Wednesday, September 22, 2010

A123 – or how to lose money on YouTube…

One of the things I promised with this blog was to explore ideas rather than talk my book. I also promised to explore my failures (of which there have been a few). So here goes.

To make real money in tech your company must do three things. Two out these three and the results will be (at best) inadequate.

  • You need to have an idea that effectively changes the world in some way (even small ideas are OK as there are surprising profits if you can pull the next two tricks).

  • You need to execute – that is you need to bring the idea to reality.

    And you need to keep the competition out.

Of these normally number 3 is the thing that trips up tech companies – they work really hard to get the idea implemented and then someone with less expense – and with the benefit of watching your failures, trials and tribulations – copies the idea (usually slightly better or less clunky) and the margins go to zip. Microsoft is such a fantastic company not because they have the technology right – but because people build on them proprietary software (developers, developers, developers) and that makes people reluctant to change even if the new product is superior.

But a tech company can easily be tripped up on the execution phase as well. (Anyone remember Friendster? Remember when their site took 2 minutes to load a page because they couldn’t get the IT implemented properly? And look how valuable the position they lost is…)

At Bronte we normally don’t own tech stocks unless all the ducks are lined up – that is we want demonstration of execution and we want to understand how they keep the competition out.

This year we broke the rules and paid for it. Our largest losers (cumulatively about 5 percent) are two tech stocks that are having trouble at the execution phase.

One of them is small cap and too painful to mention – the other has some hope – and it is a well known company – possibly the hottest float of 2009. The company is A123 systems and it has one of the first viable nano-batteries. It has yet to scale production to a level which demonstrates execution and even if it can execute we are not sure how well it will keep the competition out.

What is a nano-battery?

A battery works by chemical reactions which liberate electrons which have to travel through circuits (delivering power) to complete the reaction. The chemical reactions work on the surfaces inside the battery (eg the lead plates inside the lead-acid battery in your car).

One of the limits to how much power a battery can produce and how fast it can recharge and the like is the amount of surface area that the reaction can take place on and how much of the chemical can be stored on that surface area. More surface area is good and your car battery has lots of plates to increase surface area to volume ratios.

A nano-battery makes the contact area very large relative to volumes by making all the contacts at a “nano-scale”. Obviously the smaller you make such stuff the larger the surface area to volume ratio.

A123 have produced the first commercially viable nano battery. It is no longer the only one – Toshiba for instance has demonstrated one. The specifications for this battery are a step increase from the past. If the battery can be made cheaply enough (and that is a big if) then it will change the world because it will make mass storage of electricity viable for lots of applications. The obvious applications are cars but also storage of solar energy and management of peak load electricity would come into play. If A123 executes it changes the world.

When we saw the specs – well – frankly we had our doubts. So we wanted to find people who used them. And remember in the early stage these batteries were frighteningly expensive. So we went to a group that we thought would use these batteries to their full potential and be insensitive to the cost. Besides it gave us a chance to pretend we are kids again – because the real enthusiasts never grew up (they still fly model planes). This little demonstration on YouTube translates raw battery specification into something visual.

The video is astonishing but we wish we never saw it because after seeing it we would have crawled over broken glass to buy the stock. This video cost us a lot of money!

Anyway – the demonstration is a 17 pound remote control plane powered by A123 batteries. The owner will enthuse endlessly – and indeed does.

When this film was taken the batteries were so expensive that only a nutcase enthusiast would pay for them. But who cares, or so we thought! Mass production makes everything cheap and this company had a technological edge and patents we thought might keep the competition out for a while.

There was an implicit assumption here – which is that, provided the battery did not contain super expensive materials (ie rare metals at thousands of dollars per kilogram), then mass production would make anything cheap… in other words we assumed away the risk and difficulty of execution.

And alas execution is really difficult – and whilst A123 is struggling to get a product to market at a price low enough to change the world – other competitors are turning up.  And they continue to burn cash in the hope of reaching some manufacturing promised land. 

Linked is recent article on a new nano-battery technology (and that alas is one of many, many of which look superior to A123). What got us was just how complicated the manufacturing process seems when you read this article. The company talks about “nano-wires” taking in lithium without breaking but the process not being sufficiently mechanically stable. After all things heat up and flex. So the nano-wires are built on thin metal cores that the company likens to steel rebar. Picture this: how small is this rebar? How do you manufacture it? Who builds the machines to make the machines?

The point is that we lost money because the company just can’t get manufacturing costs low enough fast enough to produce the rosy future we saw. We assumed away execution risk and paid the price.

A123 might get there in the end – and the stock is almost certainly a better buy now than when we purchased it – in that they are further developed and the stock is half the price. But we are hardly in a position to judge whether they will execute in the end. And we are already seeing competitive products in development.

The other tech stock where we assumed away execution risk – well that was an even worse outcome. And the pain of loss makes me not even want to talk about it.




We should note some informed comment on just how much battery technology has moved in the remote control plane space.  A123 might yet get to a desirable cost structure – but it is highly likely there will be lots of competition (at least nearby) when it gets there.


Anonymous said...

What about Ultracapacitors? I heard that EEStor has demonstrated a capacitor of 50F (!! wow) at 33kV.
Would have thought that serious power applications would be more interested in that kind of tech.
Of course, EEStor is old news now, so your point about execution is still well made.

Bytefield said...

A123 is executing, just not in the timeframe you hoped for. 2010 was a transition year, in which they yet again doubled production to keep up with coming demand for electric vehicles.

AONE has done poorly because the company is not yet profitable and therefore became a target of shorts. A123 management warned investors this would be the case, that profitability would be deferred until 2011.

You should be averaging down. This is a solid company, and all it takes is positive news to send the stock soaring again. At least three near-term events will trigger this:

1) A123 previously reported they have a sole supplier agreement with a major automaker. When that vehicle is announced, AONE will jump 20-50%. That could happen any day, A123 can't say anything until the automaker announces.

2) The Nissan Leaf and Chevy Volt will be delivered late this year. The huge demand for these EVs means every automaker will be introducing one. There will be a severe shortage of Li-ion batteries for years to come: it takes a year and $250M to build a single plant. Short-term demand for EVs will require 20-50 new plants. A123's competitors can't underbid on every contract, they don't have the capacity. Plus performance-oriented customers like BMW may prefer A123's product.

3) A123 has its first profitable quarter. They could have chosen to do this earlier, by delaying construction. They chose not to because they know their sales pipeline, and must expand to keep up. EVs aren't their only market, they are also bug in grid stabilization and solar/wind storage.

Bytefield said...

(continued due to comment length restriction...)

Finally, don't be distracted by competitors with superior technologies in development. It takes 5-10 years to get something out of the lab and into quantity production. EEStor is an example of a product that is promising but unproven. A123 recently spun off 24M to develop new discoveries in flow batteries. They did this because the technology is a decade from commercialization.

Be patient with AONE, you will be rewarded over the next few months, hugely rewarded if you hold for a couple of years. The EV is going to be a revolutionary, disruptive change in transportation, and A123 is perfectly positioned to ride this wave.

tsport100 said...

Surely a basic for betting on technology is to fully comprehend the technology and the market it sells to?

A123 cells have market beating POWER density but below average ENERGY density. That means they have an outstanding power to weight ratio but their battery specs are not competitive in energy storage per kg.

A123 cells are the perfect choice for short burst applications like power tools or Electric vehicle drag racing or even F1 KERS, but not for road going EVs where range anxiety is perceived as the biggest customer concern and battery with the top energy density spec wins.

This would explain why they've never progressed beyond the trial stage with a MVP.

EV battery development is at such an early stage with so many different technologies backed by so many multinational war chests it is simply foolhardy to try and predict a winner at this point in time.

Anonymous said...

The embedded Youtube video does not work in Germany.

John Hempton said...

I got TSPORTS point. If you think they are for power-density and recharge time then the right use is plug-in hybrids.

I have my doubts about fully electric vehicles (range anxiety wins there). But plug-in hybrids work if A123 gets battery cost low.

But then I had always thought hybrids work (my next car will be a hybrid) and once you have a hybrid a plug-in hybrid makes some sense.


Ira Stoll said...

At least you had a choice on whether to invest in A123, which is less than can be said for the taxpayers whose funds have been taken by force and used to subsidize the company (and by extension, its shareholders, i.e., you and the investors in your fund).
See here:

John Hempton said...

Fair comment...

Matt Perdew said...

Ira... I disagree. Really all you are doing is plugging in an article that does a very poor job of explaining the Bronte Capital article. The future of capitalism article shouldn't even be called that. Its not reporting anything new. I had purchased the stock at the original IPO and watch it soar and got out before it tanked. I was lucky.

The problem is everyone is so angry about the tax-payers subsidizing small businesses, but its actually quite foolish. I believe in the government giving out grants to find new sources of energy. $250M is nothing. Our government contracts for Defense are sickening. Yet Obama doesn't get any good press about the work he has done there. He has turned the table on excessive Defense Contracting and moved the majority of contracts to government positions which cost half as much as contractor positions.

He is trying to change our way of thinking by holding his hand out to people/companies with new ideas, in order to help us foster our own manufacturing, which is what made us a super economy to begin with.

Short AONE said...

My criticism of A123 is fairly simple. The battery business is a horrible business - we spoke to a long-time executive in the battery business and he was downright depressed; the best scale players are lucky to have 20% gross margins. Given the complexity associated with AONE's manufacturing process, which is still completely unproven from an economic standpoint, it is hard to see how the company every reaches even 15% gross margins over time. In addition, the company is at a competitive disadvantage relative to Asian competitors, with the majority of the supply chain in Asia (and yes I know they have facilities in Asia too). Finally, there is huge overcapacity in this space, which is causing significant pricing pressure and further limiting the potential for the manufacturing process to ever become economic.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.