By Mitch Vine :
Lithium batteries are a hot spot for development stage public companies. The potential for supplying billions of dollars of battery systems to the electric vehicle market has attracted capital to large and small battery system makers. Some of those companies will go bright like an incandescent light bulb just about to fail, (spending money like there is no tomorrow), and then disappear from sight. Having said that, we expect Valence Technology to be a survivor.
Compared with its competitors, Valence Technology ( VLNC ) isn't that young anymore. Valence is 21-years old, was founded in 1989 and developed the current lithium battery material in 2002. The company develops, manufactures and sells advanced energy storage systems utilizing phosphate-based lithium-ion technology. The products are in commercial use by customers such as Smith Electric Vehicles, Segway, Howard Medical Solutions, Oxygen S.p.A., Rubbermaid Medical Solutions, Enova Systems ( ENA ), PVI, Tennant Company ( TNC ), and Wrightbus.
The phosphate based lithium-ion batteries are claimed to have advantages over other lithium batteries. These advantages include higher performance, longer life, more reliability, environmental advantages and greater safety. (We won't delve into the validity of these claims in any detail in this article). On the negative side, the upfront cost of these batteries is higher than the competition, but the argument is made that longer service life can result in a lower lifetime cost.
Valence can claim some maturity as a manufacturer. The cost of goods sold, and the opex have been consistently coming down, and it is conceivable that the company could break even in the next year. It shipped to 54 customers in the last quarter, and several customers appear to be emerging from the technology assessment stage and moving into the volume production stage.
Valence identifies five possible markets for its products: Motive (Hybrid and all electric vehicles including car, bus, truck, tram and scooter); Marine (yachts); Industrial (floor cleaners, forklifts, medical carts, wheelchairs); Military; and Stationary (power outage and voltage stabilizing). Recently medical devices and bus fleets have been strong for the company. The CEO mentions going into "numerous" bus companies in Europe.
The Lithium Battery Market
The excitement in the large lithium battery market has been centered in motive applications. This is due to the relatively high energy density (small package, low weight) of lithium batteries. Compact, light batteries storing a lot of energy are critical for the range of an all-electric vehicle.
While most of the media attention has been focused on electric cars and hybrid electric cars there are many other motive applications such as truck fleets, bus fleets, and golf carts that could make a large market. These vehicles need a safe battery capable of heavy daily use, and are expected to last for many years of use. This is a primary target for Valence.
Portable tools and consumer devices are a hot market for small lithium batteries. Competition in this segment is more price intensive due to the number of Chinese companies making standardized small cylindrical batteries, plus faster product qualification. Fortunately, this is not Valence's target.
In the center, there are medium sized consumer and commercial applications such as portable medical carts, floor cleaners and cordless vacuum cleaners. These are applications where Valence can participate with the high density energy, long cycle life and safer products.
Although it is not out of the woods yet, we like what we see in Valence's income statement. The company has had fairly consistent revenue growth. From FY2007 to FY2011, the company grew from $16.6 million to $45.8 million. Even better, it has shown gradually improving profitability. Gross profits as a percentage of sales have improved from 2% to 20% in the last year and in the June quarter. Management has kept R&D spending, marketing and admin spending under control so that operating expenses have reduced from 97% of sales in FY2007; they have reduced spending to 40% of sales.
The company is still losing money. There is a silver lining here. The losses (at $ 3.3 million for the quarter) for the June quarter are at a point where near-term financing requirements should be modest.
A small number of customers are responsible for 74% of the company's revenue. Orders from Smith Electric Vehicles have caused revenue in the past two years to be highly variable. In the June quarter the sales came from: Smith Electric Vehicles (36%), Segway (18%), Rubbermaid Medical (10%) and Howard Medical (10%).
Unfortunately the company has had the largest share of its revenue coming from one customer, Smith Electric Vehicles. As reported by the company: "Sales to Smith accounted for 36% of our total product sales for the three month period ended June 30, 2011, and 28% of our total product sales for the three month period ended June 30, 2010. Segway accounted for 18% of our total product sales for the three month period ended June 30, 2011, and 40% of our total product sales for the three month period ended June 30, 2010." Worse, Smith has decided to find a second source for batteries and has awarded a contract to A123 ( AONE ).
After 20 years of operations, having only a handful of significant customers is not the sign of a robust business sector. Dependence upon one or two customers has been the downfall of many technology companies. On the positive side, the company has recently seen an increase in the portion of business coming from other sectors. In the last conference call, the company mentioned sales are coming from 54 separate customers.
Geographically, revenue is very USA and Europe centric. Of the $14 mln sales in the quarter, $11.7 of that came from the United States and $2.2 mln of that came from Europe.
Competition is pretty fierce in the lithium-ion space. The company considers LG Chem, Matsushita Industrial Co., Ltd. (Panasonic), Sony, Toshiba and SAFT, A123 Systems, Dow - Kokam, Thundersky - Winston Battery, Altair Nanotechnologies ( ALTI ) , and Ener1 (HEV) to be main competitors. We would consider established lead-acid companies like Exide (XIDE), [[JCI]] and Enersys (ENS) to be potential competitors, as their brand strength, OEM relationships and large size could give them a fast start should they choose to be aggressive in lithium batteries.
Valence's claim is that phosphate based batteries are safer and more environmentally friendly than less stable cathode materials. In the most recent 10-K it claims that the phosphate properties render the batteries "almost incombustible if mishandled during changing and discharging." It also claims several performance advantages over lead-acid, nickel-cadmium, nickel metal hydride and oxide based lithium batteries. Other sources have indicated that Valences' batteries are relatively expensive, although Valence claims a lower lifetime cost in numerous applications due to lower maintenance costs, longer cycle life and longer service life.
Valence doesn't own the whole Lithium - phosphate segment. A quick Google (GOOG) scan will reveal many Chinese mainland and Hong Kong based companies selling small LiFePo4 cylindrical and prismatic cells. These companies will be strong in segments such as consumer products made in China, and batteries for e-bikes. Possibly to differentiate from these small format competitors, Valence is emphasizing larger modules such as the XP modules and RT modules in standard BCI lead-acid battery sizes.
Today, there is no indication of potential electric car business. However, it would seem that the "non combustible" safety advantages should be attractive to an OEM.
Valence lists 133 US patents on its website, many related to phosphate based formulations. It is outside our expertise and resources to value the patents, but the quantity of patents does point to Valence's credibility and position as a leader in technology.
Valence states that the next phase of the strategy is to move beyond its current in-production technology to commercialize its (patented) Lithium Vanadium Phosphate ((LVP)) and Lithium Vanadium Phosphate Fluoride ((LVPF)) cathode materials into large-format, high capacity cells. The new materials are claimed to offer improved performance with additional energy storage and higher voltage capabilities for the motive, stationary power, consumer appliance, telecommunication, utility and other industries.
Potential for Acquisition
Valence could also become an interesting acquisition target for a large battery maker (like Exide or ENS or Johnson Controls) choosing to buy some technology and patents. At current market capitalizations, Valence is not that large a fish to swallow.
Valence has made good progress on cost control. In the four years from FY2007 to FY2011
- Gross profits increased from 2% to 21% of revenue
- R&D spending reduced from 24% to 8% of revenue
- Opex reduced from 97% to 40% of revenue
- Net loss reduced from 134% to 28% of revenue
The company had $11.5 mln in cash at the end June 30, 2011. Net cash used in operating activities was $2.3 mln in that quarter.
On the negative side, the company is a small player in a highly competitive market. It is still very dependent on revenue from two customers, and one of them is partly moving away. There will continue to be price pressure from the cheap Chinese suppliers at the low end of the business, and we are not sure the patents have enough teeth to fight off imitators.
On the positive side, this company has a focus on the bottom line that we like very much, and has been gradually broadening the revenue percentage away from the top 2 customers. It is making some progress in finding applications that go beyond motive power. Their near-term financing needs look modest, and so further dilution may be limited.
Overall we rate the risk level as speculative .
Valuing the Investment
VineSecurityJournal.com uses a proprietary method to value technology growth stocks. The core of the technique is a projection of future revenue and net earnings, and we discount earnings according to the risk level.
Key to our model are the revenue and net profit assumptions. Our long-term revenue growth assumption for Valence is 25% per annum. We further assume that the net income for a company like Valence with a good eye for the bottom line and manufacturing in China will reach 10%.
Conclusion - Speculative Buy
Although we are bullish about Valence in the long run, we fear the next quarter or two could be rocky. Valence isn't quite ready to go profitable without the largest customer, Smith Vehicles. Yet Smith has decided to second source most of its US purchases to a competitor. The company can't say that it will get any revenue from Smith in the current quarter, which means the next report or two could show a big drop in revenue and bigger losses. Even though this is anticipated, we doubt that the market will be kind to VLNC if or when it happens.
With our assumptions of 25% long-term revenue growth, we feel Valence is fairly valued at $1.10-$1.25. On the other hand, depending on how optimistic you are, just one or two large OEM deals could give some serious upside potential to that number. We like the odds.
With the nervous market we wil look for a significant pull-back in price over the next couple of months, as a possible buying opportunity.
See also 7 Big Buys Of PNC Financial Services on seekingalpha.com