FREY - FREYR Battery: Exiting Position After Multiple Red Flags (Rating Downgrade)

2023-12-01 12:06:22 ET

Summary

• The Customer Qualification Plant was delayed and the timeline to complete commissioning has been pushed back beyond 4Q23 due to engineering and scaling challenges.
• Scaling the 24M platform has proven to be more challenging and time-consuming than expected.
• A huge red flag for me this quarter is that the company is pursuing conventional technology partnerships alongside its 24M technology.
• According to FREYR Battery, its financial runway brings it to 2026 but financing will only come with the CQP commissioning and technology validation.
• I am exiting the position in FREYR Battery due to the red flag with the conventional technology partnership, the delay of the CQP, and how these then affects financing and growth in the business.

FREYR Battery ( FREY ) reported 3Q23 results recently, and it raised red flags as the management team seems to have difficulty with just commissioning of the Customer Qualification Plant and it does seem that they have a rather poor understanding of the 24M technology. In fact, they are even choosing to "diversify" its technology through a conventional technology partnership.

I have covered FREYR Battery extensively in the past, which can be found here , and have been optimistic about their value proposition and potential. However, with the multiple red flags that I will highlight in the article below along with the flip flopping that management has been doing in the past few quarters, I am downgrading the company to a Sell rating and have exited my full position in the company, although it was a very small one.

Let's dive right in.

3Q23 results

In 3Q23, FREYR Battery reported a net loss of $9.8 million , compared to a net loss of $94 million from the prior year.

The net loss was, as expected, primarily due to corporate overhead, spending to support FREYR's projects and business development activities, and research and development spending, partially offset by a non-cash gain on warrant liability fair value adjustment.

Difficulty in CQP

The Customer Qualification Plant, also known as CQP, was delayed.

The timeline to complete commissioning has been pushed back beyond 4Q23 .

Things do not look particularly good for FREYR Battery given that it is already struggling at the CQP.

While two key technical milestones were reached at the CQP during 3Q23, the timeline to complete commissioning was pushed beyond 4Q23, as the introduction of automated casting with live electrolyte in dry room environment and commissioning and testing of merge unit have not been completed.

Based on what was mentioned by the management team, the process of completing the commissioning has been more difficult than they expected. While management has already identified that commissioning of Casting & Unit Cell Assembly equipment is highly complex, this is not the only highly complex problem for FREYR Battery.

While trying to problem solve during the commissioning process, the team continued to find " difficult but surmountable engineering and scaling challenges".

Of course, I get the impression that management is actively trying to identify and address issues on the path to commissioning of the CQP.

In addition, management has increased the coordination as well as involvement of partners and vendors, and also established a Technology Advisory Board which consists of subject matter experts.

Difficulty in scaling

FREYR Battery said that scaling the 24M platform is proving to be more challenging and time consuming than expected.

However, the company has not provided material details on this delay in terms of pushed timeline or increased costs.

Management is now pursuing conventional technology partnerships that it claims bring strategic alternatives to complement 24M and bring new paths to more financing.

There are now discussions with multiple conventional technology partnership candidates.

This pivot is strange and is in contrast to claims management has made earlier about the scalability of the 24M platform.

Of course, the key reason for pursuing the conventional technology partnership is less to diversify its technology, but rather more so because scaling of the 24M technology is more challenging and time consuming than expected.

In turn, this has huge implications for the funding that FREYR Battery is able to get as project financing will only come if the company's technology is validated.

Cash runway

One of the takeaways on the cash and liquidity runway is that FREYR has ensured that its current financial resources is able to last the company for more than two years .

Essentially, that runway brings FREYR Battery to 2026.

Based on the current strength of the balance sheet and the cost reduction initiatives taken, 2024's annual cash burn rate is actually expected to be half that of 2023.

Management emphasized on multiple occasions that any meaningful capital expenditure will come when incremental financing has been secured.

FREYR Battery is also looking for non-dilutive funding and thus, does not expect to or have any intention to raise common equity from shareholders in 2024.

I think this alone is what we as shareholders want to hear.

For Giga America, while project level equity is available, this will depend very much on getting the CQP up and running so that technology validation can occur.

Without getting the CQP up and running and getting the batteries out of the CQP, project level financing for Giga America will remain impacted.

Another source of financing would be the US Department of Energy Title 17 loan for Giga America. The company is now waiting for the invite to part two of the process from the DOE. FREYR Battery will likely be part of a group of other companies that are entitled to the loan and the actual quantum remains to be seen.

In addition, for the financing of Giga America, there is also the Section 45X of the IRA with its annual production tax credits.

For Giga Arctic, it was awarded €100 million grant for Giga Arctic by the European Innovation Fund. For those who are aware, the European Innovation Fund has a very intensive review process and for FREYR Battery to obtain funding from them, it adds further validation to the company's business model.

Management has decided to minimize spending for the Giga Arctic project as the focus will be on the CQP.

In the meantime, the team continues to engage with Norwegian and European government stakeholders for any potential funding.

Giga America

As mentioned briefly above, to obtain project financing required for the funding of the Giga America project, there needs to be customer acceptance.

However, to get customer acceptances, FREYR Battery needs to first ensure that CQP is commissioned, up and running, and scaled to provide cells for technology validation.

As a result, the longer the CQP timeline is delayed, the longer the Giga America timeline is delayed.

As a result of the delay in the CQP, the value of Phase 1a development of Giga America has already been cut, as expected.

Giga America will be pursuing and can accommodate two tracks.

The first track is track 1, which is the multi-line 24M scaled technology and there is a potential for the FID to be in 2024.

The second track is track 2, which has a faster FID timing as it is intended to accelerate the SOP timing of Giga America.

It does seem to me like FREYR Battery is pulling out all the possible options and may be quite desperate in this sense given the company even needs to rely on other conventional technologies given that this is expected to help accelerate the timeline and potentially bring new funding.

Also, this is an example of the company flip flopping with regards to its Giga America story and plans, given that it has only just been one quarter since the plans were changed.

Giga Arctic

Management intends to stop activities in Giga Arctic for two main reasons.

Firstly, the company wants to prioritize the liquidity that it has today to scale the CQP.

Secondly, it wants to make sure that there is a competitive incentive program delivered in order for more capital spending to be carried out for Giga Arctic.

As a result, by the end of 2023, Giga Arctic will complete its initial phase to secure the asset, while the company focuses on scaling opportunities in the US to capture the IRA benefits.

To accelerate funding and a competitive incentive program in Norway, FREYR battery sent a letter in March 2023 to the Ministry of Trade and Industry.

This letter outlined a prerequisite financial support package of about €800 million plus Production Tax Credits through the EU Temporary Crisis and Transition Framework ("TCTF").

While this does sound prudent financially, it means that there are many uncontrollable factors for Giga Arctic given the lack of liquidity for it.

Once again, the flip flopping here is another red flag for me given the story has changed more than once.

Valuation

With all the flip flopping the management team is doing, the forecasting of FREYR Battery has become a rather difficult and unpredictable task.

In fact, anyone trying to forecast FREYR Battery's financials is essentially playing a guessing game given the uncertainties in both the near-term and long-term for the company.

Per Bloomberg, consensus estimates are at $32 million and $121 million revenues in 2024 and 2025 respectively.

FREYR Battery is trading at 7x and 2x 2024 and 2025 P/S respectively.

Conclusion

While management may have been persuasive on the financial runway side of things and having at least two years of runway to go, for FREYR Battery to reach its full potential, it needs to show it can commission and scale the 24M technology.

With the comments about the company finding scaling the 24M platform more challenging and time consuming than expected, it starts to make me doubt how much the company and management team knows about the 24M technology in the first place.

With the challenges faced by the team to commission just the CQP, it makes me wonder about the difficulties that they will face in Giga America and Arctic. It does seem that the commissioning process is much more complex and results in both a scaling and engineering challenge for the team.

While the team may be a fully competent team, the team needs to get the 24M technology scaled up and validated to ensure that it can get the project financing it needs. This is because without being able to validate its technology, there will be no project financing for FREYR Battery to build either Giga America or Giga Arctic.

Last but not least, the need to pursue a conventional technology partnership is a huge red flag for me. This suggests to me that the company needs to hedge its option if the 24M platform proves more difficult to scale.

Imagine if Tesla ( TSLA ) was at an early stage as an electric vehicle company, and it told investors that it would be rolling out internal combustion engine vehicles because it was having difficulty scaling its electric vehicles.

You can see why I find the move to have a conventional partnership rather disappointing.

Of course, there are two tracks, track 1 is based on the 24M platform and track 2 is based on conventional production line equipment, and thus the 24M platform could still be successful after the necessary modifications and solving of key issues.

However, the deviation from its main technology platform is a huge red flag to me, and one that was a big negative surprise in my view, resulting in my decision to exit FREYR Battery after the 3Q23 results.

As a result of all that I have mentioned above, I will be exiting the FREYR Battery position as soon as possible.

All in all, while I am disappointed with FREYR Battery's business progress, I think that it is a positive that our FREYR Battery position is very small at less than 1%.

There were a few members that asked me earlier in the year why I did not make FREYR Battery a much larger weight in the portfolio if their return profile was so large. The reason is that the risk profile for FREYR Battery is high given its in an early stage.

As a result, from a portfolio management standpoint, to minimize risk for the overall portfolio, the position was purposely kept small. If anything, it does show that the risk management and portfolio management aspect of the portfolio is working well, and that it is heading in the right direction as we are putting more of the capital into where the conviction is higher and the risk is lower.

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