Aqua Metals: Potential Meme Stock Status A Short Selling Opportunity

Introduction

In June, I wrote a bearish article on SA about Aqua Metals (NASDAQ:AQMS) in which I said that I was skeptical its pivot to lithium-ion battery recycling would work.

I was surprised to learn that this is among the best-performing stocks on NASDAQ since the start of the year, and that it has even regained compliance with listing requirements. The valuation of the company had dropped by almost 40% by the middle of December, but it has been rising steadily since then, and I think it’s possible that Aqua Metals has gained meme stock status. In my view, this opens an interesting short selling opportunity. Let’s review.

Overview of the recent developments

In case you haven’t read any of my previous articles about Aqua Metals, here’s a brief description of the business and the company’s history. Aqua Metals was established in 2014, and it developed a closed-loop, water-based process for the recycling of lead-acid batteries which was hyped as the next big thing in the battery industry. Aqua Metals closed a $30 million initial public offering in 2015 and the technology seemed like the real deal as the company won several awards over the next few years, perhaps most notably the Rising Star category in the 2016 Platts Global Metals Awards program. Aqua Metals used the proceeds from the IPO to start the construction of its first recycling facility and the financial projections looked good, perhaps too good. A single 80/t per day plant costing $28.5 million was forecast to pay for itself in just a few years with an internal rate of return (IRR) of 38%. At the time of the IPO, Aqua Metals had already picked 8 potential sites for its AquaRefinery plants, which meant that it could be generating an annual operating profit of above $100 million before the end of the decade.

Yet, moving to commercial production is often accompanied by technical issues and the ones here were serious as the recovered lead was hanging up on the exit chutes of the modules. In addition, production and margins were far below expectations and quarterly sales barely passed the $2 million mark by 2019 despite retrofits and fixes being implemented.

Unfortunately, the facility was damaged severely by a fire in December 2019. Instead of rebuilding, Aqua Metals decided to use the $30.25 million insurance payments to pivot its technology to lithium-ion battery recycling. I find this surprising, considering it’s an unproven tech that the company couldn’t make it work well for lead-acid battery recycling.

Aqua Metals now claims that its AquaRefining process can recover pure minerals such as lithium and manganese and that its technology is superior to market leaders such as Li-Cycle (LICY) in terms of profitability.

Even if we assume that the new optimistic expectations of Aqua Metals are somehow true this time around despite minimal investment into R&D over the past few years, the company faces several major issues, including a lack of funding and feedstock supply. As of September 2022, Aqua Metals had just $9.3 million of cash and cash equivalents and its main asset was a $15.8 million lease receivable as its old facility was leased to a small lithium battery recycling firm named LiNiCo. The lease expires at the end of March 2023 and LiNiCo is currently making monthly payments of $100,640 under a triple-net lease agreement. The latter has the option to buy the land and facilities for $15.25 million but if this option doesn’t get exercised, you can expect the asset base of Aqua Metals to shrink significantly at the end of Q1 2023.

Considering that LiNiCo is 89%-owned by Comstock (LODE) which had just $1.15 million in cash in September 2022 and its market valuation stands at $47.4 million as of the time of writing, I think that the chances for the exercise of the option are at best slim.

Aqua Metals has just put into production a 6-10 tons per month pilot plant, which formed part of the company’s $3 million R&D budget for 2022. However, the company wants to scale the plant to 70 tons of recycled black mass per month and then build a 10,000 tons per year commercial plant. That facility will use on-site renewable energy and is likely to cost tens of millions of dollars to build, and I doubt that Aqua Metals can secure the funding for this endeavor.

Regarding the feedstock, it was mentioned in the latest corporate presentation that Aqua Metals is in discussions with over 10 electric vehicle manufacturers, cell component manufacturers, and CAM manufacturers for strategic partnerships, but no deals have been announced yet. Considering many of the leading EV players have already partnered with major competitors like Li-Cycle, this is a red flag.

Overall, I think the fundamentals of Aqua Metals haven’t improved since the last time I covered the company. Yet, the share price has been rising rapidly since December 21.

In my view, the main reason behind this could be high retail investor interest. There are currently a significant number of posts every day on websites like StockTwits and Twitter, including links on the latter for large trading communities on Discord such as House of Traders. The latter alone has almost 60,000 members. Note that the company isn’t doing the promotion of its business or shares itself, but this is being done by a significant number of private investors and traders.

So, how do you play this? Well, short selling seems like a viable idea as data from Fintel shows that the short borrow fee rate is just 2.71% as of the time of writing. However, hedging could be an issue as the lowest available strike price for call options is $2.50.

Looking at the risks for the bear case, I think that the major one is that the share prices of microcap companies can sometimes increase for spurious and unknown reasons. It’s also possible that I’m underestimating the viability of the technology of Aqua Metals or its ability to secure non-dilutive funding for the construction of its commercial-scale recycling facility.

Investor takeaway

Besides the opening of a small pilot plant, I think that not much has changed at Aqua Metals since June. The company is still low on cash and there are no significant feedstock supply partnerships. Yet, the market valuation of the company has increased significantly, and it’s possible that the reason for this is high retail investor interest.

The short borrow fee rate seems low enough to make opening a small short position viable, but hedging is tricky. It could be a good idea to set a stop-loss price, and its level depends on your risk tolerance. In my view, it’s best for risk-averse investors to avoid this stock.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.