Best Investments: High conviction paired trade - short Tesla Motors and buy Exide Technologies

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High Conviction Paired Trade – Short Tesla Motors And Buy Exide Technologies | Alternative Energy Stocks

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High Conviction Paired Trade – Short Tesla Motors And Buy Exide Technologies John Petersen

Short sellers are the bane of every securities lawyer who representssmall public companies. In over thirty years of practice I've neveradvocated a short sale because I hate the idea of profiting fromsomeone else's misery. Based on recent quarterly reports filed by myshort-list of pure play energy storage companies, which includes TeslaMotors (TSLA)as an honorary member, I'm compelled to break with tradition andsuggest a paired trade that involves a short sale of Tesla coupled witha long purchase of Exide Technologies (XIDE).

The following table summarizes the year-to-date and quarter-to-dateperformance of the short-list companies. On a year-to-date basis, Teslahas been a runaway success while Exide languished. For the reasonsdiscussed below, that dynamic is sure to change over the coming year.

11.15.10 Performance.png

Most of us know that money managers, analysts and investors tend tofollow the herd without asking whether the herd's behavior is rational.Even a simplistic comparison of business fundamentals and marketrealities shows just how irrational the herd has become over the lastyear as electric vehicle hype reaches the peak of inflatedexpectations.

The following table is complex and I apologize for that, but ithighlights the huge disconnects between market values and financialstatement values that are common in the sector. To keep thingscomparable I started with data in the most recent quarterly reportsfiled by the short list companies and adjusted for financingtransactions that occurred after the last balance sheet date. Thecolumns with gold headers are business fundamentals derived fromfinancial statements. The columns with green headers are market drivenvariables.

11.15.10 Fundamentals.png

Why I Would Short Tesla - Itdoesn't take much market experience to know that companies cannot longsustain market capitalizations of almost twelve times book value, butthat's exactly what Tesla is doing. When you drill down into thedisclosures in Tesla's most recent quarterly report, you'll find that$88 million of its $202 million in working capital is set aside asrestricted cash for capital investments in facilities construction,which leaves a paltry $114 in real working capital to cover anticipatedoperating losses and the pre-production costs for the 2012 introductionof its Model S sedan.

Any way you cut it, Tesla does not have enough cash to support itsbusiness for another year and it's already tapped Panasonic and Toyota.That means Tesla will have to go into the financial markets foradditional cash – lots of additional cash. While stock market investorsfrequently ignore financial statement fundamentals when makinginvestment decisions, I've met very few professionals with a similarlyblasé attitude. The probability that hundreds of millions in newcapital will be available to Tesla at anywhere close to a 1,200%premium to book value is remote beyond reckoning and it's a virtualcertainty that substantial transactions with independent investors willnot happen at anything close to the current market price.

Since the market can stay irrational longer than many of us can staysolvent, the safest way to play the likely price collapse will be along-dated out of the money put option. For purposes of tracking theperformance of this long-short pair over time, I'll use the publiclytraded January 2012 $25 put, which last traded for $6. The short won'tbe profitable unless Tesla's price falls below $19, but I still likethe risk/reward ratio.

Why I Would Buy Exide - I'vediscussed Exide at length in other articles including "ValuationPrimer For Energy Storage Companies – Lesson #1." The short storyis that it's taken Exide five years to emerge from Chapter 11 andrestructure its manufacturing operations to a point where consistentlong-term profitability is likely. Exide's current price earnings ratiois significantly below normal valuations of 15 to 18 times earnings andits prospects for rapid and sustained growth over the next five yearsare outstanding due to technological changes like stop-start idleelimination that are sweeping the automotive sector and will improvemargins in both its OEM and after-market replacement business. Whilethe financial analysts that follow Exide have an average price targetof $10, my sense is that a price toward the high end of the $10 to $15range is more likely.

Why Valence Terrifies Me -Valence Technologies (VLNC)has been around for years and is making significant progress in itsefforts to commercialize a good lithium-ion battery technology. Forseveral years it has depended on the commitment and generosity of aprincipal stockholder to keep the doors open. Currently Valence has a$7.3 million working capital deficit and a whopping $75.3 millionstockholders equity deficit. As long as the principal stockholder iswilling to continue providing additional financing on terms that arelittle more than gifts to the public stockholders, Valence stands achance. If it is forced to go to unrelated investors that are unwillingto be sugar daddies, the likelihood that it will be able to raise overa hundred million dollars of new capital at prices that bear anyrelation to the current market price is less than slim. While I haveoften been forced to rely on the kindness of strangers, hope is not aninvestment strategy.

Disclosure: Author is a formerdirector of Axion Power International (AXPW.OB)and has a substantial long position in its common stock.

Posted by John Petersen on November 16, 2010 08:41 AM | High Conviction Paired Trade – Short Tesla Motors And Buy Exide Technologies

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