Plug Power: Uneconomic And Subsidized Business Model Combined With Cash Burn Justifies Short (NASDAQ:PLUG)

Editor's Note: Plug Power has published a response to this article, which you can view here.

Plug Power, Inc. (NASDAQ:PLUG) has an uneconomical business model and is burning through more cash than it has. At this rate, it will need dilutive financing within another 12 months after just having raised $35m a month ago. Total cost of ownership (TCO) benefit for customers is between 10% and 5% versus a regular battery forklift. This TCO is calculated based on a net present value approach and thus ignores that regular forklifts are actually cheaper on an annual basis. Furthermore, federal tax credits are subsidizing the purchase price of fuel systems by up to 30%.

Plug Power is a company that engages in the selling of fuel cells and most notably forklift fuel cells called "GenDrive". The company provides ancillary services like maintenance, "GenCare," and hydrogen delivery to customer sites, as well as building hydrogen stations, "GenFuel", and backup power referred to as "GenSure". It also offers these individual products/services in a one-stop-shopping product named GenKey. Customers can choose a package between GenDrive, GenFuel, and GenCare, or a package consisting of GenSure, GenFuel, and GenCare. In other words, only GenDrive and GenSure are interchangeable. By far, the biggest source of revenue is generated from the sales of fuel cells and more specifically forklift fuel cells. The company's added value is clear. Using these cells, forklifts can perform for longer stretches and require less charging time:

Battery changing requires 15 minutes per shift compared to two minutes for hydrogen refueling. Over a year, that 13 minutes per shift saved represents over 234 hours of lost productivity per forklift truck in a three-shift operation. One fuel cell for one truck - it's that simple.

So far, the company has delivered 23,000 units, granting it a market share of 95%. In other words, PLUG is the market leader in terms of forklift fuel cells. What is perhaps more interesting is that the company is a market leader with less than a quarter billion in annual sales.

Expanding on that, the company's biggest customers are Amazon (AMZN) and Walmart (WMT), jointly making up 75.3% of the company's receivable balance and 61.9% of its revenue. Basically, the company is a market leader because Amazon and Walmart are its customers. In fact, Amazon and Walmart are both so keen on Plug Power that they have both acquired warrants, which will allow each of them to purchase 55,286,696 if certain conditions are met. While these facts (i.e., Walmart and Amazon being 95% of the market) may imply that this is a very niche business and may also question the extent of the growth, PLUG itself is very optimistic. The company mentions that there are over 6 million forklift trucks in the field. Further commenting that with 23,000 units deployed, it is "just starting to scratch the surface of the market possibilities for this application".

I wasn't able to find the average price of PLUG's fuel cells, so I tried to be a bit creative. Below is a table from the National Renewable Energy Laboratory (NREL) study, which compares hydrogen total annual cost of ownership (TCO) vs. traditional batteries. For what it's worth, the NREL is a federal institution which focuses on researching all aspects of renewable energy (development, commercialization, etc.).

Source

To better understand the table, I should note that Class I, Class II, and Class III refer to three- and four-wheel, sit-down, counter-balanced and pallet jacks, respectively. In any case, according to the NREL, fuel cell lifts can potentially reduce the TCO by 10% for Class I and II and by 5% for Class III. It is unclear to me which type of forklifts are generally used by Walmart and Amazon, so therefore I'll assume that they use 100% of Class I and II, which means that PLUG is saving them 10%. Additionally, there should be two caveats placed. First, the study does not take into account improved productivity (we'll get to that later). Second, the lower TCO includes a federal tax credit which according to the same study is:

A federal tax credit available for fuel cell systems, set at the lesser of $3,000/kW or 30% of the cost. For an average system costing $33,000, this tax credit reduces the effective cost of the fuel cell system by about $10,000.

These numbers apply to the Class I and II forklifts. Buyers can obtain up to $4,600 in federal tax credits when buying Class III forklifts. The formula for calculating the Class I and II forklifts and the Class III forklifts is the same. Nonetheless, according to the study, fuel cell forklifts would still be cheaper than regular battery cells had there not been a subsidy. This is mainly because fuel cell systems have a longer useful life (10 vs. 4.4 vs. battery cells). Keep in mind that the cost analysis is done on a net present value basis. In any case, specifically, the absence of the federal tax credit for fuel cells would increase the annual cost of the system $1,100. Lastly, on a dollar basis, it is more expensive (without the subsidy) to buy a fuel cell forklift than a traditional forklift. Earlier, productivity improvements were mentioned. The company mentions that using a fuel cell forklift releases 239 hours per year versus using a traditional forklift.

Amazon warehouses are open 24/7, so that is a saving of 9.75 days or an increase in annual productivity of 2.7% (calculation excludes holidays). For large companies like Amazon and Walmart, this may definitely be beneficial. However, just because there is more time left doesn't mean that there is more work to do. Warehouse logistics are still determined by customer demands, and this doesn't change if the companies use more efficient forklifts. Therefore, I understand that the study did not try and model any potential benefit because it is a highly speculative endeavor. The key takeaways here are: 1) Fuel cell forklifts are being heavily subsidized by the government (up to 30%), 2) fuel cell forklifts have a higher initial cost than traditional forklifts, and 3) most importantly, there is only a 10% cost improvement (including subsidy), which means that gross margins for PLUG cannot grow more than 10% based on the pricing power (there are other potential ways).

Currently, PLUG's fuel cell segment sports a gross margin of 25% based on 3Q18 filings and a negative operating margin of -23.8%. If we apply a gross margin improvement of 10% (the max price improvement), the operating margin becomes negative 17%. Keep in mind that I have only improved the gross margin for the fuel cell systems sales and not the other segments. The point here is that the economics look tough. Sure, greater economies of scale have the potential to reduce the cost of revenue as well. If the company can source parts at mass scale as well as assemble at max scale, it might be able to reduce costs. According to the company, it has the capacity to produce over 20,000 fuel cell products on an annual basis, and has the potential to reduce the cost of revenue as well. For perspective, it produced 1,483 GenDrive units (fuel cell systems) in 3Q18.

In other words, the economics look rather poor. It's hard to see how the company's fuel cell division, which is its biggest segment representing 69% of sales, becomes economical. It's very understandable why Walmart and Amazon would invest in Plug. Effectively, Plug and the government are subsidizing their operational improvements. The government through tax credits and Plug by subsidizing losses. The only way this technology becomes economically viable is for rather substantial technology advancements to occur. Unfortunately, the company does not have a lot of money, let alone a lot of money to spend on R&D. This brings us to a very important topic, which is the company's (lack of) liquidity.

A cursory glance shows a cash balance of $62 million. However, $48.2m of that cash is restricted, leaving $13.8m available. On top of that, it has recently announced a $35m convertible preferred financing, which puts the total cash balance at $48.8m.The convertibles have a conversion price of $2.31 per share. Usually, convertible financing is very undesirable for equity holders because it has the potential to cap the stock price at the conversion price as well as dilute existing holders. However, since PLUG's market cap is over $350m and the convertibles total $35m, the dilution is low. Additionally, I would not expect this to put any meaningful cap on the stock price. Not surprisingly, PLUG has a cash burn. The company had a TTM negative FCF of $54 million. In other words, even with this recent convertible financing, the company will need to raise cash very soon again.

Most investors believe that PLUG could eventually be bought out by Amazon. After all, that is why Amazon purchased the rights to acquire 23% of the company. However, most do not know that Walmart has the right to acquire the exact same amount. One might now conclude that these two would start a bidding war, however, I think this means quite the opposite. I think this means that they have purchased this right to deter potential acquirers as they fear they might lose access in certain scenarios. Such a scenario would be, for example, a competitor - let's say Amazon - buying PLUG and making it impossible for Walmart to purchase from PLUG.

Another risk is that PLUG manages to secure the business of another giant retailer with large warehouse operations. This is a legitimate possibility. After all, this is what PLUG is actively working towards. However, given the slow pace that sales are going through at Walmart and Amazon, combined with the fact that fuel cell systems aren't really that much better, makes me hesitant to conclude that large retailers are banging at the door.

Walmart was PLUG's most significant customer until Amazon inked a deal in 2017. Amazon is known to experiment a lot. If that is indeed what it is doing with PLUG, it would explain the lack of significant customers (besides Walmart). Still, this is a risk we cannot discount and that we must accept.

In terms of practicalities, the company has a float of 230 million shares. At the same time, there are only 350k shares available for borrowing at Interactive Brokers. However, there are options being traded which will allow for shorting. Keep in mind that this indicates PLUG is heavily shorted and that a risk of a short squeeze is greater than average should substantial good news hit the public markets.

PLUG's business model is poor and the economic value-add is speculative at best. Additionally, the company has only $48.8m of liquidity left, which will last a little less than a year. At this rate, the company would need to raise additional capital in roughly 10 months or so. Therefore, I believe that the company is going to raise equity either through common or preferred shares. Regardless, both will provide meaningful downside pressure on the stock.

Rating: Sell Short

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