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Why A123 Systems Still Not Worth It

Clearly, numbers like this make it impossible to value A123 in a traditional way, and assumptions are necessary to make any kind of a forecast. To do this, I created a few very generous hypothetical scenarios and tried to answer my original question: "What revenue and margin forecasts are required to justify the current valuation of A123?" I assume a generous, full-year hypothetical 2009 and then compare it to a very generous hypothetical 2011, making assumptions for revenue growth and margin improvement. My analysis looks like this.

How A123 Could Justify Its Multiple
Product Revenues
Cost of Product Revenues
Gross profit
% of product revenues
Total operating expenses
% of product revenues
Income tax expense
Net Income
Implied P/E multiple
*All numbers in US$ millions except percentages.

From the table above, it can be seen that in order to justify a P/E multiple of 100, it will have to do the following things:
  • quadruple revenue.
  • transform from negative gross margins to margins of 25%.
  • maintain operating expenses at current levels with no increase.
  • pay no income taxes due to tax-loss carry forwards.

If A123 does all of those things, net income should be around $20 million, and the current valuation of $2 billion will represent a P/E ratio of 100. With the exception of the tax losses, none of this seems particularly likely.

Compare this with a different lithium-ion battery maker, China Digital Communications. CMTP makes standard lithium-ion batteries for portable devices and has a direct comparable company, Hong Kong High Tech Power (HPJ - Get Report). CMTP is highly profitable, with gross margins in excess of 30% and net margins of over 20%. The company has no long-term debt, and the market cap consists of 30% cash. CMTP is in the same business as its Shenzhen neighbor HPJ, but while HPJ trades at a P/E of 21 times trailing 12 months' earnings, CMTP trades at only five times earnings.

For CMTP, I can see two reasons why the stock trades at a discount: its fundamentals and close peer. First, CMTP is not Nasdaq-listed. Second, CMTP has no research analyst coverage. To the extent that these factors change, CMTP is easy to benchmark against HPJ and should be trading at a price in the low $20s, up from its current level of only $6-$7. This would place it on a P/E similar to that of HPJ in the low 20s. It is notable that as recently as August, HPJ was an underfollowed company as well and traded at $1.38 (a P/E of 9) when coverage was initiated by Rodman & Renshaw. Less than three weeks later, it traded as high as $3.89.
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