American Superconductor Flickering

By Stephen D. Simpson, CFA | June 03, 2011 AAA

The bad news just keeps coming for alternative energy company American Superconductor (Nasdaq:AMSC). Although the company thought it had made a major step forward when it diversified into wind turbine components, that plan has run off the rails recently. It remains to be seen whether the company can repair its relationship with a major customer and/or find a new and more stable business plan to grow the company.

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The Latest Setbacks
American Superconductor reported a double-whammy related to ongoing issues with its biggest customer Sinovel. The company announced that not only will revenue be "materially less" than $355 million for the quarter (which itself was a big step down from prior hopes), but the company would need an extension to file its 10-K due to the probable need to reverse already recognized revenue.

Sinovel is the second-largest wind turbine maker in the world (and the largest in China) and has been a huge customer for AMSC's turbine components business, making up close to three-quarters of sales. Unfortunately, the company decided a few months ago to stop accepting any deliveries of components for 1.5MW and 3MW turbines and hasn't fully paid for prior accepted shipments. (For related reading, see What Does It Mean To Be Green?)

A Power-Play?
It is certainly fair for American Superconductor shareholders to wonder what the heck is going on with Sinovel and the relationship between the two companies.

True, the wind turbine business as a whole has seen some setbacks. Companies like Sinovel, Vestas (Nasdaq:VWDRY), Gamesa (Nasdaq:GCTAY), and Zoltek (Nasdaq:ZOLT) - whose carbon fiber is used in turbine blades - have all been under pressure as turbine orders have lagged in the face of lower government subsidies and ongoing improvements in solar panel efficiency.

Still, there are more than hints that there is something more going on here. Sinovel may well be having a hard time collecting from its own customers, but reading between the lines suggests a possible power-play between the two companies. Sinovel wants and arguably needs a better internal cost structure so that it can compete more effectively on price. It is logical from their perspective, then, to squeeze American Superconductor hard on price - threatening to end the relationship without concessions. Along those lines, it would hardly be a surprise if Sinovel itself was the source of the many and varied rumors that the company is designing AMSC's components out of future (and current) turbine designs. (For related reading, see Top 10 Green Industries.)

What Does AMSC Do Now?
If Sinovel is playing a game of chicken with AMSC - figuring that AMSC's survival is dependent upon ongoing business with them - AMSC may not have a lot of good options in the short term. The company is cutting headcount immediately to conserve cash, but the need to scramble for resources to finish the acquisition of The Switch Engineering Oy clearly indicates that AMSC has little strength in its bargaining position. What's more, the market's disappointment with these developments has crushed the stock, hurting the company's chances of raising capital on good terms and bringing out the ambulance-chasers in force.

Longer-term, there is no question that AMSC needs to broaden its customer base. Maybe there is a place for AMSC components in turbines made by Vestas, GE (NYSE:GE) -number three in the world - or Siemens (NYSE:SI). American Superconductor shareholders had certainly better hope so, as it is clear that Sinovel is no longer a customer with whom anybody should feel comfortable as a long-term partner in mutual success. (For more, see Can Business Evolve In A Green World?)

The Bottom Line
Maybe Sinovel really is an honest partner going through some hard times. Unfortunately, investors who operate with rose-colored glasses usually end up taking capital loss deductions on their taxes and wondering what went wrong. American Superconductor looks like a bargain in some respects, but investors should realize that those valuation ratios will get much worse as if or when the Sinovel business rolls off and nothing replaces it. What's more, the superconducting wire business is still not close to making a meaningful contribution to earnings.

For the sake of the business, management is probably better off swallowing hard and giving in to Sinovel - if it turns out that Sinovel is squeezing the company for concessions, that is. In the end, 20% of something is better than 100% of nothing and it is probable that there is some level of compromise that would keep AMSC profitable long enough to find some new business alternatives.

For investors, this looks like a situation of maximum pessimism - a good time to commit for those truly brave (and/or a little crazy) and capable of absorbing the losses of being wrong. In no way, though, is this a sure thing or anything like an investment - this is speculation and a very risky situation. (For more, see Five Companies Leading The Green Charge.)

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