Active Power (Nasdaq: ACPW) is an odd little company. Debuting as a public company amidst the final gasps of the tech bubble, the stock traded above $70 before the market abandoned risky and unproven energy-tech ideas and investor disillusionment pushed the stock below $0.30. Sometimes, though, there can be real opportunity in cherry-picking small companies with interesting proprietary technology that have been through the fires of mass investor abandonment and emerged alive. Such is my interest in Active Power.
What They Do
Active Power is in the business of manufacturing flywheel-based uninterrupted power supply systems. While traditional UPS options have an efficiency level in the low 90's (under optimal conditions), Active Power boasts an efficiency level of 98% for its flywheels. Better still, priced at only about 10% more than traditional lead acid battery-based systems, it is not as though Active Power is demanding that would-be customers pay up dramatically for new technology.
It should also be noted that flywheel approaches are not really new or unproven. The problem is that prior iterations just didn't deliver much in the way of performance or reliability advantages and could be a little ... well, "finnicky". Active Power, then, has not invented a new concept but rather significantly improved an existing idea.
The High Price Of Failure
These kinds of UPS are not meant to replace a diesel generator at a hospital or somesuch. No, these systems are meant for high-level applications where any interruption can be bad news. To offer one example, there was a story that came out a little while ago about how a power problem at a Toshiba factory ruined about 20% of the flash memory chips the plant was intending to ship in Jan/Feb of 2011. What caused this mess? A voltage drop that lasted all of 0.07 seconds. Yes, 0.07 seconds.
Anyway ... Active Power targets data centers and other sorts of markets where price sensitivity is not so critical, but where absolute performance and reliability must be in place. The company has Caterpillar (NYSE: CAT) (a major player in diesel generators) on board as a partner and CAT markets Active Power flywheel systems under their own name. Active Power also has Hewlett-Packard (NYSE: HPQ) and Oracle (Nasdaq: ORCL) on board as IT partners, and boasts customers like the software giant SAS.
So What Is Active Power Worth?
Okay, now back to the point of this whole post - what is Active Power worth? I'm a hard core cash flow guy, so I had to build a model of what ACPW's earnings and cash flow might look like out through 2020. Along the way I took some shortcuts and made some assumptions, but here are the basics.
I'm looking for the company to go from $64 million in revenue in 2010 to $140 million in 2014 and $310 million in 2020. That's a 10-yr CAGR of 17%.
I'm looking for the gross margin to go from 28% in '10 to 41% in '14 and 46% in '20.
For operating margin, I model (7%) in 2010, 18% in 2014, and 20% in 2020 - 20%, by the way, is 25% better than the current S&P 500 average and well ahead of where companies like Eaton (NYSE: ETN) and Emerson (NYSE: EMR) are today.
I estimated a 30% tax rate starting in 2013.
For depreciation and cap-ex, I assumed that the company will use an asset-light model that will not require a lot of capital investment. Consequently, I pegged D&A at about 3% of sales and cap-ex at 2% of sales.
The bottom line, then, was to produce a FCF-sales margin of 13% in 2014 and 15% in 2020 - both pretty high margins by the standards of industrial companies. Assigning a 12% discount rate to the free cash flow and using the current share count gives me a price target of ... $2.69, or about 14% higher than today's price.
So, Active Power may be undervalued, but not hugely undervalued.
Just for kicks, I decided to re-run the numbers if Active Power was able to double my 2020 revenue estimate (so, ending at $600 million instead of $310 million). That sends the DCF-based price target rocketing up to $11.11, but would also mean that Active Power had 10% of the estimated $6.1 billion market for UPS (though that's today's market size, not 2020's).
Of course, any one of my numbers could also be adjusted or modified, including the gross margin, sales & marketing spend, R&D investment, tax rate, and so on. Likewise, I probably underestimated the company's tax loss benefits.
In any case, I'm not sure whether to really recommend Active Power shares at today's price, but if the company can grow revenue at a 25% CAGR for 10 years (and do so profitably), there could definitely be a lot of value here. Then again, how many companies manage a decade of 25% compound annual revenue growth? At a minimum, it's at least worth a bit more due diligence.
Oh, and by all means, if there are readers out there interested in or knowledgable about Active Power and its prospects, feel free to chime in with any comments on my model assumptions.