Tuesday, December 27, 2011

An Update on American Superconductor (AMSC)

In June 2011, we wrote an article about American Superconductor (AMSC), and its key investor – Kevin Douglas. We noticed the company because its stock dropped sharply after a loss of a major customer (Sinovel), while Kevin Douglas – a large investor in AMSC – continued to acquire shares. Let's revisit AMSC and our past forecasts for the company.

We previously estimated that AMSC would record a net loss of $4M - $34M for the fiscal 2011, translating into a book value drop of up to $0.75 per share. Once the company restated its income statement for FY 2011, the actual loss turned out to be $186M, or $3.95 per share – much worse than expected.

The difference came from several factors:
Revenue drop$75M$144M
Gross margin40%(7.5%)
Goodwill write-off--$50M
Operating income drop$30M
(from $39M to $9M)
(from $39M to -$178M)

Our estimates had relied on the company’s guidance that annual revenue may drop from $430M to "below $355M" – a drop of $75M+. Eventually, the company reported revenue of $286M for the year – a drop of $144M.

Gross margin
To gauge the impact of the revenue drop on operating income, we had used a gross margin of 40%. This was foolish. Given that AMSC had already manufactured the products that were rejected by Sinovel, we should have assumed that all of the revenue drop would go straight into a decrease in operating income.

Goodwill write-off
We did not factor in any goodwill write-offs, but the company ended up writing off all of its goodwill – to the tune of $50M. This could have been anticipated, given that much of the goodwill came from the acquisition of Windtec, a business unit whose wind turbine sales were primarily to Sinovel. According to its 10-K filing for FY 2011 (page 71), the company now values Windtec at net assets.

AMSC is actively restructuring in an attempt to return to profitability. It has cut its work force by 50%, which should bring annual SG&A and R&D expenses from about $100M down to $50M. Assuming that the gross margin returns to 40%, AMSC would need revenue of $125M to break even. It has booked revenues of $21M and $30M for the quarter and six months ending Sept 30, 2011 – a run rate well short of the break-even point.

AMSC should not face liquidity problems in the immediate future. The company has a current ratio of 1.8, $94M in cash, and no debt. It has terminated the planned merger with The Switch, which would have required it to raise funds at a challenging time. AMSC shares are trading close to the book value of $4.09.

In September, Mr. Douglas purchased close to 1M additional AMSC shares at $4.32 - $4.36, increasing his stake to 25%. We maintain a speculative long position, on the hope that this insider has an accurate view of the value of AMSC, but want to clearly state that AMSC does not meet our criteria for a long-term value investment.