"Why would I want to let data get in the way of a good story?" -- Archaic engineering adage
As a former gas turbine designer at GE (NYSE:GE) and Rolls-Royce Allison, I had to give my colleague Seth Jayson a bit of a hard time Tuesday. While he is certainly correct in being leery of Capstone Turbine's (NASDAQ:CPST) purported deal with Wal-Mart (NYSE:WMT), he missed a few key details. And by that, I mean the "story" here is even less likely than he described.
First, the economics of gas turbines are straightforward and they go like this: Bigger is better. More air means more power. Higher temperatures mean more power and better efficiency. High pressures mean more power and much better efficiency. So the more air a turbine can suck, squeeze, bang, and blow, the better the performance and the better the returns. This is why buying low-cost electricity from utilities operating large gas turbines is more cost-effective than producing power locally at your home or building.
Let me give you some numbers. According to its data, GE has more than 10,000 steam and gas turbines in the field with well over 200 million hours of firing time and 875,000 megawatts of generating capacity. Those are staggering numbers!
Capstone has more than 3,000 units in the field with over 10 million fired hours. Needless to say, with a product line made up of 30-kilowatt, 60-kilowatt, and 65-kilowatt turbines, Capstone's total generating capacity is a tiny fraction of GE's.
Based on this data, where have investment dollars found the best returns in the past? Sorry folks, bigger is better, as GE has spent billions of dollars making turbines bigger over time, not smaller (see the size table on page 3) -- and made tons of money doing it.
Looking at the sales figures for last quarter, Capstone sold 5.1 megawatts worth of product for $4.5 million. That's $882 per kilowatt. To give you another glimpse into the economics of the gas turbine, large industrial gas turbines can be sold for well under $200 per kilowatt. And while electricity generation should be compared on a life cycle basis where the price of fuel and maintenance costs enter the equations, micro turbines start behind the eight ball because of high prices.
Now, there are some real applications for micro gas turbines. They can be used as localized backup power supplies or in cogeneration applications for apartment or office buildings (making electricity and using the waste heat in some fashion). And they can also be in vehicles. But essentially, if you are investing in micro gas turbines, you are betting on diseconomies of scale working in your favor (i.e., smaller is better). Is that a bet you really want to make? And if it is, don't you think that GE and Siemens (NYSE:SI) would have already spent millions of dollars fighting for market share?
Finally, I wouldn't get too excited about the smaller gross margin percentage loss. Capstone has actually had positive gross margins three times before, only to swing back to the negative. So I don't know how reliable the two-point trend can really be, based on historical data.
And statements like these in the latest 10-Q don't inspire additional confidence:
- Our operating history is characterized by net losses, and we anticipate further losses and may never become profitable.
- The deficiencies in this area of internal controls were concluded to be a material weakness based on the significance of the potential misstatement of the annual and interim financial statements and the significance of the controls over inventory to the preparation of reliable financial statements.
Everyone is free to do what they want with their money. But I caution you to be very careful with an investment in Capstone. I don't think the economics are in its favor, regardless of the opportunities at Wal-Mart, in New York City office buildings, or in rural China. But why should I let data get in the way of a good story?
David Meier owns shares of GE, but he does not own shares in any of the other companies mentioned. The Motley Fool has a disclosure policy.
