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Active Power (ACPW) is a small-cap company that designs and develops backup power systems and provides continuous infrastructure solutions, through its uninterrupted power supply (UPS) and modular infrastructure solution (MIS) products, to data centers and other mission critical applications. The 21-year old company, which trades on the NASDAQ, is headquartered in Austin, Texas and serves the local, as well as British, German and Chinese markets. Last year, Active Power earned 40% of its revenues from international markets.
The company's top line growth significantly slowed down in 2012 and finally turned negative in 2013. Moreover, the management's confusion with its partner in China exacerbated the situation. As a result, the business's shares have dropped by 14% this year and are now trading just 0.93 times its trailing sales. The company has made some key changes and there are several catalysts at work that could translate into a significant upside for shareholders.
Products: UPS and MIS
Active Power introduced its patented flywheel-based UPS systems in 1999 and so far, by the end of September, it has sold more than 3,900 flywheels in UPS systems to customers located in 57 different countries around the world. The flywheel based UPS products, which are sold under the brand name CleanSource, provide higher power efficiencies, higher power densities, greater space savings and an environmental friendly energy storage solution as compared to other battery-based conventional UPS products manufactured by its competitors. These products come with load capabilities of up to 8,400 kVA.
Last year, Active Power introduced its next generation CSHD 625kVA and 750 kVA UPS products, which will be released in the current quarter.
Besides UPS systems, Active Power also sells MIS, which includes its UPS as well as other equipment, such as switchboards and generators, which provide short term and long term protection against power disturbance. In case of integrated solution, the MIS is sold under the brand PowerHouse in a containerized package. These systems are sold to customers whose power requirements are considerably higher and are "designed to handle the demands of the most technically advanced facilities requiring the highest power integrity available while maximizing up-time, useable floor space and operational efficiency."
Active Power can also sell its products in non-containerized format, depending on the customer's requirement.
In 2010, Active Power started developing MIS that were designed for the IT sector. Active Power integrates and develops modular power and IT infrastructure solutions, with enclosures and built-out interiors so that once the customer adds its equipment, it will start operating as a "self-contained fully functioning data" center.
Revenue Sources
The business sells its products to a variety of customers including data centers, government agencies, manufacturing corporations, etc. The company's focus, however, is on data center applications of these customers.
Active Power uses five main distribution methods to sell its products to customers in North America, Europe and Asia. They are:
1. By directly selling products to customers
2. manufacturer's representatives
3. distributors
4. original equipment manufacturing (OEM) partners
5. strategic IT partners.
Active Power reports its revenues in two segments; 'Product revenues', which represent the revenues earned from the sale of UPS and MIS products, and 'Service and other revenues', which includes after-market service and customer-specific system engineering revenues. The company has historically earned most of its revenues by selling products. Last year, nearly 81% of the total revenues came from the sale of UPS and MIS products. Of this product revenue, 57% was attributed to UPS products and 43% to MIS.
On an average, over the last three years, Active Power has earned 43% of its total revenues from the sale of UPS products and 40% of the total revenues from the sale of MIS products.
2010 | 2011 | 2012 | |
MIS Rev. as % of Total Rev. | 37.8% | 48.0% | 34.9% |
UPS Rev. as % of Total Rev. | 47.8% | 35.0% | 46.3% |
Active Power's largest customer of fly-wheel based products, and its main OEM customer, is the construction and mining equipment giant Caterpillar (CAT) while its largest IT channel partner is Hewlett-Packard (HPQ). Last year, Caterpillar and Hewlett-Packard accounted for 13% and 35% of Active Power's 2012 revenue respectively.
Robust Market To Power Long-Term Growth
Active Power operates in a growing UPS market, of systems greater than 100kVA, which has nearly doubled from 2004 to $2.2 billion. This growth was driven by a massive 266% increase in data center IP traffic from 1.8 ZB in 2011 to 6.6 ZB in 2012, showing a CAGR of 31%. Moreover, the prefabricated modular data center market is expected to double from 2013, in just two years, to $1.0 billion and is on track to become a $2.5 billion market by 2015; showing a CAGR of 52% from 2011 till 2015.
This rapidly growing market will provide ample growth opportunities to Active Power. The company's products have industry leading energy efficiency in terms of losses and energy consumption. Moreover, Active Power's products reduce the carbon footprint and are more environmental friendly as compared to other conventional products.
On the other hand, the UPS market has been a victim of the sluggish economic environment over the last few quarters. While the industry has not witnessed a large number of order cancellations but customers are delaying their purchase decisions, which has slowed down the growth of this industry. This is evident in the results of Active Power. This, however, is a short-term phenomena as the market conditions are expected to improve from next year.
Financial Performance
Active Power has been reporting operating losses, although the revenues have been increasing while the losses have been shrinking.
From 2008 till the end of 2012, Active Power witnessed a 77.5% increase in revenues to $76.3 million while its net loss narrowed from $13.4 million in 2008 to $1.9 million in 2012. However, the top line growth has not been consistent and includes a decline in 2009, followed by a 61% increase in 2010, to just 1.1% growth in 2012.
(click to enlarge)
As shown in the chart above, Active Power's top line growth nearly came to a halt in 2012. In 2013, things got worse, not only in terms of revenue and income growth, but also the management's blunder in China.
Current Year: Financial Performance and The Chinese Blunder
In its previous quarterly results announced earlier in mid-November, Active Power witnessed a 33% year-over-year drop and a 35% sequential drop in total revenues to $13.2 million. The company's net losses increased by 270% year-over-year, and plummeted from a net profit of $0.3 million in the previous quarter, to $3.1 million in Q3. As a result, Active Power missed both revenue and income estimates.
The revenue decline was due to the 51.8% drop in product revenues from the same quarter last year to $8.0 million, which completely offset the impressive 73% increase reported in the service and other revenues to $5.1 million. The year-over-year drop was due to lower UPS revenues while sequential drop was due to the lower MIS revenues. The significant drop in revenues from the two comparable quarters caused an even bigger decline in net income.
So far this year, in its last three quarterly results, Active Power has not reported any year-over-year improvements in total revenues. Its product revenues have fallen in every quarter, but its service and other revenues have improved in Q2 and Q3. In terms of net profit and losses, Active Power reported better results in Q1-2013, which was followed by a 32% year-over-year drop in net income in Q2-2013 and the significant expansion of net losses in Q3-2013 mentioned earlier.
Therefore, it is not surprising that a review of the company's performance in the first nine months of the current year also gives a similar view as compared to its Q3 results. Its total revenue in the last three quarters of 2013 has dropped by 21.8% from last year to $47.8 million due to a 31% drop in product revenues which offset the 22.6% increase in service revenues. Meanwhile, its net losses have swelled by 180.9% to $4.2 million.
While the financial performance has been disappointing, the business was looking towards a better future in China. Earlier this year, in April, Active Power announced that they have entered into a partnership agreement with China's leading IT solutions distribution and system integration company, Digital China Information Service, which is a subsidiary of Digital China Holdings (OTCPK:DCHIY), a Fortune China 100 company. Under the agreement, Digital China was supposed to sell Active Power's CleanSource and PowerHouse products.
The deal was supposed to propel Active Power's growth in China. Moreover, the partnership with a leading Chinese firm was also taken as a vote of confidence in Active Power's products. However, the business's long term growth ambitions in China, and its annual revenue and earnings guidance, were shattered when it realized that it has actually entered into an agreement with Qiyuan Network System Limited, which is "neither an affiliate nor a subsidiary of Digital China Information Service Company Limited." This was revealed in a press release dated September 5.
Active Power has already shipped products to Qiyuan and had recognized the revenues, accounts receivables, and other related transactions in its previous quarterly results. However, Steve Fife, Active Power's CFO now believes that the revenue from Qiyuan "was not reasonable assured to be collectable at the date of shipment and at March 31, 2013 [end of Q1-2013]." As a result, the company had to restate its financial results for Q1 and Q2 2013. The company, however, has now received the payments on "substantially all products shipped to Qiyuan"
On the balance sheet side, the company currently has $14.2 million of cash reserves and more than $500,000 in restrictive cash, that is better than $13.5 million of cash reserves and no restrictive cash it had by the end of last year. The company has no long term debt and generates positive free cash flow. In the last twelve months, Active Power has generated leveraged free cash flow of $1.32 million.
Essentially, Active Power has a decent product portfolio, a healthy balance sheet, and is operating in a booming industry; but the business has performed miserably in terms of execution.
So What's next?
Like dozens of other companies that were lured by China's enormous market, only to become a victim of fraud or misrepresentation, Active Power is now trying to quickly get past the fiasco. The company has now terminated its agreement with Qiyuan and the employee who misrepresented the relationship between Qiyuan and Digital China. The silver lining, out of this is that it turned out to be a good learning experience for Active Power with respect to doing business in China.
The company has now hired a GM, exclusively for its operations in Asia Pacific in general and China in particular. The individual comes with years of experience of working in these markets and will be responsible for improving Active Power's distribution channels in Asia Pacific.
Moreover, the company is now making several changes in its key managerial positions. Firstly, investors should also note that Qiyuan agreement happened under the leadership of J. Douglas Milner, who, in July, resigned from the post of CEO and board member, nearly five weeks before the revelation of the fiasco. Earlier in September, Active Power got Mark Ascolese as its new President and CEO. Ascolese, who has extensive experience of working in mission critical and data center markets, is a former CEO of an electrical infrastructure enterprise software company called Power Analytics, and was a former executive at Powerware Corporation, which was later acquired by Eaton Corp.
Secondly, Active Power also got Randall J. Adleman as the new head of global sales and marketing, a former VP of Sales at Valence Technology, a developer of large format energy storage solutions from Austin. He has also served as VP at a division of Secure Power Americas Group, which is also, coincidentally, now a part of Eaton Corp.
Finally, Active Power has also changed its CFO. The company has hired Jay Powers as the new CFO and VP Finance. Fife will remain with Active Power through 2013. Powers has held senior finance positions at Ply Gem (PGEM), Xerium Technologies (XRM) and the LSE listed Invensys PLC (OTCQX:IVNYY).
Room For Significant Upside
With the change of guard at the three key positions, Active Power has shown its seriousness in its desire to turn itself around. The new executives have only settled in for a few months and therefore, they do not have a lot to show for their achievements. The new GM of Asia Pacific and the new head of sales have just taken over and will, likely, report their first major contract in the coming months. If, and when, that happens, then that will be a catalyst for an upside.
Any positive news related to its top line growth, particularly in the products division, could turn into a catalyst for a significant upside. While the company has reported considerable improvements in service and other revenues, it has struggled with product revenues. Any news that could send a clear indication of improvements in sales of UPS and MIS, will likely become a catalyst.
Moreover, the business is also rolling out its CSHD product line mentioned earlier, which is another area to look forward to.
As mentioned in the introduction, the company's shares have underperformed this year and are undervalued as they are trading less than 1x their trailing sales. If Active Power's shares were trading at the industry's average of 3.5x, then they would be priced at $11.39, which is 277% above its current price.
However, Active Power is a company that, since its inception in 1992, has not reported even a single annual operating profit. The company has consistently reported annual losses in its more than two decades of operations. Therefore, although it will likely not trade at the industry's average; even at 1.5x trailing sales, the company's shares would be priced more than 60% above the current price.
I have considered 1.5x trailing sales as historically, over a period of last five years, from mid-2009 till the final days of 2012, the company's shares have traded near, or significantly above, its 1.5x trailing sales. But since early 2012, when it started struggling with growth, the shares have hovered around 0.9x trailing sales. Therefore, I believe the positive developments could easily push its shares back at 1.5x level.
Downside Risks
Active Power, however, has downside risks as well. The obvious ones are its small size (it's a micro-cap stock), which makes it inherently riskier and a long history of losses. Secondly, the company operates in an extremely competitive market where there are dozens of other players that are considerably bigger and better established than Active Power in international as well as American market. These include names such as Schneider Electric (OTCPK:SBGSY), Emerson Electric (EMR) and Eaton.
Thirdly, Active Power focuses on larger, complex and considerably more expensive systems. Therefore, a significant portion of its revenues comes from a small number of clients. For instance, last year, Active Power got 60% of its revenues from just 3 customers. Any loss of business from these customers, and other large customers, can have a considerable adverse impact on its share prices.
Fourthly, Active Power does not have a diverse product portfolio and a significant portion of its revenues comes from its 250-900 kVA UPS product family. These UPS products are then used in the MIS products. The company's future depends on the markets' acceptance of this product. Although there is no indication of a change in this in the foreseeable future, if that happens, then the company's long term prospects could become questionable.
Lastly, the company manufactures all of its UPS products at its facility in Austin, Texas. Any one-off event, that could cause a shutdown or a downtime at the facility, could have an immediate negative impact on the share prices and quarterly revenues.
Investors should note that Active Power has also experienced seasonal drop in demand, which usually occurs in Q1. As a result, the company could report a sequential decline in 2014-Q1.
Conclusion
Active Power's problem has been its inability to post any meaningful increase in product revenues. The company has witnessed increasing service and other revenues in the past, and could post further improvements in the future, but these will be largely ignored unless Active Power shows improvements in its core business; the UPS and MIS product sales.
However, Active Power has taken a big step towards a full scale turnaround by getting a new management, which appears to have a clear idea about the company's problems. In its previous conference call, the new CEO has rightly pointed out that the business has to improve its "overall execution."
The company has struggled with growth and its track record is not in its favor. But the business has a healthy balance sheet and there are several catalysts at work that push its shares higher, which have remained under pressure since early 2012.
Notes:
Active Power's CEO Discusses Q3 2013 Results - Earnings Call Transcript
Active Power SEC Filing Form 10-Q and Form 10-K [Pdf Files]
Active Power Investor Presentation [Pdf File]
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Business relationship disclosure: This article expresses my own opinions and does not constitute investment advice. The article contains information that was obtained from company's official documents and/or other sources which I believed were reliable, but has not been independently verified. Therefore, I cannot guarantee its accuracy. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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