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Why A123 Systems Still Not Worth It

A123 Systems (AONE) shares reached $28.20 today, implying a market cap of approximately $2 billion. This is more than double its IPO price, and triple the low end of the initial IPO offering range.

Investors are clearly placing a lot of hope in A123's technology, but are also ignoring the company's fundamentals and playing the stock for its momentum.

At the other end of the spectrum, other lithium-ion battery plays such as China Digital Communications (CMTP) are also trading out of line with their fundamentals, but are undervalued rather than overvalued.

In my last article on A123+, I questioned its valuation when it was trading around $18 per share; I received massive amounts of feedback suggesting I didn't understand the potential for A123's lithium iron phosphate technology. I responded to many of these emails with a simple question: "What revenue and margin forecasts are required to justify the current valuation of A123?" I received zero responses that actually answered the question, so I decided to construct an analysis of my own.

From the IPO prospectus, one can see that A123 has two business lines, battery products as well as R&D services. The majority of revenue and presumably the basis for growth expectations is derived from product sales, so I will confine my analysis to this part of the business.

Historical Financials of A123
2006
2007
2008
1H 2009
Product Revenues
$ 28,346
$ 35,504
$53,514
$36,638
Cost of Product Revenues
(28,960)
(38,320)
(70,474)
(39,186)
Gross profit
(614)
(2,816)
(16,960)
(2,548)
% of product revenues
-2.2%
-7.9%
-31.7%
-7.0%
Total operating expenses
16,517
30,884
67,348
39,493
% of product revenues
58%
87%
126%
108%
*All numbers in US$ millions except percentages.

A few key things to note here. First, A123 has negative gross margins. Every time it sells another product, it loses a bit more money, although in the first half of 2009 it did start coming close to being able to sell its products for above what they cost, coming only 7% short. Second, even if A123 were selling its products at a profit, its operating expenses are still greater that 100% of revenue.
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