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 compelling medium-term opportunity; and it provides 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.
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.
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 evaluation 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 evaluation 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 capitalization that was hovering around 75% of stockholders equity, it was clear that Active Power had limited downside risk and huge upside potential.
Over time, stocks tend to oscillate between undervalued and overvalued and they only touch fair value briefly during the transitions. If Active Power's management can stay the course and continue to execute the way they have over the last few years, I believe today's price is but a fraction of what it will be in 2012. I don't expect another 923% gain because companies, like trees, don't keep growing forever. However a double or even a triple from current levels would not be an unreasonable target given the magnitude of the undervaluation Active Power suffered through in late 2008.
I've previously written about the Gartner Group's Hype Cycle and think it's worth revisiting here. The following graph shows a stylized version of what happened to Active Power between its peak of inflated expectations in the fall of 2000 and its trough of disillusionment in the winter of 2008. I've seen a similar pattern in the stock of every public company I've ever represented.
In my view there are only two great times to buy a stock for investment. The first is in the early days of the innovation trigger, but investments at that stage are usually reserved for venture capital and by the time a company makes its public debut, the price is already in nosebleed territory. The second is at or near the bottom of the trough of disillusionment when business and financial fundamentals are sound, but the market is too tired or distracted to recognize the opportunity.
I am frequently and fervently chastised for expressing negative opinions on high-flying market superstars and favorable opinions on unloved companies with simple products. My goal, however, is to point out the risks of companies that are near the peak of inflated expectations and the opportunities of companies that are preparing to emerge from the trough of disillusionment. It's more art than science, outcomes are never certain and timetables are impossible to predict because of the market's ability to stay irrational for extended periods. In the fullness of time, however, the weighing machine always does its job.
The next couple years should be a lot of fun as Active Power makes the transition from losing money to making money. It's always an exciting time where positive surprises generate favorable price swings but negative surprises are discounted as part of the maturation process. I look forward to devoting more attention to Active Power.
Disclosure: Author is a former director of Axion Power International (AXPW.OB) and owns a substantial long position in its common stock.