American Superconductor (Nasdaq:AMSC)- One Product + One Customer + One Country = Many Problems

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During the past week, many companies associated with the wind industry in China have shown weakness.  Citron would like to single out one company which we believe has a lot more downside potential….and it seems as if the CEO agrees with us.

Background

American Superconductor is a classic old-school “story stock” … a company with an electric distribution grid innovation – a superconducting wire, that when supercooled, carries 100 times more electricity.  The company has touted this invention for more than a decade as “the next big thing”…but other than a single demonstration project, it has never been monetized.

A couple of years ago, AMSC bought a small German wind turbine design firm named Windtec, which had a promising relationship with one of China’s largest wind turbine manufacturers, Sinovel.  As Sinovel has solidified its market share in China, AMSC began to announce huge revenues for delivering its electricity management componentry for those units.

In fact, AMSC’s filings disclose that its Sinovel revenues represent 67% to 76% of its revenues for various periods spanning 2008 and 2009.  So investors had better heed the company’s relationship to this one customer…if Sinovel gets a cold, AMSC catches a flu.

This week, Miao Wei, vice minister of Industry and Information Technology came out and called many China wind power projects “vanity projects” made the whole industry sit back and give one collective headscratch.
http://www.chinadaily.com.cn/bizchina/2010-03/10/content_9568535.htm

What about the numbers?

Oddly enough, even during this enormous boom time of shipping to one customer, AMSC was never really able to put up a huge profit.  After reporting huge losses for years, the best they have been able to put up in 2009 is an 12c qtr, a run rate which prices the company for a 60 P/E … if they can keep it up.  Last quarter was so back-end loaded to Sinovel, that the company had to field questions by analysts about the unexpectedly high receivables number it reported, to which it replied that it had already collected.

But Now The Game Has Changed

Two events occurred this month that raise the uncertainty level for AMSC’s future:

Firstly, Sinovel has filed to go public and we get a peek into their business.  Without a prospectus yet, this is what Citron was able to learn.

Sinovel estimated its 2009 production at 2,000 sets of 1.5 Mw turbines and 100 sets of 3.0 Mw turbines. http://www.windpowermonthly.com/go/asiaPacific/news/987739/Sinovel-seek-IPO-fund-expansion-plans/

That totals appx. 3,300 Mw of production, for which AMSC has been earning, according to our math, about $36K pre Mw, or about $118 million for 2009.  However, its revenues attributable to Sinovel for 2009 were $198 million, leading to a substantial concern of an $80 million disconnect between units AMSC is delivering and completed turbines that Sinovel is actually installing.  It appears that AMSC is booking 140-200% more revenue from Sinovel in the current year that Sinovel actually delivers to the market.  While it initially could have been considered a “ramping up”, that myth is now debunked.  Unfortunately for AMSC, by the time Sinovel’s installs catch up with inventory, it might be too late.  Citron notes that Sinovel is now opening new research facilities … and wonders how long AMSC’s sweetheart deal survives before Sinovel turns out its own power subsystems to replace AMSC’s high margin power module.

But it Gets Much Worse

All we’ve heard from China for the last 2 or 3 years was that they were going full blast on wind turbine installations, and determined to become the world leader in wind power.  This weather has changed dramatically on this story over the past week, beyond the above vanity comment.

  1. China dramatically tightening credit, which is slowing down the proliferation of capital intensive projects, particularly those notorious ones that are leading to overbuilding.
  2. China clamps down specifically on wind turbine production due to oversupply.  http://www.bloomberg.com/apps/news?pid=newsarchive&sid=abrVEoOp6.bU
    http://www.businessweek.com/news/2010-03-11/china-idles-40-of-windpower-turbine-output-capacity-update1-.html
    Global growth in the turbine business is down from 30% to 40% earlier in the decade to 8%, and China is idling 40% of its wind turbine factories.  Also investors must note this piece, which observes that pricing per kilowatt has fallen nearly 20% during 2009.  This is projected to lead to a further narrowing of margins in the business looking forward.
    http://www.upi.com/Science_News/Resource-Wars/2010/02/22/Chinas-wind-power-sector-faces-challenges/UPI-57761266871911/
  3. Now comes word that Chinese officials are floating a rethinking of the massive commitment to wind energy:  “China ‘not suitable’ for wind power generation”, according to a government official in the Beijing Times.  http://www.chinadaily.com.cn/bizchina/2010-03/10/content_9568535.htm

He comments that idling and life-expectancy erosion due to sandstorms, making an example of the 10 Gig project in Gansu province.   Sinovel is a primary supplier to the project, through China WindPower Group.  http://www.zero2ipo.com.cn/en/n/2010-3-4/20103493118.shtml
Now there have been sandstorms in China for decades, but we note a significant “wind shift” that Chinese officials are beginning to mention them, in light of life-expectancy concerns for capital-intensive wind projects, particularly those that publicly get tagged as “vanity projects” by government officials.

Insider Sales

CEO Greg Yurek alone has sold over 375,000 shares just this year, and consistently bangs out his options as they are earned, retaining fewer shares than he’s sold just during 2010.

Conclusion

Citron believes AMSC is vulnerable to the perfect storm of converging concerns, not even considering an escalating trade conflict with China.  Looming over AMSC is its extraordinary revenue dependency on a single customer, with no real transparency on how it maintains huge gross margins by providing an increasingly commoditized subsystem, in China, the most price-competitive marketplace on earth.

Additionally, it now faces vulnerabilities due to a concern of an overfilled pipeline, plugged by a downturn in China’s rate of installation of wind turbines, caused by macro-economic conditions, as capital for projects of questionable return dries up.

And when in doubt, Citron advises readers to “follow the money”.   The furious rate of CEO Yurek’s insider selling should cause any investor to ask why they should be on the other side of his trade.

Cautious investing to all.