Description

I will keep the writeup short and sweet: if you can get the borrow and hold on tight, you should short AMSC as it will never grow into its valuation.  The short thesis rests on 3 legs:

1)     Read the postings at www.citronresearch.com.  While I think it is unlikely that Sinotec is fraudulent, there is at least some reason to consider this a related-party dealing. 

2)     The recently-announced contract with Sinotec is unlikely to be fully realized in the timeframe of the contract, based on our due diligence.

3)     The market for wind turbines is simply not large enough to support AMSC’s valuation.

In addition, the breath-taking recent insider sales ($10m yesterday) reinforce our belief in the overvaluation.

More detail on each point:

1)     Citron’s points are mostly reasonable.  They discuss the company’s checkered past, the implausibility of the Sinovel contract, the potential for related-party transactions, and the possibility of shady accounting.  This is basically self-explanatory though.

2)     Our diligence confirms that Sinovel is a real, though secretive, company, currently capable of building roughly 600 1.5 MW turbines a year.  However, the AMSC contract implies roughly 8,300 units to be delivered over 3 years, or roughly 2,800 units a year.  None of the people with whom we spoke believe this is feasible, and instead expect Sinovel to ramp from 600 to roughly 1,000 units, and keep the remaining components in inventory (as a generous explanation!).  In 2007, Sinovel built roughly 20% of the 3.5 GW of turbines.  There are roughly 50 turbine manufacturers in China, several of which are as large as or larger than Sinovel, and the Chinese turbine market is estimated to grow to 6-8 GW a year in a few years.  If Sinovel retains its 20%, this would indicate 1.5 GW, or 1,000 units of 1.5 MW, supplied by them over time, which is consistent with this commentary.

3)     The total world turbine market is 20 GW/ yr.  This is projected to grow to 40 GW/ yr by 2012.  However, most of this is fully-integrated production- ie, GE, Vestas, and other large manufacturers all make their own electrical components, and are thus not an addressable market for AMSC.  Assume that 25% of the market is non-captive/addressable (I believe this is generous), then 10 GW/ yr is 6,700 1.5 MW turbines, at $55k revenue per component and 30% gross margin, with a 5% sg&a load and a 30% tax rate, a little under $10k net profit per component.  This leads to $64m of profit for AMSC, which is roughly 30x earnings.  And remember, this assumes that AMSC captures 100% of the market, and that market doubles from the current level.

A rough estimate would be, best-case scenario, AMSC captures 70% of the market and gets a 20x multiple, which would lead to a stock price of roughly $20.  Fraud or lack of business execution leads to additional downside.  Like all silly valuations, of course, they can get sillier, and any help identifying a catalyst here would be appreciated!

Catalyst