Author: willthrower

Advance Nanotek’s Massive Cost Advantage

One of the common concerns I hear from investors regarding $ANO.AX is the difficulty in quantifying the “known unknown” probability of a competitor developing a new process to make cheaper or better zinc oxide than Zinclear. Recent headlines about research out of Imperial College London and the University of Sheffield claiming a “cheaper” and “more sustainable” method of making zinc oxide for sunscreen have set off some alarm bells that this day may have already arrived. Before hitting the panic button, let’s dive in and see how it stacks up against ANO’s mechanochemical processing (MCP) technology.

The new proposed method is “Oxidative Ionothermal Synthesis (OIS)” through which zinc oxide particles are formed by direct oxidation of metallic zinc in an ionic liquid (salt with a low melting point, in this case 1-butyl-3-methylimidazolium chloride or C4mim) mixed with water. Due to the low melting point, the desired reactions take place at relatively low temperatures (<120°C), and morphology and chemical composition can tuned by adjusting the water concentration, temperature and exposure time. Additionally, C4mim can be infinitely recycled, making for a “low cost, energy efficient synthetic approach in a sustainable medium.” This approach could also be used with other metals and ultimately lead to more cost-effective and environmentally-friendly processes for large-scale synthesis of a wide range of nano and micro materials, with physiochemical properties tailored to meet specific industrial needs.

https://pubs.rsc.org/image/article/2020/ma/d0ma00660b/d0ma00660b-f2.gif
Source: Oxidative ionothermal synthesis for micro and macro ZN-based materials

Whereas OIS uses a “green” solvent that reduces energy requirements for zinc oxide synthesis, MCP uses no solvent at all. MCP utilizes a ball mill to grind compounds together in a salt matrix at low ambient temperatures. When the balls collide, the intensification of focal pressure and heat induces solid-state chemical reactions that create nano and micro particles. Similarly to OIS, MCP allows for a high degree of control in particle size and size distribution, as well as dispersibility, all critical properties for meeting the demands of specific industrial applications. No waste is produced in the process, but some electrical energy is required to operate the ball mill. As electrical energy can be generated by renewable sources, ultimately MCP is also a cost-effective, environmentally-friendly solution.

So if both processes cut out costly requirements for extremely high heat and are relatively environmentally benign, what’s with all the revolutionary talk? Going through the articles and research, you will see that they are only benchmarking against the industry players using vaporization techniques.

Most of the commercial zinc oxide is manufactured using the French process. In this process, metallic zinc is vaporised at 1000–1400 °C and instantly air-oxidised into ZnO powder. Due to highly nonuniform crystallization conditions, many types of one-dimensional nanostructures and irregularly shaped particles are formed. Oxidative ionothermal synthesis for micro and macro Zn-based materials

Zinc oxide is currently energy-intensive and expensive to make, requiring heating to more than 900C in a furnace, where the vapourised zinc mixes with oxygen in the air to create zinc oxide. Cheaper zinc oxide developed by UK scientists could mean end to ‘reef-toxic’ chemical sun cream

Zinc oxide is produced in two ways. Firstly, in mass, using extremely energy intensive processes creating generic materials. Secondly, using specialty smaller scale manufacturing that creates specific materials at a high cost and a large environmental footprint. Affordable reef-safe sunscreen promised by new, more sustainable way to make zinc oxide

Simply put, the omission of MCP from the discussion comes down to three possibilities: ignorance, denial, or strategic positioning. I think strategic positioning is the most likely, given that the researchers have started a company, Nanomox, and are “looking for an industrial partner to help bring the product to market.” It makes sense to frame the opportunity this way, because the broader specialty zinc oxide market large enough for multiple winners (they say £4 billion annually) and the sunscreen market is ripe for disruption, with 99% of the active ingredients being either harmful chemicals or high-cost minerals. It would be great to see this technology succeed and play a part in making the world a better place for our kids. However, as ANO investors, should we be concerned about competition from a nascent technology like this eventually eroding our own competitive moat and eating into revenue and margins?

First, let’s look at unit economics. In FY2019, ANO sold 292 MT of Zinclear to generate A$11.06m of revenue, or about A$37.87/kg. Zinclear made up 90% of product revenue, with Alusion accounting for the remaining 10%. The blended product gross margin was 52%, implying an A$18.15/kg cost of production. This is the only year of volume (MT) data we have, so we have to fill in some blanks for FY20 and FY21. My cost estimates assume a flat ASP.

Source: ANO Brochure 2021

In FY20, Zinclear made up 88% of product revenue, and product gross margin rose to 61%, implying a blended cost of A$14.76/kg. In H1FY21, Zinclear slipped to 58% of product revenue due to Covid-related industry destocking and a one-time shift in revenue recognition, and gross margin surged to 75%, implying a blended cost of A$9.47/kg. Although some of the cost decrease in H1FY21 is due to a larger contribution from higher margin Alusion sales, margins also increased significantly in FY20 when the sales split was roughly unchanged. Ongoing unit cost reduction efforts during this time included diversification of precursor supply, a new production facility in Brisbane, upgraded production equipment, rooftop solar and storage battery installation, an upgraded electrical system, and the addition of a lab to bring required quality testing in-house.

PeriodZinclear/AlusionProduct RevenueProduct GM%Cost per kg
FY201882%/18%A$6.58m63%A$14.01
FY201990%/10%A$12.26m52%A$18.15
FY202088%/12%A$17.97m61%A$14.76
H1 FY202158%/42%A$3.43m75%A$9.47

Nanomox calculates that their new method “uses 97 per cent less energy than the furnace method, and could reduce the cost per kilo from more than €30 (A$46.86) to less than €10 (A$15.62).” If this information is accurate, it means that the competition’s cost of production is higher than ANO’s sales price, and that ANO’s cost of production has already fallen well below Nanomox’s initial long-term target. While we already knew that ANO was the lowest priced zinc oxide in the market, this demonstrates just how unlikely it is that we will see a price war anytime soon. As two-thirds of the competition’s cost of production is linked to the cost of energy needed for extremely high temperatures, and that energy can likely only be supplied by combustible gases, the competition face structurally high costs that cannot be improved without a radical change in their chemical process. It may not be possible for this radical change to come from within; the more likely course of action could be to secure IP for a new process through the acquisition of a company like Nanomox.

If Nanomox determines that maintaining independence offers them the best path to unlocking the full potential of their novel OIS technology, then I suspect they would have a long road ahead to commercialization. It remains to be seen whether the zinc oxide nanoparticles they have produced in a lab setting are optimal for sunscreen or cosmetic applications, which require high transparency, broad spectrum UV absorbance, and dispersibility. It seems Nanomox are roughly where ANO was in 1997, when the company was first formed to develop MCP technology after successful trials at the University of Western Australia. It took ANO another 5 years to launch Zinclear after a partnership with Samsung Corning to refine the technology, and another fifteen years after that to turn a profit. It may take a similar period of time for Nanomox to refine their process through trial and error and achieve consistent scale production of particles with commercial applications, and currently they are still in the phase of looking for an industrial partner.

As ANO shareholders are well aware, the talents required to invent a breakthrough technology may not translate into the ability to scale it into a profitable business. For those just catching up, I covered the history of the Company’s turnaround led by current management here. Prior to the management change, sales stagnated and gross margins averaged about 20%:

Source: TIKR

Despite a lull in sales due to the previously mentioned industry-wide inventory destocking, management has continued to focus on improving the production cost, quality, and availability of Zinclear powders, dispersions, and concentrates in anticipation of a market recovery. Specifically, the Company has “established stockpiles in a central US logistics facility” to service its major manufacturing customers, expanded capacity and lowered the production cost of its dispersions by upgrading its high-speed mixing equipment, and received TGA approval for a range of vegan/organic dispersions and concentrates, an important step toward management’s goal of making a cost-efficient mineral alternative to chemical sunscreens widely available.

The takeaway here is that while it should not be unexpected that new methods of synthesizing zinc oxide will surface or that competitors will find ways to lower their cost of production, it will be very difficult to close such a wide gap with a leader that is also rapidly lowering their own cost of production. Vaporization techniques require structurally high energy costs, and new techniques will face many hurdles to reach commercialization at scale. To be clear, I’m optimistic that Nanomox will find commercial applications for its OIS technology and wish them the best in their endeavors to make the chemical industry more sustainable. However, I think from the standpoint of an ANO shareholder, I am not too concerned about other zinc oxide competitors and more focused on the opportunity to take market share from chemical sunscreens. The likelihood of a cheaper or more sustainable method than solar-powered MCP emerging is very low. At scale, the cost of production should trend toward the cost of raw materials, and ANO should continue to generate high margins even at lower prices as they increasingly move downstream into concentrates.

The other takeaway is that Alusion deserves more attention from investors going forward. Given its strong revenue growth through a weak economic environment, an even more attractive margin profile and competitive position than Zinclear, and the potential for the unique material to unlock some very large addressable markets, Alusion could have a bigger impact on ANO’s future profits than you might expect. I will attempt to quantify the Alusion opportunity in a future post, so keep an eye out for that. As always, thanks for reading!

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$TSLA Tesla’s Battery Advantage, Part I

The first mass-produced electric vehicles appeared in the U.S. in 1902, introduced by Studebaker, the world’s largest manufacturer of wagons and buggies at the time. While electric vehicles of the time had some key advantages over early gasoline-powered cars, which emitted particularly noxious fumes and were prone to deadly explosions, the first battle between gas and electric cars didn’t last long. The economics of gas cars proved far superior to electric cars, as the advent of Henry Ford’s Model T assembly line in 1913 dropped the price of gas cars to less than half of electric cars, and the discovery of cheap oil in Texas, Oklahoma, and California made filling up the gas tank far cheaper than charging the electric car’s primitive lead-acid battery. Not surprisingly, consumers opted for efficiency and convenience, and the gasoline car became ubiquitous, shaping the world as we know it today.

However, electric vehicles attracted renewed interest in the late 20th century as emissions from the ever-expanding fleet of gasoline cars were linked to climate and public health crises. In addition to the 1960’s introduction of the U.S. Clean Air Act, which mandates increasingly stringent controls on vehicle engine technology and reductions in tailpipe emissions over time, the California Air Resources Board introduced a Zero-Emissions Vehicle (ZEV) mandate in 1990, requiring major automakers to phase in ZEVs over time. While lobbying in the background to overturn the mandate in federal court, the major OEMs produced limited numbers of EVs for California drivers to comply with the law while it was still on the books. Most OEMs created electric versions of existing models, but General Motors’ EV1 was designed as an electric vehicle from inception and became the first mass-produced electric vehicle of the modern era. Later versions introduced a Nickel Metal Hydride (NiMH) battery, which significantly reduced the car’s weight and increased range over the original lead-acid battery version from 60 miles to 105 miles in one charge. Although the revolutionary vehicle seemed to win the hearts of the lucky few who were able to navigate the curiously complicated process of buying one, the program was seen as a money pit by GM executives, due to the high cost of batteries and initial production. Once the ZEV mandate was rejected by a federal court, the Company discontinued the program, took back the cars as the leases expired and crushed them (Highly recommended viewing: Who Killed the Electric Car? EV1 Documentary).

Tesla was started in response to the cancellation of the EV1 program in 2003. As the major OEMs mothballed their EV R&D and pushed hydrogen vehicles as a better alternative (arguably because they knew it was less likely to succeed and disrupt their legacy business), the only way to continue to push forward EV technology was to start a new automotive company, a notoriously difficult venture that had not been successfully attempted in the U.S. for almost a century. However, the willful neglect of the major OEMs to advance EV technology created a window of opportunity for Tesla to carve out a durable competitive advantage by taking the next logical step in automotive battery tech and developing a proprietary battery management system around lithium-ion cells, which not only gave them a fighting chance at survival but may ultimately cement their dominance in a new era of transportation.

Source: Battery Comparison of Energy Density – Cylindrical and Prismatic Cells

Tesla was the first company to use lithium-ion batteries in electric cars. While lithium-ion batteries had greater density and thus held promise for far superior efficiency, performance, and cycle life than previous generations of electric vehicles using lead-acid and NiMH batteries, they were still very expensive and much more difficult to use in automotive applications. Li-ion encompasses a variety of chemistries and form factors with trade-offs around space utilization, cost, density, safety, and longevity. As the first mover in the EV space to use Li-ion, Tesla had the luxury of choosing the best cells for the job, with an eye toward cost and density as well as the potential for improvements over the long run. Tesla ultimately selected Panasonic 18650 cylindrical NCA (Nickel-Cobalt-Aluminum Oxide) cells, which offered an “exceptional combination of cycle life and energy density” (A Bit About Batteries | Tesla). Safety was another key consideration and is one of the biggest advantages over prismatic or pouch cells, as cylindrical cells are designed to rupture if the internal pressure grows too high, mitigating the safety risks from fires or explosions. The cylindrical cells were also the cheapest and most commonly available for use in consumer electronic applications such as laptop computers, as the standardized form factor allowed for faster production and thus lower cost per kilowatt-hour (Lithium Batteries: Cylindrical Versus Prismatic).

The battery pack of the 2008 Tesla Roadster contained 6,831 individual Li-ion cells operating in parallel. The high number of small cells was ideal for limiting the impact of any one cell failure on the overall pack; it was also ideal for cooling as there was more surface area for heat dissipation than there would be with a smaller number of larger prismatic cells. One of Tesla’s key inventions to maximize battery lifetime was a sophisticated liquid cooling system that maintains a favorable temperature for the cells, even under extreme ambient conditions (like you might get from parking in the sun in Abu Dhabi, from recent personal experience). The 53-kwh battery packed roughly twice the power of the EV1’s NiMH battery while weighing slightly less. Together with the Company’s proprietary power electronics, software and motors (which will get their own chapter), the battery management system was capable of delivering enough power to accelerate the Roadster from 0 to 60mph in 3.9 seconds and travel for more than 240 miles in one charge, well in excess of any production electric vehicle capabilities up to that point. Beyond creating a new standard for electric vehicles, the Tesla Roadster stood in a league of its own pushing the boundaries of automotive propulsion, with vastly superior well-to-wheel efficiency and significantly lower carbon emissions than any other technology on the road:

Source: The 21st Century Electric Car – Tesla Motors

While this performance was good enough to cover 99% of drivers’ daily needs on a single overnight charge, the obvious drawbacks were high cost and lack of cell production capacity. Learning from GM’s premature and costly foray into mass-market EVs, Tesla determined that the best course of action was to first launch a premium sports car and then follow with progressively more affordable models as cell production ramped and the cost of Li-ion cells decreased. Industry cost declines to date have predictably followed Wright’s Law, which observes that for every cumulative doubling of production for a given manufactured good, the cost will fall by a fixed percentage, depending on the product and the industry.

“Lithium-ion battery pack costs worldwide between 2011 and 2030” Source: Statista
Source: ARK Invest – Big Ideas 2021

Although Tesla sold only 1,000 units of the $109,000 Roadster by January 2010, its impact on the industry was profound. The Roadster’s performance and efficiency led the major OEMs to jumpstart their electrification programs, and electric models started hitting the market again, starting with the Nissan Leaf (which debuted with only 73 miles of range) in December 2010. Bob Lutz, then the vice-chairman of GM, attributed this newfound urgency entirely to Tesla, saying in 2009:

“All the geniuses here at General Motors kept saying lithium-ion technology is ten years away, and Toyota agrees with us—and, boom, along comes Tesla. So I said, ‘How come some teeny little California start-up run by guys who know nothing about the car business can do this, and we can’t?’ That was the crowbar that helped break up the logjam.”

By the time it IPO’d in July 2010, it was clear that Tesla’s first-mover advantage and sole focus on electrified transportation had enabled it to take the lead in harnessing the power of lithium ion batteries for automotive applications, but the competition definitely took notice. In Part II, I will explore how Tesla has been able to maintain and arguably widen their lead in battery technology, despite intensifying competition over the past decade, by deepening their involvement in battery cell design and manufacturing.

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Opening the File on Tesla $TSLA

Tesla is a widely known company, yet its business is still widely misunderstood.

Tesla is a widely known company, yet its business is still widely misunderstood. From the outside, it may look like one of many auto manufacturers, selling a handful of models into a fiercely competitive market, operating at a much smaller scale than the leading OEMs while barely breaking even. Paradoxically, Tesla has a larger market capitalization than the next three largest OEMs combined, which together delivered about 51x more cars than Tesla in 2020, generating more net income than Tesla’s sales for the year:

World’s Largest Automakers by Market Cap

CompanyMarket Cap2020 Deliveries2020 Sales2020 Net Income2020 P/S2020 P/E
Tesla$714B499,550$31.5B$0.7B22.6x1020x
Toyota$212B9,528,438$257B$14.8B0.82x14.3x
Volkswagen$157B9,305,400$272B$10.8B0.57x14.5x
General Motors$80B6,830,000$122B$6.4B0.65x12.5x

Just as there are plenty of people who buy cars based on curb appeal, there are many investors who have never touched the stock because of headline valuation numbers and a surface-level understanding of competitive dynamics in the automotive industry. Even if the market has correctly determined that Tesla is in the early days of reshaping the automotive industry such that everybody else will be forced to follow, the typical level-headed investor reasons, the stock must have gotten ahead of itself with a valuation like that. Easy money has made speculators forget that the automotive industry is hypercompetitive, cyclical and low margin, and it’s only a matter of time before the incumbents react to stop this little start-up in its tracks, right?

However, making sense of Tesla’s meteoric rise and future prospects requires a comprehensive understanding of what’s under the hood, literally and otherwise. Battery Electric Vehicles (BEVs) offer several important advantages over Internal Combustion Engine (ICE) vehicles to consumers. First, BEVs have already become cheaper than their ICE equivalents based on the total cost of ownership (TCO). According to a recent Consumer Reports study, the average BEV owner saves about 50% on maintenance and repair and 60% on fuel costs over the life of their vehicle. Tesla’s most popular models particularly stand out in terms of lifetime savings over the best-selling ICE vehicles in their class:

In addition to a lower cost of ownership, BEVs have the environmental benefits of zero tailpipe emissions (which is estimated to have caused 385,000 annual premature deaths worldwide as of 2015) and the ability to leverage the ongoing transformation of energy grids worldwide to a higher mix of renewable sources. This transformation should continue to accelerate over the next decade, as the cost of new renewable energy capacity has already fallen below fossil fuel power generation and should continue to fall on an exponential cost curve. Most governments around the world have grasped the importance of BEV adoption to achieving long-term goals for decarbonization and energy independence and have put in place various incentives, taxes and scheduled sales bans to further accelerate the transition away from ICE vehicles.

Beyond the cost of ownership and environmental advantages of their electric vehicles, Tesla has a unique organizational advantage as it competes in many more fields than the incumbent automotive OEMs, which rely heavily on outsourcing for non-core components and functions.

Source: Tesla is a Giant Group of Startups that Will Dominate Each Field

While there are a growing number of competitors in the electric vehicle market, none have achieved such a deep level of vertical integration of hardware, software, and services on a global scale. Tesla’s technological advantages have also enabled them to establish leading positions in adjacent industries, such as energy and artificial intelligence, which must be considered for an accurate appraisal of the Company’s value.

Trailing financial metrics have very limited utility when an industry is facing a major upheaval brought on by new technology. To determine the present value of any industry player, we have to start with figuring out what their place in the world will look like in 2030. This requires combing through a sea of often conflicting information to establish a ground truth about the factors that are most likely to shape the future, and extrapolating them to their natural conclusion. Analyzing Tesla in detail from the bottom up is a more challenging approach to take than most are up for, but it is necessary to figure out how we got here and to have a high level of confidence about where we are going. To bring readers up to speed and develop a useful framework for analyzing the future potential of Tesla and other companies within its orbit, I plan to tackle the foundational components of the business, technology, and competitive environment over a series of posts. This may take awhile; be sure to subscribe so you don’t miss anything!

On that note, dear subscribers: If you thought you were here for uncovering obscure global small caps and are wondering whether I have just emerged from a coma or something for spending all my time researching one of the world’s biggest companies with one of the world’s most widely talked about and polarizing stocks, please stick around! I think a deep understanding of Tesla’s business can pay dividends for any investor down the road, whether it fits into your portfolio or not, as many listed companies around the world, large and small, will be impacted by the revolution in transportation and energy that is only just getting started.

For example, suppose your mandate is confined to Asian small caps. If you also knew what was going on at Tesla six months ago, you might have caught part of the 20x rise in 558:HK LK Technology, which makes a strategically critical machine that will go into all of Tesla’s new factories going forward:

I suspect we will dig up a few more of these along the way, before they happen.

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$ANO – Don’t Fight the LEV

The blackout period is over and Lev Mizikovsky is back in the market for ANO shares. How deep are his pockets and what’s his end game?

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$4477 BASE – Long-Term Long-Tail Winner

A homegrown Shopify rival is emerging as a market leader in Japanese long-tail e-commerce by focusing on the needs of individuals opening their first online shop. How big is the opportunity for BASE in Japan, and can they successfully export their unique model abroad?

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