Plug Power ‘Dilution Bears’ Missing the Point

An increasing number of analysts are meting out bearish remarks targeted at Plug Power's (NASDAQ: PLUG  ) massive shareholder dilution over the past several years. These analysts, who I will conveniently refer to as 'dilution bears,' have taken great issue with the fact that Plug Power's shares outstanding have increased from 12.5 million shares in 2011 to the current 143.96 million shares. They sensibly argue that this has devastatingly diluted shares.

Agreeably, share dilution is something to be cautious about. It not only reduces earnings per share (EPS), but also reduces an individual shareholder's overall stake in a company. However, it is not always a bad thing and can be used to actually deliver more long-term growth for investors.

Inescapable fate
Raising capital through equity is an inescapable fate for Plug Power. Despite Plug Power going public fifteen years ago and fuel cell technology being around for a while, commercialization of the technology is still in its infancy stage. This means that the market is not sufficiently big to bring in revenues that can support the kind of growth and scale that Plug Power is targeting. This further implies that the only meaningful sources of capital right now that can support Plug Power's appetite for expansion are external sources, which are debt and equity.

The discussion therefore shouldn't exclusively focus on Plug Power issuing more shares to finance its expansion drive, as put forth by the majority of the dilution bears, but rather what Plug Power will do with the money. The dilution bears are essentially missing the forest for the trees here.

All important indications point toward prudent and timely investments by Plug Power. The company is looking to double its sales force by the end of the year. This comes against the backdrop of increased bookings, which came in above $80 million during the first quarter of the year, twice the amount in the year-ago quarter. In addition, Plug Power had more than doubled (year-over-year) its backlog to 3,200 units as at April.

By increasing its sales force, Plug Power will not only be able to effectively handle these increased orders, but deepen relations with accounts by giving each salesperson fewer accounts to handle. This could translate into customers doing more repeat business, allowing Plug Power to deepen its existing revenue streams amid alternate strategies to rope in new customers.

Moreover, Plug Power made a great acquisition with ReliOn inc. The $4 million deal, which was paid in stock, will allow Plug Power to start producing its own fuel cell systems as early as this year, according to statements from chief executive Andy Marsh. This will reduce reliance on Ballard Power Systems, Plug Power's current sole supplier. In the long run, in-house development of fuel cells will lead to a decline in costs.

Plug Power's operating results are telling of a compelling operating cost structure. By the end of 2013, Plug Power had managed to reduce its operating loss to $28.9 million, lower than the $36 million in 2012, according to its income statements. Increased investments in other cost-cutting measures (such as the one made in ReliOn) will enable Plug Power to slash its costs even further, enhancing its profitability outlook.

Plug Power's current worrying EPS of -1.33 misrepresents its actual prospects. One element that greatly weighs on Plug Power's EPS is its extensive use of stock warrants to secure financing. A stock warrant is a debt instrument that gives the lender the option or right to buy shares at a specific price as and when they please, as long as they provide debt upfront.

Considering the meteoric rise in Plug Power's stock in 2013, most of its warrant holders sensibly bought shares at the earlier agreed upon discounted price and sold them in the market at a premium. This is clearly represented in the change in fair value of Plug Power's common stock warrant liability in 2013, which increased by $37.1 million compared with a $4.8 million decline in 2012, according to the company's 10-K report. Increased investments in warranties, which are later converted to equity, lead to an artificially low EPS that doesn't truly represent the company's actual prospects. Plug Power's actual prospects are more clearly outlined in its operating results

Foolish bottom line
Plug Power's troubling EPS is a product of complex financial instruments such as stock warrants and genuine and informed need to raise capital through equity in order to drive growth. Going forward, the company will need to issue more shares to expand.

This will lead to a bigger plunge in earnings per share. However, if this future capital is used in the fashion we have seen so far, Plug Power will be able carve out a bigger niche for itself in the rapidly growing fuel cell market. Plug Power's share price, too, will record a corresponding rise. This is because growth investors will have faith in the company's ability to prudently invest, increasing the demand and price of its stock. 

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