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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
Hypothetical
Hypothetical
2009
2011
Product Revenues
$100,000
$400,000
Cost of Product Revenues
(100,000)
(300,000)
Gross profit
0
100,000
% of product revenues
100%
25%
Total operating expenses
(80,000)
(80,000)
% of product revenues
80%
20%
Income tax expense
0
0
Net Income
(80,000)
20,000
Implied P/E multiple
N/M
100x
*All numbers in US$ 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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