Description

Thesis

FuelCell Energy (FCEL) is a 45 year old perpetually unprofitable fuel cell company that has been caught up in the fuel cell frenzy over the past month. Like the other fuel cell story stocks (PLUG, BLDP, HYGS, et cetera) FCEL’s share price has gone vertical -- up 120% over the last month and 224% over the past year. Trading volume has reached a mania with average daily trading volumes of 94mm shares (37% of shares outstanding) so far in March. Day traders seemingly insatiable desire for the company’s shares stands in stark contrast to the company’s deteriorating fundamentals – anemic orders, thin margins, declining deferred revenues and significant year over year declines in backlog. In addition, the company faces a major revenue cliff in 2016/2017 when its POSCO Energy (13% shareholder, 73% of revenue) contract expires and U.S. tax credits for fuel cells expire. Trading at 4.2x TTM revenues, shares are significantly overvalued and likely to fall substantially over the next year as the momentum traders depart and the company misses revenue and “earnings” estimates. 

Capital Structure

The preferred stock is convertible at $11.72/share and currently trades at 53% of par value.

Book common equity value per share is roughly $0.11/share.

$22MM of the par value $23MM 8% convertible bonds the company issued in June 2013 with a conversion price of $1.55/share converted to stock over the last 4 months.

The company sold 2.7mm shares in Q1, 4.3mm shares in 2013 and 2.0mm shares in 2012 “at prevailing market prices through periodic trades on the open market.” These share sales have been used to pay the dividends on the company’s preferred stock.

From the 2012 10-K (pg. 78):

The Company may sell common stock on the open market from time to time to raise funds in order to pay obligations related to the Company's outstanding Series I and Series B preferred shares.

NRG Energy owns 5MM warrants with a strike price of $2.18/share.

Company Overview

FuelCell Energy designs, manufactures, sells, installs, operates and services stationary fuel cell power plants for distributed baseload power generation. FCEL was founded in Connecticut in 1969 as an applied research organization, providing contract research and development. The Company went public in 1992, raising capital to develop and commercialize fuel cells and reincorporated in Delaware in 1999. FCEL began selling stationary fuel cell power plants commercially in 2003.

In 45 years, FCEL has never been profitable. Over the last 3 years, cumulative net loss has been $117MM, with cumulative free cash burn of $98MM. FCEL has funded these losses by engaging in numerous equity offerings, including a 25.3mm share offering in late January at $1.25/share. Over the last 39 months, the company has raised $136MM in equity offerings and $50MM in debt offerings. Shares outstanding have more than doubled over that time period.

According to FCEL, the unsubsidized levelized cost of energy for their products is $0.14 to $0.15/kW making it significantly more expensive than solar ($0.07 to $0.10/kw), Wind ($0.05-$0.10/kw) as well as nuclear ($0.09 to $0.12/kw), coal ($0.07 to $0.15/kw), and combined cycle gas generation ($0.06 to $0.09/kw.)

FCEL has a 65,000 square foot manufacturing facility in Torrington, CT which has capacity to produce 100MW of fuel cells in a given year. According to the company, the company is gross margin positive at 50MW, EBITDA positive at 70-80MW and Net Income positive at 80-90MW of deliveries. In FQ1 2014 the company produced 17.5MW (ie at an annual rate of 70MW or 70% of design capacity.)

You can see the company’s promotional videos on youtube to get a sense of the product they sell. http://www.youtube.com/user/FuelCellEnergyInc?feature=watch

The company’s pitchbook can be found here:  http://files.shareholder.com/downloads/FCEL/3015768726x0x729582/9500ef21-a003-4321-8db3-77ae50343674/Company_Update.pdf

POSCO

FCEL derives the majority of its revenues from contracts to build small scale electrical generation facilities. So far the company has had few customers willing to purchase uneconomic power and therefore the company has a highly concentrated customer base.

In November 2004, FCEL formed a partnership with POSCO Energy, a $2.5 billion revenue subsidiary of POSCO. In February 2007, FCEL signed a 10 year manufacturing and distribution agreement with POSCO Energy. In October 2009, the company entered into a Stack Technology Transfer and License agreement allowing POSCO Energy to assemble fuel cell module replacements from cell and module components provided by FCEL.

In October, 2012, FCEL announced the execution of a series of strategic initiatives with POSCO to expand the market for stationary fuel cell power plants in Asia, including a license agreement for POSCO to manufacture Direct FuelCell® (DFC®) power plants in South Korea and sell throughout Asia. The Cell Technology Transfer and License Agreement provides POSCO the rights to manufacture carbonate fuel cell components in South Korea based on DFC technology and grants commercial rights to Asian markets. The agreement harmonizes two prior license agreements so that POSCO has rights to manufacture the entire carbonate DFC power plant. The License Agreement payments total $18 million and the amendment to prior agreements payments total $8 million. The initial payment of $10 million was received on November 1, 2012. POSCO will also pay a 3.0 percent royalty to the Company for each power plant built and sold by POSCO during the next 15 years. The license agreement may be extended for two additional terms of five years each by mutual agreement.

In October 2012, the Company also announced an order from POSCO for 121.8 megawatts of fuel cell kits to be manufactured at the FuelCell Energy production facility in Torrington, Connecticut through 2016. The estimated value of the multi-year contract is approximately $181 million. During fiscal year 2013, the Company recognized revenue of approximately $101.9 million from the sale of power plants and fuel cell components as well as long-term service agreements with POSCO.

According to the 2013 10-K, of the roughly 300MW of orders FCEL has had in its history roughly 260MW of those orders have come from POSCO.

POSCO, holds 30,786,418 shares; approximately 13% of the Company’s common stock of which 3,822,630 shares were acquired in February 2007; 6,963,788 shares were acquired in October 2009 and 20,000,000 shares were acquired on April 30, 2012.

Dominion

In December 2012, the company announced a contract to build a 14.9MW fuel cell park in Bridgeport, CT for Dominion. The Dominion project was completed in December 2013.  The Dominion project was ~$54MM of FCEL’s revenues in F2013. The service contract associated with the Dominion project will last 15 years and has a $69MM value (annual recurring revenues of $4.6MM.)

NRG

In September 2013, FCEL announced a co-marketing agreement with NRG. NRG will market FuelCell Energy power plants to its customer base offering a financing option utilizing a power purchase agreement whereby NRG will purchase and own the power plant and sell the electricity to the end user or the customer can purchase the power plant. As part of the agreement, FCEL issued 5MM warrants to NRG with a strike price of $2.18/share.

Recent Results

The Dominion and POSCO orders have driven a significant increase in the company’s revenues over the part year. That said, as FCEL has performed on these contracts, the rate of revenue growth has slowed with revenues declining QoQ in FQ1 2014.

The Dominion and Posco orders drove a significant increase in the company’s products backlog in the October 2012 and January 2013 quarters. As the company has performed on these projects over the last 4 quarters backlog has fallen sequentially every quarter as FCEL has been unable to win any other material contracts.

Defining orders as the QoQ change in backlog plus the revenues reported in a period, the anemic steady state level of the business outside of these 2 large contracts becomes much more apparent. Over the last 12 months total orders have been $94.4MM with product orders down significantly over the past year.

In addition, with the POSCO contract expiring in 2016, and the U.S. Federal 30% investment tax credit for fuel cells expiring at the end of 2016 it is likely that FCEL will have a significant revenue cliff in 2016/2017.

Similar to the trends in orders and backlog, deferred revenue has fallen QoQ for the last 4 quarters.

In contrast to the declining order, deferred revenue and backlog trends, sell side estimates have FCEL revenues from 17% YoY in the FQ2 and over 8% for F2014. Given there will only be around $1MM in service revenues form Dominion in FQ2 vs. the remaining Dominion construction revenues in FQ1, these estimates would appear to be pretty aggressive.

Margins

Even with the Dominion and POSCO contracts providing higher than normal levels of sales, FCEL remains unprofitable with negligible gross margins. Operating Expenses are running around $40MM/year (20% of sell side estimated 2014 sales.)

Amazingly, in spite of selling its product at very low gross margins, FCEL is incapable of generating material orders outside of the 2 larger contracts won at the end of 2012. Unless FCEL can win another POSCO sized order by 2016 it seems unlikely that the company will ever generate positive EBITDA, let alone positive earnings.

Valuation

As a limited customer, subscale, low margin business that is unlikely to ever achieve profitability it is hard to ascertain a value for FCEL’s equity. Over the last 4 years, FCEL’s EV/Sales multiple has fluctuated between 1 and 2x sales. While even this strikes me as aggressive, if we put a 2x sales multiple on street estimates of $203MM in sales for this fiscal year (a number I believe will end up being too high) this would result in a price target of $1.70/share roughly 50% below the current share price. Given the company has been willing to sell significant amounts of stock below this level over the last 12 months this seems like a reasonably conservative price target. A more realistic price target would be 1x the current order rate of sales ($94MM) or roughly $0.50/share.

Risks

The company is able to win new large contracts that cause backlog and revenues to grow. Given the fact that Fuel Cell power is not economic and other forms of “clean energy” are cheaper and subsidized as well it would appear that the universe of companies looking to buy utility scale fuel sales is limited.

Short interest is high at 20.7MM shares (8.1% of shares outstanding.) The stock is hyper volatile with intraday swings of 20%+ over the last couple of days.

Catalyst

The company takes advantage of the tripling in its share price and announces another equity offering to shore up its balance sheet.

The day traders who have driven the company’s stock up over the last month decide to move onto another security.

The Company misses revenue or “earnings” estimates.

POSCO decides to sell its shares to take advantage of the surge in the share price.

Other of the fuel cell story stocks have disappointing numbers.

Catalyst

The company takes advantage of the tripling in its share price and announces another equity offering to shore up its balance sheet.

The day traders who have driven the company’s stock up over the last month decide to move onto another security.

The Company misses revenue or “earnings” estimates.

POSCO decides to sell its shares to take advantage of the surge in the share price.

Other of the fuel cell story stocks have disappointing numbers.