Story Stock of the Day

Maxwell, ticker MXWL.

This thing has a great story. I am truly impressed with the prospects as described by a very energetic management team and the obvious tailwinds for its main product. I’m gonna stick my head out here and say it needs to be shorted sometime soon. It has a market cap of 500mln and is expected to earn non-GAAP net income of 9.5mln. But story stocks don’t necessarily pop easily.

My first criteria for a short on a story stock is whether it makes money. MXWL does not disappoint as it has never consistently reported profits and has not at all since 2000. Profitless story stock? Check.

Next is whether it needs cash. This gets a little sticky as you need to make a model on the thing and plug in guidance to get a feel for where sales and margins go. The first thing to remember when looking at transcripts is to ignore statements like this one made by the CFO on the Q4 conf call:

Given our fairly modest cash consumption, our ability to generate cash from operations, the Q4 cash proceeds of $7.5 million from warrant exercises and the settlement terms of the SEC and DOJ, which spread settlement payments over the next couple of years, we do not anticipate the need to raise additional capital in order to make the remaining settlement payments to the SEC and DOJ.

It is obscene how often statements like this fail. Ignoring the CFO and making our own assessment…

Wait a sec, immediately after saying he does not need to raise capital, these words fall out of his mouth:

However, depending on whether the convertible debt that matures in 2011 is converted to common stock or paid in cash and the timing and the amount of future capital spending for capacity expansions, it is reasonable to expect that we may sell stock in the future but our intention would be – opportunistically.

Crazily, stated within seconds of each other. Simply amazing. Companies are behaving badly again and they need to be punished. I like how this short idea is setting up. I am definitely not a fan of management at this point.

It turns out there are other demands on company cash than simply operations. It was busted for bribing Chinese utilities and needs to make sizable cash payments to the DOJ and SEC as a result. It also has a convert due this year. It plans for ~13mln capex in 2011. These payments come to ~29mln on 48mln gross cash. Tall fucking order for a company that has not turned a GAAP profit in 11yrs and was barely cash flow breakeven recently.

OK, hate the stock, not the company. Maybe it will generate cash flow in 2011 to help out. Let’s look at margins.

There was a series in the Q4 call talking about forward margins as sales grow in the auto segment. Here it is

<Q – Craig Irwin>: Thank you for taking my questions. One thing I’d really like to understand a little bit better, and I get a lot of questions on, is the potential leverage to stop-start. So if we were to assume that there were a couple more customers potentially ramping on the revenue line, what sort of incremental SG&A spending and R&D spending do you think Maxwell will have to incur to support maybe two or three additional customers in the 2012, 2013 timeframe?

<A – David J. Schramm>: Great question, Craig and the answer is not very much. You know we’ve got the – the cells are designed, the modules are designed, and frankly it becomes volume at that point. You know if Continental or I should say when Continental is successful on selling their system to other customers, that’s the same product to us. The engineering is already done, so it’s going to be minimal SG&A and minimal R&D expenses going forward. So in effect what’s going to happen is we’re going to grow that top line down the operating expense line and really put a focus on the operating income.

<Q – Craig Irwin>: Excellent, excellent. The second thing I wanted to understand about this business is I know we are at the very front end of a new automotive application and typically at the front end the margins can be pretty attractive, but we are talking about the automotive industry here. Do you expect sales into this market to be fairly consistent with the impressive gross profits that you’ve been seeing in the ultracapacitor business over the last few quarters, or are they likely to – are margins likely to come in a little bit as automotive volumes lift?

<A – David J. Schramm>: No, I guess the way I’d look at that is we’re selling a technology, not a commodity, and two things happen. One is, with volume customers do expect some price decreases, but along with volume, I also get some cost reduction. So we’re going to do everything we can to maintain that margin level where it’s at. That being said, if we can grow that top line fast enough, dilute the OpEx, we’re really going to grow that operating income line.

I especially like the line “dilute the opex.” My takeaway from this is that margins are going down and it will be a fight between growing sales and growing opex. Elsewhere management says they hope to reach 40% gross margin again by end of year, suggesting this is a cap to use in the model.

Brilliant! My model is set. Assuming we can believe management and they are not sandbagging (not a good assumption knowing that this team already has a propensity to lie), I come to 1Q11 = 5c and 2011 = 23c. I can get to 2011 = 34c if I use 40% gross margin. This compares to Consensus 4c and 35c, so Consensus estimates are not especially at risk as long as it can keep folks believing in 40% gross margin.

My 4Q11 cash estimate is 8mln. This is way too low to support a company growing “leaps and bounds” with sales supposedly approaching 200mln in 2012.

Conclusion? This thing is trying to raise money, likely something in the 50mln-100mln range. At $10/share, that is 5mln-10mln share dilution and obviously much less if the offer comes at $15. Current share count is 27mln. Short interest is not so high at 10%. Watch for brokers to ramp this thing in an effort to win the business. Longer term, this business comes with lower margins and/or share loss to Korean competitors (who, I might add, are much better at bribing Chinese officials without being caught…). I will not stand in the way of the current ramp and will reassess this short idea when we get closer to earnings at the end of April.