Date: Jul 23, 2013 Author: Tom Konrad Source: Forbes (
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Axion Power International, Inc. (OTC:AXPW) has been developing its patented PbC lead-carbon battery technology, and in 2013 those efforts seem on the verge of paying off. Unfortunately, Axion's financing situation makes me unwilling to recommend its stock as an investment in the near term, but I do consider it one to watch. This article will take a look at Axion's technology and near term potential markets. A follow-up article (published here) will discuss the company's financing situation, and the things which will need to change before I consider the stock an attractive investment.
Axion's PbC batteries are conventional Lead-Acid (PbA) batteries with the lead sponge negative electrodes replaced by a sandwich of a copper current collector protected by corrosion barriers which are in turn surrounded by carbon electrodes. Not only does this reduce the lead used in the batteries, but, compared to PbA batteries, results in a much more durable battery capable of a much faster recharge rate.
While they cannot compete with Lithium-Ion batteries on energy density, PbC batteries require less complicated battery management, have better low temperature performance, are more cost effective to recycle, and have a much better safety record. They deliver all these advantages at significantly lower cost.
ePower
According to Jay Bowman, the Chief Technology Officer at Axion customer ePower Engine Systems, it was as if Axion's batteries had been specifically designed for ePower's application. ePower has developed a series hybrid drive system similar to that used in railway locomotives intended for retrofit into heavy-duty class 8 trucks. Retrofit is a practical application for heavy-duty trucks because a heavy-duty truck's engine is rebuilt several times during the life of the chassis. Hence, ePower has the opportunity to achieve significant penetration into the heavy-duty truck fleet without having to manufacture complete trucks. The cost effectiveness of ePower's hybrid retrofit is also enhanced because much of its cost is offset against the cost of conventional engine replacement.
After two years of testing various types of batteries (both PbA and Lithium-Ion,) Bowman concluded that only Axion's PbC batteries had the durability and recharging capacity required for a series hybrid drive in heavy duty diesel trucks.
Earlier this month, ePower ordered $234,000 worth of PbC batteries for retrofit into ten trucks. It will be placing these truck with different trucking fleets to allow the operators to gain experience with the system and allay any concerns about durability. Multiple operators have informed Bowman that, if the trucks perform as he expects, they will quickly begin placing orders in quantity. The economics and fuel savings of ePower's system are so significant that fleet operators will be compelled to use the system to compete, assuming durability concerns can be adequately addressed.
Norfolk Southern
The second generation NS 999 electric switcher locomotive uses Axion Batteries. Photo by Missy Schmidt.
Norfolk Southern Corporation (NYSE:NSC) released its 2013 corporate sustainability report on July 16th. The report devoted most of a page (30 of 130) to the NS 999 all-electric switching locomotive, which uses Axion PbC batteries. The NS 999 was the first of four "Alternative Power" projects mentioned, and was given considerably more space than the other three. In contrast, Norfolk Southern's 2012 report only mentioned the NS 999 prototype once, in its environmental timeline, where the prototype was mistakenly said to have been unveiled in 2010, rather than 2009. The timeline was corrected in the 2013 sustainability report.
NSC's second generation NS 999 is equipped with Axion PbC batteries, which the sustainability report describes as "more technologically advanced" than the lead-acid batteries the previous NS 999 had used, and with which NSC had encountered "technical challenges" during trial field operations.
Axion completed delivery of the 1,080 batteries for the second generation NS 999 in January, generating $475,000 in revenue in the fourth quarter of 2012.
It seems reasonable to believe that the greatly increased prominence of the NS 999 in Norfolk Southern's sustainability report reflects increased confidence on the part of NSC's management that its previous "technical difficulties" may have been overcome.
Stationary Power
While Norfolk Southern and especially ePower could potentially produce orders which lead to explosive sales growth in coming years, Axion's initiatives in stationary markets are most likely to lead to significant revenue and cash flow this year.
Axion's PowerCube is an array of PbC batteries with associated control electronics mounted in a standard cargo container. These can be quickly deployed to remote locations, and are being marketed to commercial, military, and utility operations especially on offshore islands. Axion has responded to a large number of RFPs in these markets which could lead to orders and this year. Since payment is typically up-front, any such orders would greatly help Axion's financing situation.
Offshore islands and other remote locations, and military operations have very expensive electricity, since the marginal source of power is almost uniformly diesel generators. That increases the value of grid stability and power-shifting services from stationary storage. The fact that these applications are stationary makes PbC's disadvantage compared to Lithium-Ion (higher weight and volume) much less significant. Axion has preferred vendor status for a number of offshore island projects, and expects commercial sales to commence this year or in early 2014.
The scale of grid tied applications is also an advantage for PbC, since price becomes more significant at scale, and PbC batteries work well in long strings (high voltage installations.) Operation in long strings is much more problematic with Lithium-ion (and other battery chemistries) because variability between batteries requires either complex battery management or significantly reduced performance and leads to early battery failures. This sort of variability is why we are told to keep sets of rechargeable batteries together, and not mix batteries of different types, ages, or even manufacturers [PDF].
Stop-Start
I, and most of my readers, were introduced to Axion Power by John Petersen, Esq., an attorney and former board chair and general counsel for Axion. From 2007 to 2012, John wrote prolifically about energy storage and the electrification of transportation for Seeking Alpha and my own website, AltEnergyStocks.com. While he did write about the NS 999, ePower's hybrid truck application, a more typical example of his articles was spent critiquing the economics of plug-in vehicles (with special attention to Tesla Motors (NASD:TSLA),) and talking up the economics of PbC batteries for Stop-Start hybrid vehicles. Given all this background, I will not go into detail on the economics of Stop-Start technology, but simply refer you to Petersen's article archive on Seeking Alpha.
In terms of Axion's progress on stop-start, I spoke with Axion's CEO Thomas Granville on Thursday. BMW has completed third party testing on its prototypes, but does not want to adopt the technology if Axion is its sole supplier. With an introduction from BMW, Axion is working with at least one major battery manufacturer to allow it to be a second manufacturer for BMW.
Like BMW, many potential customers will be unwilling to design PbC batteries into their own products until they can be certain there will be a supplier even if Axion Power, a microcap company with financing difficulties, goes bankrupt. If Axion successfully negotiates a deal with a major battery manufacturer, it will open a lot of doors, and not just to inclusion in BMW's Stop-Start vehicles.
Conclusion
I'm extremely optimistic about Axion Power's business prospects over the next twelve months. I anticipate a breakthrough in at least one of the four business areas I outlined. Unfortunately, Axion was forced to raise money to fund its continuing operations in a $10 million offering of non-conventional convertible notes. The conversion price of these notes is tied to Axion's market price is based on the recent market price, and so a falling share price for the stock leads to greater dilution of shareholders and further stock price declines.
Even with Axion's bright business prospects, the continuing issuance of new shares to repay these notes, and Axion's likely need to raise additional capital next year make careful timing of any stock purchases essential. I discuss my ideas on the most advantageous timing in a follow-up article. But, if I owned the stock today, I would be a seller at the current price of $0.17.
Disclosure: no position in any of the stocks mentioned.
Correction -
In my last article, Axion Power's Potential For Explosive Growth, I outlined a number of near-term business opportunities for Axion Power International, (OTC:AXPW) any one of which could catapult the company into profitability in 2014, and more than one of which could produce significant revenue growth this year. While I'm quite bullish about Axion's prospects, I concluded with a skeptical comment about Axion's stock:
[I]f I owned the stock today, I would be a seller at the current price of $0.17.
Down the PIPE
How can I be so bullish about the company's business but still want to sell the stock? It's all because of the recent private investment in public equity (PIPE) convertible note financing. This is an unconventional convertible financing, because the conversion price of the notes falls with the market price. Convertible financing of this type is variously known as "ratchet," "toxic", or "death spiral" because as the stock price falls, the convertible notes convert into more shares. Because the convertible note holders end up owning more shares, existing shares represent a smaller percentage ownership of the company, and are worth less. This sets up a vicous cycle, which frequently ends with the original shareholders owning only a small slice of the company.
There is also an element of the self-fulfilling prophecy: Because existing shareholders expect to be diluted, they sell the stock, which depresses the share price and leads to further dilution of those shareholders who held on. It's a sort of prisoner's dilemma: if all shareholders would just hold on, or even buy into price declines, they can prevent the financing from creating a self-fulfilling death spiral.
Could Be Worse
That said, this is far from the worst such convertible financing I have seen. For one thing, the conversion option is held by Axion: they can choose to pay in cash or shares. For another, the note is payable in nine equal installments over nine months, and the conversion price is the average price of over the 20 trading days (approximately one month) for which the price was lowest out of the last 40 trading days (two months) before each payment. CORRECTION: The conversion price is 85% of the lower of the price on the previous trading day, or the average price over the 20 trading days (approximately one month) for which the price was lowest out of the last 40 trading days (two months) before each payment. Many toxic convertibles are payable all at once and the conversion price is based on the stock price over a shorter period. This makes it very easy for the holders of the convertible to sell a large amount of stock during the period the conversion price is being set, artificially reducing the conversion price and awarding themselves more shares at conversion.
There was also a $1 million subordinated convertible note sold to company insiders. Unlike the $9 million of convertible notes described above, this entire note (principal and interest) is payable at the end of the term, in cash or shares, at the company's option. Both sets of investors also received approximately 50% coverage of the notes with warrants that can be exercised after six months and before five years at $0.302. If there is a future financing at better terms over that period, the exercise price on the warrants is reset to the price of the future financing.
The Next Round
According to Axion's CEO, Thomas Granville, Axion has enough cash that it won't need to return to the markets for additional financing until 2014. If things go well (I recently argued that they could,) Axion may not need to return to the markets for additional financing any time soon.
On the other hand, if new business is slow to materialize, the prospects for an additional round of financing could put more pressure on the stock.
Incentives
The first convertible payment was made on July 3rd, at a conversion price of approximately $0.193 $0.136 (by my estimate.) That means the investors were paid with approximately 5 7.1 million shares of stock. The second payment will be on August 3rd, and, given the 40 day look-back, we know that the conversion price will be at most $0.155 $0.131, with a minimum of 7.4 million shares issued.
AXPW trades an average of less than 10 million shares a month, so the market is simply not liquid enough to absorb all of this stock if they choose to sell. That means that the investors have enough shares to force down the price of Axion's stock quickly. Since they can force down the price of Axion stock, it's helpful to ask: Do they want to?
The reason to reduce the stock price is so that they will get more shares in future payments. On the other hand, if the stock price remains low at the end of the nine months, most of the new stock issued will go to the company insiders who bought the $1 million subordinated notes. A low share price at the end of the nine months would also likely mean a low share price in early 2014, when Axion will most likely need to raise additional funds. If the share price is low then, Axion will likely be forced into another, even less favorable deal, and they will find themselves diluted just like Axion's long term shareholders are now.
Finally, if the convertible note holders force the stock price "too low," Axion might choose to pay them in cash rather than shares, betting that it will be able to raise cash from other sources on more favorable terms. Management might also be forced to pay in cash because Axion is only authorized to issue 200 million shares without a shareholder vote. 114 million shares were outstanding in the first quarter, and an additional 5 million are reserved for options. This leaves at most 81 million shares for payments to the note holders.
The 81 million authorized shares may not prove to be a hard limit. If Axion were to run up against this share issuance limit, the company has the option to make the remaining payments in cash, or ask shareholders to approve the issuance of additional stock. If cash were unavailable, as is likely, and shareholders were to fail to approve the issuance of additional stock, Axion would be forced to default on the notes. Any default would likely lead to bankruptcy or a negotiated settlement with the note-holders. Either would probably be worse for shareholders than the expected dilution from additional share issuance.
Axion shareholders should not be comforted by a seemingly parallel situation at ZBB Energy Corporation (NYSE:ZBB). While ZBB cancelled plans to hold a shareholder meeting needed to sell shares to Aspire Capital Fund because of lack of shareholder support, failure to obtain shareholder approval does not lead to default under ZBB's agreement with Aspire. It is the threat of default which would most likely lead shareholders to agree to additional share issuance, if necessary.
This chart replaces a previous version to reflect my changed understanding of the conversion price.
In the chart above, I've run three possible scenarios of what might happen to Axion's stock price over the next 8 months, and the resulting likely dilution of existing shareholders.
In my first scenario, the share price stays roughly where it has been for the last month (purple lines.) In this case, the convertible note holders will end up owning approximately 66 79 million shares, or 37% 41% of the company for their $10 million investment, or about 15 13 cents a share. I don't think this scenario is at all likely, but I included it as a baseline.
In my second scenario, which I consider most likely. the note holders will attempt to drive the share price down in the short term, when there are a lot of convertible payments ahead of them, but ease up in the later months to avoid destroying the value of a company they will own a substantial portion of. In the scenario I modeled, they succeed in driving the price down below 5 6 cents in the September-October time frame, after which it begins to recover. This would result in the issuance of 111 131 million new shares, more than are currently authorized. However, as discussed above, it seems likely that shareholders would approve additional share issuance if the only alternative is bankruptcy. This scenario would result in the note holders owning being issued nearly 50% 54% of the company for their $10 million investment, or about 7.6 9 cents a share.
In my third and final scenario (green lines,) a positive business development triggers a quick share price recovery in the near future. Fears of dilution wane, creating a virtuous cycle, and the share price quickly rises above $0.264 $0.31, at which price note holders can choose to take payment in shares priced at $0.264 at their option, not the company's. This scenario results in the issuance of approximately 58 million shares (30% 34% of the company) at 21 17 cents a share.
Strategy
I think the most likely result is some combination of scenarios 2 and 3. The note holders will succeed in driving down Axion's share price in the short term, but this process may be interrupted by positive news resulting from one of the business opportunities I outlined in the last article.
Hence, I think a small investors' best approach is to sell or stay out of the stock now, and buy back in at the first sign of significant positive news. If there is not any significant news in the next few months, I expect the stock will be considerably lower in the September-November time frame, at which point I will consider buying the stock.
Since the liquidity of the stock is limited, larger shareholders will have to sit tight. There is also a concern that if all small shareholders rush for the exit at the same time. John Petersen, a large shareholder and frequent Axion commentator, put it this way:
[A]ny significant incremental selling can only serve to drive the price down in the short term and exacerbate the problematic aspects of the financing. … [I]t's like yelling fire in a crowded theatre. Sometimes the only thing long investors can do is suffer through what may prove to be a difficult period.
For myself, I'm fortunate not to own the stock, which I sold last year (at a loss) when it became clear to me that Axion would be in no position to negotiate favorable terms on this financing.
I realize that this article could be construed as yelling "Fire" in a crowded theater, but I feel my first priority with my writing should be to give you, my readers, my honest opinion. You'll have to decide for yourselves if you want to find out if the light at the end of the PIPE is an all-electric NS 999 switcher locomotive, or get out now before being sucked down a death spiral.
Disclosure: No position in any of the securities mentioned.
