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I have been trying to decide how much I am willing to pay for shares of A123 which is scheduled to issue shares for the first time (IPO) after market close tomorrow. As I noted in my last post, I am pretty excited about the whole battery sector and this has the potential to draw a lot more attention to the sector. Having said that, this is a risky investment case.
First, A123 is a battery company that makes Lithium phosphate batteries for use in consumer products (ex. cordless drills), vehicles (such as the Chevy Volt which they lost) and maybe the electricity grid. I am not a chemist, but my understanding is that Lithium phosphate chemistry has a better safety profile than Lithium Ion, but doesn't pack quite as much punch either.
Let me start with the risks, because they are more significant than I originally thought. First, if you buy this stock, you are expecting that Lithium phosphate chemistry will participate in the industry growth. Early indications were very good, but GM recently picked LG Chem over A123 to provide the batteries for the Chevy Volt car. Granted, this was just one car, but a company that was able to do much better analysis than I can do determined that A123 was not the best choice. I have heard that A123 may not have had the capacity in place to produce enough batteries and that was a big determinant of the outcome. I don't know if that is true. It could be more substantive issues.
Another big risk is that A123 is involved in a couple legal disputes over patents. A123 has an exclusive license from MIT for some nanotechnology used to make the lithium phosphate batteries. Evidently, there are some other patents that are in dispute. It is possible that A123 could be required to license additional patents which would be detrimental to their ability to turn a profit.
The last big risk really incorporates the others as well. A123 is not profitable right now. How much I am willing to pay for this stock depends a great deal on how soon they can break even, and how big future profits will be. These are difficult projections to make. I did end up buying shares of ENS which has an existing business that is profitable and offers some downside protection. A123 does not have that downside protection.
I hope you are reasonably nervous now. Despite those risks, this is also a company that has tremendous upside if it works. It is part of an industry that I think has huge growth ahead of it. To cut to the chase, I am going to try to buy some shares if I can get it under $9.00 per share.
To get that number I have to make some aggressive assumptions so hold on to your hats. First I think revenues will be $100m this year, then $175m in 2010, $350m in 2011, $525m in 2012 and continued high growth thereafter than gradually slows to 10% in ten years. More importantly, I am projecting an operating margin of -93% in 2009, -30% in 2010, break even in 2011, 5% in 2012, and 10% thereafter. I am expecting battery prices to fall by 8% per year.
If those revenue assumption seem crazy, consider this scenario. There are about 70m vehicles with internal combustion engines sold globally every year. If 5% of those have an advanced battery in 2012, A123 has a 2% market share, and they sell the battery for about $8400 each, that would represent revenue of $588 million in 2012. Of course we have almost no way of knowing whether they will miss or exceed those assumptions, but I don't think they are crazy. This does not include any revenue from the power grid or consumer products.
Under those assumptions, I think the company is worth $9.94 per share, assuming a share count of 111 million after the IPO. I think it is likely that there will be a sentiment multiplier on this stock of maybe 1.2 (people will get excited about this stuff). So this stock could easily trade to $12 per share under that scenario. Given the risks, I am not willing to pay a sentiment multiplier and would like to get it at a discount to my estimated intrinsic value. As such I will probably buy a below average position if I can get it below $9, or buy an average size position if I can buy it closer to $8. My guess is that this will be a very successful IPO however, so there is a pretty good chance I won't get a shot below $9. If you buy some, please remember that this is a stock that can go to zero easier than most, so control your risk with position size and be disciplined on what you pay.
Tuesday, September 22, 2009
Thursday, September 10, 2009
Market Update and Batteries
I apologize for the delay making a post. I have been working through several ideas as well as continuing my job search. But maybe most important for me, I have been refining a valuation methodology that I came up with in grad school, but never really fleshed out. As I have been using it over the last few weeks, I have become increasingly convinced that the overall market is fairly valued between 1000 and 1050 on the S&P500. This is consistent with my prior view that the S&P would be up about 10% this year and another 20% next year. The S&P 500 is currently up about 15% ytd, so a little ahead of what I was expecting. Given that performance and my valuation work, I think the market is most likely to tread water for a quarter or two. The next leg up will need to be driven by real economic data which probably won't happen until well into 2010.
With that view, I think it continues to make sense to be invested in equities since the rally could start sooner than I think, but I think good stock selection or thematic ideas will be key to positive performance over the next few quarters (as opposed to just being in the market).
The theme I have been doing a lot of work on recently is batteries. Not the AA kind, but industrial batteries. There are two trends that are already in play that I think will have a long duration. First, I expect the percentage of vehicles sold around the world that have some level of hybrid capacity will skyrocket. It would not surprise me if hybrid/electric cars represent over 50% of the market within five years. Whether these cars are micro hybrid (use a battery to run functions when car is stopped), mild hybrid (that use a battery to assist the conventional engine), full hybrid (that occasionally use only a battery power to move), or Electric Vehicles (that don't have an internal combustion engine); I think the demand for advanced batteries for vehicles is likely to boom over almost a full decade. The second trend is toward using batteries to stabilize the electricity grid and to integrate alternative power sources into the grid. The existing grid is not good at storing power for peak periods of consumption. Furthermore, my understanding is that peak electricity demand is at about 7pm, but solar output is highest in the early afternoon and wind power is usually highest overnight. Large arrays of industrial batteries are a way to store power during off-peak periods and use it during peak periods. These batteries could be installed at the point of generation (for example, at a wind farm), or potentially in homes across the country (the batteries charge in your basement overnight and then run your AC in the afternoon).
There are a lot of competing technologies as you might expect. Lead acid has been around a long time and is what you use in your car. It is relatively cheap, but the batteries are heavy. There has been a new wave of R&D in this space to see if there can be improvements. If nothing else, it is a proven technology with well established recycling capacity for the lead. Some of that R&D has been toward Lead Carbon batteries, which replace the negative electrode with a carbon based material. This increases the life-cycle of the batteries, reduces their weight, and in some cases improves the speed at which they can be charged. Nickel based batteries are currently the most common in hybrid vehicles. They work pretty well, but there are concerns about the availability of nickel as an input commodity. Finally, lithium ion batteries are the coolest kid on the block. They are much lighter, have higher energy density, but cost a lot more. In addition, there are flow batteries, compressed air batteries, flywheel technology, sodium batteries, all of which are vying for acceptance.
At first, I was trying to determine which technology was likely to be the winner, but I decided that I don't need to. My best guess is that this trend is big enough to accommodate multiple technologies for various applications. The highest performance electric vehicles will probably end up using lithium ion, but mild hybrids can probably use lead carbon as a more economical solution. The power grid probably won't use lithium ion because it will be focused on economics and the cheaper, more established, solutions are more likely to win.
There are three stocks I have decided I like for now. SAFT is a french company (which makes it hard to buy in my brokerage account but maybe not yours) that has a very well established industrial and defense battery business. This offers good downside protection since that business probably won't go away even if my growth thesis doesn't play out. The interesting part is that they have a JV with Johnson Controls to build lithium ion batteries for the auto market. This is not generating a profit yet, but I think the potential is massive. I like this stock under 33 euros. I think SAFT has a great balance of downside protection and a great chance of capitalizing on the lithium ion wave, but I probably won't be buying it unless I switch brokers.
Enersys (ticker ENS) is another established industrial battery company based in the US that is also doing work on lithium ion batteries. Again, their established business provides some downside protection and I think they are especially well positioned to win business from the electricity grid thesis. I like this stock under $25. I currently have a limit order in trying to buy it at $20.10. This is my favorite idea given the low growth assumptions needed to make $25 look attractive.
Finally, Axion Power (ticker AXPW) is a micro cap company that has a lead carbon technology. This one is much more risky because they do not have an established business so you are completely dependent on dramatic growth for their new technology. They lost money in the most recently reported quarter, but they also recently signed some contracts with Exide to provide the carbon electrodes. I just listened to a conference webcast today and it sounded to me that their biggest obstacle is increasing their capacity. Having said that, this one is tricky to value because the range of outcomes is simply massive. I am hoping to buy it closer to $2 per share. For now, I'm watching it and continuing to do more work on it.
With that view, I think it continues to make sense to be invested in equities since the rally could start sooner than I think, but I think good stock selection or thematic ideas will be key to positive performance over the next few quarters (as opposed to just being in the market).
The theme I have been doing a lot of work on recently is batteries. Not the AA kind, but industrial batteries. There are two trends that are already in play that I think will have a long duration. First, I expect the percentage of vehicles sold around the world that have some level of hybrid capacity will skyrocket. It would not surprise me if hybrid/electric cars represent over 50% of the market within five years. Whether these cars are micro hybrid (use a battery to run functions when car is stopped), mild hybrid (that use a battery to assist the conventional engine), full hybrid (that occasionally use only a battery power to move), or Electric Vehicles (that don't have an internal combustion engine); I think the demand for advanced batteries for vehicles is likely to boom over almost a full decade. The second trend is toward using batteries to stabilize the electricity grid and to integrate alternative power sources into the grid. The existing grid is not good at storing power for peak periods of consumption. Furthermore, my understanding is that peak electricity demand is at about 7pm, but solar output is highest in the early afternoon and wind power is usually highest overnight. Large arrays of industrial batteries are a way to store power during off-peak periods and use it during peak periods. These batteries could be installed at the point of generation (for example, at a wind farm), or potentially in homes across the country (the batteries charge in your basement overnight and then run your AC in the afternoon).
There are a lot of competing technologies as you might expect. Lead acid has been around a long time and is what you use in your car. It is relatively cheap, but the batteries are heavy. There has been a new wave of R&D in this space to see if there can be improvements. If nothing else, it is a proven technology with well established recycling capacity for the lead. Some of that R&D has been toward Lead Carbon batteries, which replace the negative electrode with a carbon based material. This increases the life-cycle of the batteries, reduces their weight, and in some cases improves the speed at which they can be charged. Nickel based batteries are currently the most common in hybrid vehicles. They work pretty well, but there are concerns about the availability of nickel as an input commodity. Finally, lithium ion batteries are the coolest kid on the block. They are much lighter, have higher energy density, but cost a lot more. In addition, there are flow batteries, compressed air batteries, flywheel technology, sodium batteries, all of which are vying for acceptance.
At first, I was trying to determine which technology was likely to be the winner, but I decided that I don't need to. My best guess is that this trend is big enough to accommodate multiple technologies for various applications. The highest performance electric vehicles will probably end up using lithium ion, but mild hybrids can probably use lead carbon as a more economical solution. The power grid probably won't use lithium ion because it will be focused on economics and the cheaper, more established, solutions are more likely to win.
There are three stocks I have decided I like for now. SAFT is a french company (which makes it hard to buy in my brokerage account but maybe not yours) that has a very well established industrial and defense battery business. This offers good downside protection since that business probably won't go away even if my growth thesis doesn't play out. The interesting part is that they have a JV with Johnson Controls to build lithium ion batteries for the auto market. This is not generating a profit yet, but I think the potential is massive. I like this stock under 33 euros. I think SAFT has a great balance of downside protection and a great chance of capitalizing on the lithium ion wave, but I probably won't be buying it unless I switch brokers.
Enersys (ticker ENS) is another established industrial battery company based in the US that is also doing work on lithium ion batteries. Again, their established business provides some downside protection and I think they are especially well positioned to win business from the electricity grid thesis. I like this stock under $25. I currently have a limit order in trying to buy it at $20.10. This is my favorite idea given the low growth assumptions needed to make $25 look attractive.
Finally, Axion Power (ticker AXPW) is a micro cap company that has a lead carbon technology. This one is much more risky because they do not have an established business so you are completely dependent on dramatic growth for their new technology. They lost money in the most recently reported quarter, but they also recently signed some contracts with Exide to provide the carbon electrodes. I just listened to a conference webcast today and it sounded to me that their biggest obstacle is increasing their capacity. Having said that, this one is tricky to value because the range of outcomes is simply massive. I am hoping to buy it closer to $2 per share. For now, I'm watching it and continuing to do more work on it.
Wednesday, August 5, 2009
Two sells
I shared some of the stocks I purchased and thought I should share when I was selling them. In the last couple days I sold about 40% of my CLWR shares at $8.96. I had put in a limit order to sell 40% of my shares at a 50% gain and that order executed. Yesterday, I sold about a third of my PFG shares at $25.81, also with a limit order I had in place. This was the second tranche of PFG shares I sold. I bought the shares at the bottom of the market in March and I sold a third when it doubled and another third when it tripled. I actually like this company, so I still have a third of my original shares and need to decide if I want to keep it as a longer term holding, or set another limit order.
I also forgot to mention that I bought some HSBC ADRs (ticker HBC) in late June at $42.13. This was largely a macro purchase. I have been an admirer of the bank for a long time and decided to use some of my idle cash to buy shares. The stock pays a good dividend that I think is more likely to go up than down over the coming years. They are one of the best positioned banks in China and in emerging markets around the world. Because I am generally bullish, I decided a diversified global bank could be a long term holding. I do not have any limit orders in to sell this stock and plan to hold it for a long time. I think of this a core holding that I will probably add to over time. Lastly on HBC, the US is both a black eye and huge opportunity in my opinion. For investors in the stock, HSBC's entry into the US consumer lending business turned out to be ill-timed and a very costly mistake. At this point, I am willing to bet that most of the losses from that portfolio have been taken. Longer term, the US is really an opportunity for HSBC. Despite being one of the largest banks in the world, most Americans have never heard of it. They have a fledgling retail and private banking presence in a few large cities, but it represents a rounding error.
I am also using HBC as a way to improve my skills analyzing non-US companies, so I will make a more detailed post on this stock in the future.
I also forgot to mention that I bought some HSBC ADRs (ticker HBC) in late June at $42.13. This was largely a macro purchase. I have been an admirer of the bank for a long time and decided to use some of my idle cash to buy shares. The stock pays a good dividend that I think is more likely to go up than down over the coming years. They are one of the best positioned banks in China and in emerging markets around the world. Because I am generally bullish, I decided a diversified global bank could be a long term holding. I do not have any limit orders in to sell this stock and plan to hold it for a long time. I think of this a core holding that I will probably add to over time. Lastly on HBC, the US is both a black eye and huge opportunity in my opinion. For investors in the stock, HSBC's entry into the US consumer lending business turned out to be ill-timed and a very costly mistake. At this point, I am willing to bet that most of the losses from that portfolio have been taken. Longer term, the US is really an opportunity for HSBC. Despite being one of the largest banks in the world, most Americans have never heard of it. They have a fledgling retail and private banking presence in a few large cities, but it represents a rounding error.
I am also using HBC as a way to improve my skills analyzing non-US companies, so I will make a more detailed post on this stock in the future.
Tuesday, July 28, 2009
Housing has bottomed, and some market commentary
There have been three data points over the last week that lead me to believe we are at the bottom for housing prices in the US.
Today, Case-Shiller announced the their 20 city home price index rose from April to May 2009, which was the first month to month increase in three years. The data is not seasonally adjusted, but the point is that prices have stabilized enough for seasonality to generate a positive datapoint. For three years, that wasn't the case.
Second, yesterday, new home sales jumped 11% which was the biggest monthly jump in eight years. This one is a little bit ambiguous because we don't really need a lot of new homes being built if we are trying to stabilize housing prices. It does have the potential to be good news if it implies that the builders are either finally clearing out their inventory, or they are seeing real new demand.
And finally, data from the National Association of Realtors indicates that the share of sales coming from foreclosures is dropping. I couldn't find the data on their website directly, but here is a clip from a Bloomberg article. "The share of homes sold as foreclosures or otherwise distressed properties fell to about 31 percent in June, down from 45 percent to 50 percent seen earlier this year, the real- estate agents’ group said last week". This is great news as it means one of the downward levers on prices appears to be coming off a bit.
If I take these three datapoints, and mesh them with the fact that housing peaked in 2006 (we are in 2009 now), and that the housing price index I mentioned earlier is down 32% from that peak, and that there are other indications that the economy is entering a recovery; I come to the conclusion that housing prices have bottomed. This is great news.
This leads me to a second topic: the changing nature of the current bull market. The conventional definition of a bull market is a 20% gain in the market. What I want to talk about though is the change. From the market low on the S&P500 in early March, the market ran from about 670 to over 900 by early May. I consider this run to have been a relief rally. Fundamentals did not improve much at all during that stretch, but the fear of collapse dissipated. Then the S&P500 stagnated from early May through early July. But the markets started to climb again in the back half of July. I think this most recent rally, to about 975, has been more fundamentally driven and that is a very big deal. Technically, it has all been one bull market, but I think the first leg was sentiment driven, and the second leg has had fundamental underpinnings.
Q2 earnings season is not over, but I have been amazed at how many companies are beating estimates and giving positive guidance. I don't have good statistics on this, just my overall impressions from reading the news every day. My guess is that the S&P500 ends 2009 up about 10%, but I think 2010 will be a very good year for the markets (probably 20+%).
Today, Case-Shiller announced the their 20 city home price index rose from April to May 2009, which was the first month to month increase in three years. The data is not seasonally adjusted, but the point is that prices have stabilized enough for seasonality to generate a positive datapoint. For three years, that wasn't the case.
Second, yesterday, new home sales jumped 11% which was the biggest monthly jump in eight years. This one is a little bit ambiguous because we don't really need a lot of new homes being built if we are trying to stabilize housing prices. It does have the potential to be good news if it implies that the builders are either finally clearing out their inventory, or they are seeing real new demand.
And finally, data from the National Association of Realtors indicates that the share of sales coming from foreclosures is dropping. I couldn't find the data on their website directly, but here is a clip from a Bloomberg article. "The share of homes sold as foreclosures or otherwise distressed properties fell to about 31 percent in June, down from 45 percent to 50 percent seen earlier this year, the real- estate agents’ group said last week". This is great news as it means one of the downward levers on prices appears to be coming off a bit.
If I take these three datapoints, and mesh them with the fact that housing peaked in 2006 (we are in 2009 now), and that the housing price index I mentioned earlier is down 32% from that peak, and that there are other indications that the economy is entering a recovery; I come to the conclusion that housing prices have bottomed. This is great news.
This leads me to a second topic: the changing nature of the current bull market. The conventional definition of a bull market is a 20% gain in the market. What I want to talk about though is the change. From the market low on the S&P500 in early March, the market ran from about 670 to over 900 by early May. I consider this run to have been a relief rally. Fundamentals did not improve much at all during that stretch, but the fear of collapse dissipated. Then the S&P500 stagnated from early May through early July. But the markets started to climb again in the back half of July. I think this most recent rally, to about 975, has been more fundamentally driven and that is a very big deal. Technically, it has all been one bull market, but I think the first leg was sentiment driven, and the second leg has had fundamental underpinnings.
Q2 earnings season is not over, but I have been amazed at how many companies are beating estimates and giving positive guidance. I don't have good statistics on this, just my overall impressions from reading the news every day. My guess is that the S&P500 ends 2009 up about 10%, but I think 2010 will be a very good year for the markets (probably 20+%).
My mistake selling CBG
I sold about 60% of my remaining position in CB Richard Ellis yesterday. I had already sold half my shares after the stock doubled from my purchase price. The stock was up 200% from my purchase price yesterday, so I decided to sell some shares.
The question I wrestled with yesterday was whether to sell the whole thing. My investment thesis on CBG was that it was dramatically oversold (as were a lot of stocks). This was a stock I knew pretty well having covered it at my last job. The point is that I didn't buy the stock because I thought the fundamentals of the commercial real estate market were about to get a lot better. Ultimately, this thesis was based on an improvement in sentiment, not intrinsic value. I think sentiment has largely normalized now so that trade is over. For the stock to rise dramatically from here, either sentiment needs to swing to the exuberant side of the spectrum (very unlikely in my opinion) or the fundamentals need to improve enough to raise Intrinsic Value. I have been reading about some renewed interest in commercial real estate from foreign investors, but ultimately, I think fundamentals will come back slowly.
So why didn't I sell the whole position. I think I fell victim to some classic thinking traps. CBG has been my best performing stock and I like owning it as a result. Keeping a small position serves as a trophy of sorts. Second, it is simply hard to sell a stock when it is going up. The fear of missing future gains is powerful and I think I was lured in.
Just wanted to share some of what I'm learning.
The question I wrestled with yesterday was whether to sell the whole thing. My investment thesis on CBG was that it was dramatically oversold (as were a lot of stocks). This was a stock I knew pretty well having covered it at my last job. The point is that I didn't buy the stock because I thought the fundamentals of the commercial real estate market were about to get a lot better. Ultimately, this thesis was based on an improvement in sentiment, not intrinsic value. I think sentiment has largely normalized now so that trade is over. For the stock to rise dramatically from here, either sentiment needs to swing to the exuberant side of the spectrum (very unlikely in my opinion) or the fundamentals need to improve enough to raise Intrinsic Value. I have been reading about some renewed interest in commercial real estate from foreign investors, but ultimately, I think fundamentals will come back slowly.
So why didn't I sell the whole position. I think I fell victim to some classic thinking traps. CBG has been my best performing stock and I like owning it as a result. Keeping a small position serves as a trophy of sorts. Second, it is simply hard to sell a stock when it is going up. The fear of missing future gains is powerful and I think I was lured in.
Just wanted to share some of what I'm learning.
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