No Cheers in Latest China Green Energy War

NEW YORK ( TheStreet) -- American Superconductor ( AMSC) said it had no choice but to sue Chinese wind giant Sinovel for intellectual property theft, but that doesn't leave investors with much of a choice when it comes to shares of the technology company and former supplier to China's largest wind turbine maker.

American Superconductor announced late on Wednesday that it was suing Sinovel for stealing its intellectual property -- related to the software and electric components it makes that allow Sinovel's wind turbines to connect to the electricity grid. The turbine produces electricity that must be converted for the grid and the software card inside the electrical components facilitates this process. A former employee of an American Superconductor affiliate in Europe was arrested by Austrian law enforcement in July for corporate espionage, essentially for providing a way for Sinovel to hack through the encryption that protects AMSC's source code.

It's the latest twist in a downward spiral of the relationship between the Devens, Mass-based company and its former revenue stalwart Sinovel, which had accounted for as much as 75% of American Superconductor's revenue. The issue started as an inventory backlog at Sinovel, which forced the Chinese company to stop accepting shipments from AMSC, it said. As a result, AMSC had to restate its financials and lower expectations for revenue as it tried to work out a deal with Sinovel.

The issue occurs within the larger context of lower margins for Sinovel in the Chinese wind market where pricing has moved rapidly lower. Sinovel was also reportedly buying more electrical components from an affiliated supplier in China at the time of the AMSC hard stop, a relationship given new light now that the AMSC source code within the more commoditized nuts and bolts of the eletrical component has allegedly been stolen.

However, until AMSC's surprise announcement on Wednesday night alleging corporate espionage and IP theft, Wall Street had hoped AMSC eventually would work out its differences with Sinovel, getting it back to some semblance of a relationship to sell its electrical components that support Sinovel wind turbines, even if it was lower revenue in total, predicated on Sinovel's need to bolster its declining margins.

Suing Sinovel ends that dream, and even if AMSC ultimately recovers cash through a legal settlement, there is no telling how long that could take or what amount of cash a settlement could add to its balance sheet.

If the charges of source code theft are true, AMSC had no choice and its case against Sinovel is a positive step since there was no other steps to take. But all the same, it leaves investors caught between a rock and a hard place. Here are the issues for American Superconductor which mean any bet on AMSC by an investor at this point is a purely speculative play:

When the company announced a work force reduction of 150 employees earlier this year, as part of its attempt to recover from the Sinovel situation, Wunderlich Securities analyst Theodore O'Neill noted the size of the job cuts suggested the Sinovel relationship would be resuscitated. In fact, the analyst said that if Sinovel wasn't coming back as a sales agreement, AMSC would have had to lay off as many as 600 employees.

In conjunction with the announcement from AMSC about the corporate espionage, John Kerry (D- Mass), head of the Senate foreign relations committee, said that jobs were at stake. Indeed, one question for AMSC is how large of a work force reduction it may now be forced to make in conceding that the AMSC relationship won't return at any level of sales.

This hints at a larger question, too, which is how much cash the company is generating per quarter and whether its cash flow can recover from the loss of Sinovel in the short-term, even if at some later date its court challenge is successful.

This makes the company's planned acquisition of Switch, the Scandinavian wind power company, crucial as a way to replace lost revenue, and yet, it has to make the acquisition at a time of a weaker balance sheet. That's not a new issue, but it is now even more acute as there is no expectation of any future revenue from Sinovel, or reasonable time line for when court damages would be awarded to the company. "I don't think there's much cash burn risk here but I don't think they have the cash to do acquisitions either," O'Neill said, referring to the Switch acquisition.

"The Switch acquisition seems doubtful," said Paul Clegg, analyst at Mizuho Securities. "In order to make the acquisition they need to raise capital, but for that they need a better story on a cash flow and revenue rate without Sinovel."

"Some clouds have been removed and other clouds have moved in," said Capstone Investments analyst Carter Driscoll, who rates the stock a hold. "But what other alternative were they left with? Theft is not an inventory problem. It's a positive but small step," Driscoll said.

In any event, shares of American Superconductor were down 13% on Thursday.

Do other OEMs in the wind turbine market step up and soften the blow of the complete loss of Sinovel sales? One thing AMSC noted on its Thursday morning conference call is that with the lawsuit pending, any buyer of a 1.5MW Sinovel turbine would be taking a legal risk. That could be a short-term market share positive for AMSC through other customers in China. However, the wind market overall is moving away from the 1.5MW turbine. "It's last year's Buick," said Wunderlich's O'Neill.

Without the Switch acquisition and without Sinovel, no one knows what the revenue run rate is exactly, though Wall Street models should be emerging later today and tomorrow. Investors will get a first look at the cash flow and revenue at the end of the month when the company expects to file updated financials. And even if it adds another $140 million in revenue by bringing in Switch, it still could be at half the former level of revenue.

"It could be less than half of what people were looking for, but it's not zero either," said Capstone's Driscoll.

Wunderlich's O'Neil thinks that AMSC can get to $50 million in revenue without the Switch acquisition. In the third quarter of 2010, the company had $115 million in revenue, its best quarterly revenue during the Sinovel heyday.

Yet Mizuho's Clegg thinks it's the fact that this revenue profile would take ASMC back to where it was years ago before it began its rapid growth with Sinovel that really stings.

"If you thought there was any optionality in the stock for Sinovel coming back on even at a lower margin, which seemed reasonable, or doing some licensing agreement, it's no longer possible and for me that makes this a net negative," Clegg said, adding that suing for IP theft might be the rational response, but also might be the equivalent of buying a lottery ticket. "This stuff usually takes a very long time and the profile of the companies involved can have an impact on the outcome," the analyst said, though he stressed he is not an IP expert.

At a time when White House-backed and bankrupt solar company Solyndra claims unfair competition from China as the reason for its downfall, AMSC may get a little more help from its political friends than it otherwise would have expected, but it's still not Cisco fighting an IP war. In its commentary on the criminal and civil suits, AMSC made a point of saying that its action was not taken against China or China's green energy industry, but against Sinovel specifically.

"What's the point in owning the stock? They can't make money for the next several years and they are spending on a lawsuit with China that could be like the lottery, and even reducing their cost structure, they've been set back years on profitability targets," the Mizuho analyst, who rates AMSC a sell, argued.

On the positive side, the company has no debt, and even if its revenue profile is diminished, it's not an existential risk that AMSC faces.

"The past has been explained in way that ties it up in a nice neat bow, but whether the market pays a penny for $50 million in quarterly earnings, I don't know," the Wunderlich analyst O'Neill added.

-- Written by Eric Rosenbaum from New York

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