Loewen, Ondaatje, McCutcheon Limited www.lomltd.com 1
Toronto / Canada / U.S. 1-800-567-1566 • Montreal 514-393-4600 • Europe 00-800-5660-5660
VRB Power Systems – Initiating Coverage with a
Speculative BUY Recommendation, $1.75 Target Price
Russell Stanley, MBA
rstanley@lomltd.com
Event
We are initiating coverage with a Speculative BUY
recommendation and a $1.75 target price. A detailed
report on VRB Power Systems Inc. will follow shortly.
Summary
VRB Power Systems Inc. is the only provider of a full
range of energy storage products for utilities and end
users. VRB has commercialized the Vanadium Redox
Battery Energy Storage System (VRB-ESS), a high capacity
energy storage system ideal for applications between
5kW and 10MW. The company has also acquired the
intellectual property rights and assets to the Regenesys
Energy Storage System (RGN-ESS), which is designed for
larger applications in the 10MW-100MW range. These
systems allow users to store electricity in the form of
electrochemical energy for later use.
Target markets for these systems include:
• Utilities
• Commercial Buildings & Production Facilities
• Electricity Market Trading
• Telecommunications & Cellular Sites
• Renewable Resource Generation
• Remote Area Power Supply (RAPS)
The demand for energy storage is expected to be
significant in the years ahead due to the deregulation of
electricity markets, the need for renewable energy
resources, and concerns about energy security. Perhaps
most importantly for VRB Power Systems, the market
for energy storage should be substantial with or without
widespread adoption of renewable power systems.
The VRB-ESS
The VRB-ESS is an electrical storage system based on the
redox flow battery (see Exhibit-1), and is ideal for
applications from 5kW to 10MW. Energy is stored
chemically in ionic forms of vanadium in a dilute sulphuric
acid electrolyte. The electrolyte is pumped from separate
plastic storage tanks into flow cells across a proton
exchange membrane (PEM) where one form of
electrolyte is electrochemically reduced and the other is
electrochemically oxidized (hence the term ‘redox’).
This creates a current that is collected by electrodes and
made available to an external circuit. This reaction is
reversible, allowing the battery to be charged, discharged
and recharged.
The VRB-ESS employs vanadium ions in both half-cell
electrolytes, so cross-contamination of ions through the
membrane separator has no detrimental influence on
battery capacity (unlike other redox flow batteries, which
employ different metal species in the positive and
negative half-cells). Furthermore, the vanadium half-cell
solutions can even be remixed, bringing the system back
to its original state.
Speculative BUY Fiscal Y/E: Jun 30
12-Month Target Price $1.75
Current Price $0.78
52-Week Range $0.49 - $1.20
Basic S/O (mm) 92.2
Market Capitalization (mm) $71.9
Cash & Equivalents (mm) $3.5
2004A 2005E 2006E 2007E
Revenue (mm) $0.7 $4.7 $26.0 $144.8
FD EPS ($0.09) ($0.05) ($0.03) $0.15
P/E nm nm nm 5.2x
416-964-4434
SPECIAL
SITUATIONS VRB Power Systems Inc.
(VRB – TSXV)
December 22, 2004 www.vrbpower.com
VRB Power Systems Inc. (VRB-TSXV)
Loewen, Ondaatje, McCutcheon Limited www.lomltd.com 2
Toronto / Canada / U.S. 1-800-567-1566 • Montreal 514-393-4600 • Europe 00-800-5660-5660
Exhibit 1: The Redox Flow Battery System
Source: VRB Power Systems Inc.
Two successful installations of the technology have
already been completed. The first was at King Island,
Australia, and was completed in November 2003 for
Hydro Tasmania. This installation is designed to operate
as part of a hybrid system with wind and diesel
generators, allowing for increased fuel efficiency of the
diesel system and more complete use of the local wind
generating potential. The second installation was
completed in February 2004 at Castle Valley, Utah for
PacifiCorp, a division of Scottish Power (SPI-NYSE;
SPW-LSE). This installation is used for load leveling (peak
shaving) and effectively allows the utility to defer a costly
expansion of the local infrastructure by making more
efficient use of existing assets.
The VRB technology was originally developed in the early
1980s at the University of New South Wales. Several
licensing agreements were made, including one with
Sumitomo Electric Industries (SEI), which is the only one
still in force today. The patents for the technology were
later sold to Pinnacle VRB Limited (PCE-AX).
Vanteck (later renamed VRB Power Systems) initially
acquired the rights to market the technology in Africa,
and later acquired 73% ownership of Pinnacle itself as
part of an arm's length takeover attempt. On December
20th, VRB announced that Pinnacle shareholders had
approved an agreement that transfers all patents
(excluding the Australian patents) to VRB Power
Systems. In return, VRB will cease to be a shareholder of
Pinnacle. This agreement will free Pinnacle to pursue its
own clients and capital, and allow VRB to bring the
intellectual property in house. The related transactions
required by the agreement are expected to be completed
in January 2005.
The RGN-ESS
This system uses electrolytes of concentrated solutions
of sodium bromide and sodium polysulphide. The system
itself is otherwise quite similar to that of the VRB-ESS.
This technology was acquired in September 2004 from
RWE npower PLC, an integrated U.K. energy business,
and subsidiary of RWE AG (RWEG-F), a German utility
giant. VRB acquired the flow frame designs, as well as
assembly equipment and techniques for US$1.3 million.
This transaction gives VRB an exclusive, 5-year global
license to the intellectual property surrounding the
RGN-ESS. RWE also became a shareholder of VRB with
the purchase of 3.6 million shares, or approximately 4%
of the shares outstanding.
This technology is complementary to the VRB-ESS. It is
designed for large-scale applications (10MW-100MW)
where the vanadium requirements of the VRB-ESS
become too expensive. This acquisition extended VRB’s
product lineup to larger scale applications, and also
added valuable assembly equipment, know how and
inventory that can also be used to advance the VRB-ESS
product line.
Industry and Competition
According to an energy report by Wachovia Securities in
2002, the market for energy storage in the U.S. is
estimated to be 10GW (gigawatts) per annum through to
2010. This estimate includes applications in energy
arbitrage, power quality and load leveling/peak shaving.
Given a projected sales price for the VRB-ESS of
US$250-$350 per kWh (kilowatt hour), this implies a
market potential of US$2.5 billion per year. This estimate
is conservative relative to market estimates for energy
storage from the U.S. Department of Energy (DOE) of
US$3.8 billion per year, and Pearl Street’s estimate of
US$11 billion per year. Furthermore, the VRB estimate
does not include the market potential for applications in
wind generation and RAPS.
Energy storage is not new. Many utilities recognized the
importance of energy storage, and built pumped hydro
storage facilities in the 1970s and 1980s. Long lead times
for construction and the ecological disruption caused by
these facilities has limited the development of new
installations. Without energy storage, the market must
develop and maintain an entire delivery network capable
of meeting the highest peak of the year at any point in
time. Energy storage facilities allow users to limit the
infrastructure build to what is required to carry a
VRB Power Systems Inc. (VRB-TSXV)
Loewen, Ondaatje, McCutcheon Limited www.lomltd.com 3
Toronto / Canada / U.S. 1-800-567-1566 • Montreal 514-393-4600 • Europe 00-800-5660-5660
normal, heavy load, while relying on the energy storage
capability to supplement that network during peak times.
The most widely used energy storage systems are
pumped hydroelectric storage, batteries, and compressed
air energy storage (CAES). Newer technologies include
flywheels, superconducting magnets and redox flow cells,
which include the VRB-ESS and RGN-ESS. Flywheels and
superconducting magnets both have short-term ridethrough,
making them inappropriate for storing the large
quantities of energy that the VRB-ESS can. Hydroelectric
storage and CAES can both store large quantities of
electricity, but also require specific geographic locations
that make them area-specific, whereas the VRB-ESS is
portable and can be situated virtually anywhere. Lastly,
the VRB-ESS should not be confused with fuel cells,
which generate power rather than store it. Fuel cells
have different applications and markets, with a focus on
electrical vehicles. Fuel cells also require a supply of
hydrogen rich fuel, as well as a costly catalyst to convert
hydrogen into electricity.
The technologies that more directly compete with the
VRB-ESS, particularly the lead-acid systems that are the
current de facto standard, are generally less energy
efficient and more costly. As a green technology, the
VRB-ESS also has the lowest ecological impact of all
energy storage technologies. Lithium ion batteries are a
more likely longer-term competing technology, but
management believes that this technology is still 3-4 years
away from commercialization in large-scale applications.
Though this technology has half the footprint of the
VRB-ESS, it is still 25% more expensive. Furthermore,
problems involving control in larger applications have
thus far limited this technology’s use to smaller
applications such as cellular phones and laptop
computers.
The only other party with the legal right to market VRB
technology is Reliable Power. Reliable Power is based in
Arlington, Virginia, and is partnered with SEI. VRB
management believes that Reliable Power is still far
behind VRB in the commercialization of the technology.
Furthermore, Reliable Power does not have the steady
access to vanadium that VRB does. These factors give
VRB a significant advantage over Reliable Power.
Market Opportunity
VRB Power is well positioned in this market because of
its technological advantages combined with strategic
alliances that ensure access to key materials and markets.
VRB’s technological advantages include rapid layout and
design (6-8 months), low operating and maintenance
costs, as well as efficient and long-lasting performance.
Furthermore, the VRB-ESS and RGN-ESS have the lowest
ecological impact of all energy storage technologies, and
unlike lead acid systems, they have indefinite life spans
and are reusable.
VRB Power has developed the following relationships:
• Highveld Steel and Vanadium Corporation (HSVLYNASDAQ)
– for the supply of vanadium.
• Magnetek (MAG-NYSE) – through the Telecom
Power Group, for the development and marketing of
the VRB-ESS to the telecommunications industry.
• RWE AG – through RWE npower PLC, for the
intellectual property surrounding the RGN-ESS
technology.
• NORAM Engineering & Constructors Ltd. (private) –
for further development of the 5kW VRB-ESS
systems, as well as further development of the larger
systems.
• Sea Breeze Power Corp. (SBX-TSXV) – for
marketing of the VRB-ESS to the wind power
generation market.
It is the combination of these relationships with key
suppliers and sales channels, combined with superior
technology that creates VRB Power’s competitive
advantage.
Near term sales opportunities for the larger VRB-ESS
products are predominantly in the RAPS, renewable
resource generation and peak shaving markets, where
the high costs of fuel and/or power, and issues regarding
the variability of wind make the VRB-ESS economic now.
As production economies and further design
improvements are achieved, the price per kWh should
come down so that the addressable market expands.
Management expects that commercial sales of these units
should begin in Q3 2005 (January to March). They also
expect rapid penetration of the small systems, which are
to be marketed as replacements for lead acid batteries in
cellular sites (through the Magnetek alliance), with a full
rollout in Q4 2005.
Recent Events
Key recent events for VRB Power include:
• February 2004 – the company announced substantial
completion of the first large-scale North American
VRB Power Systems Inc. (VRB-TSXV)
Loewen, Ondaatje, McCutcheon Limited www.lomltd.com 4
Toronto / Canada / U.S. 1-800-567-1566 • Montreal 514-393-4600 • Europe 00-800-5660-5660
installation of a VRB-ESS for PacifiCorp in Castle
Valley, Utah.
• September 2004 – the company announced
completion of the asset acquisition from RWE npower
PLC.
• December 2004 – the company announced that
Pinnacle shareholders had approved an agreement that
will transfer all patents to VRB Power Systems
(excluding the Australian patents), and in return, VRB
Power will cease to be a shareholder of Pinnacle.
VRB has also strengthened its Technical Advisory Board
with the appointments of Dr. Clive Brereton (August),
Dr. J. David Genders and Mr. Bradley R. Williams (both
in September). In November, the company announced
the appointment of Mr. Mark Kuntz as VP Marketing &
Business Development. These personnel additions should
strengthen VRB’s technical and sales abilities.
Recent Financial Results
As the technology has only recently reached the
commercialization stage, revenues for VRB Power have
been minimal. For FY 2004 ended June 30th, the
company reported sales revenues (excluding Interest and
Other Income) of $0.7 million, and a net loss of
$6.3 million or $0.09 per fully diluted share.
For Q1 2005, the company reported no revenues
(excluding Interest and Other Income) and a net loss of
$1.6 million or $0.02 per fully diluted share.
As at September 30th, the company had approximately
$3.5 million in cash and equivalents, and the company’s
only debt was $0.2 million in loans payable, which were
repaid subsequent to quarter end. The company’s
monthly cash burn rate is approximately $0.4 million,
based on the trailing 12 months of cash used in
operations and investing, implying 8 months of available
cash.
Financial Projections
We anticipate sales of the large VRB-ESS systems to
begin in Q3 2005, with sales of the smaller systems to
begin the following quarter. We expect unit sales to
grow rapidly in FY 2006 and FY 2007, as economies of
scale should broaden the market for these applications.
The key highlights from our financial projections are
shown in Exhibit-2.
Exhibit 2: Financial Projections
Source: LOM Ltd. estimates.
VRB has significant operating leverage, and so we expect
very little growth in SG&A expenses relative to revenue
growth. This should help drive earnings growth.
We do not anticipate any sales revenue in Q2 2005. We
forecast revenues of $1.5 million in Q3 2005, and
$3.2 million in Q4 2005. We expect per share losses of
approximately $0.01 in each of Q2, Q3 and Q4 2005.
These estimates imply total revenue in FY 2005 of
$4.7 million, with a loss per share of $0.05. Given that
the technology is still two years away from
commercialization, we have excluded sales of the RGNESS
product line from our projections.
Valuation and Recommendation
VRB’s recent financial results and near term financial
projections make valuation by comparables inappropriate.
We have therefore employed a multiple model method,
based on our discounted cash flow (DCF) model and a
justified P/E valuation estimate. Our DCF valuation, using
a conservative discount rate of 17.5% and a terminal
growth rate of 3.0%, produces an estimate of $2.37 per
share. Applying a 10x multiple on our FY 2007 EPS
estimate of $0.15 produces a valuation estimate of $1.50.
We believe this multiple is justified, given the company’s
competitive advantage in this market. The simple average
of these two estimates is $1.94.
Based on our multiple model approach employing
conservative assumptions, we are initiating coverage of
VRB Power Systems with a Speculative BUY
recommendation and a 12-month target price of $1.75.
The information contained in this report is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not
guaranteed, nor in providing it does Loewen, Ondaatje, McCutcheon Limited assume any responsibility of liability. This report is not to be construed as
an offer to sell or the solicitation of an offer to buy any securities. The inventories of Loewen, Ondaatje, McCutcheon Limited its affiliated companies
and the holdings of their respective directors and officers and companies with which they are associated, may from time to time include the securities
mentioned in this report. Copyright © 2004 Loewen, Ondaatje, McCutcheon Limited.
LOM’s rating system can be found in the equity research section of our website at www.lomltd.com. Our research is electronically available on
First Call and Multex.
Revenue (mm)
EBITDA (mm)
$4.7
FY 2005
($4.0)
Net Earnings (mm)
Diluted EPS
($4.5)
($0.05)
$26.0
FY 2006
($1.7)
($3.0)
($0.03)
$144.8
FY 2007
$28.7
$17.0
$0.15
$351.1
FY 2008
$79.8
$49.8
$0.44 |
