On February 6, 2017, American Superconductor (NASDAQ:AMSC) held its Q3 2016 Earnings Conference Call. While beating on both quarterly revenue and EPS estimates, the discussion worth having is the massive upside that this company’s technology offers to long-term investors willing to be patient.
Those of us who have been following for some time are all too familiar with the backstory. In 2010, AMSC was flying high, both with its share price and annual revenues of over $315M. On March 31, 2011, Chinese customer Sinovel Wind Group announced that they would no longer be accepting shipments, or that they would make any outstanding payments going forward. The announcement from Sinovel, which accounted for about 70% of total revenue, sent the stock price crashing. The ensuing investigation turned up evidence of intellectual property theft and economic espionage. Since then, multiple civil action cases, seeking combined monetary damages of over $1 billion, have been brought by AMSC in Chinese courts. All have been dismissed. Appeals are ongoing, though the consensus seems to be that the likelihood of judicial victory is essentially zero.
Coincidentally, CBS show 60 Minutes just aired a segment on January 17, 2017, called “The Great Brain Robbery.” The interview with AMSC CEO Dan McGahn discusses the intellectual theft that the Chinese are committing. Mr. McGahn should be commended for his very public commentary on this issue. Unfortunately, other CEOs of companies that still do big business in China were reluctant to be interviewed.
The story here, though, is not where this company has been, but where it might be going.
AMSC’s current revenue breakdown, with one customer accounting for the lion’s share, looks very similar to what it was before the Sinovel incident. Indian wind giant INOX Wind accounts for about 60% of total revenue. Not surprisingly, any negative news relating to the INOX channel leads to heavy market punishment. Witness what happened on August 9, 2016, when AMSC shares slid over 22% after reporting 2016 Q1 earnings. While the central government of India is vigorously pushing wind energy, INOX is facing some operational challenges from some Indian states in the form of lower wind energy tariffs and delayed payments. Though the December 2015 $210M multi-year agreement with INOX remains intact, the current over-reliance on one customer is risk that needs to be strongly considered. But the Grid segment, with the budding Navy ship degaussing contract and multi-city Resilient Electric Grid (REG) deployment studies, offers enough reward to make the risk worthwhile.
The All-Electric Navy
Back on March 3, 2003, a press release announced that AMSC had won a multi-year, $70M U.S. Navy contract to, in partnership with shipbuilder Northrop Grumman (NYSE:NOC), “optimize the design, integration and testing of the HTS (high temperature superconductor) propulsion motor for integration into electric warships.” Included in the release is a very telling statement from Rear Admiral Jay M. Cohen, the former Chief of Naval Research:
“The U.S. Navy is going electric. Superconductor technology will help reduce the size and weight of motors, generators, power transmission and supporting electrical components to help speed the transition to electric this decade. This contract is an important step along the road to attaining these capabilities.”
Fast forward a decade or so, and the Navy’s new all-electric future is starting to take form.
On October 15, 2016, the Navy’s most technologically advanced warship was commissioned into active service in Baltimore Harbor. Among the defining features of the USS Zumwalt (DDG 1000) are its wave-piercing tumblehome hull, stealth design, and a state-of-the-art electronic propulsion system. IEEE Spectrum magazine provides a detailed inside look at the inner-workings of this next-generation destroyer. Perhaps the most prominent features are its two electric induction motors, which are powered by four gas-turbine engines that generate as much as 78mw of electricity. While larger commercial ships have been using combustion engines connected to electric propulsion motors for some time, what is interesting about the Zumwalt’s design is that the gas-turbine engines are not connected directly to the electric motors. Instead, generated electricity flows throughout the ship’s network to where it is needed. This design feature allows for future weapons or computing systems, such as an electromagnetic railgun or high-energy laser, to be integrated seamlessly with current ship needs. Due to ballooning costs, the future of the Zumwalt-class destroyer is in doubt, but the continued push towards all-electric warship seems likely.
In addition to offering technology that could play an integral part of a ship’s electric distribution and propulsion needs, AMSC’s effort to partner with the Navy exists on another front as well: ship degaussing.
Degaussing is the process by which a ship’s magnetic field is decreased or eliminated. During World War II, Allied forces spent a great deal of effort trying to counter German magnetic naval mines that detected and were activated by a passing ship’s magnetic field. Since the Germans used the gauss (named after fabled 19th century mathematician Carl Friedrich Gauss) as the unit of measure to trigger the mines, scientists referred to the various methods to counter the mines as “degaussing.” The term stuck.
Though the techniques developed to avoid mine detection have proved more or less successful, the large weight and cost of degaussing systems (which often involve wrapping a large metallic coil around the hull) have long proved a hindrance. Over the last several years, AMSC and the Navy have developed an HTS Degaussing Coil System that reduces degaussing system weight by as much as 80%. On May 19, 2015, AMSC was rewarded for its efforts with a contract worth up to $8.5M to provide HTS-based ship protection system equipment. Though the contract award is for a relatively small amount, the Q4 2015 conference call provided some potential pricing details to get excited about (see table below).
|Ship Size||Ship Type||Revenue/Ship ($M)||# Ships|
|Small||Littoral Combat Ship||3-5||56-60|
With approximately 280 ships (and possibly growing, but maybe not), it’s easy to see how the Navy revenue stream could turn into something big. Management has pointed out that HTS-based mine countermeasure technology can be retrofitted into existing ships, or it can be worked into the design of new construction. Additionally, CEO McGahn mentioned that there exists an opportunity to utilize AMSC’s technology for an alternative application at the tune of $5M per ship, regardless of ship size. While other companies have developed an HTS (see this author’s analysis), AMSC does have first mover advantage when it comes to Naval ship applications. The 2016 annual filing states:
“We believe we are currently the only company that can offer HTS-based SPS products that have been fully qualified for use aboard Navy surface combatants.”
There seems a high likelihood that AMSC will grab a large piece of the total addressable market for HTS-based ship protection systems (estimated by management to be between $75M and $120M by 2020).
Resilient Electric Grid
In April 2011, the Department of Energy’s (DOE) Undersecretary for Energy established the Grid Tech Team (GTT). Understanding the pressing need for electric grid modernization, the GTT laid out some key requirements for the grid of the future. Included in the list: “Reliability, security (cyber and physical) and resiliency.” In addition to these three items, power operators also face challenges to increase the grid’s capacity and efficiency. AMSC’s REG system offers solutions in two ways.
For reliability improvements, the REG cable can be used to “loop” nearby and existing urban substations to each other in order to distribute excess capacity when needed. Currently, urban substations tend not to be linked to one another. In the event of a power outage (from extreme weather, cyber or terrorist attack, power surge, etc.), the neighborhood served by that substation will be without power until it is repaired. The high cost of the thick copper wire needed to link substations was one reason it typically wasn’t done. But AMSC’s cable has the ability to carry 100 times the current of equivalent sized copper wire. Additionally, its design features allow it to protect against the high fault current that usually develops when substations are linked. This makes connecting substations more feasible.
To improve capacity, the REG cable can be used in a “branch” configuration. This involves connecting existing urban substations with newer, smaller substations that do not require large power transformers. AMSC’s proprietary HTS wire, with its high-load handling capacity and fault current limiting characteristics, would significantly reduce real estate, construction, and operating costs.
The Department of Homeland Security (DHS), in partnership with different local utilities, has already awarded AMSC with some contracts to perform deployment studies. Commencing in 2007, Project HYDRA is a deployment study that is taking place in Manhattan in conjunction with local utility Consolidated Edison (ConEd) (NYSE:ED). The DHS has committed the full amount of the $29M in expected funding. Commencing in 2014, Project REG is a deployment study with Commonwealth Edison (ComEd), a unit of Chicago-based Exelon Corporation (NYSE:EXC). The DHS is expected to invest up to $60M under Project REG. Deployment studies are currently ongoing in three other cities, making AMSC well positioned to tap into the potential $5.7B annual market opportunity that management estimates for upgrading urban substations in the US.
Q3 2016 Earnings Call
During the recent call, Mr. McGahn discussed the introduction of AMSC’s third new product in three years, D-VAR VVO. It was well received at the DistribuTECH Transmission & Distribution Conference in San Diego. D-VAR VVO extends the D-VAR product line from transmission to distribution, as it is “specifically designed to mitigate power quality issues on the distribution power grid for increased solar capacity, increased penetration of electric vehicles, and support conservation voltage reduction (CVR) management.” By introducing this product, management believes it is doubling the potential market for its FACTS products. This should help alleviate some of the concern that AMSC is currently too reliant on INOX as a single customer.
Another positive from the call was that cash burn was in line with previous guidance of only $600K. The loss for Q4 is anticipated to be less than $2M. For the time being, it seems cash burn has stabilized (relatively speaking). With $26M in cash, liquidity will not be a problem for some time. Dilution, though, is never welcome. Unfortunately, the January 27, 2017, At Market Issuance (ATM) Sales Agreement does just that. However, management has made it clear that the $10M in common stock that can be raised will be used to fund growth initiatives or to collateralize performance bonds on future customer contracts (contracts that are not part of the existing revenue base).
While there still are no commercial orders for REG products, the updates were positive. In addition to the five US utilities that are actively evaluating AMSC technology, AMSC is actively tracking activity in over two dozen utilities. And for the first time, the sales force began targeting outside of North America, hitting Australia and the United Kingdom.
With regard to the Navy, management reiterated applications on three fronts: SPS, ship power distribution, and ship propulsion. The January 3, 2017, $4.5M award from the DOE to participate in its Next Generation Electric Machines program goes hand in hand with the ship propulsion application. Additionally, the marketing efforts are expanding beyond the US for SPS as well. In the months ahead, we should know more about the NATO partner being courted.
All in all, things are moving in the right direction, though at a slower pace than anxious investors would like. But it’s important to remember who AMSC’s Grid customers are. The Navy is a large government bureaucracy, and utility companies are large, quasi-government bureaucracies. Adoption of new technologies that require large capital investments is almost always glacial. CEO McGahn even said during the call that “the REG conversations take about a year to get to the point where we know if there is a project in the near term.” He also speculated, given that there have been no commercial orders yet, that it would take about a year to go from the study phase to commercial orders.
For investors aware of AMSC’s potential to be quite a turnaround story, it continues to be a long wait. But a wait still worth waiting.
The Raven Group is a Corporate Counterintelligence consulting firm that helps companies protect their trade secrets, intellectual property (IP), employees, and reputation. Raven’s consultants have spent a lifetime protecting our nation from threats of every kind and are second to none. Let us bring that expertise to your company.