008 with a $1,000 investment in each of Ener1 (HEV), Valence Technologies (VLNC), Altair Nanotechnologies (ALTI) and Beacon Power (BCON) would have been worth $2,284 at Friday's close, for a two-year portfolio depreciation of 43%. In simple terms, cheap energy storage has outperformed cool energy storage for two years running and I don't expect that dynamic to change anytime soon.

While an occasional glance in the rearview mirror can be an ego booster, it's rarely helpful for investors who want to position their portfolios for an uncertain future. Since Active Power was the best performer over the last two years; it offers a solid medium-term opportunity; and it can serve as a valuable object lesson in speculative stock picking, the balance of this article will focus on Active Power, its growth opportunities and the object lessons hidden in its history.

A recurring theme of this blog is that the energy storage sector plays by a different set of rules than the ones we came to know and love during the information and communications technology revolution. While IT companies can bloom and grow like wildflowers in an alpine meadow, companies in the energy storage sector behave more like vineyards that need years of careful attention before they begin bearing fruit. Investors who do not understand the differences will suffer.

Active Power manufactures, sells and services mission critical power infrastructure solutions for end-users that demand power quality and reliability at the 99.99999%, or seven nines, level. Past customers include factories, refineries, banks, datacenters, broadcasters, law enforcement command centers, airports and hospitals around the world.

Active Power's infrastructure solutions are not the simple battery backups most of us think of when somebody mentions uninterruptible power. Instead, they're multiply redundant integrated power solutions for users that can't afford outages like the one encountered earlier this month at a Toshiba factory in Japan where a 0.07 second voltage drop interrupted operations and damaged up to 20% of the flash memory chips the plant was planning to ship to customers in January and February of 2011. While the incident was an extreme example, credible estimates peg the total productivity losses from power outages in the US at $150 to $200 billion per year.

Active Power went public in August of 2000 and raised $156 million at $17 per share. It was one of the last major IPOs before the tech-wreck. By September 2000, Active Power's stock had surged to a peak of $79.75 before starting a hellish decline to $0.25 a share by December 2008. It was a classic case of a young company that had a promising technology and ambitious plans that:
  • let irrational expectations run wild in the early days;
  • learned its technology and market development challenges were far more difficult, time consuming and costly than anyone expected them to be;
  • buckled down to hard work of refining a world-class technology solution and then proving the value of that solution to skeptical customers who can't afford failures or mistakes; and
  • turned the corner at a time of maximum discontent and outright investor capitulation.
Since a ten-year stock price chart is too ugly for an upbeat article like this one, I'll use a five-year version instead.

12.20.10 ACPW Price.png

The following graph tracks several important financial statement metrics over the last decade. Since hard numbers for 2010 won't be available till next March, I've used September 30th balance sheet data and trailing-twelve-month income statement data as approximations. Active Power's actual 2010 numbers should be better than they appear in the graph.

12.20.10 ACPW Financial.png

While a detailed discussion of Active Power's products, history and future could fill a small book, there are a few key points that investors need to understand when evaluating Active Power as an investment or as an object lesson.

First, Active Power needed several years to complete the development of its technology and begin installing systems for end-user validation and testing. In the beginning Active Power relied on Caterpillar (CAT) to include its flywheels in power quality systems sold by them. By 2005, it became clear that leaving the marketing function to a large partner that had ready access to several competitive energy storage options didn't always benefit Active Power. That dynamic forced Active Power to adopt a more proactive marketing approach and when it began integrating Caterpillar generators into its own systems instead of relying on Caterpillar as a principal sales channel, the game changed.

Second, end-users needed several years of validation and testing before there was a broad enough experience base to drive working relationships with first tier industrial engineering firms and distribution partnerships with companies like Hewlett Packard (HPQ) and Sun Microsystems (JAVA). Now that core business relationships are established, along with a widespread end-user experience base, Active Power can focus on selling its product line to a rapidly expanding market based on competitive capital cost, high power density, extraordinary system performance and low total cost of ownership.

Third, Active Power's target market is growing very rapidly because global reliance on automation and computerization is increasing while the level of power quality and reliability in many countries is declining. Active Power has no desire to stabilize the grid, but it knows that many industrial, commercial and governmental facilities will readily pay a premium price for the power quality and reliability their utilities can't deliver. Utilities in China typically promise customers 99.1% reliability. While that's an impressive accomplishment for a rapidly developing economy like China's, it's a far cry from the seven nines that many end-users must have.

Fourth, Active Power understands that its flywheel systems must compete with battery-based systems from companies like Emerson/Liebert, Eaton/Powerware and APC/MGE, and rotary systems from companies like Piller, Eurodiesel and Hitec. It also knows that a rapidly growing multi-billion dollar market is large enough to support several successful competitors. Accordingly, its primary goal is market credibility rather than market dominance.

When I first evaluated Active Power in late-2008, it had completed most of the heavy lifting associated with technology development and end-user validation. Its sales were ramping at respectable rates and its losses were narrowing. While Active Power's balance sheet was a mere shadow of its post-IPO glory, it had enough cash and working capital to finance a full year of operations and continue the orderly execution of its business plan. When I combined those factors with a market capita