Is Ballard a Breaker?

Good evening, Fool brethren. As part of our search for a new Rule Breaker, I took a look at the fuel cell industry yesterday. I'm focusing on Ballard Power Systems (Nasdaq: BLDP), the stock most favored by the participants in the recent Rule Breaker seminar. At the end, you'll get a chance to give your opinion about Ballard in tonight's poll!

Fuel cells have myriad applications in every powered device, from cell phones to power stations. Through its Ballard Generating Systems subsidiary, Ballard is developing one-kilowatt generators for residential markets and 250-kilowatt stationary units for utility companies. Both are fueled by natural gas. Ballard also is working on portable and standby power products based on the Mark 900 fuel cell. In 2001, it will launch this product line in partnership with the Coleman Powermate division of Sunbeam Corp (NYSE: SOC). Ballard will also provide fuel cells for 20-30 DaimlerChrysler (NYSE: DCX) buses in 2002.

These aren't really its Rule-Breaking businesses, however. I'm going to focus on the automotive industry, for three reasons:

1. It's in this space that Ballard has the top-dog advantage through its participation in the California Fuel Cell Partnership, as I mentioned yesterday.

2. Significant market penetration in the automotive sector far more than any other market would drive the kind of exponential revenue growth we want to see in our Breakers.

3. Automotive fuel cells are the primary area where Ballard can differentiate itself from its numerous competitors. Plug Power (Nasdaq: PLUG), FuelCell Energy (Nasdaq: FCEL), and the International Fuel Cells unit of United Technologies (NYSE: UTX) all plan commercial launches of residential and commercial fuel cells in 2001. Siemens Westinghouse has a prototype 250-kilowatt power plant cell in operation already. The list goes on and on. We don't care for competitive parity in our Rule Breakers. We want, as Rule Breaker criterion #2 states:

   Sustainable advantage gained through business momentum, patent protection, visionary leadership, or inept competitors.

The business in which Ballard is building its "moat," as far as I can tell, is cars and cars only. That's my premise, anyway. In that arena, I think the lack of consumer demand will stunt its growth.

Production and Cost

Fuel cell vehicles are at least four years away from mass production. Ballard doesn't anticipate producing quantities of fuel cells until 2004-2005. DaimlerChrysler, Ford (NYSE: F), and GM (NYSE: GM) intend to mass-produce fuel cell based cars in 2004. I seriously doubt that the supply will hit the levels necessary in California and the North East Trading Region (NETR), which has agreed with the EPA to use California's standards. Those targets will have to be reevaluated, pushing the pace of expected rollout further into the future.

The trouble is that, as mass production is delayed, commercialization of the manufacturing process also slows. The claims of low emissions, fuel efficiency, and product integrity all have yet to be proven. It's hard to believe that there won't be significant problems to iron out once the products come to market.

Cost is another issue. The hand-made DaimlerChrysler prototype cost 100x more than a standard internal combustion engine (ICE). Ballard assures us that, once they enter mass production, prices for the cells will be comparable to ICEs, but that remains to be seen. If fuel cells remain noticeably more expensive, customers won't buy 'em.

Fuel

Since tank capacity and hydrogen availability hinder the use of the gas in auto fuel cells, current incarnations run on methanol. There is no central distribution infrastructure for methanol, neither in the industry nor at the pumps. DaimlerChrysler estimates that it will cost about $400 million just to add methanol to 30% of service stations in California, New York, and Massachusetts. Who's going to pay for that? It's not likely that Joe Exxon Station will want to add the capacity unless it is subsidized. Even at that, folks would have to search for a methanol-equipped filling station. That's not a selling point.

Fuel cells using hydrocarbons like diesel, natural gas, or a cleaner formulation of gasoline have been demonstrated for automotive use, but they haven't appeared in a prototype yet. Besides, they don't offer a significant improvement in emissions or mileage over the current hybrid cars, like the Toyota Prius and the Honda Insight, that combine gas and electric engines.

Public Acceptance

Both of these points would be moot, however, if customers were demanding the technology, but we aren't. We Americans are not generally driven by environmental, health, or even economic concerns, however much individual Fools may be. If we were, we would all buy Priuses and Insights, or at least Geo Metros. We'd use rechargeable batteries instead of disposable ones. We'd cook our own food with lots of vegetables rather than order Pizza in a Cup.

What we want is satisfaction. We see it in ease and appearance. We get it by sating our vanity and indulging our desires. You want to take Jane Consumer out of her Explorer or Hummer and put her in a quieter, cleaner, more fuel-efficient car? What makes you think that's what she wants from her vehicle? The trend has been away from efficiency, not toward it. Jane wants her car to be loud, stylish and -- above all -- fast. Fast off the line, fast around the turns, fast down the straightaway. She wants 200 horsepower, not 100. In a nutshell, she's perfectly content with the car that she has now.

That's the main difference I see between fuel cells and Rule-Breaking "industries" like the Internet, e-commerce, and biotech: People generally don't want fuel cells, even at competitive prices. They aren't seeking them out.

I don't want to lean on legislation, either. I'm not anxious to have my investment depend on forcing people to use something they don't want. The Feds successfully mandated the use of catalytic converters and unleaded gasoline, but the change to fuel cells would be another order of magnitude. It would alter completely the driving experience. Folks would be up in arms.

Wrap Up

Nobody would rather see automotive fuel cells catch on than I. I love to camp and hike and look at the stars, and it'd be a lot more pleasant if our air were clean. But I've seen alternative-fuel cars discussed for 25 years, and they haven't gotten any traction.

That's why I'm arguing here that fuel cells for cars are not an important, emerging industry. I don't think it's emerging, I think it's incubating. Fuel cells could disappear, or not appear for 30 years, and no one will notice until oil prices skyrocket. Maybe that will happen, but when I was a kid, people were saying that we'd use up the world's oil by the year 2000. We didn't, and it doesn't look like we will anytime soon. Meanwhile, improvements in the ICE, hybrids, electric, and even solar cars have time to infringe on the fuel cell's turf.

I don't think that Ballard is a Rule Breaker. I think it's a good company that will make money in its business, but I don't think it will achieve Rule-Breaker type returns.

I'm open to debate, however -- in fact, I'd love to be convinced I'm wrong! I'm sure that a lot of you (maybe even David, Jeff and the other Breaker writers) disagree with me. Let's take it to the Rule Breaker Companies discussion board again, where a great conversation started yesterday.

Here's your poll:

Do you think Ballard is a Rule Breaker?