From: kay.mann@enron.com
To: jeffery.ader@enron.com, ozzie.pagan@enron.com, heather.kroll@enron.com
Date: 2000-11-30 10:48:00+00:00
Subject: FCE

Fuel cells kindle investor energy
By Beverly Goodman
Redherring.com, November 27, 2000 
Companies with no earnings. Market capitalizations in the billions even 
though revenue hovers in the tens of millions. Analyst optimism bordering on 
the feverish. We know -- this probably sounds all too familiar. But this time 
we're not talking about some pie-in-the-sky dot-com stock valuations. We're 
talking about companies with new technologies, tangible assets, and a clear 
source of future revenue. We're talking about makers of fuel cells, a highly 
efficient and environmentally sound means of generating electricity. 
And while we won't deny that the recent run-up in their stocks befits the 
pattern of investor enthusiasm for the latest fad, we at Red Herring expect 
that alternative energy will be in fashion for quite some time. Investors 
more interested in companies that sell dog food over the Internet can stop 
reading here.
There's no mystery why fuel cells are an appealing source of energy: they 
provide more reliable and efficient power with lower emissions and noise than 
traditional generating sources (see Trend No. 9: Energy, December 4). Most 
only require the simplest of gases and throw off only water and heat as 
by-products, both of which are reusable. Simply put, fuel cells consist of 
hydrogen and oxygen, separated by a catalyst. Typically, the fuel cell is 
heated, causing a chemical reaction that generates electricity. Since nothing 
is burned, no pollutants are created. In time, proponents say, fuel cells 
will power everything from your cell phone to your car to the factories that 
manufacture them.
During this era of greater environmental awareness and rising fuel prices, 
fuel cell technology is increasingly looking like an appealing investment. 
Stocks powered by fuel cell technology are up an average of 139 percent in 
the last 12 months. That's despite a slow recovery from the 40 percent hit 
they took in the spring. The Nasdaq, by comparison, has fallen 15 percent 
since last November.
Investor interest has also prompted a recent spate of IPOs. H Power (Nasdaq: 
HPOW), Millennium Cell (Nasdaq: MCEL), and Proton Energy Systems (Nasdaq: 
PRTN) all went public within the past few months. While those IPOs may seem 
to coincide neatly with the rising cost of fuel, that's not the whole 
picture. "We're seeing a convergence of factors never seen before," says 
William Fogel, a power technology analyst for First Albany. "The deregulation 
in the utility industry has increased innovation; the transportation grid is 
in jeopardy thanks to an increase in electrical demand from an Internet-based 
economy; there's a growing need for increased reliability; and there's an 
increasing recognition of the environmental degradation caused by the 
combustion engine."
Admittedly, truly widespread applications remain more than a decade away, so 
profits are similarly distant for fuel cell companies. But investors have 
proven themselves willing to invest in technologies long before they become 
mainstream, buying stocks that often defy traditional valuations. (Still 
holding JDS Uniphase (Nasdaq: JDSU)?) With early-stage fuel cell technology 
due out of the labs and available to individual and corporate consumers 
within the year, this is still the early part of the adoption (and investing) 
curve.
CELL DIVISION
The fuel cell market is generally divided into four segments: stationary, 
portable, residential, and automotive. Fuel cells will likely hit the large 
stationary market first, powering strip malls and factories, according to 
David Redstone, editor of the Hydrogen and Fuel Cell Investor newsletter. 
"We're talking about unprecedented efficiency," he says, noting that fuel 
cells approach 60 percent efficiency (that is, 60 percent of the potential 
energy in fuel entering the cell actually results in energy coming out).
Fuel cells can also be coupled with turbines to get their efficiency up to 80 
percent, whereas traditional combustion engines only run at 35 percent 
efficiency. The leading developer of these stationary cells is Fuelcell 
Energy (Nasdaq: FCEL) (FCE), which is poised to be the first to commercialize 
them in 2001. At first blush, FCE's 442 percent run-up in the last 12 months 
and the fact that it won't be profitable until 2006 doesn't make its $59.50 
stock price and price/sales ratio of 58 seem cheap. But using a variety of 
metrics, including discounted cash flow, discounted 2006 net income, and 
discounted 2006 revenue, Lehman Brothers analyst Maureen Murphy considers FCE 
undervalued by 40 percent. Using a projected market value of five times 
estimated 2006 revenue of $1 billion, she applies a discount rate of 17.5 
percent annually to arrive at a 12-month price target of $124.
Portable applications for fuel cells, like generators and boat engines, are 
also expected to be commercialized soon. Ballard Power Systems (Nasdaq: BLDP
), with more than 370 patents issued or pending, has proven itself in nearly 
all fuel cell applications and has promised to bring a small fuel 
cell-powered generator to market in 2001. "They don't make promises they're 
not able to keep," says Christine Farkas, a senior specialist and director at 
Merrill Lynch. "They've never disappointed." Ballard has also made 
significant strides in the automotive market and owns 27 percent of Xcellsis, 
a fuel cell engine maker that is a joint venture with DaimlerChrysler (NYSE: 
DCX) and Ford Motor (NYSE: F).
Analysts expect Ballard to continue to post losses until sometime in 2004, 
and its current price-to-sales ratio is a whopping 265. Still, Ballard's 
involvement in all aspects of fuel cell applications leads Ms. Farkas to 
expect the company to earn $24.22 per share by 2013 -- which works out to 
approximately $2.2 billion in net income. Applying a multiple of 25 to those 
earnings, and a 15 percent discount rate, she comes up with a projected stock 
price of $150 a year from today, or 93 percent above recent prices.
INDUSTRY REVOLUTION
Even though powering cars with fuel cells is still some years off, the notion 
has found allies in some unlikely industries -- the major oil and automotive 
sectors. Ford chairman William Clay Ford Jr. declared at the 2000 Detroit 
Auto Show, "Longer term, the fuel cell will end the 100-year reign of the 
internal combustion engine." Legislation such as California's mandate that by 
2003 fully 10 percent of cars sold (an estimated 22,000) must run on 
alternative energy will also help speed industry and public acceptance.
While not a pure-play on fuel cells, Impco Technologies is well positioned to 
see its fuel cell business grow along with its other alternative fuel 
delivery, storage, and power electronics systems. Mr. Fogel expects Impco's 
products to compete for 40 percent, or $5 billion of the forecasted $12.5 
billion automotive fuel cell market in 2010. (Its much more down-to-earth P/S 
ratio of 1.6 is an added attraction for investors -- any risk involved in 
Impco's fuel cell development is hedged by its full involvement in the 
alternative fuel industry.) "They're involved with almost every aspect of 
General Motors's global alternative fuel production, design, and 
implementation efforts," Mr. Fogel says.
Impco was hit particularly hard this spring, and is still, at $18, 65 percent 
off its March 6 high of $52. But by using a 45 multiple on projected 2006 
earnings per share of $2.86 and applying a 20 percent discount, Mr. Fogel 
arrives at a price-to-earnings-to-growth ratio of less than one -- a 
conservative multiple for stocks with similar growth prospects. Mr. Fogel 
sees more than a 100 percent upside for the company's stock, expecting it to 
return to its high in the coming 12 months.
Despite the industry hype and science fiction scenarios, there will 
inevitably be setbacks. Take, for example, Plug Power (Nasdaq: PLUG), which 
ran out of gas when General Electric (NYSE: GE), which owns one-third of a 
joint venture with Detroit Edison (NYSE: DTA) and Plug, decided to change 
course. Plug's trailing 12-month revenue of $13 million (giving it a 
price-to-sales ratio of 64) hinged on the venture, in which a fuel cell 
powered a house, independent of the local electrical grid. Instead, GE now 
wants to develop a "grid parallel" system, which would work in tandem with 
the existing system. That news, coupled with management woes and Nasdaq 
turbulence, sent Plug's share price falling 80 percent, from $140 on March 13 
to $16.50 on November 24. It will take all the energy fuel cells can generate 
to get that stock back on track.
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