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Active Power Inc: ‘Disruptive Technology’ Not So Revolutionary After All

Summary Flywheel technology has been much hyped as the next big thing in the UPS space, although batteries have prevailed as the dominant solution. Wider market acceptance of flywheel technology would not necessarily result in upside, due too immense competition in a business where reliability and economics of scale are key. Significant loss of market share on a relative and absolute basis invalidates the bull thesis. Rapidly deteriorating financials in the most recent years suggests that their competitive situation has only become worse. 3x book value for a company that has never been profitable and has a declining top-line is just too much, a market cap at liquidation value is more appropriate. The first impression one gets from reading all the information on Active Power, Inc.(NASDAQ: ACPW )’ website is one of a business with a great product that is at the cusp of gaining market acceptance, as soon as these darn datacenter-architects would finally realize the benefits of flywheel-technology. They make a compelling case, where it not for the fact that: The technology is about 20 years old and market acceptance would surely have already taken place if the product really were superior. Rather than being a scrappy start-up, the company is a tiny player in a relatively mature industry, where long-term customer relations and scale are key. While touting their product’s perceived benefits they basically conceded that it’s not working out by offering the same product utilizing legacy technology Active Power Inc. builds so-called Uninterrupted Power Supplies (UPS). A UPS is an electrical apparatus that provides emergency power to a load when the main power source fails. A UPS differs from an auxiliary or emergency power system or standby generator in that it will provide near-instantaneous protection from input power interruptions, by supplying energy stored in batteries, supercapacitors, or flywheels. The on-battery runtime of most uninterruptible power sources is relatively short (only a few minutes) but sufficient to start a standby power source or properly shut down the protected equipment. In essence, they serve to bridge the time-gap between the occurrence of a power-outage and the start-up of a backup generator. It is a typical value-add business, with the overall addressable market estimated to be in the area of ~17B, with the sub segment of relatively large scale UPS with more than 150 kVA, the market that Active Power is targeting, around 4.6B. Most of these UPS’ utilize batteries to store energy. Active Power’s UPS’ on the other hand use flywheel technology. Instead of storing chemical energy, like batteries do, flywheels are brought to spin very fast, storing kinetic energy in the process, which can then be converted to electrical energy if need be. The bull thesis in essence, is that flywheel UPS’s While having larger upfront costs, have lower lifetime costs, as the maintenance intervals are larger; Are “greener” compared to batteries, as the latter end up being toxic waste; While runtime lies in the area of 10-15 seconds for flywheel UPS, compared to ~15 minutes for battery UPS, usually only a few seconds would be needed until the backup generator comes on-line. Combined these factors would make the market gradually shift to flywheel technology. Back in reality, the company, which has been in business for 15 years and never made a profit, saw a shrinking top line. (click to enlarge) Source: Morningstar In their 2010 10-K they state that their addressable market at the time was in the area of ~1.8B, compared to 4.6B in 2014. Using their revenue numbers in these years implies that their market share has actually dropped from around 3.6% in 2010 to 1% in 2014. This certainly doesn’t support the bull thesis, although market statistics on UPS are scarce, and it’s unclear how much of this is attributable to flywheel UPS gaining (or losing) traction or if the company plainly can’t compete. The UPS market is highly concentrated, with the bulk of the market share lying with Schneider-Electric (OTCPK: SBGSF ) and Emerson (NYSE: EMR ), both 40B market-cap behemoths. (click to enlarge) Source: VDC research The scrappy up-start picture isn’t supported by the fact that both of these companies massively invested in flywheel UPS themselves, With Schneider-Electric having bought APC, the until then US-market leader in the UPS market and Emerson’s acquisition of Liebert. Both of these subsidiaries offered extensive flywheel UPS products . Though Emerson at some point in the recent past opted to discontinue their flywheel product line, suggesting that the flywheel sub segment may be even more concentrated with Schneider Electric than the overall UPS market. Bottom line, these findings are still ambivalent as to whether the flywheel technology has gained traction in the market, but the significant reduction in market share AND absolute sales suggests a severe competitive disadvantage in a market that has more than doubled in the past four years. If one chooses to buy one of these, one wants to be really sure it will work. The lifetime of UPS are in the area of 15-20 years, and incur significant recurring service costs and warranty coverage. The slightly lower life time costs of flywheel UPS compared to UPS cost is simply a negligible criteria for customers compared to the vendors ability and reputation to service their products regularly and guarantee warranty coverage. Source: VDC research In the case of Active Power, there is substantial uncertainty as to whether the company will even be around in 10 years time, which greatly reduces their value proposition vs their peers. Bigger is simply better in this market. Financials As stated before, the company has never made a profit during it’s lifetime. In the most recent years it has additionally seen rapidly deteriorating operating margins as seen below: (click to enlarge) Source: Morningstar Yet they publish slides like this titles “gaining momentum”: (click to enlarge) witness the momentum To stay afloat, they regularly dilute their share count every 2 years: (click to enlarge) Source: Morningstar In spite of rapidly deteriorating financials, massive loss of market share on a relative and absolute basis in a market that has seen huge growth and severe competitive disadvantages versus their large peers that offer a substantially better value proposition, the company still trades at 3x book value, with a market cap of around $50M. My best guess as to why this is the case, is that they make a good case to the investing world of their superior product and tell a good story of how the break-out is right around the corner. The facts however tell the opposite story. Most of their assets are in the form of current assets, which makes their book value a decent proxy for liquidation value, a more appropriate yardstick of what this company should be trading for, implying 60% downside. I’ve used several sources throughout this analysis, most notably the 10-K’s of Active Power Inc, Schneider Electric and Emerson, as well as some research papers on the flywheel vs battery UPS debate from Mitsubishi , Schneider , datacenter dynamics and VDC research . Financial data was taken from Morningstar. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Why I Am Hedging My Portfolio With UVXY

Summary The stock market is hovering near all time highs. The current bull market at 6 years is approaching the historical average. The VIX Index has not closed a month over 30 in more than 3 years. I usually stay away from investments that do not have tangible asset backing, but I have made an exception in the case of the Pro Shares Ultra VIX Short Term ETF (NYSEARCA: UVXY ). Perfect Portfolio Insurance What exactly is UVXY? According to its prospectus on the Pro Shares website, it seeks daily investment results that correspond to 2x the daily performance of the S&P 500 VIX Short-Term Futures Index. What this basically means is that this ETF rises and falls with the level of the VIX, which is more commonly referred to as “The Fear Index.” With general market levels at all time highs, there is not much fear permeating today’s business landscape. However, as market historians have learned time and again, fear is one of the most powerful human emotions, and can skyrocket at a moment’s notice. Let’s look at some of the possible reasons why the VIX could increase dramatically in the near future. The VIX Is Below Its 20-Year Averages Take a look at the following 20 year chart for the VIX: ^VIX data by YCharts As you can see, the VIX hasn’t closed a month above 30 since November of 2011, over 3 years ago. The VIX has risen to 30 or above on 10 different occasions throughout the past two decades, leaving us with an average of one spike above 30 every two years. The longest time the VIX remained below 30 was 3/31/03-9/30/08, a period of 5.5 years. Although this was a long wait, the VIX jumped all the way to its 20 year high of over 65 shortly thereafter. An era of low fear can only exist for so long in the volatile world of the stock market. This current run of low VIX readings is the second longest of the past two decades, and the longer that it continues, the higher the probability of a spike, based on historic averages. The Current Bull Market Is Almost 6 Years Old As a student of the stock market, I am fascinated by the bull and bear trends that are the fabric of investing. Although hindsight is always 20/20 in the stock market, the current trend is approaching the historical average bull market length. The longer that the market keeps running, the harder the inevitable fall will become. Since the 1950s, there have been 9 bear markets , which are defined as a drop in the S&P 500 by 20% or more from its high point. That leaves us with roughly one bear market every 6.5 years. The current bull market began in March 2009, which makes it almost 6 years old. The longer that this bull market runs past its historical average, the higher the likelihood that it will sell off and become a bear market. Current Statistics Indicate An Overvalued Market I’d love to say that I can predict exactly when the correction will happen, but I know that is a fool’s errand. I just know that the longer a trend continues in the stock market, the more people believe it to be true, which is ultimately when the sentiment changes. Robert Shiller, a renowned economist, created the Cyclically Adjusted Price-Earnings (CAPE) ratio in an effort to create a gauge of how expensive the current market is. It is tallied by dividing price by the 10 year moving average of earnings, adjusted for inflation. Check out the following historical CAPE chart for the S&P 500: S&P 500 Cyclically Adjusted Price-Earnings Ratio data by YCharts As you can see, we are currently at the same level that we were at during the peak of the 2008 market, and just under the level of the infamous 1929 crescendo. This does not mean that a crash is imminent, but it does mean that we are entering dangerous waters. Another tell tale sign of a roaring bull market is high speculation on margin. This chart shows an eerie correlation between stock prices and margin levels: (click to enlarge) Source: Business Insider As the famous Mark Twain quote goes, “history doesn’t repeat itself, but it does rhyme.” As stock prices keep increasing, people become more confident, and overextend themselves. It is a reality of the stock market today. Unless we are truly entering a fairy tale era of high margin speculation and never ending growth, this trend has to reverse itself eventually. Other Considerations The Federal Reserve has officially ended its unprecedented QE program, which has been the largest economic stimulus in world history. This is important because it is now only a matter of time before the Fed raises interest rates. It will be fascinating to see how the financial markets react to the inevitable rate hike. This will negatively impact earnings for thousands of companies that rely on borrowed money. When this happens, volatility will spike. From a macro perspective, it is a harsh reality that there is a tremendous amount of uncertainty in the world today. With Greece teetering on the edge of default and ISIS being in the news almost daily, there is high potential for a negative trigger sometime in the near future. Unfortunately, subprime lending is making a comeback and student loan debt is burdening an entire generation, causing first time home buyer rates to drop to 30 year lows . As the student loan generation ages, they will have less disposable income to spend, and thus will impact the revenues of many companies. All of these are potential catalysts that could trigger a long overdue negative reaction in the stock markets. Why Choose A Leveraged Fund? The reason I chose a leveraged ETF like UVXY rather than a standard futures ETF like the iPath S&P 500 VIX Short Term Futures ETF (NYSEARCA: VXX ) is simple: a strong conviction that the facts mentioned above will contribute to a market volatility higher than current levels in the near future. UVXY attempts to return 2x the VIX’s performance for that particular day. This means that when a spike in volatility occurs, UVXY will significantly outperform VXX, which only attempts to achieve 1x the VIX performance. Although UVXY will decline more than VXX in a low volatility market, the increased profit potential outweighs that drawback in my opinion. Risks There is one dominant risk concerning this strategy: the structure of UVXY itself. UVXY is a leveraged futures ETF, which means that it suffers exponential decay when in a period of contango. Contango is when the futures price is more expensive than the current spot price. Unfortunately, in a low volatility market like the present one, UVXY is in contango the majority of the time. Accordingly, the risk of holding UVXY for a long period of time should be obvious. It WILL lose money if the market keeps up its slow ascent and fear fails to materialize. However, history shows us that record high stock prices and low volatility cannot go on indefinitely. It is of utmost importance to exit a position in UVXY as soon as the VIX spikes in a significant way. Why is this? Because fear is a much stronger emotion than greed, but lasts for a much shorter time, which makes the spikes that much more pronounced. Accordingly, fear can vanish in an instant, so huge gains in a vehicle like UVXY can vanish in the blink of an eye. Conclusion Although the near future in stocks may continue to be bright, I believe that preparing for the worst is always a good strategy. As a holder of equities, I am hoping that the stock market continues its upward trend, but I will be prepared if it does not. I consider the decay of UVXY the monthly premium that I pay in order to hold insurance in the case of disaster. If any of the aforementioned negative triggers materialize, UVXY should increase in value, which will then allow me to add to my long positions at lower prices. As Warren Buffett is famously quoted: “Only when the tide goes out do you realize who’s been swimming naked.” All I know is that when the wave of fear hits, at least I’ll have my bathing suit on. Disclosure: The author is long UVXY. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

WisdomTree Plans Another Small-Cap Hedged Europe ETF

WisdomTree Investments (NASDAQ: WETF ), the industry’s fifth largest ETF provider, has been stuffing up its product pipeline with hedged products. Already a reputable issuer with rich experience in rolling out successful currency hedged products, WisdomTree was quick to spot new opportunities latent in the international arena. Presently, WisdomTree dominates the space with the WisdomTree Japan Hedged Equity ETF (NYSEARCA: DXJ ) and the WisdomTree Europe Hedged Equity ETF (NYSEARCA: HEDJ ) having AUM of $13.5 billion and $10.6 billion, respectively. Other issuers like Deutsche Bank and iShares are far lagging the WisdomTree funds. However, the loose money market policies have now encouraged WisdomTree to file for a new hedged ETF targeting the small-cap European space. Newly Filed Product in Focus The passively managed fund looks to provide exposure to small companies across Europe by tracking the performance of the WisdomTree Europe Hedged SmallCap Equity Index. The index has a tilt toward dividends and rules out the weakness in euro against the greenback. To do so, the concerned index takes into account the dividend paying companies in the bottom 10% of the total market cap of the WisdomTree Dividend Index of Europe, Far East Asia and Australasia. Selected stocks trade in euros and are domiciled in a European country. The utmost weight of any single security is sealed at 2%, whereas the ceiling for the maximum weight of any one sector and any one country remains at 25% . The fund looks to charge 58 bps in fees. How Does It Fit in the Portfolio? The newly launched ETF can be a good choice for investors seeking exposure to the small cap companies within the Europe while avoiding current risks. For the U.S. investors, a descending euro affects total returns, when repatriating to dollars. Following the recent QE launch in the Eurozone and negative interest rates prevailing in several economies, the euro has weakened to multi-year lows versus the U.S. dollar. For this reason, investors wanted to consider a hedged euro play while intending to stay exposed in the likely recovery of Europe. This is especially true given that small cap companies are closely tied to the European economy and generate the majority of their revenues from the domestic market. Moreover, they pick up faster than their larger counterparts in a growing economy. Also, focus on dividends will benefit investors as the region is presently seeing an ultra-low interest rate environment. So monetary easing and currency weakness should support European consumption and may in turn boost small cap stocks. This clearly explains why WisdomTree’s recent filing is well timed. ETF Competition The newly launched fund is likely to face competition from other WisdomTree products such as the WisdomTree Europe Small Cap Dividend ETF (NYSEARCA: DFE ), the iShares MSCI Europe Small-Cap ETF (NASDAQ: IEUS ) and the SPDR EURO STOXX Small Cap ETF (NYSEARCA: SMEZ ). Among the trio, DFE emerged as a popular player as it has amassed as much as $734.5 million in assets and tracks the WisdomTree Europe SmallCap Dividend Index, a fundamentally weighted index that measures the performance of the small-capitalization segment of the European dividend paying market. DFE also charges 58 bps in fees. WisdomTree’s prior success in similar themed products should translate into recognition for the recently filed ETF, if approved. Plus, the new product has a hedged treatment unlike others, calling for additional gains in the current environment.