Ballard Power Systems

Ballard’s stock had a tremendous run in 2017 (+167%) based on strong revenue growth, margin improvement and a perception that the commercialization of fuel cells is on the horizon (i.e., “hype”).  This improvement occurred despite Ballard’s portfolio largely consisting of businesses in run off (e.g., backup power, materials handling), experiencing uncertainty (portable power) or in very early stages of development (e.g., drones).  The primary force underpinning recent growth and future expectations has been Ballard’s China partnership efforts with Synergy Ballard JV (customer/partner) and Broad Ocean (customer/distributor).  At current valuations an investment in Ballard with an intermediate time horizon is essentially a bet on China Heavy-Duty Motive (“HDM”) success. We have conducted on the ground due diligence in China and believe that Ballard’s Chinese growth ambitions are likely to fail from weak partnerships with Broad Ocean and Synergy, and a market that is not developed enough to support fuel cell vehicle growth; Déjà vu, Ballard’s last China deal with Azure resulted in a contract breach and revising guidance lower in early 2015; investors should brace for similar disappoints this time around too

China Industry Challenges
Unfortunately, the Chinese hydrogen fuel cell market is still in very nascent stages of development.  We believe there are currently only 36 licensed fuel cell vehicles on the road in China, only six refueling stations (one is public), and limited planning being devoted to hydrogen sourcing and transportation.  In Spruce Point’s view, the lack of refueling infrastructure, confusion around refueling subsidies and abysmal refueling station economics pose the greatest threat to fuel cell vehicle (“FCV”) commercialization.  Not surprisingly, there are only two scale auto manufacturers of hydrogen fuel cell vehicles today and we expect this number to grow to only six by the end of 2018.  At this point, it still remains highly uncertain if China will develop the fuel cell vehicle market beyond an experimental phase

As it pertains to Membrane Electrode Assemblies (“MEA”)/Stack/Engine production in China, the focus area for Ballard, there are actually two (rarely discussed) competing “value chains”.  We believe that Ballard’s partners, Yunfu City Government (Synergy) and Broad Ocean, are relatively weak given their lack of network into the central ministries of China and their limited success to date in partnering with the State-Owned Enterprise’s (“SOE”) that are the primary agents for delivering on policy

Ballard Partner Specific Challenges
It wasn’t long ago that Broad Ocean was a humble manufacturer of electric motors for appliances (e.g., air conditioners).  As the US property cycle peaked, Broad Ocean decided to diversify itself with the purchases of Prestolite (auto electronics) and Shanghai Edrive (electric vehicle power trains) in 2014 and 2015, respectively.  When Broad Ocean announced the Ballard deal in 2016, it had no prior hydrogen fuel cell experience, but likely hoped to leverage the company’s local connections with automakers in the electric vehicle space.  Unfortunately, Broad Ocean has failed to deliver partnership opportunities to Ballard with the likes of BAIC (Shanghai Edrive’s largest customer) and Yutong (leader in Chinese bus production), both of whom have chosen Sinohytec despite relying heavily on Shanghai Edrive for electric vehicles