Description

This is a Scott Fearon Dead Companies Walking-type idea. If you don’t like shorting single digit midgets or <$150mm market cap companies, read no further. But, if you like shorting cash-burning frauds that have exhausted available financing options, exhausted investor patience and should be insolvent sometime in 2017, this idea is for you!

Brief Background on Westport

Westport Innovations is a “natural gas for transportation technology” company headquartered in Vancouver Canada –the Boca Raton of the north for frauds. The company IPOd in 2008 and rallied from $5 in 2009 (~$100mm market cap) to ~$50 in 2012 (~$2.75b market cap) from relentless stock promotion (WPRT might have set a Mad Money appearance record) and extreme investor enthusiasm around 1) sustainably low natural gas prices and 2) the prospect of nat gas for transportation. WPRT and CLNE were the only two ways to invest in this popular theme. Investors were further fooled by an industry-leading patent portfolio (quantity, not quality, of course), constant press releases, and partnerships with some of the industries most respected players - Cummins, Caterpillar, Volvo, etc.

Unfortunately for all those retail investors that took the bait, it was all a mirage.  Westport had high-cost and unusable technology. The company’s partnerships were grossly misrepresented. And even the coveted joint venture with Cummins was basically a lie. The JV uses Cummins’ old school spark ignited technology and Cummins rejected WPRT’s “game changing” HPDI technology. Most bulls would be surprised to know that Westport only has a handful of employees working in the JV (<5) and they all work in marketing. So much for being a technology company!

No surprise, WPRT became a popular short with relentlessly high borrow costs (30-50+%) for a majority of 2012-2014. While the story first started to break in mid-2013 as Westport continued to wildly miss expectations, the hits kept coming as they often do for useless stock promotes. Westport was forced to restate financials due to improper classification of the Cummins JV, was scrutinized regarding the accounting of other JVs, had questionable related party transactions, continued to hemorrhage cash, and most damaging for a story stock – they kept changing their story. Westport’s key HPDI engine technology was cancelled. Then they became a nat gas tank storage company. And when that failed, the narrative pivoted back to a future HPDI 2.0. Oh, and meanwhile oil crashed making natural gas for transportation much less attractive.

Relentless Cash Burn

Before discussing some of the more current developments with the company and digging into why I believe WPRT will be insolvent sometime in 2017, I think it’s important to show the severity of the cash burn. Below are some of the high level financials starting in 2012.

Source: Company filings

- Sales for 2016 are not comparable to 2015 due to FSYS acquisition discussed later ( so excluded). Adjusted ebitda is wildly adjusted.

Despite Westport’s best efforts to rein in spending, the company is still burning over $25mm of cash a quarter. How? I honestly have no idea. I’ve had a long held suspicion that there is/was some shady business with how and where this cash is disappearing, but it has never been worth the time to go that far down the rabbit hole. All that matters is they continue to burn cash and burn has not improved despite severity of financial situation.

WPRT + FSYS = Tying Two Rocks

Westport’s days were looking numbered in mid-2015. The stock had fallen 90% from its 2012 highs and was trading in the mid-single digits. This made raising additional equity capital a daunting task, especially since WPRT needed a lot of capital. They had already raised $273mm in 2012 and $152mm in 2013. By 2Q15 WPRT had burned through all of it again and found themselves in a net debt situation. The company filed a prospectus and tried to shop a deal but was unsuccessful.

Then, miraculously, Westport connected on a 99 yard hail mary. FSYS – a company that designs, manufactures and supplies alternative fuel components, but had never been profitable – was desperate to exit the industry. And lucky for WPRT, FSYS had over $50mm of cash. So on 9/1/15, WPRT announced a stock for stock merger and talked about benefits and synergies, but the real objective was just to acquire FSYS’s cash-rich balance sheet.  WPRT’s bid, which was $135mm worth of WPRT stock at the time, was 20% below FSYS’s TBV and roughly the value of FSYS net working capital. Ouch for FSYS holders.

While WPRT was desperate to close the deal to remain solvent, FSYS was in no rush. By Jan 2016, desperate times called for desperate measures and WPRT signed a vulture financing agreement with Cartesian Capital. The deal, which involved asset sales, convertible debt (at 9%), contingency payments on new technologies (carried at effective interest rate of 23%), etc. picked over the only potentially valuable parts of WPRT and left the company straddled with some high-cost liabilities.

The Cartesian deal, which wasn’t approved or even discussed with FSYS, upset many FSYS shareholders and board members who were no longer interested in getting vultured WPRT equity. To make matters worse for FSYS, WPRT equity had continued to decline in value and FSYS shareholders could have received more value by liquidating the business then getting WPRT shares. The next 5 months of 2016 had many twists and turns including changing initial deal terms (for Cartesian financing and WPRT-FSYS stock merger ratio), a FSYS director resigning (his resignation letter is worth reading), and the FSYS’s CEO’s brother and cofounder waging a proxy battle against the merger, complete with an impressive presentation as to why WPRT would be insolvent soon – even with FSYS’s cash infusion.  Nevertheless, the Costamagna brother’s lost and the deal closed in June 2016.

Running out of options

Despite $41mm from Cartesian +  $45mm from FSYS merger in 2016, WPRT has had to continue burning the furniture to stay solvent. The company sold a Michigan tech center in July16 for $12mm and also sold a large portion of its remaining Chinese JV ownership for $7.5mm in August16.

And speaking of JVs, most analysts or bulls will highlight how the Cummins JV is likely the most valuable asset the company still has (or ever had). Those bulls likely haven’t read page 25 of the amended JV agreement with Cummins from March 2012, which says that CMI can acquire WPRT's share of the JV for 130% of Trailing 12 months EBIT, plus unpaid dividends, beginning in 7/1/19. Or that a bankruptcy filing by WPRT would also trigger the purchase option – something Cummins thinks is a high probability and a key concern of theirs over the past year. So what is trailing JV EBIT? <$20mm and down over 50% yoy, which means the Cummins JV is worth <$15mm to WPRT (only owns 50%) vs. WPRT’s current $130mm market cap.

More ugliness

Three additional red flags:

1) long-time CEO David Demers retired June 2016

2) former FSYS CEO resigns from WPRT board at start in January 2017

3) Chairman of the board steps down as Chairman on 2/1/17

Current balance sheet

So where does that leave us today? As of Sept 30, 2016 Westport had $58.7mm of cash and short term investments, which is more than offset by $79mm of debt. Of that $79mm, $58mm is due in 2017; an $11mm loan to a bank in Italy and $41mm due September 2017 (more details on subordinated debentures notes due in Sept17 on page 25).   

I struggle to see how WPRT will see 2018. When WPRT reports 4Q16 results in March, the company will likely have <$35mm of cash, will still be burning ~$20-25mm a quarter, and will owe $58mm by September. Who is going to lend to a broken company with few tangible assets and an accumulated deficit of $916mm? This company has already destroyed close to a billion dollars of value! Amazing.

From most recent quarter:  “The company has engaged advisors to address debt financing alternatives, including the extension or refinancing of debt coming due in 2017.”

WPRT is a dead company walking and a high conviction zero.

Risks:

• Crazy things happen to dollar stocks (see ACI and DRYS then knock on wood). But, short interest is just 4% of float and lowest level since 2011 as most bears have taken profits and moved on.

• WPRT continues to liquidate $65mm of PP&E buying additional time

• Cash burn slows as restructuring efforts finally prove helpful

• Banks extend or expand credit to the company.

• The $900mm of invested capital miraculously yields a technology of value.

Catalyst

Quarterly reports highlighting cash burn and/or company filing for bankrupcy