AMSC-Sinovel row could put The Switch merger at risk

UNITED STATES: Serious headwinds face American Superconductor (AMSC) because of its frayed relationship with Sinovel Wind Group of China over a refused shipment of equipment. But the size of AMSC's challenges may not become clearer until later this month, when the US company reports its financial results for the fourth quarter and full fiscal year 2010.

Alongside questions about whether the relationship with Sinovel can be repaired, another crucial factor at play is the outcome of AMSC's much-vaunted plan to purchase Finland-based competitor The Switch, for which it must raise a substantial sum of cash. The latter may be tough given AMSC's current financial state, say analysts. Complicating the picture is that The Switch's major customers include Sinovel's main Chinese rivals, Goldwind and Dongfang.

The strength of several class-action suits - alleging investor fraud by AMSC - will be easier to gauge too with the passing of deadlines in the early summer for members joining the actions, which allow a group with a common interest to sue.

AMSC's woes made headlines on April 6 - the day its stock tumbled 44% to $13.95 in pre-market trading, the lowest since March 2009. That came hours after AMSC formally announced that Sinovel had refused to accept contracted shipments on March 31 of AMSC core electrical components and spare parts for 1.5MW and 3MW wind turbines. AMSC said this was because of the slowdown in China's wind market.

The US firm also divulged that Sinovel had failed to pay for some 2010 shipments. Sinovel officials have denied wrongdoing and said they only engaged in a normal adjustment of production and management.

The refused shipment, of parts for an estimated 1.36GW worth of turbines, was a major blow to AMSC. It would have completed AMSC's first large - $450 million - contract with Sinovel as well as part of a $100 million follow-on order. The status of another $445 million order, which was due to start at the end of last month and continue for 30 months, was not known, said equity analyst Jesse Pichel of Jefferies in an April 6 note.

"Given Sinovel's sudden action before the start of its second contract, we cannot discount the possibility that Sinovel may be working with other design houses and components suppliers such as (GE-owned) Converteam or ABB," he wrote.

Unpaid shipments

Nasdaq-traded AMSC also said that it was reviewing its recognition as revenue of around $56 million of unpaid shipments in the last three quarters of 2010. Under US securities laws, such revenues can be recognised as long as their status is properly disclosed. AMSC further said it expects a loss for the fourth quarter, with revenues of less than $42 million, and reduced revenues of less than $355 million for 2010 compared with its previous forecast in excess of $430 million. Sinovel has accounted for 73% of AMSC's revenues.

Citigroup analyst Tim Arcuri estimates that AMSC had 2.5-3GW of excess product inventory, which had been produced for Sinovel. "It will take about six months to work through this inventory before AMSC's production would start to return to a more normalised level," Arcuri wrote in an April client note. In addition, AMSC will have to raise $100-$200 million to complete its $266 million buyout of The Switch, he said.

Arcuri notes that turbine prices in China are "in freefall" because of high manufacturing capacity and the market slowdown, and that companies, especially publicly traded ones such as Sinovel, are reviewing their inventories. Another problem for AMSC was that it had few "hooks" in its contracts with Sinovel, such as a substantial down payment for contracted goods, he said. "AMSC had little leverage - Sinovel was such a large client," he speculated. "If they want to consummate their deal with The Switch, it will stretch them. It's pretty bad."

According to a source in the financial community, despite the downturn in China, Sinovel would have had the cash to pay AMSC. The source said that Sinovel officials have told him that they were not happy with AMSC's acquisition of The Switch, because the Finnish company supplies Goldwind. It will not have helped that Goldwind has vowed to become number one in the Chinese market this year, overtaking Sinovel, he says. Similarly, AMSC was reportedly not happy with the possibility of Sinovel working on wind-turbine control systems with a company such as engineering giant ABB.

As Jefferies analyst Pichel wrote, "AMSC management stated that they were assured by Sinovel of delivery acceptance as late as mid-March, around the time of (The Switch) acquisition announcement. Hypothetically, Sinovel could have taken umbrage at AMSC's acquisition of a company that supplies competitor Goldwind or was potentially interested in acquiring The Switch itself. While this may or may not be the case, all we can conclusively say is that something changed significantly in the AMSC/Sinovel relationship."

The law firms now preparing class-action lawsuits - of which a few had been filed as of mid-April - will be seeking members into the early summer. Specifically, attorneys for the class members allege that AMSC wrongly provided Sinovel with contracted shipments in excess of the Chinese company's needs; its management did not disclose that Sinovel had not paid for some shipments and yet AMSC continued to provide Sinovel with contracted shipments; it improperly recognised revenue on the disputed shipments; and AMSC over-stated its revenues.

Under securities laws, the class-action lawsuits will be consolidated into one, said Reed Kathrein, who is leading the investigation at one of the firms, Hagens Berman. Kathrein questions that Sinovel refused a shipment on exactly the last day of AMSC's financial year - just two weeks after the March 14 announcement of The Switch purchase. He notes too that AMSC reportedly has an estimated six months of inventory, made for Sinovel, and that Sinovel was said to have missed payments since as long ago as mid-2010.

"This is not a sudden event unknown by (AMSC) management," he suggests.

"It hints of desperation to hide their weak demand from Sinovel for much of the year". He estimates that, as of April 14, shareholders had lost $350-$420 million in decreased market capital stemming from AMSC's stock-price plunge. Potential damages to class-action members, he concludes, could amount to as much as half of that.

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