In response to the feedback received regarding last week's article on Abakan (ABKI.PK), I would like to not only address readers' concerns, but also try to help Abakan's supporters.
But first, I would like to take readers into the world of the OTCBB promoters so they can understand the promoters motivations. OTCBB stock promoters work from qualified lists of potential retail investors. They call/mass email thousands of investors with a targeted hit rate of about 10%. In general, these retail investors are less sophisticated, and are moved more by a good story and a good chart than by the actual valuation or financial results of the company. I have been pitched by several stock promoters; they can be very effective. For readers who would like to learn more about the OTCBB world, please refer to this article and this one.
The quandary for stock promoters is when a negative article based on fundamentals appears on Yahoo Finance (a common source for retail investors, including message boards) linked to a stock that they are trying to promote. This does not happen very often, but when it does there tends to be an all-out war on the bearer of bad news. Future funding is the lifeblood of both the company and its promoters. Thus, I am not surprised to have received the barrage of attacks trying to discredit the article and my research capabilities.
The main problem with the critiques are that they avoid the big elephant in the room -- today's reality of Abakan's huge overvaluation and near-absence of commercial revenues, with little visibility on when they will occur in the future. In the meantime, the company is losing millions of dollars per year and is already saddled with $4 million of net debt that it cannot support. Instead, I receive irrelevant and misleading commentary that completely fails to address Abakan's overvaluation.
So my suggestion to Abakan's faithful is instead of assuming that Seeking Alpha readers (vs. less discriminating retail investors) are gullible enough to believe this banter, try to tackle the big issue. Hire a credible investment bank and have them write a thorough, sell-side research report with long-term projections, supporting assumptions, and a discounted cash flow model that will challenge the analysis I made in last week's article. Frankly, you will be just extending the myth, in my current view. But at least we can have an intelligent dialogue, which can engage the investors that are needed to carry Abakan to an even higher valuation.
Biomass companies like Kior (KIOR) and Ceres (CERE) have current market caps well above that of Abakan, but also lack any revenues with heavy losses expected for the next two years. What Kior and Ceres have in common is institutional support enabled by investment banking sell-side research. While we don't agree with the sell-side research, and remain short those companies' shares today, we see the value of those investment banks in supporting those companies' high valuations. Please note that both Kior and Ceres are listed on the Nasdaq; it will be more challenging to find a credible investment bank to support pink sheet-listed Abakan (but management should just do the best that it can).
I will even go a step further to help Abakan's cause. Yesterday, while Abakan was announcing the receipt of an R&D award from a magazine, a much more relevant event occurred. One of Abakan's larger peers, France-based Prezioso Technilor, was acquired by private-equity firm Cinven for about one times revenue. Founded in 1957, Prezioso provides coatings and insulation for the oil and gas and nuclear industries, serving multinational customers like BP, Total, Exxon and EDF. Last year's revenues were €320 million ($400 million), and revenues grew at a 15% annual rate over the last five years. Because of Prezioso's past and expected future double-digit growth rates, it received a premium to the peer group valuation that I used in last week's article. The bottom line is in the one-out-of-100 very rosy scenario of Abakan reaching $400 million in revenues five years from now, assuming 30% equity dilution and a 15% annual discount rate, I arrive at a net present value of $139 million. This is higher than my previously derived $73 million best-case scenario valuation, albeit still 14% below today's $161 million fully-diluted market cap. Unfortunately, Abakan's current state of affairs creates a most likely outcome of close to zero.
One critique said that I ignored the company's patents. What I actually said was that key intellectual property was licensed from third parties, and we stand by our statement. First of all, the company itself values the entire patent portfolio at just $1.9 million as of February 2012. That is a far cry from Abakan's current $165 million enterprise value. Second, the key processes that drew interest from Petrobras were the plasma arc lamps licensed from Mattson, contributing to a stronger metallic curing process, and the license for high-density fusion cladding. Third, we reviewed the four patents assigned to Abakan's 41%-owned Powdermet investment, the two patents assigned to Metso Powdermet Oy, and the expired patent assigned to Alexei Barinov that came under Abakan's domain. We then took the further step of examining Abakan's competitors' patents. Our conclusion is Abakan's patents are not blocking intellectual property (IP) that would hold a strategic value. Competitors have numerous patents with different processes, but with similar claims and results, all based on various material composites and related processing of those materials. Furthermore, competitors actually own 100% of their patents. Abakan only has a 41% non-controlling stake in its patent portfolio.
Please note that our critique of the company's IP is not a reflection of the ingenuity of Powdermet. Andrew Sherman is an accomplished inventor and researcher. His patents were precisely written with well supported patent claims.
Another bit of IP commentary made in response to my article was as follows:
Has anyone heard of a tiny little company called Microsoft that licensed the externally developed DOS operating system from Xerox? Like where the IP comes from is even an issue as long as it is owned, by licensing, assignment, or acquisition.
First of all, faulty logic by association lowers credibility. Just because both Abakan and Microsoft were licensees of IP does not make Abakan the next Microsoft. Second, there is a huge difference between owning the IP and licensing it. For example, the 51%-owned MesoCoat subsidiary's licensee agreement with UT-Battelle states limited fields of use, various up-front fees, ongoing support fees in terms of man-hours and expenditures, annual royalties of 2.5% of revenues above a minimum of $10,000 to $20,000, high late-payment fees of 18% plus legal costs, and, most importantly, UT-Battelle's right to make the agreement non-exclusive (although the royalty rate would then be cut in half).
From a strategic point of view, Abakan is in a tough situation. Its right to buy 24% more of its MesoCoat subsidiary for $16 million expires July 13, 2012. But management does not have the money. Instead, Abakan could make more acquisitions in new surface coating businesses (which could be distracting for the company). But, again, where will the capital come from? The likely answer is that Abakan will resort to issuing a lot of shares at a significant price discount, leading to heavy shareholder dilution, in order to pursue any growth path. This includes the several millions of dollars needed to set up production in Euclid, Ohio. Abakan's shareholders should be concerned about these upcoming strategic issues, and how management will even finance current ongoing operations.
Disclosure: I am short ABKI.PK, KIOR, CERE.
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