China Based Investigation Into Ballard Power (Nasdaq/TSE: BLDP) Suggests 35% - 70% Downside Risk
Report Entitled "Fuel Sell Opportunity"
Executive Summary
Spruce Point Capital Management is pleased to announce it has released the contents of a unique research report on Ballard Power Systems (Nasdaq and TSE: BLDP). Spruce Point has conducted a critical business and financial review of Ballard and its Chinese growth ambitions, which has been a key driver of its recent share price out performance. Based on our on the ground China research, in our opinion Ballard is set to disappoint expectations as a result of having selected the wrong Chinese partners, and the market and infrastructure for its products not having developed according to plan
As a result, we have issued a "Strong Sell" opinion and a long-term price target of approximately $1.15 - $2.50 per share, or approximately 35% to 70% downside risk. Please review our disclaimer at the bottom of this email.
Our detailed research report is available on our website We also encourage all of our readers to follow us on Twitter @sprucepointcap for regular updates. Please review our disclaimer at the bottom of this email.
Spruce Point Has A Successful Track Record of China Based Forensic Investment Research
ZST Digital Networks (Nasdaq: ZSTN) : 11/3/10
Outcome: Auditor resigned in March 2012 and noted ZST’s difficulty in allowing it to verify its cash. Shares were delisted and ultimately ZST’s SEC registration was terminated on Aug 2012
China Integrated Energy (Nasdaq: CBEH) : 12/5/10
Outcome: May 2011 : KPMG auditor resigned and noted concerns about management’s representations. Shares delisted and the SEC revoked its registration in Dec 2014
Camelot Information Systems (Nyse: CIS) : 8/5/11
Outcome: Following our report, CIS’s share price collapsed, and a month later management disclosed a margin call. The shares reached a low of $1; CIS was finally taken private for $2.05/sh or 77% below our initiation price
What’s Driving The Ballard Bull Story
Ballard’s stock had a tremendous run in 2017 (+167%) based on strong revenue growth, margin improvement and a perception that the commercialization of fuel cells is on the horizon (i.e., “hype”). This improvement occurred despite Ballard’s portfolio largely consisting of businesses in run off (e.g., backup power, materials handling), experiencing uncertainty (portable power) or in very early stages of development (e.g., drones). The primary force underpinning recent growth and future expectations has been Ballard’s China partnership efforts with Synergy Ballard JV (customer/partner) and Broad Ocean (customer/distributor). At current valuations an investment in Ballard with an intermediate time horizon is essentially a bet on China Heavy-Duty Motive (“HDM”) success. We have conducted on the ground due diligence in China and believe that Ballard’s Chinese growth ambitions are likely to fail from weak partnerships with Broad Ocean and Synergy, and a market that is not developed enough to support fuel cell vehicle growth; Déjà vu, Ballard’s last China deal with Azure resulted in a contract breach and revising guidance lower in early 2015; investors should brace for similar disappoints this time around too
China Industry Challenges
Unfortunately, the Chinese hydrogen fuel cell market is still in very nascent stages of development. We believe there are currently only 36 licensed fuel cell vehicles on the road in China, only six refueling stations (one is public), and limited planning being devoted to hydrogen sourcing and transportation. In Spruce Point’s view, the lack of refueling infrastructure, confusion around refueling subsidies and abysmal refueling station economics pose the greatest threat to fuel cell vehicle (“FCV”) commercialization. Not surprisingly, there are only two scale auto manufacturers of hydrogen fuel cell vehicles today and we expect this number to grow to only six by the end of 2018. At this point, it still remains highly uncertain if China will develop the fuel cell vehicle market beyond an experimental phase
As it pertains to Membrane Electrode Assemblies (“MEA”)/Stack/Engine production in China, the focus area for Ballard, there are actually two (rarely discussed) competing “value chains”. We believe that Ballard’s partners, Yunfu City Government (Synergy) and Broad Ocean, are relatively weak given their lack of network into the central ministries of China and their limited success to date in partnering with the State-Owned Enterprise’s (“SOE”) that are the primary agents for delivering on policy
Ballard Partner Specific Challenges
It wasn’t long ago that Broad Ocean was a humble manufacturer of electric motors for appliances (e.g., air conditioners). As the US property cycle peaked, Broad Ocean decided to diversify itself with the purchases of Prestolite (auto electronics) and Shanghai Edrive (electric vehicle power trains) in 2014 and 2015, respectively. When Broad Ocean announced the Ballard deal in 2016, it had no prior hydrogen fuel cell experience, but likely hoped to leverage the company’s local connections with automakers in the electric vehicle space. Unfortunately, Broad Ocean has failed to deliver partnership opportunities to Ballard with the likes of BAIC (Shanghai Edrive’s largest customer) and Yutong (leader in Chinese bus production), both of whom have chosen Sinohytec despite relying heavily on Shanghai Edrive for electric vehicles
Since the Ballard deal was inked, Broad Ocean has announced $1 bn in hydrogen investment related projects. However, in 18 months, Spruce Point has yet to see one fuel cell module produced or vehicle using its technology. Spruce Point believes that Broad Ocean appears to be experiencing a cash crunch as a result of its recent acquisitions, hydrogen investments, and inability to sell any of the MEAs that it has purchased from Ballard to date. We also believe Broad Ocean’s cash flow issues have likely contributed to the firm backing out of the Wuhan project and perhaps are responsible for the stalled/collapsed Zhongtong JV. Barring a successful convertible bond issuance this year, in what has been a difficult issuance market in China, we anticipate that Broad Ocean will be unable to continue to make good on purchasing commitments, and that 2018 purchases from Ballard/JV are at high risk of falling well short of 2017 levels
Given that Broad Ocean is the primary customer of the Synergy “Supply Chain” we would expect that there is a strong probability that Synergy will look to renegotiate the Ballard “Take or Pay” Agreement or exit the relationship completely. If these events playout as we anticipate, then not only will China sales disappoint, and the current backlog go largely unrealized, but it will have the knock on effect of failing to achieve the desired cost reduction in MEA production for other applications. **Broad Ocean owns 17.2m Ballard shares and its 2yr hold period ends July 2018. We expect this to be a major overhang on Ballard’s share price**
Spruce Point’s Take on Potential Outcomes (probability)
* The Chinese fuel cell market doesn’t move beyond an experimental stage in the near term (20%)
* The Chinese fuel cell market slowly commercializes, but Broad Ocean fails to raise capital and the “Synergy Value Chain” fails. This likely translates into a missed, or greatly reduced market opportunity, for Ballard in China over the long-term (40%)
* The Chinese market slowly commercializes, Broad Ocean is able to raise the capital needed to wait out the maturation of the industry, and eventually makes good on Ballard commitments. Synergy renegotiates take or pay (duration or value) (30%)
* The Chinese market rapidly commercializes, and Broad Ocean is able to raise the capital needed to make Synergy commitments in the near term. Synergy take or pay agreement holds (mgmt base case: 10%)
Valuation And Reasons We See 35% - 70% Downside Risk
Ballard’s heavily retail Investor base needs to exercise significant skepticism. Ballard and its management have virtually nothing at risk if its China growth ambitions fail. The company committed just $1.0m to the China JV, and insiders own a miniscule 0.45% of the Ballard’s stock. Buying into the sell-side analysts bull case for 47% upside to $5.60, requires a leap of faith that it can execute flawlessly in China with its partners, and finally turn a profit after years of losses and rampant share dilution. Analysts are unjustifiably giving Ballard an all-time high multiple, while tweaking discount rates lower to justify their price targets. Our on the ground research in China tells a different story: we believe the Company is set-up to fail yet again on its Chinese growth ambitions just like Azure was a failure in years past. We believe that Ballard shares should trade in line with its fuel cell peers historical valuation range at 2.0x-2.5x and 1.5x-3.5x Price/Book Value and Price/LTM Sales, respectively. These ranges imply a long-term price target for BLDP of $1.15 - $2.50 per share or 35% - 70% downside risk
Thank you very much for your continued interest in our work and support of independent financial research
Disclaimer
This research presentation expresses our research opinions. You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and calls on the stock) covered herein, including without limitation Ballard Power Systems Inc. (“BLDP” or “the Company”), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. All expressions of opinion are subject to change without notice, and Spruce Point Capital Management does not undertake to update this report or any information contained herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities.
This research presentation expresses our research opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in this research presentation. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. You should do your own research and due diligence, with assistance from professional financial, legal and tax experts, before making any investment decision with respect to securities covered herein. All figures assumed to be in US Dollars, unless specified otherwise.
To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of BLDP or other insiders of BLDP that has not been publicly disclosed by BLDP. Therefore, such information contained herein is presented “as is,” without warranty of any kind – whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use.
This report’s estimated fundamental value only represents a best efforts estimate of the potential fundamental valuation of a specific security, and is not expressed as, or implied as, assessments of the quality of a security, a summary of past performance, or an actionable investment strategy for an investor. This is not an offer to sell or a solicitation of an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction. Spruce Point Capital Management LLC is not registered as an investment advisor, broker/dealer, or accounting firm.
