|Shares Out. (in M):||20||P/E||18.1x||18.8x|
|Market Cap (in $M):||99||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||-4||EBIT||0||0|
|TEV (in $M):||95||TEV/EBIT||0.0x||0.0x|
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The stock of Arotech Corp., ticker ARTX has surged 41% year to date and is up 330% over the last twelve months. In addition to a higher stock price, trading volume in the stock has exploded as illustrated in a single day last month when the stock traded 70% of its public float. Much of investors’ enthusiasm for the stock has been fueled by the belief that ARTX is a play on Tesla and the growing electric vehicle (“EV”) battery market.
Investors, who are paying 19x 2014E EPS for the stock, may be surprised to learn that (i) ARTX is not a Tesla play, (ii) ARTX’s core business may be in decline (as evidenced by the 34% decline in its backlog at year end), (iii) ARTX’s 2013 results greatly benefited from a significant, non-recurring gain, (iv) analysts project ARTX’s EPS will decrease this year, (v) ARTX’s much hyped Flow battery is really an early stage technology with unclear prospects, (vi) ARTX’s management is highly paid (yet can’t even use the proper share count in calculating eps), and (vii) ARTX’s Board may not be acting in the best interest of all shareholders.
Volume in ARTX’s stock began to increase after Zacks.com published an article on February 28, 2014 entitled “Beyond Tesla: 2 Lithium Stocks to Buy Now.” Adding further fuel to the fire was a Seeking Alpha piece on March 25, 2014 entitled “Arotech Corp. - A Lithium-Battery Stock Ready To Quadruple .” This highly promotional article (which among other things, embarrassingly used the wrong share count) stated that ARTX is “strategically positioned to take advantage of the [EV] market. “ The author further claims “Sales of electric cars have yet to eclipse 1 percent of new-car sales, leaving much room for growth for ARTX and its lithium-ion electric-car batteries.” The article also prominently displays a picture of a Telsa car which the author says “is powered by a lithium-ion battery which is what ARTX manufactures.” A quick review of various online message boards also reveals numerous posts discussing ARTX’s business with TSLA.
All of this sounds great, except for one thing. ARTX isn’t involved with the electric vehicle market or with TSLA. Furthermore it has no plans to enter the market. Neither “Tesla” nor the phrase “electric vehicle” are mentioned in ARTX’s 10k or in its investor presentation. Furthermore, during the q&a on latest earnings call, ARTX’s management said “we are not currently looking to enter the EV markets as such.” ARTX makes batteries for tanks but not for electric vehicles like Tesla.
Despite some investors’ enthusiasm, B. Riley, the only sell side firm which covers the stock, is less optimistic. The firm rates the ARTX “Neutral” with a $5 price target. Considering B. Riley was the lead underwriter for ARTX’s latest equity offering (~4mm shares were sold in September for $1.75 per share), investors may wish to pay attention to the analyst’s cautionary tone.
In 2013, ARTX generated 72% of its revenue from its Training and Simulation Division. This division develops, manufactures and markets advanced high-tech multimedia and interactive digital solutions for use-of-force training and driving training of military, law enforcement, and security. This is an interesting business but its revenue stream is lumpy and very dependent upon public sector spending which has been negatively impacted by government budget constraints. The backlog of this division at the end of 2013 was down 37% from the previous year, which should make people question the business’s prospects.
The remaining 28% of ARTX’s 2013 revenue was generated by the Battery and Power Systems division. This division manufactures and sells lithium and Zinc-Air batteries for defense and security products, including tanks and the SWIPES power hubs. The backlog of this division at the end of 2013 was down 21% from the previous year, which should make people question the business’s prospects.
The latest investor ppt can be found at http://www.arotech.com/A1InvRel/A1downloads/files/ARTX%20Inv%20Pres%20Q313%20v10.pdf .
Last week the company reported Q4 results. The company reported revenue, EBITDA, and pro forma EPS of $20.9MM, $514k, and $0.01, compared with B. Riley’s estimates of $21.7MM revenue, $822k EBITDA, and $0.02 pro forma EPS. However, as discussed below, ARTX benefitted from a one time, true up gain of slightly less than $1 million which was not in the B. Riley estimates, so excluding this gain, ARTX appears to have missed badly.
Investors may wonder why ARTX was not more open about the benefit of the true up. It was not mentioned in the earnings press release and the full extent of the benefit was only revealed after investors specifically asked about it during the q&a on the earnings call. This is important because this benefit (which was slightly less than $1 million) is a non-recurring item and considering the company generated only $2.1 million of net income, the benefit is very significant.
We also believe the company used the wrong share count in calculating q4 eps. The share count used to calculate EPS in the Q3 and Q4 results are similar (~16mm) , even though the company issued 4 million shares in Sept/Oct. While this doesn’t impact our thoughts on valuation, it does raise questions about the quality of management.
Speaking of management’s credibility, we have some questions about the Board:
Firstly, why did the Board grant the CEO a 25 year, non-recourse loan for almost $0.5 million (the loan was to purchase stock and is secured by stock). ARTX isn’t a bank and it isn’t in the business of making loans, especially one with such generous terms. Furthermore, why does the CEO, who is paid handsomely and owns a significant number of shares need a loan from the company (and its shareholders)? We believe these kinds of loans were outlawed by Sarbanes Oxley but that the ARTX loan may have been grandfathered. So, even though this loan is legal, it raises questions about whether the Board is acting in the best interests of all shareholders.
We also are concerned about the excessive compensation the Board has granted to management. In 2013, the Chairman/ CEO, who is 76 years old, received $1.3 million of total compensation. In 2013, ARTX’s president received $1.1 million of compensation. Considering ARTX only generated $2.1 million of net income in 2013, we question if paying the top two executives a combined $2.4 million is really in the best interests of all shareholders.
We also note that management’s bonus appears to be tied, in part, to revenue and ebitda targets, not eps or ROE, etc. This Board established incentive structure doesn’t strike us as the best way to create shareholder value and could motivate management to pursue foolish acquisitions simply to achieve revenue or ebitda growth.
One thing that likely prevented ARTX’s stock price from falling even more after a disappointing earnings report was the company’s announcement that it acquired UEC Electronics for $28 million in cash, ~$5 million in stock and $5.5 million in possible earn outs. UEC develops and manufactures electronic components and subsystems primarily for military, aerospace and industrial customers. Although UEC’s results were down in 2013, ARTX’s management is optimistic about UEC’s future. UEC is a new business for ARTX and ARTX has limited experience operating this particular type of business.
Some investors are also bullish about ARTX’s flow battery, which is an early stage development of a low-cost solution for energy grid storage. Management describes this business as “still early stages” which will require millions of additional dollars of investment. It is unclear if and when the technology will ever be commercially viable. In his latest research report, the B. Riley analyst says this “could be a great product for ARTX down the road….” However he also warns “Recall, however, that this storage project already is scaled back in scope from what once was envisioned as a potential power plant solution, with both storage of energy and recycling of materials… [and that] Iron/Iron Ferrocyanide is but one horse in this race, and other companies have been working to commercialize other flow battery chemistries, and success is far from guaranteed.”
Although UEC will contribute positively in 2014, ARTX’s financials will be negatively impacted by the greatly reduced backlog in its standalone business that was down 34%, as well as the lack of ~$1 million true up which significantly enhanced 2013 results. As a result, B. Riley projects EPS to decrease to $0.26 in 2014 from $0.27 in 2013. Note all EPS figures are essentially untaxed as the company has a sizeable NOL.
Based on recent SEC filings, ARTX does not appear to have significant institutional ownership. We suspect many of the recent buyers have been momentum buyers (who may have already started to abandon the stock), growth oriented investors (who may have been disappointed by the weak backlog and weak guidance) and people who thought they were buying a company positioned to benefit from the growing market for EV (and are now realizing they don’t really know what they own). We suspect all 3 of these groups will continue selling stock, and note that management has been selling a bit of stock too.
Short interest has increased from 0.9mm in mid march to 2.4mm (14% of float) at the end of march.
The stock recently fell through 20 day moving average and trading volume has decreased, so perhaps the mom guys have moved on
The vic figures input at top are not pro forma the UEC acquisition.
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