American Superconductor: Where To Now?

The big recent news is of course the Sinovel Settlement. After market close on July 3, American Superconductor (NASDAQ:AMSC) announced that a settlement had been reached with Chinese wind giant Sinovel Wind Group. The aggregate cash settlement amount of $58M will be paid by Sinovel in an up-front installment of $33M (already received), and a $25M installment within 10 months. In exchange, the settlement agreement grants Sinovel a non-exclusive license for certain AMSC intellectual property to be used solely in Sinovel’s doubly fed wind turbines. But no further compensation to AMSC is mentioned in the agreement.

The market expected much more and everyone will agree that this settlement is underwhelming – to say the least. To wit, over the next few trading days, the stock lost about 25% of its value, going from $7.06/share at close on July 3 to $5.22/share at close on July 9. Investors were clearly disappointed.

Several years ago, AMSCs market cap was well over $1B. Out of the blue, their largest customer, Chinese wind giant Sinovel, announced that they would no longer be accepting product shipments of wind turbine components from AMSC. As it would later turn out, they had obtained the technology from a former AMSC engineer, and simply continued using the patented technology without permission. In the ensuing years, with the loss of such a large customer, AMSC’s market cap has fallen to under $200M.

AMSC has been the poster child for the story of American companies falling victim to Chinese IP theft. There were high hopes that the various criminal and civil court cases (working their way through both American and Chinese courtrooms since 2011) would eventually reward AMSC for the crimes committed against it. Investors who suffered through the crash in stock price in 2011 have every right to be incensed with this outcome, since a settlement of $58M is peanuts compared to the losses AMSC suffered (the judge in the federal case that has just wrapped up found that the losses exceeded $550M).

But for investors that came across AMSC after the stock price crash due to the Sinovel incident, the investment thesis was about much more than the outcome of the court case.

AMSC has two operating segments: wind and grid.

- The wind segment supplies advanced power electronics and control systems (ECS), highly engineered wind turbine designs, and customer support services to wind turbine manufacturers. Since the loss of Sinovel as a customer, AMSC has won a few new design wins, but nothing to even remotely approach the over $300M in revenue it had in 2010. Currently, Inox Wind of India is the wind segment’s largest customer, accounting for 27% ($13M) of total revenues in FY2017 ($48M). This segment currently operates at a loss.

- The grid segment enables electric utilities and renewable energy project developers (such as wind farms and solar power plants) to connect, transmit and distribute power. Their grid products offer innovative solutions to grid congestion, poor power quality, and other risks. This segment also sells ship protection products to the U.S. Navy, and also operates at a loss.

The potential of the grid segment lies in AMSC’s high-temperature superconductor (NYSE:HTS) wire, which can conduct approximately 200 times the electrical current of copper wire of similar dimensions. For decades, superconductors have been used in the lab setting, but their commercial applications were limited, given the difficulty in producing them in large quantities. Today, it seems we are on the cusp of wide-spread commercial adoption, with commercial applications that include medical imaging and diagnostics, distributed energy generation, power transmission, ship-based electric motors, magnetic levitation transport, etc.

The primary focus of AMSC’s ship protection systems (SPS) has been degaussing, which is the process of reducing or eliminating a ship’s magnetic field for the purpose of avoiding magnetic mine detection. Using HTS-based solutions, SPS is able to reduce the amount of electrical power required to operate, and the overall weight of degaussing systems, by up to 60% and 90%, respectively. On September 6, 2017, AMSC announced that it had been awarded the contract to outfit the USS Fort Lauderdale (LPD 28), the 12th amphibious ship of the USS San Antonio-class, with SPS. Additionally, SPS will be worked into the baseline design of the next class of amphibious ships. Management estimates that the annual revenue opportunity for HTS-based SPS is between $70M and $120M for the years 2020 through 2025. At the moment, they also believe they are the only company that can offer HTS-based SPS products that have been cleared for use aboard US Navy surface vessels.

On the electric utility side, AMSC’s Resilient Electric Grid (NYSE:REG) system is an HTS-based solution that has two main applications. First, it can be used to improve reliability by interconnecting existing urban substations to each other, something that was usually not done because of the prohibitive cost using conventional copper wire. In the event of a loss of power in one substation, a REG system would allow for excess power to be rerouted from working substations to a substation that’s down, potentially avoiding lengthy service disruptions that are now commonplace after storms, terrorist attacks, etc. Second, REG can be used to improve capacity by connecting existing larger substations to new, smaller substations. The high-power handling capacity of the REG cables, combined with fault current limiting properties, eliminate the need for large power transformers. These new, smaller substations can then be built with a much-reduced real estate footprint, and therefore at a much lower cost. Management estimates that if all urban substations in major US cities were connected with REG, the total annual addressable market would be approximately $1B to $2B. Furthermore, on the 2Q16 earnings call, management highlighted the revenue potential of REG per city:

“ . . . If you think about REG I mean REG is tens of millions of dollars solution regardless of what you do, right. So there is no hundreds of thousand dollar order for REG. When we even talk about smaller systems, they are in – they probably start at $20 million, $25 million and they go up to – what we are learning is $250 million, $400 million depending upon the scope . . . ”At the moment, REG is being tested in a handful of cities across the US (Chicago, Boston, DC, San Francisco, and Seattle), and they have identified at least two dozen projects in other cities. Investors who have been closely following the stock have been waiting quite some time for an update on the Chicago REG study, as the first commercial order for REG would go a long way towards validating this large new revenue stream for AMSC. After a few quarters of not discussing the matter, management said on the last earnings call (4Q17) that they “hope to report back soon on progress with Chicago.”

Viewed from the point of view of very long-term shareholders, the $58M settlement is very disappointing, given the huge revenue loss that AMSC suffered from the Sinovel theft. But if you believe in the two new opportunities for revenue growth in the grid segment, then the 25% drop from the settlement announcement offers a great opportunity to invest. With the settlement, AMSC now has a bit more breathing room before getting to break-even, and the enormous commercial prospects of the grid segment remain unchanged.