A Lithium-Ion Battery Play From China

Editor's note: This is the first column from Rick Pearson, a Beijing-based private investor focusing on U.S.-listed China small-cap stocks.

BEIJING (TheStreet) -- Judging from its latest earnings announcement and conference call, Advanced Battery Technologies(ABAT Quote) is pursuing a new and less-profitable direction.

ABAT essentially is following a business model that will place it squarely in the highly competitive electric-vehicle space rather than in the highly profitable Li-ion battery space. The markets immediately recognized this, driving ABAT down by more than 10% to $3.90 Thursday, and down from a recent high of $5.04 on Aug. 6, a decline of 23%.

Over the past year, ABAT has twice diluted shareholders by raising equity/equity-linked financing and intends to use the new funds to expand in a less profitable but more visible and rapidly growing business area, namely electric vehicles via wholly owned subsidiary Wuxi Zhongqiang Autocycle.

While ABAT did its best to post nice-looking numbers, the underlying deterioration of its business model is clear. Revenue rose 29% to $13.8 million from last quarter, primarily on increased sales of its wholly owned subsidiary, Wuxi ZQ. As a result, even with Wuxi ZQ sales accounting for only 26% of revenue, total gross margin fell from 50.8% to 45.8%.

Sales via Wuxi ZQ are expected to comprise an ever growing-portion of ABAT sales, resulting in increasing pressure on its gross margins.

Moreover, while profit increased a seemingly impressive 122% to $8 million quarter over quarter, the increase was due to a one-time gain of $9.9 million on the purchase of Wuxi ZQ. It's unclear how that gain was calculated.

Excluding the one-time gains, net profit would have been $1.3 million, a decrease of 50% quarter over quarter, representing a net margin of only 10%.