The Good Idea, Horrible Investment Paradox

Maxxwell A.R. is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

One sobering reality of investing is that not every company with the potential to change the world is a great investment. All good investors realize this at some point, some through costly mistakes of their own (my hand is raised). Initially, it is difficult to rationalize how this can possibly be true. A company that makes it to the public market has surely survived the “big” problems in product development, right?

How can a company with an amazing product – perhaps the best in its industry – not be successful? How can a company flush with hundreds of millions of dollars in cash fail? How can a company at the top of an emerging industry not experience tremendous growth?

You can search for any number complicated answers to these difficult questions. Perhaps the best is to acknowledge, quite simply, that it may be impossible to find a perfect investment.  That shouldn’t be surprising given the amount of moving parts involved. The surprising part is that small, often overlooked red flags become major headwinds (read: the term “goodwill” and Hewlett-Packard).

Unfortunately, investors often convince themselves that those “little” problems are just that: little problems. All of those smart people leading the company will surely figure it out…right?...guys?

A123 strikes and you’re out

One of the best recent examples of the Good Idea, Horrible Investment Paradox is A123 Systems. Partners, customers, researchers, and even competitors throughout the EV battery industry agreed on one thing: A123 flaunted some of the best lithium ion technology ever created. Study the company’s super-clean website and you’ll come to a similar conclusion.

Industry leading products? Check. First-mover/pioneer? Check. Flush with cash? Check (2009 IPO raised $380 million, plus government grants, plus $100 million from the state of Michigan). A123 had a long list of illustrious partners including Chevrolet, Fisker, Stanley Black and Decker, and The AES Corporation. Now competitors such as Johnson Controls (NYSE: JCI) and Wanxiang are locked in a bidding war for its assets.

How then, did things go so wrong for investors?

<img src="/media/images/user_6293/a123-killacycle-warming-tire_1_large.jpg" />

Burnouts, motorbikes, and bankruptcy. Not exactly the trifecta investors expect from a company that began at MIT. Source: mavizen

The Projection Problem

A lot of things went wrong for A123, but the biggest was market projections. The company gained nearly 50% at its IPO in 2009. Investors didn’t mind that the lithium ion market for EVs was only $32 million at the time because all projections for the future of the industry were monstrous – some predicting a $22 billion opportunity by 2015. Current projections peg the opportunity at just $14.6 billion by 2017.

A two or three year delay may not seem like much, but for a budding company in a capital intensive industry it can make the difference between success and failure. In A123’s case, the delay in market adoption created a snowball effect of headwinds – liquidity, investor sentiment, revenue generation, and debt repayments – that ultimately led to the company’s bankruptcy. Any of those problems alone may have been adequately addressed, but combining them proved too much.

There are numerous companies with the odds seemingly in their favor that stare down bankruptcy after unrealistic projections fail to materialize:

Pacific Ethanol, which once reached a high of $42 per share on high hopes for the corn-ethanol industry, now trades for a split-adjusted $0.0457 per share. The ethanol industry grew immensely in the last decade: in 2011 the U.S. produced over 13 billion gallons of the alcohol fuel. Despite the growth Pacific Ethanol was plagued by competition, poor-execution, and lack of revenue realization.

ATP Oil and Gas bet heavily on the high-growth sector of deep-water oil drilling, only to be blindsided by a government imposed moratorium in the wake of the BP disaster in 2010. The company now trades at $0.09 per share.

Industrial synthetic biology company Amyris (NASDAQ: AMRS), born of a Berkeley laboratory, once traded at $34 per share after projecting 50 million gallons of farnesene production. The company now trades below $3 and has produced less than 2 million gallons of farnesene this year.

Thin-film solar pioneer First Solar (NASDAQ: FSLR) got a little ahead of itself with growth projections, which quickly sank back to Earth after international government funding dried up –along with investors’ willingness to pay a premium for growth. The company once traded for $311 per share. While the company should keep bankruptcy at bay, it has one heck of an uphill climb from here.

Problems Ahead?

The 3D printing industry revolution was caught by several open-minded (and lucky) investors years ago. Now that the industry has proven its ability to achieve steady growth it may be considered "less risky" than other unproven industries. That may be somewhat true for leaders 3D Systems (NYSE: DDD) and Stratasys (NASDAQ: SSYS), which have achieved 104% and 57.5% revenue growth, respectively, since 2009. But lofty valuations could prove fatal if the market doesn't quite materialize as projected or other "little" problems, such as precariously high intangible asset ratios (IAR), continue to go unaccounted for.

Remember, all of the companies listed above were "too hot to touch" at one point in time too. I would show some concern for 3D Systems and Stratasys, but would also argue that they are a bit further in their growth trajectories as well. 

Foolish Bottom Line

Sure, it’s much easier to look back in hindsight and declare which companies were horrible investments. The point is not every company with industry-leading technology or a game-changing idea automatically qualifies as a great investment. Even seasoned investors can become starry-eyed when imagining the potential – and profitability – of a newly commercialized technology. Maybe on a subconscious level we all dream of bagging the big one, no matter how much we try to take emotions out of investing.

A piece of Foolish advice: be nimble and don’t rely too heavily on projections. The riskier (less proven) an investment the more time it requires on a day-to-day basis. Keep up with industry papers, inventories, trends, competitors, and consolidations. And remember that market projections, margin projections, and revenue projections are not set in stone. Let companies prove that they belong in your portfolio - you are not a venture capitalist. 

Follow me on Twitter to keep up with my future posts on energy, sustainable chemicals, and undervalued growth companies @BlacknGoldFool.

Make better investments with science.

BlacknGold has no positions in the stocks mentioned above. The Motley Fool owns shares of 3D Systems, First Solar, and Stratasys and has the following options: short JAN 2014 $55.00 calls on 3D Systems and short JAN 2014 $30.00 puts on 3D Systems. Motley Fool newsletter services recommend 3D Systems, First Solar, and Stratasys. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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