American SuperConductor (AMSC) - Buy at $5 - UPDATED

Today: Enterprise Value approx $1 billion ( $26 per share)

Buy at Enterprise Value of approx $250 million ($5 per share)

Background:

AMSC is a interesting phenomenon, Its executive team has paid itself a fortune over the last decade, while producing nothing of substantial value for the owners. I have known AMSC for more than 15 years. The AMSC lead team is a master of managing information and publicity, but they believe they deserve big rewards today rather than later.

The superconducting wires do perform as AMSC promises. The HTS motor/generators are indeed game changers and perform much better than AMSC reports. But, dropping electricity consumption will not create a sudden need for HTS wire

US electricity demand has dropped 3% y.o.y. Chinese electricity demand is also dropping, albeit at a slower pace. The drops in electricity demand is a pure function of the economic downturn. When electricity demand exceeds grid capacity will be dependent on when economic growth returns and how quickly this growth impacts the grid. Only when the grid requires massive expansion will HTS wire be needed.

HTS isn't going to generate meaniful revenues until well into the next business cycle. AMSC's HTS competitors will likely have caught up to AMSC's technology by that time. Even the ham fisted bureaucrats over at GE might have finally completed their HTS program in time to compete with AMSC.

Yurek was masterful in buying the Wind Turbine business. The Wind Turbine business saved him from hard questions about HTS. He finally is showing revenue and swears AMSC will be positive cash flow real soon. Yurek knows he better show some positive cash flow fast if only to molify AMSCs owners.

Yurek recognizes even his brilliant PR work won't be able to obscure the simple fact that a AMSC is a Engineering Company in a highly commoditized sector of the power business: wind turbines.

So let's examine AMSC from the standpoint of a Engineering Company

The most recent quarter's P&L shows $60 million revenue and $40 million COGS - say 30% gross margin. That's nice for a 2nd tier manufacturing company, but not so good for an engineering enterprise with 520 employees, 125 who are paid Chinese wages.

This leaves $20 million for Yurek to play around with. How does he spend the $20 million ? A paltry $5 million goes into R&D (yeah that's the much vaunted HTS and next generation wind turbine). $10 million gets hoovered by Yurek and his managment team. So in other words, AMSC spends twice as much on its management team as it does on R&D.

UPDATE: The reader's comment is well taken (see below). Perhaps by way of clarification: 'AMSC spends twice as much of its discrtstionary budget on its management team. Gudovac understands that customer funded work may have legitimate R&D value. Gudovac has also taken orders at low margins because of their R&D value to his Enterprise. He therefore understands the limitations of P&L conventions to illuminate the long term value such orders may generate. However, Gudovac also is painfully aware that customer funded development work is often a distraction..........

Readers should note, that the SEC disclosures on management team pay will not show how much is being spent on 'Executive Meetings in Boca" and 'my girlfriend needs a plush consulting gig'. Therefore, we won't know the precise details of how this $10 million was spent.

However, we can discern from the company's own records just how well management thinks of itself. Page 24 of the most recent proxy statement is illuminating. It lists how much each member of the management team earned in 2008. Each and every member of management generates a cash wage far greater than he would having similar responsibilities in a comparable Engineering enterprise.

In addition to the rich cash wages, owners are also expected to double the number of shares available for stock options to management.

A quick glance though the prior pricing of options already granted show strike prices which hardly inspire confidence in management's incentive to drive the stock value up significantly.

Equity investors (ie the company's owners) can safely conclude that AMSC management does think highly enough of themselves to get paid richly. We can also safely conclude that AMSC management isn't a lean & hungry team of technologists pulling all nighters while living on peanut butter and cold pizza - obessively driven to generate over sized returns for AMSC's owners.

UPDATE The reader's comment (see below) suggests that applying an appropriate percentage ( in this case 17% ) of revenue to R&D should satisfy owners' who value AMSC as generating value through breaktrough technology. Gudovac1941 believes that hungry managers are most likely to generate breakthroughs regardless of the ratio of R&D to revenue. AMSC"s managers simply are not hungry and incentivized enough for Gudovac to believe they will create the-next-big-thing...........

The good news is that, we can believe that Yurek will eek out positive cash flow sometime soon. Positive cash flow means he can put off another equity fund raising round for years. AMSC also still has about $2 a share in cash which provides a modest cushion. However, since AMSC has limited ability to raise debt for woring capital needs, owners should consider the $2 cash a minimum working capital support.

A growing engineering company with $250 million of revenues ( 4 times mrq revenues) with a breakeven cash flow should have an enterprise value of roughly 2 to 3 times revenue. This valuation must be tempered with the knowledge that AMSC management will continue to skim off much of any gains the company generates. A prudent owner would require a discount from typical value to allow for management's lifestyle needs. Therefore, AMSC might garner a reasonable value of 1 times revenue - $250 million - or $5 a share

Don't Get Massacred

Gudovac1941@gmail.com