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No. of Recommendations: 4
Hi everyone,

Here are some notes I put together a while back. I've updated what I can to include the most recent quarterly results.


     • Market cap: $974 million (11/8/10)
     • Share price: $9.54 (106.3 M shares outstanding; 6.7 M avg volume)
     • No dividend
     • PE, diluted: 12.7
     • FCF ttm: $104.1 M (7/4/10)
     • Cash: $194.6 M
     • Total debt: $39.7 M (about half what it was 3 months ago)
Power-One is a pick-and-shovel company in two important and rapidly growing markets.
First, it provides power inverters (which convert DC electricity generated by wind or solar to AC so that it can be fed into power grids) for the renewable energy market.
     • Inverter market currently is $5.1 billion and is expected to grow by 25% to 35% per year as more nations move toward green sources of energy.
     • Over the past two years, Power-One has moved from #9 market share (3%) to #2 market share (11%).
     • Has grown sales from $13 M in 1Q2009 to $228 M in 3Q2010.
          • These represented 13% and 73% of total sales, respectively.
     • Currently, solar and wind produce ~32% of 34.8 TWh of renewable energy (rest is small hydro, geothermal, biomass, biogas).
     • In five years, total output is expected to be twice that at 72.3 TWh, with solar and wind combining for ~62% of the total, a four-fold increase total in wind and solar.
     • A growing reputation of highly reliable products that operate at a higher yield than competitors' products (efficiency, harvesting, uptime) over a wider range of operating voltages.
     • Wide geographic range: U.S., Canada, western Europe, Turkey, China, Australia
Second, it provides converters and power management for technology and telecom devices (communications, Internet, server farms and storage, etc.), which are requiring more power, denser power, reliable delivery, and fine control of power delivered.
     • High conversion efficiency (AD/DC and DC/DC) and control (e.g., delivering different amounts to multiple users on same circuit board).
     • High density -- devices are decreasing in size while doing more things. OEMs are outsourcing power control needs due to growing complexity of problem.
     • High reliability -- the grid delivers 99.9% spike free power, or all but 9 hours per year. But one instance of bad (or zero) power can knock out tech devices (e.g. server farms) for much longer periods with high costs.
     • Growth of distributed power and power management -- more devices, homes, and businesses becoming "smart" about both power use and generation (local, small power generation plus grid, rather than just grid).
After several years of losses focusing just on the second part of the above, it has entered renewable energy in a big way, rapidly moving to the #2 spot. Higher margins have followed.
     • Gross margin has grown from 20% in 2007 to 36% TTM.
     • Operating margin has grown from (2.2%) last year to 23.8% TTM.
     • Has swung from net loss (negative 14.7% net margin) a year ago to 12.1% net margin TTM.
Management and inside ownership:
     • Long-time chairman and CEO (since 1990), Steve Goldman retired in June 2007.
          • He still holds 2.9% of the company.
     • Replaced by Richard Thompson (started Feb 2008), transferring and moving up from CFO of American Power Conversion. Improvement in company performance followed (though end of recession also helped).
          • He owns 1.5% of the company.
     • Long-time board member Jay Walters (since 2000) took over the chairman position when Goldman retired.
          • Walters owns 0.04% of the company.
     • All told, insiders own 7.98% of the company.
     • World economy dips again.
          • As the company swings further toward renewable energy (was 13% of revenue in early 2009, 66% of revenue in mid 2010), becomes more dependent on continued growth of renewable energy installations around the world. Governments currently subsidize a significant portion of drive to green energy. Companies don't want to upgrade to expensive infrastructure.
               • Cost of renewable energy continues to drop (has reached grid parity in a few locations), so government subsidies will become less important. As it reaches and drops below grid parity in costs, private industry will more rapidly adopt.
               • There are many indications that the world economy will not drop into recession again, though the recovery will probably continue to be slow.
     • Reputation suffers.
          • It is building a reputation of high quality products. This is a significant competitive advantage, as nobody wants downtime or lengthy repairs. The company's products have less downtime and shorter repair times than competitors', which management believes is a major factor in its rapid growth in the renewable energy field.
     • Customer concentration.
          • Five customers accounted for 22% of sales in 2009, down from 28% in 2007.
     • Manufacturing and supply chain problems.
          • The company has experienced problems in manufacturing, ability to deliver on time. Supplies of certain components has also tightened up.
               • Has addressed these, but fixes may not be optimal.
     • Many players in industry and product cost erosion / obsolescence.
          • Rapid technological change leads to obsolescence, with cheaper, newer products replacing older generations.
     • History of operating losses.
          • Recorded operating losses for the last nine fiscal years. Changes to business model may not be sufficient to bring about sustained profitability.
               • So far, though, management seems to be pulling the right levers, controlling working capital better and becoming a significant player in renewable energy power conversion.
     • Average analyst expectation for long-term earnings growth is 26% (10 analysts, up from 4).
     • Current price expects 5.9% growth (FCF) for five years, and then 2.5% from then on, at a 15% discount rate.
     • Alternately, current price expects 7.0% growth for five years, 3.5% for five years, and then 0% forever.
     • While it's hard to judge what the company has done, thanks to its long string of losses, the 18-month growth in the renewable energy market far, far outpaces that low level of expected growth. I feel this is an unreasonably low level of expectation currently implied by the price.
The two markets it operates in are significant and growing. A company with a reputation for high-quality products will be able to expand even faster than the market as it captures market share. Power-One has demonstrated this ability in the renewable energy market, rapidly rising from #9 to #2. Green energy is here to stay and will become a bigger part of the world's energy supply. By providing needed components, it can sell to anyone, regardless of the success or failure of the individual players, just like the sellers of picks and shovels were independent of the gold miners' success. Further, demonstrated expertise in the growing complexity of technology and telecom power needs provides another avenue of growth. New blood at the top has moved the company away from losses, expanded margins, and grown its opportunities significantly.
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