Below is the latest from Kerrisdale Capital, which has disclosed a short in Plug Power Inc (NASDAQ:PLUG)
We are short shares of PLUG. Please click here to read full disclosures. – See more at: http://kerrisdalecap.com/commentary/#sthash.sInRGdUB.dpuf
Introduction
It’s been a sensational year for investors in Plug Power (PLUG), with shares rising from pennies to more than $10. But now, it appears the party has ended, as investors are starting to cut through the promotional hype that has enveloped the company to rediscover the business’s less than promising fundamental outlook. We expect shares to continue declining sharply in coming weeks. In particular, it’s hard to imagine a company that no one wanted to buy at 15 cents a share last year is now worth $7.50. Plug Power, contrary to the bullish hype, faces severe competition, has a weak and unproven business model, and likely lacks in the research capability to innovate its way out of its current precarious financial situation.
At $7.54/share, 17.7x 2014 revenue, and a market capitalization of $1.2 billion, we believe Plug Power is flagrantly overvalued. PLUG’s dramatic share price surge has fueled speculation from investors who seem to know little about Plug Power’s history and operating background.
We explored what a best-case scenario would yield for equity investors. Using a 10-year DCF, we believe that PLUG is worth less than $2.50/share, well below the current price of $7.54. Even under the highly optimistic assumption that PLUG achieves its $70m revenue target in 2014, quadruples its sales over an eight-year period, and achieves a long-term gross profit target of 32%, shares would be 68% overvalued. Even worse, in the much more likely scenario that PLUG disappoints investors and misses its long-term guidance targets, PLUG shares are worth a fraction of that target.
After the February announcement of its 1,738 unit Walmart deal, PLUG’s shares nearly doubled on investors becoming entranced with a growth story. However, a single order is not an indication of sustained growth, especially in the context of PLUG’s existing customer list. And even though most of these customers have been with the company since 2008-2010, none have adopted PLUG’s solution on a substantial scale. For example, the Walmart order represents just 5% of its entire fleet. Third-party research further suggests that PLUG’s lack of customer penetration is due to the expense of fuel cells relative to battery – fuel cells are only economically viable for a small subset of distribution centers: those with space constraints, round-the-clock shifts, and expensive workforces. Facilities that lack these difficulties will continue to prefer lower-cost options.
Evidence strongly suggests that fuel cells will remain a niche solution in the warehouse. According to General Electric‘s chief engineering officer of GE’s Power Conversion division, fuel cell technology is too dependent on platinum to be more than a niche product. But should fuel cell technology ever reach cost parity with batteries, the economic benefits will largely accrue to Ballard Power (BLDP) and other owners of the underlying fuel cell technology. After all, Plug Power is merely a value-added integrator of Ballard’s fuel cells, and no more. If Honda or Toyota decided to produce fuel cell powered forklifts tomorrow, these better capitalized competitors could probably produce a more sophisticated fuel stack, undercut PLUG on price, and aggressively take market share. In fact, Toyota has already developed a prototype for its line of fuel cell forklifts with plans to produce a commercial line “in the near future”. With a threat as imposing as Toyota looming, investors should be skeptical of PLUG’s long-term growth projections.
The recent surge in the stock price has been driven by speculative investors hoping to make a quick profit, as indicated by the past 1-month average daily trading volume of 89.5 million (CapitalIQ), representing 62% of PLUG’s 144 million basic shares outstanding (latest 10-K, 10-Q). On March 7th, 2014 CEO Andrew Marsh appeared on CNBC and presented no new information, yet the stock closed 30% higher. Three days later, the stock surged another 25% despite the absence of new updates. We believe that as this speculative momentum ends, investors will look to lock in short-term gains and move on, making PLUG an extremely compelling short opportunity at its current price of 18x 2014E revenue.
Stark Overvaluation Relative to Peers and Other Speculative Stocks
PLUG’s stock price has multiplied by 44x in the past year based on statements made by CEO Andy Marsh. At its current valuation of $7.54 per share, investors are no longer adequately compensated for bearing PLUG’s many execution risks. Shareholders have ignored downside risk on the notion that the company has already transformed its industry, but PLUG has yet to deliver on any of its promises.
PLUG’s current share price of $7.54 implies LTM and 2014E revenue multiples of 43x and 18x, respectively. To put this into perspective, PLUG’s current market capitalization is higher than the sum of the market capitalizations of Ballard Power (PLUG’s critical supplier of fuel cell stacks) and Hydrogenics Corporation (competing manufacturer of hydrogen equipment and fuel cell-based backup power systems), despite expecting to generate less than half of their combined revenues. Even more astounding, PLUG’s forward sales multiple of 18x exceeds that of even Tesla and Facebook, more innovative companies that have already demonstrated above-market growth. Elon Musk himself had a colorful opinion of the technology: “Fuel cells are so bullshit.”
PLUG is no Innovator — It’s Merely an Integrator of Third-Party Technology
Despite PLUG’s claims to be an innovative manufacturer, our research suggests that PLUG is actually a value-added integrator. Crucially, PLUG does not manufacture critical components of the GenDrive system. This includes the all-important fuel cell stacks that PLUG sources exclusively from Ballard Power Systems. From PLUG’s 2012 10-K:
“Although most components essential to our business are generally available from multiple sources, we currently obtain certain key components including, but not limited to, fuel cell stack materials, energy storage devices, and other major components from single or limited sources. In 2010, we signed a supply agreement with Ballard Power Systems, or Ballard, which continues through December 31, 2014. Under this agreement, Ballard serves as the exclusive supplier of fuel cell stacks for Plug Power’s GenDrive product line for North America and select European countries.”
While investors expect PLUG to eventually achieve significant revenue growth via mass customer adoption, we’d argue that PLUG’s economics will largely pass to Ballard Power. After all, an integrator of parts is far more commoditized, and far more expendable, than a technology innovator.
If PLUG were truly a pioneer in the fuel cell industry, we would expect it to expend significant resources on research & development. Comparatively, fuel cell companies like Ballard, which focus on developing fuel cell stacks and systems for automobile OEMs and system integrators, spend significantly more on R&D. Since 2009, Ballard has spent more than 2.6x on R&D than PLUG, which makes sense given PLUG’s inferior placement in the value chain.
Given PLUG’s dependence on Ballard as its sole supplier of fuel cell stacks, shareholders should be aware that Ballard, like PLUG, has never been profitable. In the event that Ballard faces a liquidity crisis or is unable to deliver fuel cell stacks, PLUG would certainly face adversity. Though PLUG announced its intention to seek alternative suppliers, there have been no updates regarding that process.
Driving the Hype Machine: A Catalogue of PLUG’s Failed Promises
Since taking over as CEO, Andy Marsh has had a history of missing projections for revenue, unit shipments and gross margins. PLUG significantly underperformed against Marsh’s forecasts for the FY periods of 2010, 2011 and 2012.
2010 Guidance (03/15/2010): Andrew Marsh on Q4 2009 Earnings Call:
“First, Power Plug will dramatically increase unit shipments for the year, shipping between 2,100 and 2,300 systems, consisting of at least 1,100 GenDrive and 1,000 GenSys fuel cells. Second, consistent with these shipments for the year, Plug Power will generate between mid-$40 million and low-$50 million in revenue. Third, Plug Power will achieve a gross margin percentage in the mid-teens. Fourth, Plug Power will set its earnings before interest, taxes, depreciation, amortization in non-cash stock or equity compensation targeted at mid-$20 million loss for the year.”
2011 Guidance (05/25/2011): Andrew Marsh on Q1 2011 Earnings Call:
“Coming into this year, we plan to ship between 1,600 and 2,300 units. We have the biggest backlog we’ve ever had. The revenue for the business continues to grow, indicated by the fact that in the last 4.5 months, the company has booked over $18 million of business, and that $18 million of business represents 555 unit orders received in the first quarter alone.”
We’d like to point out that Marsh made the forecast on May 25, 2011, almost halfway through the year, yet only shipped 1,024 units, significantly underperforming against his forecast. This calls into question Marsh’s judgment given that he had almost six months of data at hand, yet could still not make an accurate forecast.
2012 Guidance (03/08/2012): Andrew Marsh on Q4 2011 Earnings Call:
“Plug Power is setting our 2012 shipment expectations at 2,300 systems and we expect product and service revenue to be approximately $40 million. At the moment, we have $36 million in backlog, of which $27 million is expected to ship in 2012.”
2012 Guidance (06/07/2012): Company Presentation
Again, it’s critical to know that the presentation was on June 7, 2012, almost halfway through the year, yet PLUG missed its 2012 forecast for units shipped and revenue by 40% and 35%, respectively. This type of underperformance is inexplicable were it not for PLUG’s need to generate support for its perpetual dilutive secondary offerings.
For 2014 Marsh has forecasted 3,000 units, revenue of $70 million, gross margin of 25% and EBITDA margin of 5%.
2014 Guidance (01/16/2014): Andrew Marsh on Business Update Call:
“I’d like to now reiterate our goals for the entire year. Plug Power will ship over 3,000 units to 20 manufacturing and distribution centers. We’ll achieve $70 million in revenue and 25% gross margin and 5% EBITDAS.”
While Walmart’s recent order is certainly positive news for PLUG, we question PLUG’s ability to forecast given the company’s poor track record. The Walmart order was for a total of 1,738 units, set to be delivered over a two-year period. If we assume that PLUG can deliver half of the order, or 869 units, it would still need to deliver an additional 2,131 units to meet the 2014 forecast. To put that into context, a delivery of 2,131 units would be 53% higher than what PLUG shipped in 2012. If past performance is indicative of 2014 performance, PLUG could again miss its 2014 unit guidance by 30-50%, making its already extreme forward revenue multiple even more untenable.
PLUG Remains a Niche Solution that has Gained Minimal Customer Penetration
According to 2013 Fuel Cell 2000 report, PLUG was already the market leader in the fuel cell material handling industry with around 85% market share, and yet the business generated only $26 million of revenue. Fuel Cell 2000?s report includes a list of companies currently utilizing fuel cell systems for its forklifts. As shown below, PLUG competes with a variety of alternate competitors, including Oorja, Hydrogenics, and even Ballard itself.
Viewing PLUG’s competitors above, Hydrogenics (HYGS) stands out. Hydrogenics is a publicly-listed manufacturer of hydrogen-based fuel cell products. This Canadian company has strategic investors that include Commscope, Enbridge, and General Motors, the latter of which owns 5% of the business. In addition to forklift deployments, Hydrogenics sells hydrogen fueling stations, backup power systems, and power-systems for transit buses. Customers include General Motor, Michelin, and the U.S. government. Hydrogenics generated $42m of revenue in 2013, more than 50% higher than PLUG, and yet trades with a market capitalization that is one-third that of PLUG’s.
Oorja, a private California-based business, has nearly a dozen fuel cell customers that include Nissan, U.S. Foodservice, and Baldor Specialty Foods. Oorja uses methanol-based recharging system to keep on-board lead-acid batteries fully charged, eliminating the need for battery swapping. Refueling the liquid-based system takes less than one minute, thereby improving productivity for the busiest distribution centers. Oorja had shipped over 400 units as of Q4 2011.
While PLUG certainly has a robust customer list, we ask ourselves why none of these customers utilize PLUG’s products on a larger scale. PLUG argues about the compelling benefits of utilizing a fuel cell based solution; however, the low levels of customer penetration raise serious suspicion.
Sysco, one of PLUG’s largest customers, operates over 100 distribution centers and has a fleet of over 11,000 forklifts. PLUG first deployed its solution with Sysco in 2010 and yet has managed to deliver only 763 units (as of 2012 report), representing a penetration rate of 7%. Kroger, another marquee client, has been a customer since 2011 and has only 161 forklifts with PLUG’s solution. Coca-Cola, also a customer since 2011, has only 96. Although the market appreciated Walmart’s recent order of 1,738 units (which is to be delivered over a two-year period), the order represents only 5% of Walmart’s total fleet which is surprising considering Walmart’s status as a PLUG customer since 2005.
We believe that PLUG’s lack of customer penetration can be explained easily: fuel cell forklifts are only economically viable for space-constrained facilities that demand round-the-clock shifts. According to a study by Colorado State University, “…fuel cell forklifts were considered most commercially viable at materials handling facilities that had extraordinary costs of facility space, labor and electricity. These outlier facilities might be physically unable to expand a battery room with increasing workload, located in geographic areas with high prevailing wages, and which are subject to high electricity peak demand prices.”
In most other cases, fuel-cell based solutions simply cannot compete with existing battery technologies from a cost perspective. The Colorado State report goes on to argue that there are few scenarios in which fuel cell powered forklifts had an economic advantage.
“Analysis of the project NPC and project NPC per unit of workload shows that fuel cell forklifts cannot compete with battery technologies on an economic basis for the workloads and facility types considered.”
However, the researchers did note the following:
“The fuel cell powered forklifts are the most scalable forklift system. Charging is eliminated and refueling takes only ~5 min at a hydrogen filling station. Fuel cell forklifts have no thermal management problems at the workloads considered for this study. For workloads under 3 EBUs, the fuel cell forklifts are assumed to require no additional floor space and no duplicated vehicles or powerplants.”
These facts lead us to believe that PLUG is a niche solution for a small subset of warehouse facilities that operate on three shifts in large, 24-hour distribution centers. This helps explain PLUG’s lack of organic growth and reminds us that PLUG may already have largely penetrated its addressable market. For the vast majority of distribution centers, fuel cells are simply not the correct solution.
An Unlikely Best Case Discounted Cash Flow Analysis Implies a Share Price Near $2.50
Our DCF analysis is based on a scenario where all the stars align for PLUG. But even under these generous assumptions, we arrive at a share value of $2.44, 68% below where the stock closed on Tuesday. This valuation implies a much more reasonable 4.7x 2014E revenue multiple, far below the current 17.7x multiple. We challenge PLUG’s proponents to construct their own fundamental models; only then might they realize how absurdly overvalued this equity has become.
DCF Assumptions:
- 2014 financials per management guidance
- 26% revenue growth in 2015-2017, 21% from 2018-2019, and 16% from 2020-2021
- All-in revenue (product + service) per unit of $23,333 in 2014 (based on management’s estimate of $70 million and 3,000 shipped units in 2014) growing at 5% per year
- Gross profit margins of 25% in 2014 expanding to 32% by 2021. Marsh stated on a business update call on 12/04/2013 that overall gross margins should be 32%-33%, “I expect that our margins will settle down in the 32% to 33% range. And that when I look at gross margins, and when I look at the service business, the labor portion of it is little less than lower gross margins than the parts business. So overall, about 32% to 33%.”
- EBITDA margins of 5% in 2014 expanding to 23% by 2021. We grew SG&A and R&D at half the pace of shipped units growth
- Working capital at 10% of sales
- Capex growing at half the pace of shipped units growth
- Discount rate of 10.0%
- Terminal FCF growth of 3.0%
Misunderstood Share Count
Many shareholders seem unaware of PLUG’s true number of fully diluted shares of common stock. Investors should be aware of the dilutive impact of options, warrants and restricted stock units, each of which significantly affects the company’s diluted share count. Based on our analysis, we arrived at a total diluted share count of 160.5 million shares, far above what appears on news sites like Google and Yahoo Finance.
On March 19, 2014, Air Liquide filed a form schedule 13D stating that it could convert its preferred stake on May 8, 2014 to 10.9 million common shares. We believe that Air Liquide is seriously considering this conversion as its stake is worth $83 million, representing 32x its initial investment of $2.6 million. This would further dilute existing shareholders.
As of April 1, 2014, Google Finance and Yahoo Finance displayed outstanding share counts of 106.3 million and 103.5 million, respectively. In reality, there are 160.5 million shares outstanding (using the treasury stock method), rather than the reported figures on Google and Yahoo. These share count differences result in a material market capitalization delta of $408 million (Google) and $430 million (Yahoo).
Google Finance (As of 4/1/2014):
Yahoo Finance (As of 4/1/2014):
Operating Cash Burn and Equity Dilution
PLUG has never been profitable in the history of its existence. Since 2006, the company has burned through about $320 million, generating only $154 million of revenue over the same period. In order to stay afloat, PLUG required multiple secondary share offerings. If market conditions had been less favorable for speculative companies like PLUG, it may have gone out of business long ago.
Over the same period, PLUG managed to raise over $316 million through secondary common and preferred issuances, often underwritten by the same investment bank which published research reports in favor of the company. Cowen and Company, sole underwriter of PLUG’s secondary offerings from 9/16/2013, 01/15/2014 and 03/06/2014, currently rates the company a buy with a target of $7.50. Though these instances are common on Wall Street, we were concerned when Cowen released favorable commentary and raised its price target to $5.50 from $5.00 on March 3, 2014, sending the shares up 25% three days before it underwrote 3.9 million shares in a secondary offering.
Over time, these secondary offerings would have caused ~94% of dilution for a shareholder that owned PLUG stock in 2006. To put this into perspective, a shareholder that owned 1,000 shares in 2006 would effectively own a mere 60 shares today.
Some of these secondary offerings have been combined with warrants to further sweeten the deal for new institutional investors. PLUG’s 1/15/2014 offering marketed 10.0 million common shares combined with 4.0 million warrants and was sold to a single institutional investor for $3.00 per share, representing an extremely aggressive 16% discount to the previous day’s close price. In these arrangements, PLUG only receives the upfront proceeds on the common shares and nothing from the warrants. As a result, PLUG shareholders gain nothing from the warrants except further dilution of their ownership.
Conclusion
The speculative ramp-up of PLUG’s share price is unjustified, and we believe the downside potential is immense. PLUG has never been profitable, operates a business with low barriers to entry, and operates in an unproven industry, all while shareholders have suffered extreme dilution. PLUG describes itself as an innovative manufacturer at the forefront of the fuel cell industry, but in reality PLUG is nothing more than a value-added integrator, sourcing key fuel cell components from third parties. While the market gives PLUG substantial credit for its recent Walmart order, the company must demonstrate significantly more growth and profitability to justify a realistic valuation. And even then we believe that PLUG deserves to trade closer to 4-5x revenue, or 70% below the current forward trading multiple.
Shareholders must consider whether a company that has generated $27 million of LTM sales, has been uncompetitive for more than a decade and has survived by diluting shareholders, is truly worth $1.1 billion. Should PLUG miss its projections for 2014, it will likely need to issue additional shares. This would induce further dilution and additional pain for current shareholders. With speculative investors driving excess trading volume each day, in what looks like a game of musical chairs, don’t be left without a seat when PLUG shares correct downwards.
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